SEEKING A NEW STRATEGY FOR JAPAN’S ECONOMY

The political parties have unveiled new manifestoes and entered into a policy debate in advance of the August 30 election for the House of Representatives. The two big parties are not, however, asking voters to decide between them based on differences in the external strategy they want Japan to pursue in today’s global context. Where do they intend to take Japan in the world? The year 2010 will mark a turning point, as China’s gross domestic product is set to overtake Japan’s and become the world’s second largest after that of the United States. Japan will be relinquishing its status as number two, which it had come to take for granted after retaining it over the four decades since the end of the 1960s, and this will change the nature of the nation’s quest to stand ever taller as an economic power. No longer able to take pride in being number two, Japan will have to fashion a new identity for itself.

There is an urgent need for Japan to formulate a new external economic strategy. This is partly because we may be approaching an age in which the United States and China join hands in a Group of Two partnership. Their shared interests are growing broader, and they may come to an agreement on decisions involving the basic shape not just of the global economic system but also of the international security setup. In addition, as a result of the recent financial crisis, the developed and emerging countries alike have turned in the direction of big government and are greatly increasing the degree of government intervention in the market economy. Japan needs to come up with the wisdom for dealing with an international situation in which fiscal deficits and national debts are mounting and protectionism is spreading around the world.

A study of the impact of the recent global downturn on the world economy found that world trade has fallen further than it did in the Great Depression of the 1930s. In the case of industrial production, meanwhile, the extent of the global drop is about equivalent to that of the 1930s. Production in Japan has plummeted even more steeply, however. In the light of the powerful shock that hit the world, some observers say we need a paradigm shift in our way of thinking. What happened in the 1930s was that governments began to exert more influence over business affairs, moving away from a market-centered system. They strengthened financial regulations, provided better protection to bank depositors, propped up employment, and lifted minimum wages. But in the end, they arrived at a controlled economy not unlike that of a nation at war. If this happens again, leading to greater government intervention and a failure to rein in protectionist tendencies, the world economy may be badly damaged.

SLOW START IN THE FTA RACE At such a time of global-scale change, when governments around the world have embarked on massive programs in response, the Japanese government needs to present the people with a vision of the external economic strategy Japan should pursue. Among the articles in this section, two present theoretical and practical reasons for utilizing free trade agreements as an external strategy, wielding them as a tool to check the slide into protectionism.

Kimura Fukunari argues in one of these articles that it should be possible to promote free trade for the world as a whole by promoting regional cooperation based on FTAs. Some economists have criticized such regional arrangements on the grounds that they may detract from the multilateralism the World Trade Organization is seeking to promote. Multilateralism, they say, is the proper way to pursue free trade. The fact is, however, that the WTO’s Doha round of multilateral trade talks has bogged down, while FTAs are spreading like wildfire. As of August 2008, there were almost 150 such agreements in existence. Countries are entering into multiple pacts, and this has prompted another criticism: Trade may be hindered, it is said, by the “spaghetti bowl” effect—that is to say, by the complexities of overlapping rules and regulations. According to Kimura, however, most researchers are in agreement that the FTAs in East Asia have instead created an opening for progress in the free trade direction.

He introduces one researcher’s theory of three mechanisms that are working to enhance trade liberalization. For example, there is a “juggernaut effect” involving the momentum that liberalization achieves during the FTA process through the interplay between two forces within a country. One force derives its power from the export industry, which in order to persuade other countries to remove barriers to trade seeks to remove the barriers within its own country. This brings it into conflict with the other force, which consists mainly of domestic import-competing industries.

In Japan’s case the agricultural sector is opposed to trade liberalization, but with progress going forward on the FTA front, Japan’s farmers have had to relinquish some ground. Thus far, though, Japan’s main partners in FTA talks have been members of the Association of Southeast Asian Nations, which are primarily interested in issues other than expanding exports of farm products to Japan. As a result, agriculture has not become a major stumbling block in the FTA process. That will change when Japan opens FTA negotiations with such partners as the United States and the European Union, and agricultural organizations are certain to put up fierce resistance.

The manifesto of the Democratic Party of Japan, the main opposition party, initially called for concluding an FTA with the United States, but Zen-Noh, the National Federation of Agricultural Cooperative Associations, promptly protested. DPJ President Hatoyama Yukio then backtracked, changing the wording to say the party favors “promoting negotiations” on an agreement. The DPJ’s farm policy is not, in any event, aimed at enhancing the competitive power of Japan’s farmers. It calls for income guarantees per household to protect farmers against price volatility, and the way this assistance is calculated totally disregards the scale and productivity of farming operations. Meanwhile, within the Liberal Democratic Party, the main party in the ruling coalition, some members have reportedly called for rethinking the policy of enforcing mandatory cutbacks in the acreage under rice cultivation, arguing that farmers should be allowed to decide for themselves whether to accept the cutbacks or not. The existing policy frustrates the growth of larger rice farms and tends to result in a decline in competitiveness. In the end, though, the idea was rejected, and no mention of it appears in the LDP’s manifesto.

As Kimura observes in his article, the expansion of the network of FTAs in the Asia-Pacific region may evolve into what is being called “multilateralizing regionalism,” a form of regionalism that does not work against the spirit of multilateralism, and thus it could promote free trade for the world overall. If Japan is to take part in this development, though, it will have no choice but to reverse its protectionist farm policy.

The article by Hatakeyama Noboru examines Japan’s progress on the FTA front in quantitative and qualitative terms, and it finds that our nation is lagging far behind its FTA partners. Hatakeyama points out that Japan’s “nonliberalization ratios,” which are calculated using the tariff lines to which FTAs do not apply, are higher than those of all the partners it has concluded agreements with in the Asia- Pacific region. In particular, Japan has exempted many more agricultural products from liberalization than its partners. To rectify the situation, he calls for a change in the way the government protects the farming sector. Currently it relies on tariffs, which impose the burden of protection on consumers. If the tariffs were removed, farmers would suffer a decline in income, especially in the case of full-time farmers. To prevent this from happening, the government should instead introduce direct payments to farmers, which would shift the burden to taxpayers. At first glance the DPJ’s proposal for providing income guarantees to farming households seems to be a similar idea, but it does not go far enough. To be justifiable, the guarantees would need to be coupled with other regulatory reforms aimed at revising acreage cutbacks, utilizing idle fields and uncultivated land, and promoting large-scale farming. What is needed is a policy that will provide farmers with incentives through changes in all these areas. If instead the authorities act only to safeguard the income of farming families, they will open the door to a moral hazard.

When a new administration takes over after the election, what trade policy should it adopt? My view is that it would be wise to get to work on an FTA with South Korea, on which talks have been shelved, and also to move more quickly toward FTAs with both the United States and the European Union. Basically the DPJ has taken a stance of putting the convenience of consumers ahead of the protection of farmers. If it moves into power, accordingly, it ought to seek the conclusion of FTAs because of the benefits they provide to consumers. And it should also take note of the effect such agreements have on increasing agricultural productivity.

STANDING ON OUR OWN A major structural shift has begun in the current account balances of Japan and the United States subsequent to the collapse of Lehman Brothers. Comparing the third quarter of 2008 with the first quarter of 2009, we find that Japan’s current account surplus contracted by 40% from ¥4.2 trillion to ¥2.5 trillion, while America’s deficit contracted by 45% from $184.2 billion to $101.5 billion. In the background, Japan’s savings rate fell while America’s rose.

The article below by Mikuni Akio argues that Japan should take advantage of the shift in the nation’s current account structure to promote change in the economy’s structure. This is an excellent opportunity, Mikuni says, to wean the nation from its dependence on export-led growth powered by vigorous consumer spending in the United States. If Japan’s domestic consumption can be sufficiently expanded, its manufacturing industries will become able to stand on their own. Toward this end, policy measures that provide financial support for consumption are needed. For instance, Mikuni proposes that the income tax system be revamped so that interest income would be lumped together with earned income for tax purposes, while interest paid would be deductible from taxed income. That would mean eliminating the relatively low special rate for interest income and would tend to encourage consumer spending.

He further notes that we should not expect the declining current account surplus to cause the yen to weaken. If we consider the role of foreign currency asset balances as a determinant of exchange rates, we can see that the conversion of the assets the Japanese have acquired denominated in other countries’ currencies, particularly in US dollars, into assets denominated in yen will cause the yen to rise and the dollar to weaken. A strong yen will reduce import prices, and cheaper imports will invigorate domestic consumption.

At the same time as the economy’s structure is rebuilt through an expansion of consumption, enabling Japanese industry to become economically independent, the United States and China may move toward a G2 setup dominating the world economy. To those who take this view, Mikuni points out that Japan’s geopolitical role is very different from China’s. He suggests that in the name of economic cooperation under the Japan-US alliance, Japan might even forgive part of the US debt that it holds in the form of Treasuries to help the United States put its public finances back in order. Evidently the time has come for Japan to fashion a strategy by which it can make its presence felt as a sovereign state in the world. (Nariai Osamu, Professor, Reitaku University)

© 2009 Japan Echo Inc.