Short-comings in the DPJ’s Economic Policy

NARIAI Osamu

Matsumoto Ken’ichi, one of the foremost scholars of modern Japanese ideological history, has offered an interesting analysis of the change of government resulting from the recent general election. Writing in the September 4 issue of the daily Yomiuri Shimbun, Matsumoto says that the election initiated the construction of an appropriate political system for Japan’s third opening to the world, in which the nation’s bureaucratic dictatorship will be dismantled. Japan’s first opening, of course, came with the Meiji Restoration of 1868, and the second followed its defeat in World War II. In Matsumoto’s view, the third opening is the period from the Berlin Wall’s fall in 1989 to the present day.

After the Cold War wound down and globalization gained momentum, the long-dominant Liberal Democratic Party proved unable to come up with a fresh vision for the Japanese state, and it turned to the bureaucrats to direct policy management. For many years the adoption of measures that maximized the interests advanced by business federations and industrial organizations proved effective in promoting Japan’s national interests, and the bureaucrats could be relied on to craft policies for the advancement of these national interests. This style of government was successful in part because the economy was enjoying rapid development. But when the third opening began, measures giving precedence to the interests of big business and the manufacturing sector came to harm Japan’s national interests. At the time, entrepreneurs and distinctive companies acting independently of the business federations and industrial organizations were engaged in the creation of a new business environment, and policies that favored the interests of the conventional business groups became outdated. The LDP, however, proved unable to keep abreast of this major transition, and it perpetuated the old system of bowing before elder statesmen, conducting backroom wheeling and dealing, passing National Diet seats from parents to children, and relying on so-called zoku giin ("tribes" of lawmakers affiliated with particular ministries and business lobbies). This, Matsumoto believes, is the reason why the LDP has now been dealt a stunning defeat.

After Prime Minister Koizumi Jun’ichirô took office in 2001, he tried to dismantle the old LDP structure, but in the end he was unable to construct a compelling vision for the nation under which people would patiently put up with the pain of reform. The three prime ministers who followed Koizumi in quick succession after he stepped down in 2006 basically wasted three years backpedaling on reform. Lacking ideals and ingenuity, these heads of government just sat by as the LDP self-destructed.

Judging from voter behavior in the recent election, one cannot say that the Democratic Party of Japan scored a smashing success on account of the popularity of the party or strong support for its leader, Hatoyama Yukio, who has become the new prime minister. The LDP had simply reached the end of its shelf life, and voters were receptive to the DPJ’s call for a change of government. Some commentators have said it was an election of competing political manifestoes, but one wonders how many voters actually took the trouble to look carefully over the manifestoes of the two major parties. The DPJ has played up its plans for reforming the administrative machinery, but even if it manages to get the public behind it in a mission to overthrow the bureaucrats and create a new state, it has not yet put forward a vision of what is to come after that. It has presented no new picture of Japan’s national interests and no scenario for attaining them.

A CHANGE OF COURSE

Over the period starting from the high-growth years of the 1960s and early 1970s, the LDP followed a policy course centered on a supply-side growth strategy extending support principally to companies and industries. The idea was that increased production by companies would lead to higher wage payments and thus to increased consumer spending. And the presumption was that output could be boosted effectively by devising policies for funneling assistance through the various industries’ business groups and associations.

The Koizumi administration wanted to alter this policy orientation, but its macroeconomic policy remained focused on expansion led by the manufacturing sector and export industries, with a boost from ultralow interest rates and a weak yen. The upturn that began in 2002 brought improvement in the profitability of businesses, but labor’s slice of the economic pie grew thinner. Firms shifted to hiring more nonregular employees, who do not automatically receive all the benefits guaranteed to full-time regular personnel, and this shift suppressed the growth of wage payments. As a result, it became an expansion phase with sluggish consumption. It is not clear what economic ideals Koizumi’s three successors adhered to. No external economic strategy was in evidence, and policies became increasingly inward-oriented, failing to respond to the waves of globalization washing over the world economy.

Judging from the manifesto the Democrats released in advance of the August 30 election, we can expect a sustained increase in assistance and income transfers to the household sector. The DPJ plans, for instance, to supply a "child allowance" to all families with children until they complete middle school. It is possible that this will cause consumption to grow. In contrast to the practice of supporting those on the supply side, the policy line of the LDP era, this is a prescription for stimulating the demand side, and it deserves high marks. With more demand being generated, production will expand and corporate profits will swell, which will lead to growth in tax revenue. We may also take this as a switch from a growth-first course to a distribution-oriented policy approach.

If the government follows through on the promises in the DPJ manifesto, the public’s unease about the future should be relieved to some extent. One of the points stressed in the Annual Report on the Japanese Economy and Public Finance 2009 is that there is no way to correct households’ excess savings, which are continuing to mount (with a saving rate of 3.3% in 2007), as long as people are worried about what the future may have in store for them. Action is urgently needed to eliminate this unease and reduce uncertainty about the future. In this regard, revenue sources need to be secured for the proposed distribution-oriented measures, and it must be shown that they are sustainable. The DPJ has not, however, unveiled a blueprint for the path of the economy overall.

The DPJ has announced the closing down of the Council on Economic and Fiscal Policy, which was set up in 2001 and served as the control tower overseeing the preparation of short-term and longer-range economic projections and the overall coordination of economic policies, work that for a long period before that was handled by the former Economic Planning Agency. The October 3 issue of the weekly Shûkan Daiyamondo carries an article by Tanaka Shûsei asking the National Policy Unit, which the DPJ plans to create as a new control tower, to immediately draft a five-year economic plan. Tanaka is known for having been a key member of the team of Hosokawa Morihiro, whose brief term as prime minister from August 1993 to April 1994 marked the first departure from LDP rule since 1955. He argues that the DPJ, in addition to explaining how it will secure financial resources for the campaign promises it made, needs to inform the public about how business activities and everyday life will be affected by its goal of a 25% cut in greenhouse gas emissions by 2020 compared with the 1990 level. Perhaps for a while the public will be satisfied by promises to scrounge up revenue by eliminating wasteful spending and drawing on reserves and surplus funds in government accounts, but eventually people will grow uneasy with the new administration and lose confidence in its management abilities if it fails to explain how the nation can get back on the track of sustainable growth.

ECONOMIC POLICY IN QUESTION

According to a report in the special September 19 edition of the weekly Nikkei Bijinesu, the DPJ has called on the Bank of Japan to accommodate its plans for securing additional financial resources. One has to be somewhat leery of the party’s grasp of macroeconomic management, however, since it favors the outdated monetary policy of inflation targeting. Back in March 2008 it made a truly bad choice in rejecting nominees for the BOJ’s top posts merely on the grounds that they hailed from the Ministry of Finance. For a party that now wants the central bank to accommodate its additional fiscal measures, this was hardly a wise move. The DPJ also blocked the appointment of economist Itô Takatoshi to one of the two deputy governor posts because, it explained, he was a supporter of inflation targeting, and yet, inconsistently, it now favors such targeting itself.

Japan’s monetary policy under Shirakawa Masaaki, the BOJ governor since April 2008, needs to be reexamined. According to Yale University Professor Hamada Kôichi, who wrote an article for the September issue of Voice, the BOJ is not pursuing monetary relaxation in the way Western central banks are. Whereas the US Federal Reserve and the European Central Bank have adopted a nontraditional approach to easy credit, the BOJ is not fully engaged in what can be termed true purchases of long-term government bonds. Japan’s central bank reports that its buying of additional long-term government bonds since 2008 has amounted to ¥48.5 trillion, but much of this consists of bonds that are close to maturity, and their purchase is thus basically like buying short-term securities. It can hardly be said that a central bank is making credit easy in a nontraditional way when it is engaging in what amounts to ordinary open market operations.

The Mundell-Fleming model, which is a basic model used in international economics, shows that in a situation of free capital movement and flexible exchange rates, an increase in government expenditure will cause interest rates to rise and the currency to strengthen, thereby reducing net exports and diluting the efficacy of the stimulus policy. When fiscal policy loses power in this way, monetary relaxation can be applied to restrain the rise of interest rates and the strengthening of the currency. In Japan’s case, though, the yen’s real effective exchange rate has continued to climb rapidly since October 2008. Thus the case can be made that one of the factors behind the sharp downturn in Japan’s manufacturing sector following the bankruptcy of Lehman Brothers in September 2008 was the failure of the BOJ’s monetary policy.

It is from this theoretical perspective that the performance of the central bank needs to be evaluated, and proposals for the proper handling of monetary policy should be put forward in line with the results of this evaluation. Shirakawa’s appointment as BOJ governor was approved by the DPJ, and people are now asking whether it made a good choice. He is reputed to be one of the bank’s best monetary theoreticians, but an objective appraisal is needed of the course he has taken.

Furthermore, thought must be given to properly meshing monetary policy with fiscal policy. No firm rules have been established for situations in which macroeconomic policy produces an impact on the yen’s exchange rate. Fujii Hirohisa, the new minister of finance, initially adopted a stance of opposition to intervention in exchange markets, but on witnessing how fast the yen has climbed, he has acknowledged that intervention is needed. It is not likely that Rengô (Japanese Trade Union Confederation), which represents manufacturing workers and serves as a major support base for the DPJ, will stand silently by as the yen gains strength. There are also questions about how Japan’s ballooning government debt may affect long-term interest rates and the exchange rate. These are among the matters related to the administration’s basic policy orientation that people at home and abroad want to hear more about. Two members of the Hatoyama cabinet rose from the ranks of labor at two of Japan’s most famous manufacturers, Matsushita Electric Industrial Co. (now Panasonic Corp.) and Toyota Motor Corp., and they are likely to hear many complaints from organized labor if the government allows the yen to stay strong. At present it is not clear what the administration thinks about the influence of the exchange rate on industry and the economy. Indeed, its overall policy orientation is hard to discern, and its lack of a clearly stated macroeconomic policy is worrisome.

ISSUES TO ADDRESS

The Democrats say that in order to pay for their additional assistance measures, they expect to secure funds amounting to about ¥17 trillion by fiscal 2013 (April 2013 to March 2014) through a rearrangement of the general and special accounts and the elimination of wasteful spending. In the view of Professor Doi Takerô at Keiô University, however, that is an overly optimistic estimate. The net amount of money in the general and special accounts combined is ¥207 trillion. Much of that cannot easily be reduced, including the spending on government bond redemption and interest payments (about ¥79 trillion), social security programs (about ¥69 trillion), and revenue grants to local governments (about ¥18 trillion). Excluding these leaves a total of only about ¥31 trillion for more discretionary sorts of spending in such categories as public works and education; though it should be possible to achieve some savings in these categories, it hardly seems practical to hope to squeeze ¥17 trillion out of them. Thus while the Democrats say there is plenty of excess fat that can be trimmed, they would in fact be able to put together only several trillion yen by terminating programs that, while beneficial for some citizens, are seen as unnecessary by most. To come up with as much as ¥17 trillion, they would need to make slashes in programs that, while unnecessary for a minority, benefit most. And if they cannot come up with the money they need, their redistribution policy may have the reverse of the intended effect.

The DPJ manifesto does not cover the topic of issuing additional government bonds. That is a course that could invite distrust from the market. The Democrats have promised they will neither float more bonds nor hike the consumption tax, but if they find themselves unable to keep their word, they will disappoint the people and exacerbate worries about the future, which could throw cold water on consumer spending. Lest they lose public support, they need to set a target for a return to a healthy fiscal position before they hike expenditures. To be specific, they should state a target date for regaining equilibrium in the primary balance, which excludes government bond issues and debt-servicing costs. And the only way to achieve this target will be by collecting more tax revenue. In this connection, two points need to be borne in mind. First, it is likely that the aging of the population will lower the saving rate. The household sector now has ¥1.5 quadrillion in savings, but this sum is set to contract. Second, the aging process will alter the demographic structure in a way that elevates long-term interest rates, which will increase the cost of issuing government bonds.

I recommend that the DPJ straighten out the misrepresentations in its manifesto at an early point in its new administration. When mistakes are made, it is best to correct them promptly. Drawing up a medium- to long-term projection, the administration should spell out the additional burden the people must shoulder in order to pay for the benefits they are receiving, and it should appeal to the public for understanding. Fiscal management needs to have its sights set on the future and to take into account the long-term merits of restoring health to public finance and reforming social security.

The Japanese tax system stands out for its light taxation of consumption and heavy taxation of income. In order to fund social security programs over the long term, the 5% rate of the consumption tax will have to be raised. True, this is a regressive tax, but that could be remedied when the rate is hiked by introducing a refundable tax credit for low-income taxpayers, thereby returning the consumption taxes paid by those whose income is below the minimum taxable amount. Corporate taxes, meanwhile, should be lowered. In an age of global competition, competitive companies must not be deprived of opportunities to engage in business in Japan. The DPJ has proposed that the tax rate for small and medium-sized firms be reduced from 18% to 11%. As I see it, though, the tax system should be designed to invigorate all corporate entities regardless of size, with no dividing line between small and big businesses. The long-term rule of the LDP led to the thinking that people should bear a light tax burden and receive generous benefits. Now, however, the time has come for presenting the public with an honest accounting of burdens and benefits.

The unemployment rate today is as high as it has ever been, and measures to deal with the bleak employment environment are urgently required. In this area, though, what the new administration has put on its agenda is restricting the dispatch of personnel from staffing agencies and lifting the minimum wage. A series of reforms starting in 1999 made the dispatch of workers to any job free in principle. Over the five-year period prior to Koizumi’s inauguration in 2001, the ratio of nonregular employees to all employees followed an ascending curve to the vicinity of 30%, but during his administration the increase rate actually slowed down. Now the new administration wants the dispatch of workers to jobs in the manufacturing sector to be halted, but doing that might exacerbate unemployment. If the regulation of employment formats is made more confining even as corporate taxation remains heavy, corporate flight to greener pastures overseas may pick up speed. A better approach to the problem of dispatched workers would be to adopt measures improving their treatment, making it more equal to the treatment of regular employees.

Translated from an original article in Japanese written for Japan Echo.

© 2009 Japan Echo Inc.