Strategies for Reviving the Japanese Economy


1. Assessment of the Current Economy

The Japanese economy has begun to show some signs of change as the effects of recent large-scale economic packages have gradually helped to stop the severe economic downturn. But despite this progress, private demand as a whole remains stagnant. Therefore, the economic prospects for self-supported recovery are still uncertain once the economic effects of the last packages have phased out. The fundamental problems pertinent to the weak economy are twofold. First, the true adjustment of the burst of the bubble economy is still insufficient. Second, against the background of the sharp decline in the number of births and the rapid aging of the population, the pace of which has not been experienced in other industrialized nations, the "Japanese system"--the engine of the country's astonishing high growth in the postwar era--has turned problematic with regard to economic growth.

First, fears about employment prospects, future pension plans, and the sharp rise in government deficits are obviously restraining an economic turnaround. These fears are attributable to eroding sustainability in the Japanese-style wage and employment systems and the generous social security system. To cope with the situation, provisions of renewed safety nets are urgently needed. Furthermore, the rising fiscal deficits are restraining economic upturn by making people serious about future tax hikes and raising long-term interest rates. Measures to restore government fiscal balances in the medium and long term are also required.

Second, the Japanese social system, which has looked highly on across-the-board equality, has generated a bloated public sector and inefficient resource allocation. Typical examples are excessive regulation, overprotection, lack of self-reliance, and the "convoy" system. To cope with these problems, a new system needs to be built in which all production factors such as capital, labor, and land should be best allocated in a more efficient way through fundamental reforms in the public sector and full utilization of the market mechanism.

Third, a Japanese management style that depends on unrealized capital gains has become obsolete by international standards, and has made the new challenge difficult. The Japanese financial system of indirect financial intermediation, which is based on land as collateral, has been malfunctioning. A new business management as well as a new financial system that will fit the Japanese economy in the 21st century need to be established early, so that the abundant savings of Japan are best mobilized for economic development in the next century.

Households and enterprises have lost confidence in future sustainable growth. Moreover, they have given less credence to government policies. The combination of all of these factors underlies the current economic deadlock. Severe economic and financial situations are expected in the short run, including, for example, rising deflationary pressure during the process of complete settlement of the bubble economy, and remaining unease regarding the financial system. To cope with them, it is necessary to restore confidence immediately by prompt policy action. For this purpose, strengthening safety nets in employment and raising expectations of economic growth through structural reforms are urgently needed. It is important to recognize that the revival of the Japanese economy is indispensable not only for our country but also for Asian economies and the global economy, much of which are pursuing sustainable and stable growth.

2. Strategies for Reviving the Economy

Based on this assessment, the Economic Strategy Council believes that a new economic system of Japan needs to be built in which people will be able to recover confidence toward the future. To this end, fundamental structural reforms in both the public and private sectors are indispensable and require strong political leadership, entailing a bold review of all existing systems without exception. Without them, reviving the Japanese economy is hopeless.
While credit crunches and credit contractions are said to be rampant, the financial fundamentals of Japan remain strong. The evidence is that household financial assets now amount to 1,200 trillion yen, and net external assets exceed 100 trillion yen. Furthermore, many manufacturing companies, including small and medium-sized companies, maintain a global competitive edge in the fields of semiconductors, liquid crystals, and precision machines. The Japanese economy still enjoys a high-quality and diligent labor force supported by internationally high standards of education. This indicates that the development base for further growth remains sound and safe. What is needed is the quick reformation of the old, malfunctioning system into a new one in which the merits of the incumbent system are reserved and the potentials of the Japanese economy are made best use of. Recognizing this, the Economic Strategy Council proposes the following five recommendations as strategies for economic revitalization.

(1) Scenarios for Economic Recovery and a Road Map Toward Sustainable Government Balances
The first recommendation is to show clearly the scenario for economic recovery, and to eliminate fears held by both ordinary people and the market of a fiscal crisis. The Japanese economy has maintained its potential growth rate of slightly over 2 percent per annum. By completely clearing the legacy of the bubble economy and by indicating to people the bold steps of structural reforms, it may be possible to recover expectations on future growth. If that happens, the economy would be able to shift to a true recovery path within two years.
On the other hand, the government balances of both the central and local authorities are worsening greatly due to recent large economic stimulus packages and to declining tax revenues under a stagnant economy. Early restoration of these deficits will not be easy. However, the medium-term sustainability of the government balances could be regained through vigorous efforts, including bringing the economy into a sustainable growth path with structural reforms implemented, reducing the size of government by significantly cutting spending, selling and efficiently allocating state property, and rationalizing tax bases. The government needs to relieve the worries of people and the market by publishing credit-worthy, medium-term projections of economic growth and government balances.

(2) "A Competitive Society with Soundness and Creativity"and Preparing Safety Nets
The second recommendation is to build a competitive society with soundness and creativity and to leave behind regulations, excessive protection, and the"convoy"system. The Economic Strategy Council judges that the economic revival of Japan would be impossible without reforming the current employment system of government employees, strongly implementing various institutional reforms including deregulation, improving the accounting methods in the public sector, fundamentally restructuring the Fiscal Investment and Loan Program, and streamlining the bloated and inefficient governments. At the same time, institutional reform is to be done to reorganize the local government system to help economically and financially sagging local areas to become self-supporting. Furthermore, reforms involve the taxation system, which should reward the hard worker, and an overhaul of the education system to cultivate human resources of creative talent. All of these point to the need to build a new system to enhance individual incentives and to motivate their creativity.
For the effective functioning of this new system, it is required to prepare safety nets that will match a competitive society with soundness and creativity. Such nets will give those who have failed a second chance, and will warrant security. Relevant are the labor market reforms to enhance employability and job security, judicial reforms consistent with a new society of ex post facto checking of consequences, creating a sustainable and reliable social security system covering pensions, medical services, and nursing care. These measures should provide citizens with safety nets.

(3) Complete Settlement of the Bubble Economy and the Establishment of a Financial System for the 21st Century
The third strategy is to bury the legacy of the bubble economy in all fields and to reform the financial system, which has been excessively dependent on indirect financial intermediation, into one appropriate for the 21st century. The complete settlement of the bubble economy means that the reorganization of financial institutions needs to be facilitated, and that the real disposal of bad loans, i.e. liquidation of real estate collateral, must be promoted. To this end, it is urgent to establish a new system and revised institutions. These disposals hinge critically on whether property liquidation and securitization, including good real estate, can lead to a transformation of non-performing assets into cash-generating productive assets.
On the other hand, to revive the Japanese economy, it is important to immediately restructure the malfunctioning system of indirect financial intermediation. The critical question is how a new financial channel will be established whereby household financial assets of 1,200 trillion yen are efficiently geared to strategically important industries which are indispensable for economic revival. In other words, it is necessary to complement and replace the indirect financial channel of Japan--the core of which is"the land sovereignty"--with renewed financial intermediaries. Needs for financial services vary, and increased demand is expected around the turn of the century. The flourishing of new"financial industries"preparing for these needs necessitates an efficient financial system of global standards, involving financial markets, regulation, legal frameworks, taxation, and accounting.

(4) Industrial Revitalization With Vigor and International Competitiveness
The fourth strategy is to prepare as quickly as possible the frameworks for industrial revitalization with vigor and international competitiveness. To this end, the government needs to provide an environment in which companies will be able to eliminate excess business machinery and invest their resources heavily in promising industries. The important points are fostering an environment in which failed entrepreneurs can try again, activating the replacement of old industries with new ones, enabling challenges for new businesses, supporting the reorganization of enterprises and the introduction of new management, and providing an environment in which management resources are poured into promising industrial sectors. Last but not least, comprehensive packages are indispensable for championing strategic industries for 21st century, for involving technological development, for deregulation, for obtaining global standards, and for implementing leading national projects in which private initiatives are fully utilized.

(5) Strategic Infrastructure for the 21st Century and Regional Revitalization
The last recommendation is to provide strategically important infrastructures for revitalizing the economy and realizing a higher standard of life in the 21st century. The next decade ought to be earmarked as an intensive period to invest in future-oriented social overhead capital. The government must deal with this investment in a comprehensive manner without lapsing into sectionalism. Public works projects need to be reviewed in terms of regional strategy, fund allocation with fairness and transparency, and best use of private initiatives like PFI (Private Finance Initiative). The strategic projects include urban revival, environment, information infrastructure, education and human resource development, social welfare, and housing. These are of highest importance to the government for the 21st century. Investment there should lead to new business creation and revitalization of local economies, and allow for the maximization of private initiatives.

3. Toward a New Growth Era

The structural reforms fully elaborated in the following chapters, based on these recommendations, will succeed in revitalizing the Japanese economy in the 21st century if implemented steadily. It is not a groundless hope to enter a new growth era. Structural reforms both in private and public sectors will help to lift the depressed sentiments on the future economy and to shape the optimum allocation of management resources such as human resources, goods, and money. Free and creative activities within the private sector will expand Japan's economic frontiers and enable its economy to encourage fruitful and meaningful lives for citizens.
The efforts to open the way for the brilliant future and create an attractive country should be supplemented by the positive attitude of people to boldly enter unknown fields without fearing the pain attached to reforms. Politicians, the private sector, and the government need to be brave enough to initiate unprecedented reform. They should not sit back, afraid to move forward because of lack of experience. The role of the government is to become a flagship for the reforms and to strongly support the initiatives of the private sector for them. The Economic Strategy Council will, herewith, draft visions and reform processes for the medium and long-term that could build an energetic society with freer choices and more creativity. At the same time, we hope that today's younger generation--who will soon become the core of political, economic, and social life in the 21st century--will imagine a promising future with this report.

4. Steady Implementation of Recommendations

The Economic Strategy Council has agreed to provide"the List of Laws Relevant to Recommendations"and strategy steps for the steady implementation of this report. They are expected to help the understanding of concrete ideas concerning recommendations spelled out in the following chapters.

(1) The List of Laws Relevant to Recommendations
The Economic Strategy Council conducted research on laws including possible new ones that may be relevant to recommendations in this report. It may become a valuable reference tool for those interested in this subject. The result is attached in reference 1"the List of Laws Relevant to Recommendations." It should be noted that all recommendations do not necessarily correspond to a certain law, because the implementation is associated with not only a law change but also budgets, cabinet orders, and ministry rule. This list needs to be refined further, with the help of experts in the field.

(2) Strategy Steps for Implementation
The Economic Strategy Council has decided to indicate strategy steps for economic revitalization; these steps help to clarify the priorities to implement the main recommendations in this report.
Based on the economic recovery course in the next decade, the implementation period is divided into three sub-periods:

1) stage of complete settlement of the bubble economy--around FY1999-2000
2) stage of return to a growth path and economic rehabilitation--around FY2001-2002
3) stage of full-fledged economic revival through fiscal consolidation and structural reforms--around FY2003-
Considering the above strategy steps, the Economic Strategy Council has summarized the priority of necessary strategies for economic revival in reference 2. Recommendations are classified into three categories there:1) policies with the highest priority for economic recovery and financial stability, 2) structural reforms to be implemented as soon as possible regardless of the economic trend, and 3) reforms to be initiated after full-fledged economic recovery. The Council expects reforms to be carried out, taking this classification into full account.