Akira Kojima

Chief Editorial Writer,

Nihon Keizai Shimbun

　

Calling itself a cabinet committed to reform, the Junichiro Koizumi government that was inaugurated toward the end of April 2001 is tackling the hazardous job of administrative reform. The hopes of Japanese citizens that it will live up to its pledge are shown by record-high popular support ratings of around 80 percent for the new cabinet.

Since the beginning of the 1990s Japan's economy and society have been stagnant, and the people's sense that the country is at a dead end is blamed on the ineptitude of the government in dealing with the situation. Power changed hands several times, but each of the successive administrations failed to adopt effective policies. Over and over again they instituted stopgap measures, putting off the more thoroughgoing measures that should have been implemented. Structural reform was debated, but no leader had the courage to demand that voters bear the "pain" that would accompany reform, lavishing instead taxpayers'money on temporary "painkilling" measures. A decade was thus squandered, with no progress made in strengthening the basic constitution of the Japanese economy.

　Some argue that the Koizumi administration offers the ruling Liberal Democratic Party's last cha'nce for survival. Actually it is the Japanese economy's last chance for recovery as well. If necessary structural reforms are not made within one or two years, the first ten years of the twenty-first century will likely be another lost decade. Even worse, the whole twenty-first century might be lost. Prime Minister Koizumi stresses that there will be no business recovery without structural reform. This is true enough; but it is more important to emphasize there will be no revival of the Japanese economy without structural reform.

Under the free market economy, no nation is exempt from business cycles. The United States, where prosperity had continued for quite some time, is currently facing a phase of cyclical adjustment for the first time under the New Economy. Japan is now in its third downturn since the bubble burst in 1991. Business by nature is cyclical, so times of decline are bound to be followed by better times. It is necessary, of course, to do what we can to make business fluctuations as small as possible, but what we need to keep our eye on even more is the trend lines of mid- and longterm economic growth. Since the early 1990s the growth trend line of the Japanese economy has been on a sharply downward curve. The average annual growth rate has dropped to the 1 percent level, far lower than the latent growth capacity of the Japanese economy. Because the current business cycle centers around this low trend line, the downturn is especially severe.

　Resuscitation of the economy does not mean undergoing a cyclical business recovery but rather pushing up the trend line. Through structural reforms the United States overcame its own lost 1970s and 1980s, and from the early 1990s onward it succeeded in raising the growth trend line considerably. Structural reform efforts for the purpose of resuscitating the economy cannot stop at simply adding on more measures to stimulate aggregate demand. Enough support must be given to demand to keep the economy from deteriorating, but aggregate demand measures greater than that are not necessary, The crux of the matter is not aggregate demand but the structures of supply and demand.

　The major adjustment factors with which Japan must cope are the bad loans of financial institutions resulting from past policy failures, as well as intense global competition (more specifically, cost management competition amid an intensified price war for standardized, mass-produced industrial goods), the high-tech paradigm shift (shift toward information technology and knowledge intensive industry), and the aging population. None of these problems can be solved by simply increasing aggregate demand; they must be tackled by reinvigorating the structures of supply and demand.

Among the proposed structural reforms are: 1) liquidation of bad loans as soon as possible; 2) augmentation and development of the securities and capital markets, that form the framework supplying "risk money" in support of entrepreneurs who are willing to take risks; 3) revision of the tax system to one that, breaking from egalitarianism, rewards and encourages venture enterprise; 4) decreasing employment mismatch and providing education and job training to secure workers needed in new fields of industry (that is, breaking away from the idea that launching new public works projects will absorb unemployment); 5) improvement of the environment for utilizing and expanding direct domestic investment; and 6) raising the labor participation rate by working to realize the ideal of a society without barriers of age and gender and to secure continuous improvement in labor productivity through the efforts described in 4).

　Here are some revealing figures on direct domestic investment. In 1998, direct domestic investment made up only 3 percent of internal gross capital formation in Japan, compared with 10.9 percent among the major industrial nations on the average, 12.8 percent in the United States, 25.7 percent in Britain, and 12.9 percent in China. The comparison shows how much Japan lags behind in this age of exploding global direct investment and the worldwide scramble for high-grade overseas capital. We need to examine the delay in enacting reform from a global perspective.

　The resuscitation of the U.S. economy was made possible partly by high-grade capital, management know-how, and technology brought together into the United States from all over the world in the wake of direct domestic investment. Under the policy of fostering industry after the war, Japan sought for years to keep out foreign capital in order to establish the potential of its own industry.

　This year's White Paper on International Trade calls for "expansion of direct domestic investment" as a major policy. This marks a historic policy shift by the Ministry of International Trade and Industry (now the Ministry of Economy, Trade and Industry). The Japanese government must explain to its people in detail why such a fundamental change has become necessary. We need to realize that direct investment policy is now an extremely strategic, important dimension of public policy in many countries.

Japan must increase its labor participation rate and its labor productivity because the size of its productive population has already begun to decrease and is expected to drop sharply hereafter. Productivity has to rise continually in the economy as a whole in order to bolster the growth trend line. The general standard of living is calculated by multiplying labor productivity by the rate of labor participation. Labor productivity is determined by training level of the labor force as well as by the capital equipment ratio (capital-labor ratio). The rate of labor participation, if left to take its natural course, will decline quickly because of the aging population and low birth rate. To prevent its decline it is necessary to revise current systems and practices that require workers to retire at sixty years old or so, as well as build a framework that encourages the greater utilization of women's abilities in society.

　Fostering the securities and capital markets is an indispensable management task in any mature economy. The bank-centered economy was effective when Japan's economy was developing, but today it is now a major impediment for Japan, which has reached a phase of maturity. Settling the issue of the bad loans is important in order to prevent the bank system from becoming a deflation-triggering factor. Risk money, however, cannot be generated by the bank (indirect financing)system.

　I urge the Junichiro Koizumi government to pursue a "strategic" approach to structural reform.