Focus: Economic Recovery 2

To prepare Japan for the challenges it will face in the 21^st century, the Japanese government adopted a "Program for Economic Structural Reform" in December 1996. The program envisions unprecedented reforms throughout the whole of the Japanese economy. An "Action Plan for Economic Structural Reform" was subsequently announced to ensure effective implementation.

Progressively deteriorating economic fundamentals and the need to promote growth in the face of the Asian financial crisis have accentuated the need for stimulative measures to resuscitate growth in the Japanese economy. Three supplementary stimulus packages, totaling more than $650 billion were introduced in 1998. While these measures are essential to restoring confidence and demand and to resolving the credit crunch now plaguing Japanese firms, the ultimate success of Japan's economic recovery will depend on its continuing commitment and ability to implement essential "supply-side" reforms.

Therefore, with the exception of a pending law for fiscal reform, which has been delayed to minimize its contractionary influence on the Japanese economy, the Japanese Government remains committed to the full range of measures incorporated in the "Action Plan". While this process will take time, progress is already being achieved in many areas. Major change is envisioned by FY 2001 and economic reform remains one of the highest policy priorities of the Japanese government.

From the mid-1950s until the collapse of its bubble economy in 1989, Japan's postwar legal, political, economic and social system played a critical role in supporting Japanese industry as it sought to catch up with the west. A spirit of national consensus promoted close cooperation between business and government, giving rise to a stable employment system and a willingness to emphasize savings and investment over consumption. Combining a dedication to high-quality manufacturing with a corporate structure that encouraged market share over quarterly profits, Japanese companies quickly expanded to become a formidable force in the world economy.

Today, however, the maturation of Japan's economy, rapid development of information technologies and integration of world markets have created a need for more flexible and innovative business practices. Many of the structures and institutions that proved so valuable in helping to develop Japan's industrial capacity are no longer sufficient to meet the needs of a more mature, service-oriented economy. Reform is essential to move Japan forward to embrace the changes needed to reduce high costs and encourage creativity, new business formation and the adoption and development of new technologies. It will also be necessary to eliminate the regulatory rigidities that prevent Japan from achieving the global competitiveness it will need to sustain growth into the next century.

In a sense, Japan faces a challenge similar to the one confronted by the U.S. little more than a decade ago. U.S. industry enjoyed tremendous success in the 1950s and 1960s, but over time, a sense of complacency developed, accompanied by inflated overheads, inefficient business practices and corporate structures. As Japanese and European competitors developed their competitive strength in the 1970s, U.S. companies lost market share. Americans began to question their place in the world economy, suffering through what President Carter described as a period of "national malaise. " This situation could be equated to what has been termed the "lost decade" in Japan today.

The U.S. began to initiate a range of major policy changes in the 1980s and struggled -- for well over a decade -- to deregulate its economy. Many corporate and financial restructurings occurred. Initially, unemployment rose, labor tensions escalated, consumer confidence suffered and there was a fear that these structural changes would permanently exacerbate social tensions. Ultimately, however, U.S. citizens accepted the need to implement essential changes, delivering the dynamism and competitiveness we see today in the U.S. economy.

The "Program for Economic Structural Reform" outlines comprehensive reforms in six key areas including: a) Budget, b) Finance & Banking, c) Economic Structure, d) Health & Welfare, e)Administrative and f) Education. An "Action Plan for Economic Structural Reform" was subsequently announced to provide the guidelines necessary to allow effective implementation. Backed by the Japanese government's strong commitment, major changes are envisioned by FY 2001.

Substantial progress is now being achieved as the need for comprehensive reform is more fully recognized. Nevertheless, the uncertainties that inevitably accompany any dramatic change have clearly shaken the confidence of the Japanese people. The collapse of both the Hokkaido Takushoku Bank and Yamaichi Securities Company agitated Japanese consumers, the business community and domestic and foreign investors. For the first time in Japan's post-war history, GDP growth has declined to negative rates for four consecutive quarters. Unemployment rose to a record high of 4.4%; -- matching that of the U.S. ? in November 1998. Housing starts, investment and consumption continued to shrink during 1998 and the gap between supply and demand has grown, accentuating the overall contraction of the Japanese economy.

A period of structural adjustment is essential to initiating any program that envisions dramatic change. Substantial social dislocation and pain are often unfortunate byproducts of critical transitions. In fact, some economists argue that Japan needs a sharp and painful downturn to eliminate excess capacity and uncompetitive firms. Unfortunately, progressively deteriorating economic fundamentals and the global economic volatility that has characterized since the start of the Asian financial crisis have increased deflationary pressures within Japan. This has limited Japan's ability to maintain the tight fiscal policy measures needed to reduce inefficiencies and marginal competitors. Additionally, Japan already possesses very low interest rates, making it extremely difficult to utilize monetary policy as a compensatory mechanism to stimulate demand.

Even if Japan were able to bear the pain of structural adjustment, a further Japanese economic downturn would exacerbate financial pressures among its troubled Asian neighbors. It would also reduce Japan's ability to absorb imports from the U.S. and other trading partners and would negatively impact world trade and capital flows.

To offset the deflationary influence of the "supply-side" reforms needed to promote a private sector-led recovery, the use of public funds has become a necessary policy option. Three supplementary stimulus packages, totaling more than $650 billion, were introduced in 1998. These "demand-side" initiatives combine real spending allocations and tax cuts in an effort to restore positive growth, demand and confidence in Japan and its Asian neighbors.

This will also help to reduce the credit crunch plaguing Japanese firms. It will also maximize the creation of jobs, the development of housing and the physical and social infrastructure that Japan will need to remain a strong global competitor. By injecting public money into the financial system, the credibility of Japanese financial institutions will also be restored. Additionally, Japan will be better able to absorb imports from troubled Asian economies and, most important, strengthen the social consensus needed to implement the "Action Plan for Economic Structural Reform."

By maintaining a careful balance between measures that re-ignite growth in the short term with critically needed supply-side reforms, Japan will be better prepared to meet the challenges it faces as it enters the 21st century. It is expected that the three stimulus packages that have been put into place will raise demand in Japan by two to three percent. This will help Japan achieve a positive growth rate of one percent or more in FY1999 and engineer an economic recovery by FY2000.

Recognizing that it will not be possible to resolve its economic problems without a healthy financial sector, Japan has also moved forward to authorize a second supplemental budget to deal with serious problems in this sector. Of particular importance is the legal framework created during the November 1998 session of the Diet to facilitate the resolution of bad debts. Rating agencies such as Standard & Poors have estimated these non-performing loans to be as high as $1.1 trillion. The newly established Financial Revitalization Commission has been given the authority to appoint administrators to supervise bankrupt financial institutions or to nationalize institutions after buying their common stock. This was the case with the nationalization of the Long Term Credit Bank and Nippon Credit Bank. In the event that a private entity takes over a bankrupt institution, the administrators will require that entity to assume its liabilities. In cases where a buyer cannot be found, a bridge bank will be established by the Deposit Insurance Agency to take on that risk.

Additionally, a Japanese version of the Resolution Trust Corporation has been created and charged with buying up bad debt by the end of FY 2000. In coordination with the Financial Revitalization Commission, the Japanese RTC can also help weak financial institutions with viable restructuring plans to strengthen their capital base by purchasing their stock. Already, major banks such as Sumitomo and the Industrial Bank of Japan (IBJ) have expressed interest in this program. It is anticipated that other financial institutions will follow in the months to come. Other banks, including Daiwa, Sakura, Mitsui Trust and Sanwa are announcing restructuring plans. Finally, in addition to the $114 billion fund for protecting investors, $358 billion has been set aside for nationalizing bankrupt financial institutions and establishing bridge banks, as well as for the re-capitalization of weak institutions.

The reform initiatives incorporated within the "Action Plan" are unprecedented, touching upon almost every aspect of Japan's economy. Their implementation is essential to maintaining Japan's long-term competitiveness. Over time, increased competition and flexibility will provide more choices and lower prices for Japanese consumers and businesses. This will also create new markets and jobs and promote creativity, flexibility and innovation to help improve the ability of Japanese firms to compete in the global economy.

This trend is to be encouraged; however, it should be noted that in the short term falling prices deflate price indices and lead to lower aggregate demand. Industries need to be restructured, inefficient enterprises closed and workers retrained. As seen in the U.S. experience, painful dislocations can upset the social fabric and the confidence of consumers, businesses and investors. They are, however, ultimately essential to ensure the changes that will maintain Japan's long-term competitiveness.

The Japanese retail sector has traditionally been composed of small stores and complex distribution networks. This has created inefficiencies and high mark-ups at the consumer level. However, reforms in Japan's Large Scale Retail Law and other measures are dramatically changing the face of Japanese retailing. Discounters, chain stores and foreign retailers are now emerging. Labor productivity has increased 400% since the second half of the 1980s, with employee-to-sales ratios falling by one third. Over the short term, further adjustments will cause pain as falling prices accentuate deflationary pressures and smaller stores and intermediaries feel the pressure to become more efficient in order to survive. This is, however, an essential transition. In time, increased competition will raise the efficiency of the retail sector, presenting Japanese consumers with lower prices and a greater array of choices than ever before.

Long-standing regulations governing Japan's financial sector allowed major Japanese corporations to rely on commercial banks, suppliers and other members of their business conglomerates, often joined together by cross shareholdings, as sources of capital. This system encouraged inefficient uses of capital, rewarding marginally profitable firms and penalizing more efficient competitors. Japanese consumers have also been limited in their ability to access a full range of competitive financial products. Reforms have allowed the entrance of foreign financial service firms and introduced greater flexibility to the system. Japanese financial institutions now face increased competition and need to raise their competitive standards. More stringent credit reporting and the need to achieve the reserve requirements specified by the Bank of International Settlements (BIS) have exposed weaknesses in Japanese financial institutions. Moreover, the need to achieve these objectives has resulted in a serious credit crunch for Japanese firms and the collapse of major firms including the Hokkaido Takushoku Bank and Yamaichi Securities Company. In the future, a greater reliance on market conditions will result in more efficient business practices. Consumers will be presented with a greater array of financial products. Over time, they will be able to achieve greater capital returns as they find themselves less able to depend on government and their employers. Major changes in 1998 allowed Japanese consumers to freely purchase foreign currencies, open overseas brokerage accounts with foreign financial institutions and purchase mutual funds and other financial products through commercial banks.

Japanese businesses and consumers have had to pay approximately twice as much for telecommunications services as the rates that prevail in the United States. The resulting high cost structure has discouraged the use of the Internet and other technological applications such as e-commerce. Changes in Japan's regulatory environment have allowed foreign firms such as Worldcom and Nextel to enter the Japanese market. Long-distance telephone rates have now fallen by more than 75%. This increased level of competition has made it more difficult for Japanese firms accustomed to operating in a protected environment. Businesses and consumers, however, can now access a far wider range of services at reduced prices. For example, cellular telephone subscriptions have risen by 600% since reform efforts allowed the introduction of a new sales system in 1994. Investors also recognize the opportunities that are emerging, as seen in the recent highly success public offering of Japan's public telephone utility, NTT, of its DoCoMo cellular telephone service.

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