A reason to invest in Japan

by Mamoru Ishida

What is the true nature of the current recession in Japan? Is it cyclical, a result of asset deflation, or has it been caused by the deteriorating competitiveness of this country as an industrial location? These questions must be answered to formulate an effective economic policy. In my view, the economic policy of the past decade has failed to halt the recession because policymakers have misjudged its nature.

The government relied chiefly on fiscal and monetary policy throughout the 1990s, probably because it believed that the recession was cyclical. Many economists called for fiscal and monetary measures to end the recession, and politicians took advantage of those measures. The reasoning was that structural reform, anathema to interest groups, would be unnecessary if the slump could be ended by fiscal and monetary means.

So interest rates have been reduced to almost the lowest level possible, while public works spending has increased as never before. As a result, the economy is now so dependent on such spending that drastically reducing it threatens to send the economy into a tailspin.

Resolving the bad-debt problem is one of the most important aims of Prime Minister Junichiro Koizumi’s economic reform program. But cleaning up the balance sheets of banks and certain companies is no guarantee that the economy will return to growth.

The more fundamental problem is that too few promising investment opportunities exist at home. Both large and small companies without balance-sheet problems are stepping up overseas production. Their low-cost products then flood the home market, bringing domestic prices down and exerting deflationary effects on the economy. More monetary expansion will not halt the price falls.

The present recession is a result of the nation’s weakening competitive position as an investment and production location amid mounting global competition. If the shift overseas of domestic production continues at the current rate, the demand for land will also decline, further aggravating the status of banks’ land-collateral loans.

Dealing with economic globalization is a common challenge for industrialized nations. In the United States, the Omnibus Trade and Competitiveness Act of 1988 created a policy council that presented reports to the president and Congress. The council pushed for a national strategy as well as specific measures to improve U.S. competitiveness.

In Germany, the Kohl administration in 1993 released a report titled “Zukunftssicherung des Standortes Deutschland” (Securing Germany’s Future as an Industrial Location). The report said the entry of formerly communist Eastern European states into the global market economy had undermined the country’s industrial advantage and called for creating 5 million internationally competitive jobs. The Schroeder administration carried on the initiative, instituting reforms in social security, taxation, capital markets and other areas.

The reform efforts in America and Germany were aimed at strengthening international competitiveness. By contrast, the Koizumi reforms are designed to “revive” the Japanese economy. No mention is made of restoring Japan’s international competitiveness. This will make a big difference in the outcome.

For example, the government plans to privatize road-related public corporations and review highway construction projects to reduce public spending. There is no question that such reform is necessary, but these plans say nothing about reducing the physical-distribution costs that have weakened Japan’s competitiveness as an investment location.

Trucks in Japan are taxed two to four times more than in the U.S. and Europe. The aggregate amount of tax levied on a truck with a service life of 10 years is estimated at 36 million yen, or 10,000 yen a day. That burden needs to be reduced.

Japan will put corporate taxation into effect on a consolidated basis in 2002. Yet a 2 percent tax surtax is proposed to recover some of the revenue lost from the normal corporate-tax levy on consolidated profit. Such a proposal would not have stood if the Koizumi reforms had been aimed at restoring Japan’s international competitiveness. Tax-revenue losses should be covered through cuts in low-priority spending. That’s what structural reform is about.

Production and employment levels in Japan depend largely on whether Japanese companies invest here or abroad — decisions based on an analysis of Japan’s advantages and disadvantages, such as costs and the effects of regulation. Japan’s economy will not get back on track unless the government creates conditions conducive to domestic investment.

It is widely held that the overseas transfer of Japanese manufacturing is unavoidable and that Japan should concentrate on creating jobs in the services sector. Job creation in this sector, though, is unlikely to offset manufacturing job losses.

Moves are already under way to shift some transferable services overseas, such as industrial-product design and the outsourcing of administrative work. This indicates that deregulation and cost reduction are key to job creation in the services sector.

If jobs in the nonmanufacturing sector are increased without addressing regulatory and cost problems, Japan may find it difficult, even impossible, to maintain the long-term flows of exports needed to pay for future imports. Our trading partners would not support the yen — which is not a key currency like the U.S. dollar — if Japan ran substantial trade deficits year after year.

Economic policy of the 1990s set fuzzy targets because a determination of the real nature of the recession was fuzzy. That’s partly why numerous attempts at structural reform have failed to produce the promised results.

Likewise, the Koizumi program is fuzzy. It is designed to achieve economic revival through reforms in seven selected areas, including bad-debt disposal, employment, stabilization of the financial system, privatization and deregulation. It is unclear how these reforms will lead to sustainable economic expansion. At present there is widespread hope that the economy will greatly improve if the bad-debt problem is resolved and public corporations are streamlined. That is wishful thinking.

We cannot afford to let the Koizumi reforms fail. His program should be reoriented under the guideline of bolstering Japan’s competitiveness as an investment location. On that basis, reform measures for the seven areas should be reordered by priority. In this way, an effective program of structural reform, and one that rolls back the “forces of resistance,” can be put together. Otherwise, for all his enthusiasm, some of Koizumi’s major reforms will be shelved. That would be a recipe for failure.