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Japan has made important progress in recent years in the area of regulatory and other structural reforms, but there is an urgent need for further and more rapid progress to strengthen future Japanese growth and prosperity.

While external shocks and cyclical factors have played a role in current economic difficulties in Japan, the most important factor has been structural rigidities, resulting from an increasingly outmoded regulatory and institutional framework. The engines that drove rapid Japanese growth over the past three decades (high export growth, rapid capital accumulation and labor force growth) are not likely to continue.

Without further regulatory reform, economic recovery will likely be modest and unemployment will remain high. With an aging population and shrinking workforce, it is crucial that Japan strengthen the competitive position of firms to assure future growth. A comprehensive program of regulatory reform is essential to create a more efficient and flexible economy, to encourage the growth of new industries and services and to create more jobs. This is even more urgent in the face of continuing reform in Europe, North America and elsewhere in Asia. According to OECD estimates, if the present declining trend in total factor productivity continues, Japan’s per capita GDP, currently about 21 percent higher than the European Union’s average, would be 21 percent lower than Europe’s in 25 years.

Despite hard-won progress in regulatory reform, Japan now lags behind other countries. As difficult as change is, particularly at a time of economic uncertainty, delay will only result in higher adjustment costs to maintain the international position of the Japanese economy. This is of interest not only to Japan, but to the rest of the world. The vitality of the world’s second-largest economy is important to global prosperity, and is crucial for other countries in Asia.

Why is regulatory reform so important to the Japanese economy and people? Regulatory reform is essential to create new foundations for sustained, long-term growth into the 21st century. The simple mathematics of growth accounting show that if growth in capital and labor are falling, as they are in Japan, overall economic expansion can only be sustained by an increase in the productivity of inputs. This means introducing greater efficiency into the economy. Greater competition, openness and transparency through regulatory reform will benefit Japanese consumers and industries, who currently pay higher prices for many goods and services than consumers and industries in other OECD countries.

Estimates vary, but numerous studies confirm that Japanese price levels were among the highest in the OECD in the 1990s. Prices for air travel, business services, construction, electricity and rail transport ranked first or second highest among G7 countries in the 1990s, and 40 to 60 percent above average G7 levels. In contrast, performance in the deregulated telecommunications sector was relatively good.

High prices hurt consumers and they hurt the competitive position of companies competing in world markets. Furthermore, there is no evidence that Japan’s high prices have resulted in greater protection of health and safety, the environment, reliability of supply or other important public policy goals. Other countries with far lower prices have equal or better protections in these areas.

The Japanese government has already made important progress in regulatory reform. Economic intervention has been reduced in many sectors, including large retail stores, gasoline imports, telecommunications and financial services through the “Big Bang” reforms. Competition policy has been strengthened. Consumers and industries have already seen significant results in lower prices and more choice. Pro-competitive reform in telecommunications led to price reductions for national and international long-distance calls by 77 percent through 1996. Deregulation in the distribution system has lowered prices by approximately 1 percent annually since 1990. More broadly, a study by the Economic Planning Agency in 1997 revealed that the gap between Japanese and foreign prices has started to decline due to substantial improvement in prices in deregulated sectors; prices in these sectors showed a 4 percent greater improvement between 1990-95 than in regulated sectors.

All this is good news for Japan’s international competitive standing. The challenge today is to deepen and speed up the regulatory transition already under way in Japan. Building on reforms already accomplished or under way in Japan, the OECD has produced the detailed and comprehensive Review of Regulatory Reform in Japan, which contains concrete proposals for further action. Although the report contains many options for action in important areas, I will outline just a few of the central policy steps the OECD recommends.

First, the review calls for a move away from incremental, item-by-item reforms and toward comprehensive reforms, with specific timetables and reviews. Why is this important? Regulatory reform can be very difficult to launch and success requires sustained political direction from the highest levels of government. When a government, often after great effort, finally gains the support of senior policymakers and politicians to deregulate or reform in a sector, the chances of success are greatly increased if the timetable for reform is announced in advance and if the progress of reform is closely monitored. Announcement of a timetable in advance of change gives industries and their workers a chance to prepare for the new environment, and benefits appear faster.

Second, a move to market-led growth means that competition law and policy must be at the heart of the new regulatory approach in Japan, a sharp break from traditional interventionist practices. Over the past decade, particularly since the fall of the Berlin Wall, country after country has moved toward market-based principles to introduce greater competition in the national economy. There is sound reason for this trend. Bid-rigging, cartels, the division of markets among a few favored firms and other anticompetitive practices can seriously damage economic performance. Such behavior benefits the favored few, but imposes costs on consumers and the competitiveness of an economy. To increase the potential for sustained, market-led growth, the Japan Fair Trade Commission’s resources should be strengthened to enable it to play an even stronger role in mergers, monopoly behavior, cartels, bid-rigging and market access. It would be beneficial to eliminate all “supply-demand balancing” requirements attached to permits, licenses and other administrative interventions that control or prevent pro-competitive entry into markets.

Another important step for the Japanese government would be to further strengthen the Regulatory Reform Committee by broadening its mandate to consider the full range of government policies that impede competition; clarifying its independence from ministries; and boosting its resources and analytical expertise. The importance of an independent, objective body, backed by the authority of the prime minister, cannot be overemphasized.

Officials in ministries that regulate industries understandably can become close to industry leaders; and they may not always consider the broader interests of the economy, of consumers, and of exporting industries as they regulate. This is why it is so important to have a body such as the Regulatory Reform Committee, whose members can look at regulations and other policies from a broad perspective. To be effective, such a committee needs sufficient well-trained staff to analyze the market and the regulatory and broader policy environment. Reforming regulations is essential. But Japan can also prevent regulatory problems before they occur by strengthening quality-control mechanisms inside government.

Regulatory impact analysis — now used in 24 other OECD countries — could have very beneficial effects. This would require regulatory authorities to assess the benefits and costs of regulations before reaching decisions. Transparency and the accountability of ministries should be improved. The restructuring of the Japanese public bureaucracy and the recent adoption of public comment procedures are important steps forward, but other steps also would help. Japan could, for example, consider the benefits to transparency of moving to a central regulatory registry — an approach that many countries have considered helpful. More attention could be paid to separation of policymaking from regulatory functions. The Financial Supervisory Agency is a good example in this direction, which should be followed in more sectors.

We also looked at the telecommunications and electricity sectors — both network industries that act as the “veins and arteries” of a healthy modern economy. The list of policy options we presented is too long to describe in full, but I will note a few proposed changes. Japan’s electricity prices are among the highest in the industrialized world, which hurts international competitiveness. The government rightly has set an ambitious target to reduce electricity prices to internationally comparable levels by 2001, while balancing energy security, economic growth and environmental protection in the reforms. Both the International Energy Agency and the OECD support the reforms under way, including the decision to move forward with liberalization of retail supply. However, more steps are needed to pave the way for more effective competition that will lower prices. Difficult decisions lie ahead on the separation of competitive activities from the transmission grid.

In making our policy suggestions, the OECD recognizes that a balanced reform program must take into account important social concerns. Increasing competition in the Japanese economy does not mean that consumers, small businesses and workers will be left to fend for themselves. Governments can address social concerns and protect consumer interests as they move toward more competitive markets, without unduly distorting the efficient functioning of markets. The OECD has a large body of work, drawn from the experience of our member countries, that suggest measures the Japanese government could adopt to maintain social protections. Effects on jobs are critical. Increased dynamism in reformed sectors improves performance and frequently to more new jobs being created in the medium-term than are lost through initial reform and restructuring. This has been seen in country after country. There are signs that the Japanese economy may have ceased deteriorating, but the momentum for regulatory reform must not be lost. Consumers, businesses and entrepreneurs should not reduce their expectations for better, more efficient regulation and freer opportunities. Informed public dialogue on the benefits and costs of reform is necessary for building and maintaining broad support for reform.

Japan has built an economy that has tremendous underlying strength, supported by a highly skilled and dedicated workforce. The same strengths that developed an economy long admired around the world can once again put Japan on a footing to be a leader in Asia and beyond.

Joanna R. Shelton is former deputy secretary general of the OECD.

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