Speech at Chatham House
Visiting Fellow, RIETI
Let's start with what The Economist the other day called "the miracle" and the Chairman of the Japanese Association of Corporate Executives called "the new dawn" in the Japanese economy - growth in the last quarter of 2003 at an annualized rate of 7%. Even before that announcement just a week ago it was pretty evident that the mood had changed. Instead of headlines about the dire state of some of the weaker banks and the problem of the overhang of bad loans, front page news now was all about the rise in corporate profits, the fall in bankruptcies, the increase in the number of new entrepreneurial firms preparing to list on the stock exchange, the rise in stock exchange prices and so on. The December "tankan" - short-term outlook survey - was said to have reported a new optimism among producers.
Flat-screen televisions and internet mobile phones and digitalized appliances that enable you to do not just five but twenty things that no normal person would ever want to do were selling like hot cakes. The Ginza and the dazzling new shopping and entertainment complex of Roppongi Hills seemed evidence of affluence and prosperity. Everybody acknowledged that the source of all the new optimism was the surge in exports, both to the U.S. and to China which, if you add in Hong Kong and Taiwan, has become a bigger export market than the U.S. But this time, it was said, unlike at the time of the last export surge in 2000, investment was rising and so there was every prospect that the export demand would ignite domestic demand across the economy and growth would become really self-sustaining. The one-sentence headline of last Thursday's monthly economic report was "The recovery of the economy, supported by plant and equipment investment and exports is proceeding steadily." The two sentence-headline was "The prospects are that with the recovery of the world economy the recovery of the Japanese economy will continue. There are, however concerns about movements in the yen-dollar rate". The big question being, of course, whether, having given up the hope of keeping the dollar at ¥115, future interventions can be successful in keeping it from going below ¥105.
But that looming threat apart, if one looks at the small print it is hard to be so optimistic. The investment figures were, for manufacturing, a rise of 2% in the third quarter and a fall of 1% in the fourth, for nonmanufacturing a fall of 6% in the third quarter and a rise in the fourth of 3%. The December tankan, short-term outlook figures showed that those reporting an improvement in prospects were almost all from the large manufacturing firms, though even they were still below the level of optimism reached in 1996. Those in nonmanufacturing were as pessimistic as ever, especially the small firms where those saying the outlook was gloomy exceeded those saying it was rosy by 29%. And as for private consumption, the figures were for a fall of almost one percentage point in November and December. I quote, from the consumer expenditures survey of the February 7. "One major indicator, department store sales were down in 2003 for the sixth successive year. The demand for digital appliances is brisk and expenditure on mobile phones and internet connections is growing at 20-30% a year, but overall consumer expenditure is still contracting though at a slower rate than in previous years. Looking forward, if the household income situation improved one could expect a recovery in consumption, but there is no sign at the moment of any improvement in employee income, and hence no obvious signs of an upturn." And as if to underline the point the Chairman of Keidanren, Mr. Okuda, said a couple of days later that profits were indeed improving, but that didn't mean that firms were doing well. There was no room for any more than the standard seniority increments in this spring round. As a Bank of Japan official who shall be nameless said to me, if only we had a bit of wage-cost push we might get a bit of inflation going. The trouble is that our unions are too feeble, "monowakari ga yosugiru." They are too cooperatively understanding.
The deflation is still there, with all its dampening effects on investment and consumption and the fact that firms are using their profits to pay off debt to make their balance sheets look better for the analysts they talk to so much more often than their banks these days, is a large part of the trouble. The Bank of Japan continues to be impotent. Everybody seems to agree that the new Governor is a great improvement on the old one and personality-wise that may well be true, but he is no nearer finding a solution. He continues the quantitative easing of Mr. Hayami. Last year the money base was increased by over 20% as it had been the year before. But if you ask how much of that gets put about in such a way as to affect aggregate demand, the answer is a tiny fraction. The banks put it all back in the Bank of Japan where their deposits have now grown from a normal 6-7 trillion to nearly 35. In 2002 actual money supply increased by 3.3%. Last year, with Mr. Fujii in charge, by only 1.6%. Bank lending is still contracting because everybody wants to pay off their loans and nobody seems to have the confidence to borrow anew.
One of the striking things about Japan over the last year is the disappearance of the media debate about deflation. Last spring there was vigorous debate in the economic weeklies. On the one side there were the Koizumi-ites - no gain without the pain of tough supply-side reforms and killing off the zombie companies responsible for all the bad debts - on the other the last surviving Keynesians who argued that the real problem was on the demand side, and there could be no cure for that as long as deflation was dampening consumer confidence and entrepreneurial animal spirits, and making debts more burdensome by every month that passed. In short, that there was little chance of real recovery unless deflation was cured, and since monetary policy was impotent that had to mean much bolder fiscal policies.
This was the argument, not just of Keynesian economists but also of the so-called resistance forces in Koizumi's party. You will all have come across the notion that Mr. Koizumi is a bold reformer whose excellent intentions have been thwarted by the so-called resistance forces. A gross simplification. It is not clear that Mr. Koizumi's reform intentions are as sweeping and as concrete as he suggested in his first speech to the Diet after taking office. (In 25 minutes - he used the word reform 36 times, 17 times qualified by the adjective "structural.") But certainly, rebalancing public finances or curing deflation was one major point of difference between him and his critics. The elections for party leader last autumn decisively settled the balance of power between them. The candidates of the resistance forces were decisively defeated and their major leader, Nonaka, retired from politics. And that seems to be the major reason why talk about curing deflation has now largely dropped out of the picture.
Personally, it has always seem to me that the Keynesians and the Nonakas were right, but the question does arise, supposing a real upturn in confidence does take place, what sort of growth rate is the economy now capable of? Where is the trend rate? There seems no doubt about the innovative capacity of Japanese manufacturing. One only has to look at the American patent statistics for proof of that. But with actual production increasingly being shifted out to China, and with the decline in the birth rate not only reducing the labor force, but having a heavy effect on the demand side with a falling rate of family formation and housing starts, there are plenty of reasons for pessimism about the long-term prospects for growth.
But to go back to resistance forces, the real resistance forces are in the bureaucracy. And I don't mean just the bureaucratic self-interest in resisting the two major privatizations of the motorways and the post office which have always been Mr. Koizumi's major obsession. In both those cases it is not only the bureaucrats who are resisting. The post office seems to have a good deal of popular support and the motorway privatization is still mired in a dispute as to whether the private companies should inherit the accumulated debts and how much they should be required to build new roads. I suspect their privatization will end up a bit like the privatized Hokkaido railways, ie a joint stock company in form, but for all practical terms a publicly subsidized public service.
What I had in mind when I said that the resistance forces are in the bureaucracy were two other things that have recently been making the headlines. One is North Korea and the abduction issue where the Foreign Office is trying to inject calm and reason - and at the same time reposition itself for playing a positive role in the six-nation talks due to start today - against a wave of populist nationalism, led by the LDP Secretary-General and supported by the Prime Minister, which is baying for harsh sanctions unless the North Koreans send all the relatives of the five abductees to Japan and tell better stories about the other abductees said to have died. The other issue is pensions which have come up for their regular quinquennial review. Here the Health, Labor and Welfare bureaucrats are trying to preserve as much as they can of the public pension system against the politicians and business men who say that a fundamental pensions reform is necessary because an ageing society cannot afford the burden of generous pensions and the welfare state only breeds listless dependency anyway. The advocates of reform point to the prospect that by 2030 the labor force will have fallen from 67 to 52 million and the over-65s increased from 25 to 35 million. The bureaucrat defenders say: don't overlook the prospect of economic growth. If you assume a relatively modest labor productivity growth rate of 1.2%, you could increase taxation to keep much the same ratio between wages and pensions as now, and in 2030 everybody could still be 20% better off. Moreover, the total tax burden in Japan, at 36% of national income, is still quite low - lower than the 40% that Mrs. Thatcher managed to get down to and much lower than continental Europe. And moreover, further, one can't boost consumer demand enough to get a good rate of growth going until people feel more secure about their pensions.
The relation between bureaucrat and politician is still a crucial one for the Japanese polity. You'll have heard the aphorism that in Japan politicians reign and the civil servants rule. It was the "Yes Minister" syndrome writ large and institutionalized. Ever since 1887 the most important ministries and the Bank of Japan have recruited from the brightest of the bright, the top students of the law and government departments of the top universities. Politicians are assumed to be less intelligent, more vain, more susceptible to corruption. Until the 1970s it was generally assumed that only ex-bureaucrats were fit to be prime minister. Politicians could occupy minor ministries. Indeed it came to be the practice that anyone who had been elected in 6 elections had a right to a turn at being a member of the cabinet. You didn't have to be particularly bright because a crucial element of the system was the practice of allowing civil servants to field all the detailed questions on new legislation in parliamentary committees: the Minister wasn't expected to know the answers.
Things are changing on both sides. The creme de la creme are not so attracted by the civil service, A decade of deregulation, reducing bureaucratic power, plus a good deal of populist bureaucracy-bashing set off by the discovery that a small number of rotten apples in the bureaucratic barrel were as corrupt as politicians, has reduced the reputation of the civil service. At the same time, the growth of American-style law schools, the doubling of the numbers admitted to the highly competitive bar exam, and the growing demand for corporate lawyers as Japanese business becomes more litigious a l'americaine, have provided an attractive alternative career for the very bright. The Bank of Japan and the Ministry of Finance - and especially the Foreign Office which has had the worst press - have also been losing bright sparks to the private finance sector.
Things have changed in the world of politics, too. One thing Koizumi has tried to do is to take policy formation away from the party organs and directly into the government. At the same time the civil servants have been forbidden to speak in parliamentary committees - unless, that is, an MP explicitly asks for them to do so. It's mostly the Communist Party members who actually exercise that right, one bureau chief told me: they are more likely to do their homework and want detailed information not platitudes. Ministers now have at least to be articulate, and the old rules about a Buggins-turn right to a spell in office seem to have been discarded.
The other two big changes in Japanese politics over the last decade are, first, the emergence of an opposition party which can fight elections as a more or less plausible alternative government, though the Democratic Party so lacks cohesion that it is hard to say how it would actually change policies. It is a mixture of neoliberals more intent on privatization plans than most of the LDP, miscellaneous greens, plus a number of ex-socialists with union connections. It also contains Ozawa, the charismatic spoiler who is intent on building a new party and thinks he might create a new majority by splitting off the neo-liberal modernizers from both parties.
The second big change is the decline of factions within the LDP. Once upon a time it was enough for a prime minister to win over five or six main faction leaders and they could deliver the support of their henchmen. Now henchmen don't hench so easily. One reason is because state funding of elections has reduced their dependence on faction leaders for cash. The other is the single-member constituency system replacing the multiple member system where members of different factions competed for votes. The architects of the system had in mind the British model of parties each held together by strict party discipline enforced by control over the nominations of candidates. In effect, however, the need to win elections has dictated the nomination of the candidate with the strongest local vote-getting machine. In the constituencies the crucial organization is not the party branch but the Suzuki Ichitaro Support society, which effortlessly passes the seat on to Suzuki Jiro when his father or uncle retires. Hence an LDP something like a half of whose members are second, third or even fourth generation politicians like Koizumi himself, a fractious party which only a leader with the great personal popularity, who helps all his party to win elections, can control.
Finally, a word about my own pet subject - the changes in the microeconomic structure. What some people decried as crony capitalism was a pervasive tendency for economic transactions to be embedded in interpersonal relations or intercorporate relations of mutual obligation. Relational banking is a familiar term. In Japan there was also relational trading with suppliers and distributors, relational employment with lifetime employees, relational shareholdings, usually cross-shareholdings, with stable shareholders, even relational regulation, bureaucrats who would tell you whether you were breaking or just bending the rules, strong industry associations with a wide range of cooperative relations among competitors and above all corporate governance in the hands of insiders related to each other by a lifetime of careers within the same firm. All of that the reformers wanted to change. Efficiency they argue can only come from market competition and that needs impersonal, market-driven transacting, transparent regulation, and corporate governance with transparent auditing which subordinates management agents to their shareholder principals. When the Resona Bank was in trouble and there was some ambiguity about the auditing treatment of tax liabilities, the auditors asked the Chairman of the Japan Auditing Association to go along to the Financial Services Agency for advice. The Minister, Mr. Takenaka, ordered that he be sent away. No more huggermugger fudging. We make the rules. You interpret them and if you get it wrong we take you to court.
That's the new world, a world filling up with lawyers, with expanded corporate legal departments, and transactions between firms based on complete contracts covering all contingencies, not just memoranda of understanding on a couple of sheets of A4.
The corporate governance reform movement resulted in the enactment of a revision to the commercial law which gave firms the choice of staying more or less with the old system or adopting what is generally seen as the American pattern, the formal legal jargon for which is "a company which has established committees etc." The essence is that there should be a heavy representation of external directors on the board and that its three subcommittees, audit, compensation and appointments, should each have a majority of external directors. Not many firms have taken that option, but other changes have been much more pervasive. Many firms have cut down the size of their 30-40 man boards, appointed a number of external directors, including women, introduced stock options, and so on.
But these changes were mostly in the pipeline when the prestige of the American model was at its height. There has been a distinct falling off of reforming zeal since that model was tarnished by the collapse of Nasdaq and Enron. Many of the changes are cosmetic and make little difference to the realities of decision-taking. In most firms where the board of directors has been cut down, the former board members, now known as executive officers meet as an executive officers board and it is there that the real decisions are taken. A friend who has become an external director of a large textile firm asked the president when he was appointed, "Do you expect me to act as a representative of minority shareholders" and the answer was: "Good heavens, no; just point out things that we might overlook."
Nevertheless, there has been a distinct shift in the center of gravity of managerial culture which is for real. One might describe it as a move along the stakeholder/shareholder spectrum, but since there was only one stakeholder that really counted is better described as a shift from employee sovereignty to shareholder sovereignty. This manifests itself in many ways, but two especially: first, the union-management consultation committees count for less and less in decision-making. Secondly, Investor Relations departments have grown, and whereas in the days of stable cross-holdings managers were not much bothered about their share price, now it is a major preoccupation. The stock market has become far more central to the workings of Japanese business than it ever was. It's not so much the fear of takeover, though that is there. It is that a falling share price has a much more direct impact on a company's reputation, its sales, its employees' morale, its success in the new graduate recruitment market.
But these are slow, some would say glacial changes. Mario Monti the European Commissioner for competition policy was in Japan recently. He told an audience at the Japanese Free Trade Commission that Japan had done well to increase the scale of fines for cartel behavior but they were still not tough enough. And moreover they should make it possible, as in the U.S. and Europe, to exempt from fines any cartel member which betrayed its secrets. I asked an ex-bureaucrat friend who runs a major industry association, what he thought of that idea. "I can't imagine that ever being acceptable in Japan," he said. I pressed him: "Surely the reformers, people like the CEOs of Orix or Hoya who are all for "dry" business relations and believe wholeheartedly in the virtues of competition - surely they would be in favor." "Well, they might think it would be a good idea, but I think even they would find it difficult to say so openly."
Japan, as they say, is different. Still different.
* Source: Speech delivered at Chatham House, February 25, 2004.
February 25, 2004
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