Japan works to revive its economy

Japan works to revive its economy

By Christopher Lingle

DENPASAR, Bali (JP): Japan's latest legislative package, which
was passed in March, provides some promise to revive the
country's stagnating economy.

By focusing upon tax and financial sector reform, there are
reduced dangers of Japan's economy crumbling under a combined
weight of its own looming domestic crises and the impact of
regional crises. This is welcome news after a blizzard of
revisions of plans for proposals to deal with the country's long-
suffering economy.

Japanese economic problems began as a slow-growth or no-growth
recession in the domestic economy beginning in the late 1980s,
that has become a full-blown recession. During this time, growth
was supplied by the international sector but that was unable to
keep the overall economy afloat.

In the early 1990s, while real estate and stock market values
plummeted, the yen experienced a sharp appreciation that prompted
production and jobs to move offshore. More recently, the
imposition of a consumption tax in April 1996 contributed to a
slump in retail sales. Meanwhile, consumer and business
confidence hit an all-time low over the failure of the
government's many failed programs to revive the economy.

As policy leaders in Tokyo have stumbled to find their way,
advice from foreign friends offered little clarity or
consistency. In Washington, the Clinton administration offered up
advice based upon unreconstructed Keynesian nostrums. Proposals
for pump-priming and temporary tax cuts are misguided and offer
little hope for a recovery in Japan's economic prospects.

Indeed, Japan's government has spent nearly US$800 billion on
such stimulus packages since 1992 without reviving its moribund
domestic economy. This waste of funds is a hangover from faith in
the state-directed collectivist capitalism that seemed to work in
the past but now imposes a real burden in distracting the
Japanese government from radical restructuring.

In seeking to minimize domestic political resistance arising
from structural change to avert the current recession, the
government initially placed its hopes on an export-led recovery
strategy. Unfortunately, regional financial turmoil meant that
trading partners in Southeast Asia were unable to continue
absorbing 40 percent of Japan's exports as they did before the
crises erupted. Changing realities of increased competition in
the global economy also worked against significant increases in
exports to Western markets.

In the meantime, Japan's financial services sector became
burdened with bad debts due to sharp asset disinflation in
property and stock markets combined with the collapse in
household spending.

After years of being cosseted from foreign competition as
agents of the government's program of directed development,
Japanese banks must now respond to competitive conditions
performance, measured in terms of return on equity instead of
concentrating on maximizing asset size.

The first steps of this process toward restructuring their
balance sheets and reducing nonperforming loans through write-
offs or securitization are finally being taken.

Consolidation of Japan's financial sector is long overdue due
to government inertia and mismanagement. Another looming problem
relates to reform of the postal-savings system that holds as much
as one-third of individuals' deposits.

Japan's banking sector also had extensive exposure to the rest
of Asia both as creditor and equity investor. With an estimated
loan exposure of about $300 billion, Japanese banks were the
region's largest creditor with about one-third of these loans in
Hong Kong and its precarious property market. Compounding Japan's
bad debt problem was the drastic fall in the market value of
their Asian equity portfolios.

Without these "hidden" reserves to provide the financial
cushion needed to absorb loan losses, domestic banks had to turn
to the government for an ocean of public funds.

The new Financial Supervisory Agency has begun to take action
to deal with Japan's $1 trillion banking problem by nationalizing
Nippon Credit bank and with providing 7.5 trillion ($63.5
billion) to recapitalize the 15 largest banks.

At the same time, Japan's "Big Bang" financial deregulations
are working slowly to remove anticompetitive practices. Japan's
troubled banking industry could be stabilized if it were opened
up to foreign investors in the way that investment-management was
opened to Citibank, GE Capital, Fidelity and others.

The latest legislative package includes permanent tax cuts
exceeding 6 trillion with an additional 2.6 trillion in
"strategic" tax cuts, including tax relief on mortgages.

The highest marginal tax rate for individual income tax will
be cut from 50 percent to 37 percent with a maximum allowable
reduction of 250,000.

Residential taxes will be reduced by 15 percent with a maximum
reduction of 40,000.

Corporate taxes will fall from just over 46 percent to just
over 41 percent, reducing the overall corporate tax burden by
2.3 trillion allowing an immediate increase in profit rates of
10 percent on current income and investments.

On the one hand, lower marginal tax rates boost incentives for
households and businesses to work, produce and invest. On the
other hand, permanent tax cuts alter the way consumers, taxpayers
and businesses view their futures.

They realize that they have greater access to their future
income flows. Returning control of their earned income will have
a "wealth effect" that is likely to encourage more spending that
would restore vibrancy to the domestic economy.

Japan's dalliances with Keynesian fine-tuning during the 1990s
did not serve them well. Little was done to resolve the effect of
the demographic Damocles sword hanging over the head of Japanese
taxpayers and workers who must fund future pensions. The average
age of the population is creeping upward so that fewer active
workers will be supporting more retirees.

Continued missteps today impose an increasing burden on a
shrinking work force that is also likely to find fewer job
opportunities in the future. At last, the resolute action taken
on tax cuts and bank recapitalization provides hope for Japan's
distant recovery.

The writer is an independent corporate consultant and adjunct
scholar of the Center for Independent Studies in Sydney, who
authored The Rise and Decline of the Asian Century (Hong Kong:
Asia 2000, 1998).

Window: Japan's troubled banking industry could be stabilized if
it were opened up to foreign investors in the way that
investment-management was opened to Citibank, GE Capital,
Fidelity and others.