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.