Maladies and Remedies

Introduction

In contrast to the previous decade's favorite economic topic—how to 'reform' or 'restructure' the Japanese economic system and its institutions into something new—the first decade of the new century has witnessed somewhat of a U-turn. Lately, some economists have been searching for different remedies to cure the Japanese economic and social system; not to make it into something new, but to remake it as it used to be. According to these scholars, the Japanese economy can again be stable and balanced.

This particular book, Reviving Japan's Economy: Problems and Prescriptions, was born in 2002 in Tokyo. It soon became a project coordinated by Columbia University and the University of Tokyo and, after several workshops and revisions, the manuscript was completed in March 2005. The main purpose of Reviving Japan's Economy, as 'a comprehensive policy-oriented research project', is 'to recommend economically optimal solutions to major problems thwarting Japan's return to a self-sustaining, full employment growth path' (page xiii). Jointly edited by Takatoshi Ito, Hugh Patrick and David E. Weinstein, Reviving Japan's Economy is an interesting mixture of governmental think-tank opinion and academic research. This is not to assume that the opinions of think tanks are not research-based; yet there are differences, and the two styles can be confusing when their boundaries are not clearly separated. The book is divided into four main parts: 'Macroeconomic Policy', 'Reforming the Japanese System', 'Changing Markets and Business Investments' and 'International Economic Relations'. Strangely, although the authors are from the US and Japan, there is no chapter on American-Japanese financial and currency relations, which is probably one of the most (if not the most) important issues regarding possible remedies for the Japanese economic and financial system.

Reviving Japan's Economy addresses almost all the fundamental problems of the Japanese economy and domestic financial system, with each author suggesting solutions and policies. Nevertheless, the most important issue upon which the editors carefully and professionally focus is not the old and well-publicized questions of what went wrong and why. Instead, the authors comprehensively analyze the entire period of Japan's economic success and argue that, despite 15 years of recession, it is still possible to turn back to a stable, well-balanced and thus outstandingly successful economic and social structure—to return to the economy as it was before the bubble. When making policy-related suggestions, each author assumes (either explicitly or implicitly) that Japan should be a steadily growing, socially balanced (meaning full employment) economy.

This assumption is necessary because debates on how to reform or 'liberalize' the Japanese economic system are performed on the stage of a larger debate over the merits of this American versus the Japanese models. As Feinberg (1993, 5) argues, economic success (and failure) for the Japanese model can be seen as a mirror-image of the American version: 'Japan stands as a symbolic complement to our self-image, reinforcing our idea of the way we are and the way we ought to be.'

It is perfectly reasonable to compare the two economic powers if the base of comparison is relevant; that is, if the focus of one's work is on the two economies' interdependence and how they affect each other's economic and financial performance. Readers will, therefore, understand the outcomes of the 'maladies and remedies'. Reviving Japan's Economy, however, rarely uses mutual, coherent and thus explicit methods for comparison. In fact, only in the third chapter, by Harrigan and Kuttner, does the book take this approach. Consequently, readers may be left in the dark about whether the Japanese economy should be more like the American model or whether the American model should import more aspects of the successful (pre-bubble) Japanese model.

As Takatoshi Ito and Hugh Patrick argue in the first chapter, from the 1980s Japan became the victim of its own economic success. Outstandingly fast economic (and technological) development resulted in a completely different economic and social structure, and thus required new economic and financial policies plus a new institutional setting (pages 4–5). However, reforms started late and provoked fierce conflict among ministries, big corporations, producers and consumers. Although the process of 'liberalization', internationalization and globalization began more than a decade ago, at least as governmental buzzwords, fundamental actions changed only slowly, and it is doubtful whether, institutionally, Japan could tolerate any further reduction in control over its economic system. The current institutions were, after all, designed primarily for the 'priority of economic growth' (Gao 2001; Katz 2003).

In this review, I focus on one issue: how the Japanese economic system successfully combined Soviet-style elements and the 'Anglo-Saxon' model to achieve internationally-recognized economic strength, and how this peculiar combination created a policy-related trap. This trap is seemingly solvable, but not without sacrificing the 'doctrine-like' targets of political and economic decision-makers. In Reviving Japan's Economy, the most interesting (albeit most controversial) chapters criticize the old (thus successful) parts of the Japanese economic 'miracle'. These are chapters five, six and eight. The common element in these chapters is that each critically examines the Japanese economic and financial system and recommends systemic changes, thereby suggesting an implicit model for Japan.

The Banking System

'There is almost no private capital in Japan's banking sector. [Even] using the most optimistic forecasts for near-term macroeconomic performance we find a substantial capital shortage' (page 152). Instead of private capital, it is mainly public funds that are used to support most of the banks. This is because, since the bubble burst, as Hoshi and Kashyap argue, a persistent bailing-out process has been occurring, using taxpayers' money and, before 2000, the deposited assets of the fully government-owned Postal Saving System (PSS). Furthermore, banks' subsidized interest-rate loans went to non-manufacturing sectors, which are the most regulated and thus the most protected from international competition. These include the retail and wholesale sectors, the construction industry, and the real estate sector. Commercial banks carry the negative elements of the positive economic period: they are unprofitable, intermediate lending activity is too high, too many exist, and most are undercapitalized (pages 154–160). As customers know well, most Japanese banks are still far from consumer-friendly: in particular, they are slow (a situation which has actually been worsening following the closure of many local branches from the largest Japanese banks, such as Mizuho) and their fees are very high. Innovations in banking are not welcomed since, in the old system, the regulating authorities, especially the Ministry of Finance (MOF), discouraged (and in certain fields strictly prohibited) innovative activities.

In sum, Japanese commercial banks seem to have become the victims of a double moral hazard, because subsidies from public money have failed to encourage most to seek profitable, cost-saving solutions to restructure. With many banks continuing (at the chapter's writing in 2003) to offer loans to zombie companies (page 164), this hazard is double because not only are the banks engaging in highly dangerous borrowing activities but the government is involved too. Indeed, the latter is engaged in lending without constraint by the taxpayer, even though this behavior profoundly undermines social trust in the state.

According to Hoshi and Kashyap (page 166), the only solution for creating an efficient and highly profitable banking sector would be 'to allow foreign banks to enter the Japanese market so that they will bring both innovative products and competitive pressure to bear. Other than these obvious points that derive from a general principle that the government should allow (and even encourage) private markets to work, we do not see important government policy alternatives on this issue.'

However, allowing foreign banks to participate fully in the Japanese market would be a double-edged sword for the Japanese financial system. First, were foreign banks to provide competitive, efficient services, this might turn more and more Japanese citizens away from domestic banks and investment companies. That would have a serious consequence on domestic saving, which has been in gradual decline since it became possible for Japanese individuals to invest their assets abroad. Moreover, a long-term presence of foreign banks in Japan is still inconceivable for most Japanese. There is also a strategic issue involved. Because most of Japan's internationally competitive firms do not use loans from Japanese banks, were foreign banks to enter the market fully, their presence might seriously curtail (if not eliminate) the Japanese government's ability to control the activities of the domestic financial sector (Gao 2001).

Government Financial Institutions

As Doi's comprehensive and very critical chapter suggests, it is probably the 'invisible' and institutionalized sector—the so-called 'second budget'—that is the heaviest burden on the matured Japanese economy. According to Doi, the original aim of this second budget (the Fiscal Loan and Investment Plan or FILP) was 'to undertake projects [the government] was unable to include in the general account budget because of a policy of not issuing deficit financing bonds, a policy relaxed in 1965 and largely abandoned in 1975' (page 198). Until 2001, the main source of funding for FILP was the PSS. In April 2001, the government implemented a fundamental reform of FILP and its organizations (nine government financial institutions, nineteen special public corporations, ten independent administrative agencies, and six special firms). FILP borrowed from the PSS, then lent the money for both domestic and foreign purposes, and also purchased government (deficit) financing bonds.

This state-owned financial web has been a giant of subsidization. In 2003 it managed 62 per cent of gross domestic product (311 trillion yen) (page 197). If one carefully analyzes the purposes and functions of FILP over the last half century, it is easy to recognize the strong socialist element. First, non-competitive sectors were eligible for subsidized FILP loans. Second, these sectors (including the special corporations) hosted many and various amakudari ('descent from heaven') employees (usually former government officials parachuted into senior posts). Third, as Doi (page 201) notes, citing Iwamoto (2001, 2002), FILP through its institutionalized network regularly collected information from the private financial sector because the government banks also channeled subsidized loans to certain private banks.

FILP—given its nature as a governmental or, more precisely, MOF entity—was rarely required to be transparent and accountable. Since FILP's financial activities also included almost all local governments and many municipal enterprises, a significant part of current state debt comes from the gigantic, inefficient state financial sector. Nevertheless, in 'intermediating' between local and central government, between private enterprise and banks and 'public' enterprises and banks, the government does not necessarily suffer a loss (page 201). And this is the core of the matter. Since vested interests—that is, various state authorities—are powerful enough to maintain control (as far as the quasi-mandatory saving system that existed until the 1980s), they are also powerful enough to soften the proposed privatization of FILP. Doi recommends drastic reforms for the entire FILP system. (Doi himself was a member of the special preparatory committee on the PSS privatization under the first and second Koizumi cabinets.) In his opinion, most FILP-related institutions should be abolished, some should be privatized, implicit guarantees from the central government to local governments should be abolished, and only efficient government institutions should be maintained for special (non-market related) activities (pages 228–236).

Doi's chapter leaves the clear impression that FILP and its institutional network is a huge, invisible redistributive sector within Japan's economy. It links top political circles and financial elites, local and central authorities and creates a virtual financial-political sector. Economically, most of the FILP-created and maintained companies and financial institutions have operated under soft-budget constraints. As economists familiar with these constraints well know, firms or banks receiving money almost automatically from the state rarely need to worry about how to use this money (page 236). Because there have been no cost-return criteria for most of these entities, they have spent money for decades without paying attention to efficiency. But the irony of FILP is that, as a political redistribution channel, it has, over the last 15 or so years especially, contributed significantly to minimizing the unemployment rate and maintaining social peace.

Corporate Investment and Restructuring

Another interesting chapter in Reviving Japan's Economy is Tokuo Iwaisako's 'Corporate Investment and Restructuring'. Iwaisako offers a micro-analytical perspective on the systemic and structural consequences of the old institutional system inside various corporations. Naturally, Iwaisako selects the Long-Term Credit Bank (LTCB), an unprecedented example of restructuring after its collapse in 1998. Iwaisako summarizes how the LTCB was successfully sold to Ripplewood (an American corporation, unknown to most Japanese), and how Ripplewood successfully created Shinsei Bank, which has been an outstandingly customer-friendly commercial bank since 2000. Iwaisako also looks at Nissan, remarking (page 291) that, in terms of corporate restructuring in Japan, Ghosn' s restructuring 'model' at Nissan has been the exception rather than the norm. On the other hand, attempts to restructure Kanebo failed because the government-created Industrial Revitalization Corporation of Japan (IRCJ) bailed it out, and thus from 2004 the entire company was restructured (creating independent new companies), with management resigning. Finally, Iwaisako cites the Daiei example, showing that, without a neutral, outside party, corporate restructuring cannot succeed.

Conclusion

To summarize, the real systemic problem in the Japanese economy and financial system is the peculiar combination of Soviet-style policy-making and institutions, together with national profit-maximization as the key to international competitiveness. Ten years ago, researchers labeled the Japanese economy a '1940-system', referring to the continuity between wartime economic and financial policies and the post-war economic system and its outstanding success (e.g. Okazaki 1993; Noguchi 1995). Reviving Japan's Economy sheds light on several elements of the institutional settings that clearly originated before the end of the Second World War. This raises an obvious question. Why did the Japanese maintain the institutions of this economic and financial system in the face of such mounting social and economic costs?

The answer to this question relates, as much as anything, to the established interests of the Japanese political, economic and financial elite. As Iwaisako stresses (pages 298–299), interdependent members of these elite have an overwhelming interest in maintaining the status quo: if they are even seen to support radical change they can quickly lose influence or be passed over for promotion. Consequently, Japan today faces the very painful prospects of change. Either policy makers admit the presence of structural problems—from education to retirement systems—and admit that the Japanese economy should be completely opened or they may see, over the next few years, more corporate bankruptcies, more restructuring, and more 'last minute offers' to foreign companies for help. One hopes, however, that this process does not lead to a further misconception that 'freedom and free market' are the same thing (Johnson 2007).

Chapters

1. Ito, Takatoshi and Hugh Patrick, 'Problems and Prescriptions for the Japanese Economy: An Overview'

Part I Macroeconomic Policy

2. Broda, Christian and David E. Weinstein, 'Happy News from the Dismal Science: Reassessing Japanese Fiscal Policy and Sustainability'
3. Harrigan, James and Kenneth N. Kuttner, 'Lost Decade in Translation: Did the United States Learn from Japan's Post-Bubble Mistakes?'
4. Ito, Takatoshi and Frederic S. Mishkin, 'Monetary Policy in Japan: Problems and Solutions'

Part II Reforming the Financial System

5. Hoshi, Takeo and Anil Kashyap, 'Solutions to Japan's Banking Problems: What Might Work and What Definitely Will Fail'
6. Doi, Takero, 'Government Financial Institutions: What and How to Reform'
7. Fukao, Mitsuhiro, 'Fixing Japanese Life Insurance Companies'

Part III Changing Markets and Business Investments

8. Iwaisako, Tokuo, 'Corporate Investment and Restructuring'
9. Fuji, Mariko, 'Changing Capital Markets: The Corporate Bond Market and Credit Risk'
10. Hashimoto, Masanori and Yoshio Higuchi, 'Issues Facing the Japanese Labor Market'

Part IV International Economic Relations

11. Urata, Shujiro, 'Free Trade Agreements: A Catalyst for Japan's Economic Revitalization'

References

Feinberg, Walter (1993) Japan and the Pursuit of a New American Identity: Work and Education in a Multicultural Age, New York: Routledge.

Iwamoto Yasushi (2001) 'Japan's FILP', The Economic Review, 52 (1): 2–15.

——— (2002), 'The Fiscal Investment and Loan Program in Transition', Journal of the Japanese and International Economies, 16 (4): 583–604.

Gao, Bai (2001) Japan's Economic Dilemma: The Institutional Origins of Prosperity and Stagnation, Cambridge: Cambridge University Press.

Johnson, Chalmers (2007) Nemesis: The Last Days of the American Republic, New York: Metropolitan Books.

Katz, Richard (2003) Japanese Phoenix: The Long Road to Economic Revival, Armonk: M. E. Sharpe.

Noguchi, Yukio (1995) 1940-nen Taisei: Saraba Seiji Keizai, Tokyo: Tōyō Keizai Shimpōsha.

Okazaki, Tetsuji (1993) Gendai Nihon Keizai Shisutemu no Genryū, Tokyo: Nihon Keizai Shinbunsha.

Wright, Maurice (2002) Japan's Fiscal Crisis: The Ministry of Finance and the Politics of Public Spending, Oxford: Oxford University Press.

About the Author

Katalin Ferber is Associate Professor in the School of International Liberal Studies (SILS) at Waseda University and a research editor for ejcjs. Katalin is a comparative economic historian who has taught at various universities in Japan, and her main research interest is the development of modern Japanese finance in the Meiji period. Katalin's recent English-language publications include 'Professionalism as Power: Tajiri Inajiro and the Modernisation of Meiji Finance', in Janet Hunter and Cornelia Storz (eds), Institutional And Technological Change in Japan's Economy: Past And Present (London: Routledge, 2006); and ' "Run the State Like a Business": The Origin of the Deposit Fund in Meiji Japan' (Japanese Studies, 2002). She has also written previous book reviews for ejcjs, including: 'The World of Savings' in 2006 and 'The Sins of the Princes' in 2004.

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Copyright: Katalin Ferber
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