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October 2001

Reforming Japan's "Socialistic System"

Eisuke SAKAKIBARA (Professor, Keio University)

As is well known, Prime Minister Koizumi has adopted "structural reform" as the basic policy agenda for its administration. This is very different from the administrations of former Prime Ministers Obuchi and Mori, whose main policy objective was economic recovery above all. However, it is not necessarily clear what Prime Minister Koizumi means by "structural reform." In this essay, I would like to examine what "structural reform" is all about and what policies should be formulated and executed in the name of "structural reform."

First, "structure" in the context of "structural reform" must mean political, economic and social systems or practices, which can be "reformed" by a series of policies. Of course, among these systems or practices there are cultural ones that cannot be "reformed" in the short or medium terms, due to their firm roots in history and tradition. Therefore, we should focus on those political, economic and social systems or practices that can be changed by policies in the short or medium terms.

The means that the government can use to facilitate those changes include reforms of laws such as tax codes, revisions in the central and local government budget and changes in various practices in the government and administration. What I would like to emphasize is that "structural reform" is not to change our traditional or cultural practices, but to reform our systems by legal, budgetary or other means.

Economic dualism in Japan

There seem to be at least two kinds of reforms that the Koizumi administration must urgently deal with. The first is productivity improvement by eliminating the dualistic system in the economy. The second is elimination of political dualism, closely associated with economic dualism. In fact, the latter cannot be eliminated without dealing with the former. The Japanese economy can be and should be revived by improving economic productivity structurally through political and economic reform.

It is well known that the Japanese economy consists of two different sectors: one is the globally competitive exporting manufacturing sector, and the other is the local sector protected by regulations and subsidies. This is called the dualistic system of the Japanese economy. The former sector accounts for about 10 percent of Japan's total employment and its average labor productivity is 20 percent higher than that of its U.S. counterpart, whereas in the latter sector, accounting for about 90 percent of total employment, the labor productivity is less than two thirds that in the corresponding sector in the U.S.

The main reason why the Japanese economy has been depressed for about ten years is often said to be due to the emergence and collapse of the bubble economy, and the resultant deterioration of the balance sheets of households, firms and the government. If, however, we adopt a microeconomic, structural approach, rather than a macroeconomic GDP analysis, we can see a more fundamental cause for the worsening balance sheet problem despite the massive infusion of public funds. That is due to the delay in the structural reform of the domestic industries, which have borrowed so much from financial institutions. In particular, the reorganization of such industries as the construction and distribution industries is long overdue.

Thus, it is now clear that Japan's problem is not its macroeconomic policy, but its microeconomic structural policy. That is the policy to facilitate structural and institutional reform of the domestic manufacturing and service sectors, which are suffering from low productivity and lack of competitiveness. The main cause for this low productivity is lack of competition due to various entry and exit barriers and lack of information about prices and quality. Competition is barred by legal, budgetary and tax arrangements.

Such budgetary and tax arrangement are adopted for the purpose of social stability, rather than economic efficiency, by protecting economic "have-nots." Of course, the so-called "safety net" is needed even in the capitalistic market economy, but Japan's problem is that such arrangements are being adopted not as an exception, but as a rule for the domestic manufacturing and service industries, which account for 90 percent of total employment in Japan. Put differently, in Japan the capitalistic market principle prevails only in the exporting manufacturing industry, and for the remaining domestic industries the socialistic system is preserved even today.

Alliance between politicians and bureaucrats

The fact that Japan's economic dualism involves the socialistic system, which is supported by political and administrative institutions, implies that economic dualism cannot be eliminated without reforming political and administrative institutions. Just like its economic system, Japan's political system has a very solid dualistic structure, which has been formed for a long time. Actually, Japan is the only advanced nations where political parties are so deeply involved in governmental policy decisions. There are no counterparts of the LDP's "sohmu-chohsakai" (general council), "bukai" (section councils) and "chohsakai" (committees) in the U.S. or in Germany. It is not possible for "kanjicho" (the secretary general) or "seicho-kaicho" (the policy council chairman) of the ruling party, as a non-cabinet member, to be involved in policy decisions in other countries.

Furthermore, in Japan there is a close relationship between political parties and the government in policy decisions and budgetary allocations. Bureaucrats in various ministries have built a long-standing partnership with "zoku" (special interest) politicians, and their bond with those politicians often seem stronger than their relations with the prime minister or even with their own minister. Of course, political leadership is a rule for democracy, but political "party" leadership is quite different from the rule. In Japan, due to the policy involvement of political parties through various ministries, the policy decision-making process is not very transparent and discourages political leadership in the true sense of the word. This may be regarded as a gigantic bureaucratic system that has been created jointly by political parties and bureaucrats, and is somewhat similar to that in China, Vietnam, and other socialistic countries.

What the Koizumi administration must deal with, therefore, is to eliminate the dualistic system in Japan's economy and politics, and to promote liberalization of the market economy and the democratization of politics in Japan. In other words, Japan's socialistic system should be reformed. Because it is an institutional and microeconomic problem, we must reform legal, budgetary and tax systems by breaking up the collusive alliance between parties and bureaucracy one by one in various fields.

Political leadership for budgetary reform

It is essential that the prime minister and cabinet members establish their control over political parties and bureaucracy. The tenure for the prime minister and cabinet members should be extended to about four years, and one way of achieving this is to elect the prime minister by popular vote.

As for legal and budgetary reform, it is important to focus on a number of priority areas from a strategic point of view. Prime Minster Koizumi should consider carefully what corresponds to the privatization of Japan National Railway, which was carried out by the Nakasone administration. If the privatization of the Postal Savings System is not carried out soon, then the Koizumi administration might as well cut the total amount of public works projects and change budgetary allocations.

In relation to the reduction in the total amount of public works projects, a crucially important point is to revise the relationship in the budgetary burden between the central and local governments. While the budget for public works projects is leveling off at the central government level, it is still increasing at the local government level. The budgetary breakdown of local governments, caused by loose checking systems for local governments, has contributed to the budgetary breakdown of the central government because the deficit in the local government budget is almost automatically taken care of by the central government through its local subsidy system.

Prime Minster Koizumi's structural reform would be quite interesting and highly appreciated if it focuses on the restructuring of public works projects and the reform of local government budgets as its priority agenda. It would be much better to focus on such priority areas to show some positive results to the general public as soon as possible, rather than formulating a comprehensive plan and launching simultaneous attacks on many front lines without much success.

(A larger paper on this topic was published in Japanese in the July 2001 issue of "Chuo-Koron.")

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