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December 2001

Economic Recovery Through Urban Revitalization

Tatsuo HATTA (Professor, University of Tokyo)

As the unemployment rate and the bankruptcy rate soar to record high levels, Japan's economy seems to be falling into a downward spiral. Although the Koizumi administration has been pursuing structural reforms to cut wasteful government spending, such a policy alone will not revive the Japanese economy. In order not to be trapped by a severe recession, the Koizumi administration should take into account the following three points.

Useful Public Investment in Large Cities

First, it is desirable in the short run as well as in the long run to adopt a policy of undertaking useful public investment by mobilizing idle resources in time of recession, when investments in the public facilities that are necessary anyway would not increase tax burdens in the future. Some of those investments could even raise tax revenue. For example, public infrastructure investment in urban areas tends to induce private investment and push up land values, leading to increases in property taxes and income taxes. Issuing government bonds to finance useful public investment is likely to raise expectations for economic recovery and even improve the ratings of government bonds.

Second, higher land values as a result of improved amenities and land productivity in big cities could solve the bad loan problem, which is concentrated in large urban areas. The hasty disposition of bad loans might well aggravate the recession. Instead, we should try to raise land values by deregulation and public investment and thereby turn bad loans to healthy ones for revitalization of the private economy.

Third, it is necessary to stimulate the housing market and housing-related consumption in time of recession. Housing expenditure can be adjusted more flexibly than ordinary consumption, and housing shortage is most keenly felt in the centers of large cities. Deregulation and tax reform will be needed to facilitate housing construction in recessionary periods.

In view of these three points, the government should immediately undertake the kind of structural reform, tax reform, and public investment that could facilitate urban revitalization and housing construction. As for useful public investment, probably the best example is the construction of the remaining portion of the roads officially proposed by urban planning. The total area of this remaining portion within the Tokyo ward region is about 700 hectares (7 million square meters). Such an investment will reduce traffic congestion and facilitate urban redevelopment, making the city greener and more earth-quake resistant. Furthermore, it would produce new demand for substitute land up to 700 hectares, raising land values in the Tokyo region.

Another example of useful public investment is the construction of railways to connect airports and central cities in Tokyo and Osaka. Economic efficiency will be greatly improved if non-stop express train services are provided between Tokyo's Haneda Airport and Tokyo Station and also between Osaka's Itami Airport and Umeda Station.

Necessary Deregulation and Tax Reform

As for deregulation for urban revitalization, we can think of the effective use of the floor-area ratio to facilitate high-rise development in some areas and to restrict such development in other areas. In order to avoid the so-called "heat-island phenomenon," we need to create "wind passageways" that consist of roads, green zones and low-rise buildings under strict floor-area ratio regulation. On the other hand, we should relax floor-area ratio regulation (e.g., up to 2000%) for a number of districts near subway stations, where high-rise development should be encouraged.

Furthermore, regulation of housing in central cities must be relaxed in order to facilitate housing investment. Because floor-area ratio regulation is intended to restrict business activities in order to avoid commuter traffic congestion, such regulation is not needed for housing, especially in the business districts of central cities. If water becomes in short supply in a particular area, then fees should be raised to control its demand and encourage its supply in that area.

Tax reform to facilitate housing construction is also important. The central issue is the consumption tax. It is clear that the current 5% consumption tax imposed at the time of construction is restricting housing investment. An alternative is to reduce the consumption tax rate while raising income tax to offset the resultant tax revenue losses, at least until the employment situation starts to improve. Although such a policy is tax revenue neutral, it will stimulate the economy by encouraging housing investment.

Structural reform can stimulate the economy only if it is combined with carefully designed, appropriate fiscal policy. The government should provide a clear vision for the future course of the nation and do away with the arbitrary constraint of 30 trillion yen on the new issuance of government bonds. With those appropriate policies, Japan would be able to come out of the current downward spiral and ride on an upward spiral of economic expansion.

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