Japan's Economy: Window of Opportunity

Mr. Yasuhisa Shiozaki is a member of the House of Representatives, and is regarded as the most prominent reformer in the Japanese Diet.

The following is excerpted from a presentation Mr. Shiozaki gave at the Hotel Okura Executive Luncheon Meeting on November 15, 2001.

On the basis of policy failures and mistakes during the past decade, Prime Minister Koizumi has called for reform, making himself extremely popular among the Japanese citizens. The specifics of the reform, however, have yet to be set out and put into practice. Although I have committed myself to the full support of his reform, I am not entirely sure about quick implementation, because Mr. Koizumi's reform plan will affect much of Japan's bureaucracy as well as a large number of interest groups that could be hostile to any big change in the status quo. In my view, the potential weaknesses of the Koizumi administration lay in three points: reform priority, timing and sequencing, and the reform engine.

Reform priorities

The administration needs more deliberation on priority in the reform plan. The history of Japanese politics tells us that one administration can usually accomplish only one big assignment and, therefore, a leader must set a clear priority on his policy items.

It is apparent that the Koizumi administration has put more emphasis on fiscal consolidation, symbolized by a 30 trillion yen limitation on annual JGB issuance, rather than resolution of non-performing loans and industrial consolidation. I believe the latter to be, by far, the top-priority policy issue essential for enhancing productivity and profitability of the Japanese economy. We also need to give attention to the dynamics of the global economy in implementing reform.

We should start by recognizing the grave magnitude of Japan's non-performing loan problem in the weak banking system. Although the Koizumi administration has announced that it will concentrate on disposal of non-performing loans, in reality they are basically proposing to take a little more than 12.2 trillion yen in non-performing loans off the balance sheet within the next two to three years.

This should be only an initial step in disposing of non-performing loans accumulated on the balance sheets of Japanese banks. More than 80 trillion yen, or about 16% of Japan's GDP, of so called category II, or substandard, loans are concentrated in the real estate, general construction, and retail/wholesale sectors. This magnitude is grave in light of the history of asset bubbles in the rest of the world. Aggressive restructuring of these industries, therefore, must be carried out, where not only institutions like asset management corporations may be used, but also public and private capital injections and, in some cases, nationalization. Political commitment is surely required in the process before it becomes too late.

Faced with pressure from the financial market, the Financial Services Agency (FSA), in November, began urgent on-site examination of major banks in order to specify large, deteriorated borrowers under category II. But market participants still doubt the effectiveness of the FSA examination, as do close colleagues of mine in the Diet.

I have proposed putting a financial crisis management plan in place until April 2002, which consists of three components. First, by December we must determine bank capital shortage based on more stringent asset evaluation standards to be applied in on-site examinations. Then, along with restructuring plans for large non-performing borrowers, major banks also must be restructured, both in terms of capital and management. Market capital can be augmented for a bank, but a capital increase of only two or three hundred billion yen will not be enough to cover the current shortage on their loss allowances, and public capital injection should be executed while requiring capital reduction and management change in the process.

Three years ago Japan failed to acknowledge capital shortage in the banking industry, and instead created a national fiction that capital injection was needed to make healthy major banks even healthier. The time for playing make-believe is over. The window of opportunity could close as soon as March 2002. An ultimate driving force of the process of non-performing loan resolution should be the administration itself, the FSA above all, and the Ministry of Economy, Trade, and Industry (METI), as well as the Ministry of Land, Infrastructure, and Transport (MLIT), since private initiatives have failed to solve the problem over the last decade.

In order to facilitate the process, mandatory transfer of so called risk management non-performing loans of major banks to the Resolution and Collection Corporation (RCC) may be one option, where future realized losses of the loans can be paid by banks' common stocks, which means further substantive nationalization of major banks may be inevitable. In this regard, the RCC should function as an asset management company utilized to restructure over-indebted companies. Thus, it is undesirable for the RCC to survive as a permanent institution, and should be closed within the next five years.

Timing and sequencing

Prime Minister Koizumi insists that there will be no economic rebirth without reform, saying "No pain, no gain." This is a clear declaration of departure from the "lost decade" when we have worsened the misallocation of economic resources by accumulating conventional public works spending and non-performing assets. I agree with the idea, but it needs more sophistication.

Market participants share a consensus that non-performing loan disposition and the restructuring of ailing industries should come first. Fiscal consolidation should come second. The present unemployment rate of 5.3% indicates that pain has come before non-performing loan resolution ever started, since fiscal consolidation without a clear priority is what induced then Prime Minister Hashimoto to risk fiscal tightening three years ago. Thus, a priority must be established within the cabinet.

Early this year, I proposed a plan for setting priorities over the next 10 years that consists of three steps. In the first two years we should concentrate on cleaning up bad assets and corporate and industrial structural reform. A more efficient safety net should be designed to put an emphasis on productive policies like job training programs, professional education vouchers, and incentives for job change. Instead of simply spending for conventional items, I propose to privatize and sell government assets, including airports, highways, public utilities, and government-held real estate. As long as non-performing loan resolution is being executed, fiscal spending should, at worst, be maintained neutral to the economy.

The following three years should be focused on restoring the primary balance of the national budget by cutting public spending and strengthening capital markets and real estate markets.

Over the last five years, we will fulfill fundamental reform of social security, the national pension system, and the tax code. Our ultimate goal is to prepare a program to maintain long-term, sustainable growth driven by a private sector economy.

The reform engine

The third area where the Koizumi administration needs to strengthen is their reform engine, or, in other words, their "control tower" for the reform, or governance, issue. At present, there are three major criticisms against the Koizumi administration: that it has accomplished nothing since its inception, that it has been unable to act beyond the framework set by the ruling coalition, and that it tends to disregard the opinions of LDP Diet members with respect to its reform plan.

This is the political reality that Mr. Koizumi and his administration now have to face. Japan has yet to establish a new and effective policy-making process to replace the old "iron triad" model, which collapsed a decade ago. Under the old regime, both decision-making and policy implementation were much faster. The elimination of guru politics may have meant progress for democracy, but now smaller gurus fight for political survival by seeking an ad hoc coalition for policy meddling.

The Prime Minister's Office appears to be influential, but it is still too early to tell for certain. Many outside academics and private advisors work in the Prime Minister's Office, but no one can tell who, other than bureaucrats, really shapes the administration's central doctrine on important matters. More stability in the policy decision-making process will lead to a strengthening of the reform engine, which is so crucial for the Koizumi administration.

To this end, I believe we must first integrate the ruling party and the government in order to strengthen the leadership of the Prime Minister. This cannot be achieved without eliminating the ruling party's practice of pre-clearing cabinet-sponsored bills before submission to the Diet. At the same time, more attention must be paid to the issue of democratizing the Diet in order to facilitate more productive debate and a more transparent system.

Second, the Prime Minister's Office must also be strengthened. It is essential to restore the leadership of the office by increasing the number of expertise-based political appointees and non-bureaucrat advisors within the Prime Minister's Office, and possibly within individual ministries. Politicians can be easily deprived of access to timely, unbiased, and sufficient information, let alone to new ideas independent of the bureaucracy, and such ideas are needed to make sound decisions. The introduction of an advisory committee with full-time membership, just like the "Policy Unit" of England, at the Prime Minister's Office may deserve serious consideration.

Third, a widening of the policy-making community is also important. Strengthening the intellectual base of national policy-making cannot be achieved without a strong, independent, and diverse think-tank community. Currently, many Japanese think-tanks are affiliates of financial institutions and business associations. We need more independent, strategic thinkers in this community.

Making progress

Japan's policy-making process is becoming more democratic in both positive and negative senses. Due process and disclosure are becoming more essential in the political field, but until a new regime for policy-making is established, the current chaotic situation will continue. Japan has no time to lose in putting its economy, national security, and society back on the right track, and while the current window of opportunity is open, someone has to lead. Someone has to help forge wise and timely policies and see to their effective implementation.

That someone is, of course, the prime minister. Fortunately, we have a tremendously popular prime minister at the moment. The time is ripe for gathering the best and the brightest from both inside and outside the government and mustering their efforts for policy development and implementation. It is of the utmost importance to institutionalize a new style of governance that can present, and realize, the grand vision embraced by the prime minister. That model will revitalize not only the Japanese economy, but also the Japanese democracy.