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The secrets of Japan's economic anorexia

An interview with Richard Katz, reviewing his recent book Japanese Phoenix: The Long Road to Economic Revival

Interview by Jorge Nascimento Rodrigues, February 2003
© Gurusonline.tv, 2003

Japan is like a phoenix. Richard Katz, a senior journalist and editor with more than 25 years as an observer of Japan Economy, is optimist - even if the reform will probably take one decade more. This turbulent and long reform process comes from the Japan's dilemma - the obstacles to growth are woven into the very fabric of the nation's political economy. Japan's average annual growth since the spring of 1997 has been negligible - 0,3%. At this kind of rate, it will take more than 100 years for living standards to double. Just this month, the Japanese cabinet has endorsed a forecast that the economy will grow at a rate of 0,6% in the coming fiscal year (starts April 2003) after a growth of 0,9% in 2002. In the West, we ask again and again what's wrong in a country that in the 80's was the true emergent economic superpower in the so-called Asia-Pacific Era and a kind of lighthouse for management practices and paradigms. Richard gave us some clear insights about Japan. The ideas of Katz can be studied more profoundly in his most recent book Japanese Phoenix: The Long Road to Economic Revival. Also he published a short article in Foreign Affairs magazine, January/February 2003 edition.

MAIN TOPICS
- Now is the period of consensus-building and institution-building that precedes action.
- The upshot is that each reform by itself seems to have only marginal impact. Worse yet, piecemeal reforms seem to threaten chaos, increasing the resistance to reform. It is only when reforms are all applied in a comprehensive, coordinated manner that they will work well. That's why bottom-up, incremental change won't suffice.
- Solving the nonperforming loan problem - 430 billion dollars, 10% of GDP, or probably the real number is close to 20 percent - must come first.
- By the beginning of the 1990s a mere 10-15 percent of Japan's entire workforce was employed in the efficient exporting industries.
- Consumption is too low not because households save too much but because they earn too little. The consequence is a kind of economic anorexia - Japan's inability to consume all that it produces.
- The household savings rate has steadily fallen from 14% in 1990 to 10% in 1997 to 7% in 2001.
- As Japan slowly lost its most efficient sectors, the productivity of the entire economy started being dragged down to the level of the stagnant sectors.
- Every passing day brings increasing conflicts among the LDP's assorted constituencies: farmers versus urbanites, banks versus insurance companies, young versus retirees, efficient versus inefficient.

When was the last month you have been in Japan? What impressed you more in that last visit?

I was there in December (2002). At that time, people were debating whether the new minister in charge of banking issues, Heizo Takenaka, would be able to really solve the problems. The good news was that there was some hope and people were interested in debating the topics. The bad news is that, since Prime Minister Koizumi has failed to do what he said he would, there is a lot of cynicism and depression.

You say that the most likely outcome is that Japan will reform and revive. But if history is a guide, last time Japan reformed was after imperialist chute and American protectorate. What kind of actors from inside the Japanese society can reform?

If you just talk to Japanese in their 40s and 50s in business, academia, the media, politics and the bureaucracy, you see that Japan is filled with lots of talented, smart ambitious people. They know things have gone wrong. They are capable of leading the new Japan. But they lack a clear economic program, critical mass, and an institutional vehicle. With time that will come. Now is the period of consensus-building and institution-building that precedes action. By the way, those previous instances that you mentioned would not have worked if the Japanese people themselves were not capable of reforming.

Ten more years to reach the "promised (reformed) land", as you said, isn't too much? In a decade the geo-politics and geo-economy of Asia Pacific can be very different from today - China Emergence as a super-power, Korea Peninsula crisis, Russian Asian strategy revived and so on…

I agree that it is too long. I'm not saying that they should take ten years. I'm saying that they will. Better late than never.

It was Michael Porter in "Can Japan Compete?" (published 2000, by Macmillan) that concluded: "The challenge facing Japan is that numerous things must change simultaneously. Not an easy task", and concluded: "Japan can compete. But the real question is - will it choose to compete? We believe Japan has the will, but lacks the vision and the direction". Do you think so?

I agree on both points. One of the biggest obstacles to reform is that you often can't fix one thing without having to fix other parts of the system as well. Solving the bank debt problem requires foreclosing on bad borrowers. But that would cause the loss of millions of jobs in a country without fluid labor markets. A forty-five-year-old worker needs assurance that if one firm lays him off, another firm will be willing to hire him. Thus, without reforming the labor markets, how can the bad debt problem be fixed? Corporate reform that gives firms more freedoms need to be balanced by a big increase in antitrust enforcement and shareholder power. Otherwise we'll just see stronger oligopolies. Shareholder power requires increased ownership by institutions and individuals. Yet who wants to invest in a market that can't get off the floor? Deregulation gives firms freer entry into new fields. Yet unless the moribund firms are forced out, such deregulation only leads to excess capacity, making life tougher for everyone. However, the government is reluctant to see too many firms fail, lest it bring down the banking system.

And what's the conclusion of that puzzle?

The upshot is that each reform by itself seems to have only marginal impact. Worse yet, piecemeal reforms seem to threaten chaos, increasing the resistance to reform. It is only when reforms are all applied in a comprehensive, coordinated manner that they will work well. That's why bottom-up, incremental change won't suffice. Achieving consensus for a comprehensive program will take time and political leadership. Added to this problem is the fact that the reformers themselves disagree on the content of reform and the proper sequencing. For example, Prime Minister Koizumi says lowering the budget deficit must come first. But, others, including myself, believe solving the nonperforming loan problem - 430 billion dollars, 10% of GDP, or probably the real number is close to 20 percent - must come first and this requires spending money and personal tax cuts.

So, what are the main dysfunctions?

Japan has two problems hindering growth: a supply-side problem and a demand-side problem. The supply-side problem is low productivity growth caused by the "dual economy." Japan is a dysfunctional hybrid of superstrong exporting industries and superweak domestic sectors. Under the pressure of stiff competition overseas, exporters such as the auto and machinery industries had learned to offer some of the best technology and highest productivity in the world. Within Japan, however, the picture was quite different. Coddled domestic manufacturing sectors from food processing to textiles became woefully backward by international standards. In food processing, for example, Japan's productivity is one-third of U.S. levels and falling further behind. Yet more people work in food processing than in autos and steel combined. By the beginning of the 1990s a mere 10-15 percent of Japan's entire workforce was employed in the efficient exporting industries. As a result, even if Japan were operating at full capacity, it could not grow faster than 1.25 or 1.5 percent on a sustained basis.

But you mention also a demand side problem?

Yes. Rarely understood is the demand-side of the problem: why Japan finds it so hard to run at full capacity. The same cartelization of the private sector that saps productivity also produces notoriously high consumer prices that suppress real household income and thus consumer demand. Once Japan reached economic maturity in the early 1970s, its investment needs slowed down. In a typical economy, household income and thus consumer spending rise to take up the slack. That keeps supply and demand in balance. Not in Japan. Once Japan's high prices are factored in, total household income in the private economy (primarily wages, interest and dividends) is actually a smaller share of national income today than it was in 1980. Consequently, consumption as a share of GDP is lower than in other advanced economies. Consumption is too low not because households save too much but because they earn too little. The consequence is a kind of economic anorexia - Japan's inability to consume all that it produces. Reforms that introduce more competition will not only improve supply-side efficiency but, by lowering monopolistic prices, increase real purchasing power.

How, then, did Japan manage to grow 4 percent a year during the period 1975-90?

It did so by artificially stimulating demand through huge trade surpluses, mammoth budget deficits, and, during the late 1980s, cheap interest rates that acted as monetary steroids. Today, Japan is like a patient who has abused antibiotics so much that the drugs no longer pack their previous punch.

That image of "two Japans" is very attractive. The "old" Japanese economy is eating completely 30 years of performance of the export sector?

The dual economy was sustainable only so long as efficient exporters earned enough to prop up weak domestic sectors. The high prices Toyota paid for glass, rubber, basic steel, and so forth were, in effect, subsidies to these suppliers. By the late 1980s, however, the exporters found it harder to bear the burden. They fled offshore in a process commonly termed "hollowing out." As Japan slowly lost its most efficient sectors, the productivity of the entire economy started being dragged down to the level of the stagnant sectors.

So, consuming anorexia is the Japanese malaise? In fact when I was in Japan for the first time in 1990 I was shocked with the high prices of everything, including Japanese products that were cheap in Europe. Why this "inflated" price structure?

It's disguised income transfer from Japan's efficient sectors to the inefficient. It also finances disguised unemployment.

Another thing that impressed me a lot was a speech from Akio Morita in 1992 telling the Japanese that the post-war system was ending and the "sogo shosha" model had to be reformed in the corporate world. So, the corporate elite knows from early 90's what is wrong. Why the situation doesn't change?

Because no society puts itself through wrenching transformation until it has exhausted all other alternatives. And for years many of the best and brightest economists claimed that such alternatives existed: just spend more or print more money. It's only recently that the notion "no revival without reform" has become widely accepted.

One of the financial receipts that sometimes we listen in Europe it is the necessity to lower interest rates. But the drop in these rates in Japan - last week in the overnight they become negative - haven't impact on consumer spending and on business investment. Why?

Many industries are plagued with excess capital stock. Automakers, for example, can build 14-15 million vehicles a year but can't sell more than 10-11 million. Why would such companies go even deeper into debt to add still more useless equipment just because interest rates are low? And if they did, the whole process would be self-defeating, as it would add to excess capacity. Meanwhile, real wages have been stagnant since 1997. People aren't hoarding money. The household savings rate has steadily fallen from 14% in 1990 to 10% in 1997 to 7% in 2001. Consumer spending is low, not because people are saving too much, but because they're earning too little. Consumer spending is barely higher than six years ago because total employee income is barely higher. Also, remember that low interest rates cut off some income flow to retirees who depend on interest income. The fall in interest income adds up to about 5% of total household income.

Politically speaking, the system is changing? The one-party state system - like in Mexico or ex-USSR - has already imploded?

Everything that makes Japan's political economic system work depends on a certain minimal level of nominal and real growth. Take away that growth, and unbridgeable strains and conflicts of interests arise. The relief given to one interest group inevitably hurts another. Every passing day brings increasing conflicts among the LDP's assorted constituencies: farmers versus urbanites, banks versus insurance companies, young versus retirees, efficient versus inefficient. The conflicts keep growing even as the resources to address them keep shrinking. Japan is the only industrial democracy that is still a one-party state. Except for two one-year interruptions, the LDP and its predecessor parties have ruled Japan from 1945 to the present. And that is one reason why it has been so hard for Japan to address its problems.

But LDP is completely broken, no?

Unable to deliver the goods that keep it in power, the LDP has already split once, back in 1993, causing it to temporarily lose power. It will sooner or later split again, perhaps as a consequence of the rise of Koizumi. There is now an unprecedented gap between the interests of the party and of the nation. In a democracy that gap cannot be sustained indefinitely. For years this basic conflict has steadily eroded the LDP's power. Since the 1993 split, it has never again been able to win enough votes to rule on its own. It has ruled only with a shifting set of coalition partners.

In a word, what is your main forecast for Japan?

But the most likely outcome is that Japan will reform and revive. And if it does so, bringing its host of inefficient sectors up to world benchmarks, it can achieve sustained growth of three percent a year, perhaps more. The bad news is that it will probably take ten more years - as I said - to reach this promised land. And the road from here to there will be very bumpy. Again, why ten years? Japan's dysfunctions are so deep-seated that even if it did everything right today, it would take five years to achieve truly vibrant growth. But Japan will not do everything right today. Opposition to reform is equally deep-seated. A myriad of special interests and millions of jobs are at stake.

THE BOOK
Why you decided to publish Japanese Phoenix, a truly curious title?

Back in 1998, I published Japan: The System That Soured: The Rise and Fall of the Japanese Economic Miracle. A Japanese edition was published in 1999 under the title Kusariyuku Nihon To Iu System (by Toyo Keizai Shimposa). The book has received favorable reviews from such publications as the Wall Street Journal, Business Week, Nihon Keizai Shimbun, Asahi Shimbun, Toyo Keizai, The Japan Quarterly, The Journal of Japanese Studies and the Far Eastern Economic Review, among others. Toyo Keizai named it "one of the 20 books needed to understand the 21st century". It predicted that Japan would continue to suffer economic stagnation for years to come unless it underwent thorough structural reform. Since then, some experts said Japan didn't need reform, just macroeconomic stimulus. Some said it was already undergoing rapid reform, e.g. the so-called "Big Bang" in finance (the liberalization of financial services). Some said it would never reform. I wanted to challenge these notions. Beyond that, I wanted to be more specific about what structural reform really means. I wanted to create a yardstick that we could use to measure whether all the myriad actions taking place in Japan really amount to reform.

Is it translated in Japanese? What was the specific impact in Japan?

Like the last book, this was also translated into Japanese titled Fushicho no Nikon Keizai (edited by Toyo Keizai). It received favorable reviews from two of Japan's leading newspapers, Asahi Shimbun and Nihon Keizai Shimbun.

THE AUTHOR
- 50 years old
- New yorker
- Senior editor of The Oriental Economist Report (Web: www.orientaleconomist.com), a monthly newsletter on Japan published by Toyo Keizai America, and a special correspondent at Shukan Toyo Keizai, a leading Japanese business weekly.
- A veteran journalist, he has written on Japan and U.S.-Japan relations for 25 years in both Japanese and American national publications. He doubles as a Visiting Lecturer in Economics at the State University of New York (SUNY) at Stony Brook.
- "I have not lived in Japan because my wife has her own career that requires her to live in the U.S. Instead, I've traveled back and forth to Japan for the past couple decades".
- In April of 1998, he testified before the Asia-Pacific Subcommittee of the House International Relations Committee about Japan's role in the Asian economic crisis. In the year 2000, he served on the Council of Foreign Relations' Task Force on the Japanese economy.
- He is the author of the article on the Japanese economy in the Microsoft Encarta Encyclopedia.
- Having received his B.A. degree in History from Columbia University in 1973, Katz went on to obtain his M.A. in Economics at New York University (NYU) in 1996. His M.A. thesis, entitled >From Growth Superstar to Economic Laggard, predicted Japan's current economic travails and formed the basis for his book of 1998, Japan: The System That Soured.
- E-mail: rbkatz@ix.netcom.com
 
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