Japan in Crisis

Japan in Crisis S. Javed Maswood

International Political Economy Series General Editor: Timothy M. Shaw, Professor of Commonwealth Governance and Development, and Director of the Institute of Commonwealth Studies, School of Advanced Study, University of London Titles include: Pradeep Agrawal, Subir V. Gokarn, Veena Mishra, Kirit S. Parikh and Kunal Sen POLICY REGIMES AND INDUSTRIAL COMPETITIVENESS A Comparative Study of East Asia and India Roderic Alley THE UNITED NATIONS IN SOUTHEAST ASIA AND THE SOUTH PACIFIC Dick Beason and Jason James THE POLITICAL ECONOMY OF JAPANESE FINANCIAL MARKETS Myths versus Reality Mark Beeson COMPETING CAPITALISMS Australia, Japan and Economic Competition in Asia-Pacific Deborah Bräutigam CHINESE AID AND AFRICAN DEVELOPMENT Exporting Green Revolution Steve Chan, Cal Clark and Danny Lam (editors) BEYOND THE DEVELOPMENTAL STATE East Asia’s Political Economies Reconsidered Abdul Rahman Embong STATE-LED MODERNIZATION AND THE NEW MIDDLE CLASS IN MALAYSIA Dong-Sook Shin Gills RURAL WOMEN AND TRIPLE EXPLOITATION IN KOREAN DEVELOPMENT Jeffrey Henderson (editor) INDUSTRIAL TRANSFORMATION IN EASTERN EUROPE IN THE LIGHT OF THE EAST ASIAN EXPERIENCE Takashi Inoguchi GLOBAL CHANGE A Japanese Perspective Dominic Kelly JAPAN AND THE RECONSTRUCTION OF EAST ASIA L. H. M. Ling POSTCOLONIAL INTERNATIONAL RELATIONS Conquest and Desire between Asia and the West

Pierre P. Lizée PEACE, POWER AND RESISTANCE IN CAMBODIA Global Governance and the Failure of International Conflict Resolution S. Javed Maswood JAPAN IN CRISIS Ananya Mukherjee Reed PERSPECTIVES ON THE INDIAN CORPORATE ECONOMY Exploring the Paradox of Profits Cecilia Ng POSITIONING WOMEN IN MALAYSIA Class and Gender in an Industrializing State Ian Scott (editor) INSTITUTIONAL CHANGE AND THE POLITICAL TRANSITION IN HONG KONG Mark Turner (editor) CENTRAL–LOCAL RELATIONS IN ASIA-PACIFIC Convergence or Divergence? Fei-Ling Wang INSTITUTIONS AND INSTITUTIONAL CHANGE IN CHINA Premodernity and Modernization

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Japan in Crisis S. Javed Maswood School of International Business and Asian Studies Griffith University Nathan, Brisbane, Australia

© S. Javed Maswood 2002 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2002 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 0–333–97719–X This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Maswood, Syed Javed. Japan in crisis / S. Javed Maswood. p. cm.—(International political economy series) Includes bibliographical references and index. ISBN 0–333–97719–X 1. Japan—Economic conditions—1989– 2. Financial crises—Japan. 3. Banks and banking—Japan. I. Title. II. Series. HC462.95 .M3845 2002 338.952—dc21 2001059843 10 11

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

Contents List of Tables

vii

List of Abbreviations

viii

1 Introduction Economic stagnation in Japan Structural adjustment in Japan The Asian financial crisis The Asian crisis as a catalyst for change in Japan The structure of this book

1 3 5 9 12 16

2

Economic Stagnation in Japan From a Japanese bubble to an Asian bubble The Asian crisis and the Japanese economy Explaining the failure of economic recovery packages Conclusion

17 24 28 30 36

3

Financial Reforms in Japan Crisis in the Japanese financial sector Banking sector reforms in Japan Regulatory controls and surveillance Bank reform and persisting economic weakness Conclusion

39 40 46 54 56 61

4

Corporate Reforms Main features of the J-firm Corporate reforms and convergence Corporate reform in Japan Conclusion

62 63 68 74 83

5

Regulatory Reforms Regulatory politics in Japan and the United States Regulatory reforms in Japan Bureaucratic opposition to deregulation and reform in Japan Structural reform in the context of Japanese party politics Prime Minister Koizumi and Japan’s reform agenda Conclusion

v

87 88 93 96 97 106 113

vi Contents

6

Japan’s Regional Economy and the Asian Monetary Fund The Asian crisis as a foreign policy opportunity Japanese aid to crisis countries The Asian Monetary Fund American rejection of the Asian Monetary Fund The AMF revisited Conclusion

115 119 125 128 132 136 142

7

Conclusion

144

Notes

155

Bibliography

168

Index

172

List of Tables 2.1 2.2 3.1 3.2 4.1 4.2 5.1

Official discount rates in Japan Bank lending to emerging Asian markets at end June 1997 1998 Upper House election results Bank support and restructuring goals Corporate failures in Japan Company restructuring in Japan Amakudari in selected Japanese industries

vii

24 26 44 54 70 80 97

List of Abbreviations ADB AMF APEC APT ARC ARF ASEAN CCL CEFP CEM CPSU DIA DPJ DSP EAEC EOI EPA FDI FDIC FRC GATT GDP IMF ISI JNR JSP LDP LTCB NLC NPL OPEC PKO RRC RTC SDPJ UK

Asian Development Bank Asian Monetary Fund Asia Pacific Economic Cooperation ASEAN Plus Three Administrative Reform Commission ASEAN Regional Forum Association of South East Asian Nations Contingent Credit Lines Council on Economic and Fiscal Policy Comprehensive Economic Measures Communist Party of the Soviet Union Deposit Insurance Agency Democratic Party of Japan Democratic Socialist Party East Asian Economic Caucus Export-Oriented Industrialization Economic Planning Agency Foreign Direct Investment Federal Deposit Insurance Corporation Financial Restructuring Commission General Agreement on Tariffs and Trade Gross Domestic Product International Monetary Fund Import Substitution Industrialization Japan National Railway Japan Socialist Party Liberal Democratic Party Long-Term Credit Bank New Liberal Club Non-Performing Loans Organization of Petroleum Exporting Countries Peace Keeping Operations Regulatory Reform Committee Resolution Trust Corporation Social Democratic Party of Japan United Kingdom viii

List of Abbreviations ix

UNCLOS US WTO

United Nations Law of the Sea Conference United States World Trade Organization

1 Introduction

At the end of the Second World War the Japanese economy lay in total ruin. Remarkably, however, recovery was rapid and growth rates exceeded even the ambitious official targets. In the early 1960s, a government plan to double national income over a ten-year period forecast annual GDP growth of around 7 per cent. This was dismissed as unrealistic by most observers but economic growth in the decade averaged 10 per cent a year. Even more impressive was the unlikely combination of high growth and equitable income distribution. In general, periods of high economic growth tend to widen income differentials but the Japanese experience was markedly different. Not without some justification, analysts have used the term ‘miracle economy’ to highlight Japan’s unparalleled economic achievements during the 1960s. In the 1970s the Japanese economy continued to perform better than those of other industrialized countries, despite a severe economic shock. A sudden quadrupling of crude oil prices in 1973 by the Organization of Petroleum Exporting Countries (OPEC) led to sustained stagflation1 in most western countries, but Japan recovered quickly after only one year of transitional poor economic growth despite its greater resource dependency and vulnerability to oil supply uncertainties. Similarly, in the 1980s the Japanese economy adapted quickly to a higher value of the yen and exporters regained their international competitiveness after a brief period of adjustment. Until the early 1990s, the Japanese economy appeared to gain strength from adversity and with only the slightest hyperbole analysts speculated that Japan might overtake the United States as the leading world economy. Such predictions were based on trend lines for the two countries. The trend lines, however, were reversed in the 1990s and the past no longer served as a prologue to the future. Economic performance in the 1

2 Japan in Crisis

West was exemplary. Led by the US, most western economies enjoyed high growth rates and a boom in equity markets. Japan, by contrast, remained mired in a Great Stagnation. The turning point for Japan was the collapse of the bubble economy. Not only did growth falter but Japan also experienced record levels of unemployment. Though in earlier decades it would have been hard to imagine such a thing occurring, at the end of the 1990s unemployment levels in Japan had risen above those in the United States. The new millennium had been assumed to be going to belong under Japanese and East Asian hegemony, but when it began any hint of a Pax Nipponica had long been forgotten. Instead, analysts puzzled over prolonged economic stagnation and wondered when Japan might regain its economic vitality. In the space of ten years, Japanese success had turned to failure and the ‘failed’ economies of the West had become the new economic dynamos of the world. The Japanese government reacted to its economic crisis with massive injections of public funds but failed ultimately to revive growth. The government continued its pump-priming activities throughout the decade with investments in infrastructure and major construction projects but these produced only modest results in terms of growth. Instead, fiscal profligacy succeeded only in exacerbating an already high public sector debt. In early March 2001, Finance Minister Miyazawa Kiichi made the candid admission that Japanese public finances were on the verge of a collapse. This statement immediately triggered a sell-off of the yen, and Miyazawa was blamed for his lapse in political judgment. Whether or not he was correct to openly acknowledge the state of the government’s finances, the fact that public sector debt had risen to 130 per cent of GDP pointed to the veracity of his assessment. Other negative indicators included sluggish consumer spending and the dramatic fall in the share market index in March 2001 to levels predating the bubble economy. Indeed, in the first quarter of 2001, the Japanese economy actually went backwards. The economy was poised for further deterioration if the newly appointed government of Prime Minister Koizumi Junichiro followed through on its pledge to slash public sector spending in order to balance the budget and reduce public sector debt. The prime minister’s other stated objective of introducing structural reforms threatened more hardship for the people in the immediate future, even if these were necessary to recreate the bases for long-term growth. Remarkably, though, despite warnings of more economic hurt, Koizumi’s popularity rating reached a high of about 80 per cent, a reflection perhaps of the promise of long-term sustainable growth and an end to the decade-long frustration with economic stagnation. Regardless, in mid-2001 economic growth seemed at

Introduction 3

best to be a distant possibility. In late July 2001, the ruling coalition led by the Liberal Democratic Party achieved an unlikely victory in elections for the Upper House of the Japanese Diet and to the extent that this strengthened Koizumi’s determination and mandate to introduce reforms, the stock market took a turn for the worse in anticipation of short-term economic slowdown and difficulties. Structural reforms, deregulation, and resolution of a festering financial crisis are all critical elements of removing obstacles to growth and coping with the challenges of economic globalisation. Expectations were high that Prime Minister Koizumi would succeed where his predecessors had failed but throughout the second half of 2001, the Japanese government was strong on rhetoric but indecisive in action. In early 2002, the prospect of structural reform seemed more remote than before as the Prime Minister became distracted by instability within the Cabinet. The popular but inept Foreign Minister, Tanaka Makiko, created fresh controversy over reforms of the Ministry of Foreign Affairs and the exclusion of some NGOs (non-governmental organizations) from a Tokyo summit to organize financial assistance for the reconstruction of Afghanistan. The Prime Minister was forced to remove her from Cabinet but this had an immediate impact on his own approval rating, which dipped below 50 per cent. Amid deteriorating economic conditions, equity markets sensed a lack of direction and this instigated a slide in share prices. In early February 2002, the Nikkei average of 225 listed companies had declined below 9,500, the lowest point in about 18 years.

Economic stagnation in Japan Economic stagnation in Japan did not have a single cause and there were no simple and easy remedies, but throughout the decade of the 1990s the government continued its emphasis on fiscal stimulus packages. Even after analysts began focusing on structural impediments to growth, the Japanese government continued to rely primarily on fiscal measures to stimulate the economy. A government that had previously been lauded for successful state intervention in the economy and for implementing a coherent industrial policy suddenly seemed unprepared to accept hard policy choices to reverse the spreading rot. In the middle of worsening economic conditions, the Asian crisis of 1997 jolted the Japanese government sufficiently to try additional measures. The government of Prime Minister Obuchi Keizo embarked on an ambitious plan to deal with a banking crisis that had resulted in a domestic credit squeeze. As government-sponsored reforms began the slow

4 Japan in Crisis

process of rehabilitating the financial and banking industry, the industrial sector also began corporate reform and rationalization to regain lost international competitiveness. However, rather than introduce extensive restructuring, actual measures were patchy and inadequate. The same can also be said of the half-hearted governmental attempts at regulatory reforms. A large part of the blame for continued economic stagnation can be attributed to political leaders who, apart from Prime Ministers Hashimoto and Obuchi, failed dismally to appreciate the depth of the problems and banked instead on time and good fortune to ride out the storm. Prime Minister Mori in particular proved to be not only ineffectual, but by backtracking from the reform agenda of his predecessors added to economic uncertainty and pessimism. In March 2001 the government unveiled its thirteenth stimulus package, but given the state of public finances the main measures were designed to encourage householders to draw on their savings and boost consumption demand rather than use public works spending to spark economic activity. Low consumption demand has deeply rooted historical antecedents, but in the 1990s could be attributed also to uncertainties about future economic conditions and employment prospects. Moreover, the state of public finances did not inspire public confidence that the government would continue to provide necessary programmes and services for the retired. This was an additional incentive for workers to maintain a high savings profile. As an indicator of sluggish consumer demand, total retail trade in Japan dropped from Y145644 billion in 1997 to Y135149 billion in 1999, with particularly sharp falls in sales of motor vehicles, and apparel and accessories.2 Paradoxically, if future uncertainties were a factor in curtailing consumption demand, there is evidence also to suggest that Japanese consumers were not necessarily overwhelmed by a sense of crisis, and that public ambivalence and an absence of strong societal pressure allowed the government to avoid timely and decisive action. Ordinarily, a rapid drop in share prices as happened in Japan would be expected to create panic, but the average consumer remained relatively unaffected because of low levels of individual and household participation in the stock market. Japanese shares are largely held in cross-share holding arrangements among a group of companies and only a small portion are actively traded by individual shareholders on the stock exchange. The concern for many Japanese and for the government, however, was that an undervalued share market exposed Japanese corporations to hostile foreign takeovers at bargain prices. In reality, foreign acquisition proved not to be an entirely negative outcome because foreign owners were able to aggressively introduce necessary rationalization strategies to restore companies to international competitiveness.

Introduction 5

The Asian crisis was a shock to the Japanese economy and produced an initial flurry of activities, especially in strengthening and restructuring the financial sector. In that respect, at least, the crisis was a catalyst for change. It did not, however, lead to any immediate and thorough reforms to achieve sustainable recovery. This may have been because the worst of the regional crisis was over in a relatively short period and early signs of growth returned in less than two years. In Japan and in East Asia the resumption of growth engendered a degree of complacency and removed the urgency that was necessary to reform and to remedy the obstacles to growth. Japanese recovery was short-lived, but by then the urgency had dissipated. Still, the Asian crisis was significant in that it facilitated partial financial sector and regulatory reforms in Japan that might otherwise have been further delayed. Credit for this belongs to Prime Minister Obuchi, who confounded his critics by being more resourceful and determined than his predecessor, who had projected an image of progressive dynamism. Even if the Asian crisis was not ‘the main factor in Japan’s financial sector problems coming to a head in 1997–98’,3 it still was significant in that it occurred at a bad time for the Japanese economy. Estimates of bad loans in the financial sector had almost tripled from Y 30 trillion in 1996 to Y 83 trillion in 1998, making it impossible for the government to persist in a policy of using bank profits generated in Asia to write off bad loans. It also stymied the capacity of the Japanese Ministry of Finance to continue the ‘convoy approach’ of not allowing bank failures, and reinforced low consumer spending patterns. Ultimately, the response of Obuchi’s administration was inadequate, but that was because the worst of the crisis ended quickly and because his untimely death in office stalled the reform initiative. Structural reform is difficult in the best of circumstances and was perhaps harder in Japan because it was difficult to accept that the past formulas of success had become liabilities. The new realities required a paradigm shift but one which proved difficult to accept and to implement.

Structural adjustment in Japan The inverted performance of Japan and most western economies in the 1970s and the 1990s reveals the inability of Japanese policy-makers to make fundamental yet necessary structural adjustments in the absence of a sharp and severe external shock. As described below, this is not without parallel in Japanese history. Fundamental structural reform is difficult for any country. This is largely because structural reforms impose real costs on society and impose

6 Japan in Crisis

hardships on those unprepared for the changes. Like any public policy initiative, reforms benefit some and disadvantage others and the ability to sustain a reform-oriented public policy depends on government capacity to create a coalition of support or to secure the support of the disaffected through redistributive policies. However, since redistribution rarely provides full compensation, reforms inevitably generate political opposition. Understandably, wherever possible, governments seek to avoid the pain of structural adjustment. For instance, it is clear that trade liberalization imposes costs on some sectors of the economy but instead of forcing structural adjustment to phase out uncompetitive industries, governments frequently resort to protectionism as an easier and less painful alternative. Similarly, recent experiences with IMF structural adjustment programmes also highlight difficulties that countries encounter in implementing mandatory reform policies. There are numerous examples of countries signalling a commitment to reform and then backtracking because of high political and social costs. Still, countries do manage reforms. Western countries such as the United Kingdom, the United States and Australia did introduce major reforms in the 1980s and 1990s to improve economic efficiency and enhance international competitiveness. There were considerable costs associated with these reforms, such as loss of employment opportunities and exacerbation of income inequalities, but conservative governments rushed through reforms, claiming an electoral mandate to do so. The costs of structural reform explain its infrequency and not only in Japan. The general pattern of Japanese historical progression can be characterized as ‘punctuated equilibrium’, where stability is upset only in exceptional circumstances. Japan appears to find it more difficult than do other countries to reform institutions, processes and structures on its own initiative. If a generalization can be made, it is that Japan adapts well and reforms poorly. The Japanese corporate sector has adapted well to exogenous shocks, as for example following the appreciation of the yen in the late 1980s. The exchange rate adjustment eroded Japan’s export competitiveness and there were predictions of a ‘hollowing-out’ of Japanese manufacturing, as industry relocated to cheaper production platforms in East Asia. There was some transfer of capital but no overwhelming exodus of industry from Japan and the gloomy scenario proved overly pessimistic. Instead, many industries were able to adjust to the exchange rate shock and Tsubame, a small town on the Japan Sea coast manufacturing stainless steel flatware for the export market, exemplified this process. At the higher value of the yen, Tsubame’s exports were no longer competitive with cheaper stainless steel knives and forks manufactured in South

Introduction 7

Korea and elsewhere and the worst-case scenario was that small regional towns like Tsubame would become industrial wastelands. In the end, however, Tsubame’s small-scale industries, with the help of government assistance, moved up the technology ladder and began manufacturing small consumer electronics. The appreciation of the yen did destroy an established industry at the low end of the technology spectrum, but successful adjustment enabled small communities to negotiate the crisis and remain in manufacturing. Adapting to a specific environmental change, such as exchange rate movements and oil crises, is seemingly easier than fundamental reform in response to diffuse and general shifts in environmental parameters. In the 1990s, economic globalization had exposed limitations of Japanese regulatory structures, constraints of management practices and competitive weakness of sections of Japanese industry, especially the financial sector. Still, public and private decision-makers were unable to discard trusted formulas of the past and to make fundamental changes. An inherent obstacle to structural reform in Japan is the relatively large and influential role of the bureaucracy in policy processes. This is problematic simply because bureaucracies are averse to change and have an inbuilt preference for stability and order, conditions that are ideal for managing issues based on standard operating procedures. As such, Japan’s poor record in reform can be attributed largely to bureaucratic policy-making and the inability of political leaders to assert leadership. The secretary general of the OECD, Donald Johnston, has remarked that ‘Responding to this [reformist] challenge requires leadership from Japan’s politicians ... Without reform, our conclusion is that Japan will never be able to fully enjoy the benefits of the world’s new economic environment.’4 Reforms are necessary to inject greater competition within the Japanese economy, but as Edward Lincoln points out, the Japanese bureaucracy is deeply committed to ordered markets and extremely suspicious of unregulated, presumably chaotic market conditions. Its penchant for order extended to regulations governing the location of liquor stores based on population density so that each store had its own territory and was not in competition with another liquor store in the area.5 Bureaucratic politics, in a democratic setting, implies a separation between formally elected politicians, who ‘reign’, and the unelected bureaucrats, who effectively ‘rule’. Although Japan today can be characterized as a bureaucratic polity, the separation between those who rule and those who reign is constantly repeated in Japanese history. Thus, despite being reigned by an unbroken imperial lineage, actual political power and authority in Japan has tended to reside elsewhere, whether in

8 Japan in Crisis

the Fujiwara clan, the Kamakura Bakufu, the shogun, or the SatsumaChoshu clique, at different times in Japanese history.6 This separation between formal and real authority has deprived Japan of decisive leadership and initiative in bringing about change. The present situation is worsened by the dominance of a bureaucracy, which has entrenched interests in maintaining the status quo rather than in introducing substantive change. In earlier periods as well, those who governed Japan had a commitment to the status quo, as during the 250-year rule of the Tokugawa shogunate, but the shogun proved himself willing to repeal isolationism and introduce radical reform when the existing situation became untenable and when confronted by a major international challenge. Unlike other countries, Japan has always been a poor reformer, changing only after a sharp shock to the system, such as the arrival of American warships off the coast at Tokyo in the mid-nineteenth century. This resulted in a radical reorientation of Japan’s economy and politics in order to avoid western subjugation and colonization. The objective of reforms at this time was to renegotiate the so-called ‘unequal treaties’, which forced Japan both to surrender trade sovereignty and grant extraterritorial privileges to western treaty partners. Japan transformed itself within a short period of three decades, renegotiated the treaties and emerged as a major world power. Another radical transformation took place after Japan’s defeat in the Second World War, when the occupying Allied forces remade Japan to reflect liberal political and economic principles. The shock of defeat had deprived the previous militaristic regime of its domestic legitimacy and the Japanese people readily accepted the imposed reforms. The foreign powers, expecting major domestic resistance, were pleasantly surprised by the ease with which the Japanese accepted the new structures. In each of these two instances, the readiness to embrace reforms can be attributed to a sense of acute national crisis, which eroded the legitimacy of the old regime and created a basis for its transformation.7 With that historical pattern, I argue that the Asian financial crisis of 1997, as mediated through large-scale bankruptcies in Japan, had a similar if less enduring impact on Japanese policy-makers and facilitated the longdelayed process of reform and restructuring. Others8 have pointed out that the debate on reforms began in the early 1990s, but I will argue that it was only in the post-Asian-crisis phase that key actors in Japan agreed, albeit loosely, on common purpose and objective. Prior to that different sections of the Japanese community approached the issue of reforms from divergent starting points and this stymied outcomes and achievements.

Introduction 9

To the extent that the Asian crisis was a critical event, I will look at the pre1997 response of the Japanese government to its economic malaise and the results since then in three areas: banking and financial sector reform, corporate rationalization, and regulatory and administrative reforms. I should add the caveat however that, even after the Asian crisis reforms were not as far-reaching as may have seemed necessary and one explanation may be that, despite failing economic performance and large-scale bankruptcies, there was no sense of real or impending national catastrophe at a personal level, as in the mid nineteenth century or immediately after the Second world war. Certainly there existed in the late 1990s an economic crisis or a Great Stagnation but neither was the average Japanese consumer overwhelmed by a sense of gloom nor were existing economic structures perceived as having completely lost their performance legitimacy. Thus, while consumption demand had been affected by future uncertainties, there was no great loss of a sense of prosperity. The material standard of living of the average Japanese consumer was not drastically diminished even though unemployment had climbed to record levels of about 5 per cent. This was unprecedented by postwar Japanese standards although enviably low by western standards. For instance, Australia experienced an economic boom throughout the 1990s but unemployment levels there were still substantially higher than those in Japan despite Japan’s depressed economy. Moreover, while the Asian crisis triggered reform initiatives, urgency was soon dissipated by a nascent recovery a couple of years later. This, together with bureaucratic politics, political indecision and the absence of policy competition among the leading political parties, explains the unevenness of the reform process. But in 2001 the reform message was rekindled by Prime Minister Koizumi after the Japanese economy had slipped back again into economic stagnation.

The Asian financial crisis The significance of the Asian crisis is two-fold. First, it was the first real crisis of economic globalization and a sharp demonstration of the consequences of ignoring global market forces. Second, it was a regional crisis and not one that was contained within the four main affected countries of Thailand, Malaysia, Indonesia and South Korea. It was also a serious crisis for Japan, especially for the banking sector already burdened by a high ratio of non-performing loans. Its implications extended beyond domestic policy issues to Japanese foreign policy. Before looking at how this crisis became a defining moment for Japan it is useful to reflect briefly on crises in general and the Asian crisis in particular.

10 Japan in Crisis

Crises are dysfunctional interventions that disrupt the normal flow of events. They are also difficult to predict. Yet crises rarely strike out of the blue. Warnings signals are often ignored or misinterpreted, and consequently fail to alert policy-makers to impending danger. Instead, the full import of warning signals becomes obvious only after the fact. As well, each crisis is different from the ones that precede it, and while it may be possible to prevent a recurrence of past crises it is nearly impossible to forecast and forestall the occurrence of a new one. Since we cannot anticipate the future, strategies for crisis prevention are usually modelled on past experience and have limited success. Crises, as Martin Feldstein put it, are as inevitable as death and taxes.9 Just as crises feed upon and exploit existing weaknesses they can, in turn, suggest ways of effecting systemic improvements. Indeed, in Japanese and Chinese understanding, crises reflect, simultaneously, a disturbance in the stable evolution of events and an opportunity to improve existing structures. The Japanese term for crisis, kiki, consists of two characters meaning danger and opportunity, respectively. Crises are therefore critical events that can be harnessed to achieve a superior equilibrium. It must have been this sense of historical opportunity that convinced Ishibashi Tanzan, a future Japanese prime minister, to argue, amid the gloom of August 1945, that ‘there is a future of boundless plenty ahead for a renewed Japan’. He explained that all that is necessary is for the people of Japan not to be ‘led astray by obstacles because they fail to see the broad path before them’.10 This was a rather unlikely statement at a time of unprecedented national crisis following Japan’s surrender in the Second World War. It revealed a thought process that placed a premium on opportunities offered by crises. The magnitude of the Asian crisis and its contagion effect came as a complete surprise to analysts accustomed to the prevailing wisdom that East Asian economies were immune to the kinds of economic dislocation experienced by Latin American countries in the 1980s. East Asian resilience was attributed to export-oriented industrialization (EOI) strategies that ensured the serviceability of accumulated debt. Latin American vulnerability, by contrast, was attributed to import substitution industrialization (ISI) strategies, which failed to generate sufficient export revenue to meet debt-service obligations. The Asian crisis began with speculative attacks on regional currencies that also undermined and weakened the real economy in the affected countries. The crisis affected four Asian economies in particular: Thailand, Indonesia, Malaysia and South Korea. It began in Thailand and spread quickly to other regional countries. It wiped away some of the achieve-

Introduction 11

ments of the East Asian countries and resulted in economic hardship and impoverishment for a large segment of the population that had become accustomed to continuous improvements in living conditions. Understandably, there is considerable interest in explaining the origins of the crisis. In the few years since its onset a substantial literature has emerged on its various aspects. It is noteworthy that the Asian crisis was a sequel to a still unresolved economic malaise in Japan. Both were related to failed globalization strategies and involved a bursting of speculative economic bubbles. All speculative bubbles involve a boom that is fed by an expansion of bank credit and all speculative bubbles inevitably end in a crash, often in magnitude paralleling the preceding boom. Speculative bubbles and their dramatic collapse have a long history, and in the past most such crises have had considerable international causal implications. According to Charles Kindleberger, the development of a speculative bubble is a two-step process. He calls the first stage the ‘sober stage of investment’, in which rational investors pursue production gains and profits, this then being overwhelmed in the second stage by ‘rogues interested only in quick profits’.11 The second stage is that of the bubble economy. In Japan and in East Asia, during the bubble economy phase there was excessive speculation in real estate and the equities market solely for the purpose of quick profit. The construction boom may have had sound beginnings but at some point it acquired a momentum of its own. In Japan, the speculative boom in real estate was fed also by demand for inheritance properties because of generous tax regulations. According to established guidelines, land received as inheritance was taxed at well below fair market values, and this provision accounted for the popularity of real estate as an investment asset. In a bubble economy, property and stocks are not necessarily the only focus of speculative activities. In the seventeenth century, for example, there was an enormous speculative boom in tulips which led to inordinately excessive prices for tulip bulbs, such that one bulb could be exchanged for a new horsedrawn carriage.12 During the Japanese and Asian bubble economies, ‘irrational’ price increases extended to many commodities and products beyond property and stocks. In Japan in the 1980s, for example, the price of a pet stag beetle (ohkuwagata) went up as high as US$7000 before coming down to more ‘reasonable’ levels, around $300 by the late 1990s.13 When normality returns following the collapse of a bubble economy, many are left with high levels of debt, deflated asset prices and huge losses. In his study of speculative economic bubbles and financial crises in the nineteenth and twentieth centuries, Kindleberger has observed that such

12 Japan in Crisis

crises tended to be transmitted through psychological infection, the rise and fall in prices of securities and commodities, short-term capital movements, interest rates and the rise and fall of world commodities markets.14 In the Asian crisis a distinguishing feature was the swiftness of the transmission process, which was a function of improved communications technology that had eroded boundaries between national economies and integrated them in an almost seamless web. To fully understand the regional dimensions of the crisis and of crisis resolution it is necessary to highlight the fact that the success of East Asian states had been achieved substantially through increased intraregional trade. While Japan had not featured prominently in this intra-regional trade expansion, it was imperative for regional recovery, that it compensate for the collapse in intra-regional trade by fostering greater trade linkages and by opening its large economy to regional exports. The expectation that Japan be a constructive partner in crisis management added to the importance of Japanese economic recovery. For all these reasons, the Asian crisis was an important defining moment in Japan’s recession-plagued economy because it highlighted the urgency of measures to introduce structural reforms in order to restore economic growth and move beyond the earlier reliance on time and public sector spending.

The Asian crisis as a catalyst for change in Japan Since the collapse of the bubble economy in the early 1990s, the Japanese economy has been relatively stagnant. The government seemed content to let a stagnant economy run its course, convinced that time would allow weak sectors of the economy, especially banking and finance, to recover their competitive edge. The Asian crisis, however, robbed economic planners and policy-makers in Japan of the luxury of time. The distress of several large-scale bankruptcies was a rude awakening to policymakers that a policy of benign neglect was no longer tenable. Political leaders were forced to accept the imperative of an activist strategy to repair structural weaknesses and restore the bases of growth. As mentioned above, the Asian crisis was a catalyst for change in two important aspects. First, in domestic policy, it forced the Japanese government to begin a constructive process to resolve persisting economic stagnation. Administrative and regulatory reforms had received considerable rhetorical emphasis in earlier periods, but according to Lonny Carlile the agenda for administrative reform had been linked to a need to control a pork-barrel politics that was contributing to a fiscal crisis of the state.15 In the pre-Asian crisis period, he has identified three phases of the adminis-

Introduction 13

trative reform and deregulatory agenda. The first phase was from the early 1980s to 1985 when the initial concerns were first articulated and resulted in the establishment of reform commissions to provide recommendations. In the second phase, 1985–93, reform was held in abeyance as the fiscal crisis was, at least temporarily, resolved by high growth based on speculative economic activities – the so-called bubble economy. In the third phase the collapse of the bubble economy in the early 1990s renewed pressure for reforms. In all these three phases, the primary objective of government was to tackle a burgeoning public sector debt. Public sector debt in Japan is extremely high by international standards and it is understandable that the government was concerned about reducing overall levels of debts, especially in view of an ageing population, a declining revenue base and anticipated future demand for welfare benefits. Nonetheless, there were other groups and institutions which advocated reform for the sake of efficiency. For example Keidanren (Federation of Economic Organization), a leading industry association, advocated reforms to revitalize the private sector and unleash creativity and productivity. It campaigned for bureaucrats to loosen their grip on market forces. Similarly, the Mitsubishi Research Institute argued that We must recognize that the framework of Japan’s economy is, by international standards, so far divorced from market economic principles that it not only creates friction with other countries, but also stands in the way of Japan’s growth in the 21st century.16 The Asian crisis comprehensively linked reforms to economic globalization and in so doing moved the debate to a different plane. The period since 1997 may be seen as the fourth phase in the reform and restructuring debate, when reforms assumed a new purpose. In Japan it was critical to initiate banking sector reforms, and a year after the crisis the Obuchi administration took the first steps to finally resolve a festering sore in the banking industry – the large proportion of non-performing loans (NPLs). This had affected provision of new loans to the private sector and starved industries of necessary capital injection. Resolution of the banking crisis was critical and was actively implemented, but in other areas Japanese reform efforts were less enthusiastic. Japan, of course, has a reputation as a poor reformer and the government found it particularly difficult to prosecute other necessary reforms, such as deregulation. If the crisis was a window of opportunity to introduce regulatory reforms, it should be noted that there was also resistance to it, especially

14 Japan in Crisis

within the bureaucracy. Opponents of reform were apprehensive of its impact on social stability, harmony and, importantly, equity and egalitarian achievements. As noted above, one of the remarkable achievements of the Japanese economic miracle had been the realization of high growth rates along with relative equity in income distribution, as measured by the Gini coefficient. Nonetheless the Asian crisis generated a new-found commitment to domestic structural reform, which included: 1. Regulatory reform and corporate rationalization in order to cope with global market pressures, create new markets and reinvigorate international competitiveness. 2. Financial system reform in order to overcome problems posed by a high percentage of non-performing loans and increased competition as a result of big-bang reforms. 3. Administrative reforms in order to streamline a sprawling bureaucracy, enhance the influence of elected politics in the policy-making process and subject the bureaucracy to political subordination and governance. These will be some of the main issues that will be explored in this book, but the reform agenda extends further to include social welfare reforms to deal with, as mentioned above, a smaller revenue base and a declining population. Second, the Asian crisis also affected Japan’s regional diplomacy. It effectively created an opening for the Japanese government to step in to contribute to crisis resolution and thereby enhance its regional role and influence. Without cynically dismissing Japanese contributions as selfserving, it cannot be denied that the crisis had just such a positive flow-on effect. Since the end of the Second World War, Japan’s regional identity and influence have suffered as a consequence of atrocities committed by Japanese forces in East Asia. There remains an element of lingering hostility towards Japan, fed also by a refusal of the Japanese government either to formally apologize for wartime misconduct or to compensate survivors, such as the so-called ‘comfort women’. In East Asia, the fact that Japan possessed the largest economy did not bestow on it a natural leadership role. This became painfully evident in the mid-1960s when Japan took the initiative in establishing the Asian Development Bank (ADB), but the Asian countries voted to establish the headquarters of the ADB in Manila in the Philippines rather than in Tokyo. This reminded the Japanese that Asian countries would not accept Japan’s self-appointed leadership role in East Asia simply on the basis of economic achievement.17

Introduction 15

Certainly, the negative images of Japan have faded with time but the Asian crisis was a further opportunity for Japan to offer positive policy initiatives and provide financial assistance to consolidate its East Asian links. It was an opportunity to substitute a negative perception with positive and responsible images. Apart from generous financial assistance programmes, particularly noteworthy was Japan’s proposal to establish and finance an Asian Monetary Fund (AMF) to assist regional countries in future crises. The proposal for an AMF was particularly noteworthy because it defied explanations of Japanese foreign policy as devoid of initiatives. Common explanations of Japanese foreign policy suggested that Japan was incapable of providing leadership or that leadership had different conceptual connotations for the Japanese, for instance ‘leadership from behind’. The AMF proposal marked a new departure. It showed that Japanese policy-makers were not incapable of developing innovative new solutions to resolve problems and crises, even if implementation was more difficult. Japan failed to make the proposal a reality, but that should not detract from its readiness to take the initiative and play a responsible role in managing the Asian financial crisis. The establishment of an AMF was meant to assist regional countries to withstand global economic pressures, but also to safeguard Japanese economic interests. In the decade leading up to the Asian financial crisis the Japanese economy had become much more deeply embedded in the regional economy, such that the crisis had serious economic ramifications for Japan. The spread of economic interdependence within the East Asian region meant that individual countries could no longer safeguard their economic prosperity from regional influences. The new reality was that Asian economies would prosper collectively and suffer collectively. Under these circumstances, it was logical for the Japanese government to propose measures to strengthen the regional financial architecture in order to contain regional instability and minimize adverse flow-on effects. The US government rejected the AMF proposal as being in competition with the International Monetary Fund and hence an exercise in institutional redundancy. Later, sober assessments of the AMF suggested that such an institution might have been useful in limiting the fallout and magnitude of the crisis, but the immediate American rejection of the proposal when it was first announced meant that an AMF would not receive the formal go-ahead. Still, the initiative was both interesting and important considering that Japanese foreign policy had in the past been criticized as lacking in vision and initiative. I will explain the logic and rationale for an AMF and look also at how the Japanese government used

16 Japan in Crisis

other means to realize much the same objectives as those the AMF was expected to fulfil. The project was abandoned when it encountered American resistance, but it is interesting nonetheless that the Japanese government had formulated a policy initiative and that when forced to abandon it it continued to promote it through other means, such as the ‘New Miyazawa Initiative’ and the ‘ASEAN Plus Three’ concept. Japanese foreign policy remains sensitive to American interests, but the AMF is an interesting case-study of Japanese activism, and a useful counterpoint to the common depiction of Japan as reactive.

The structure of this book The book deals with the impact of the Asian crisis not only on Japanese political economy and the reform agenda but also on Japan’s regional relations. It thus uses the Asian crisis as a prism to explain developments in Japan’s domestic politics and policy as well as international relations. In order to set the stage for discussion of the domestic reform agenda, Chapter 2 will provide a discussion of the Japanese economy in the 1990s following the bubble economy and the onset of the Great Stagnation. The next three chapters will discuss specific reform agendas and outcomes. Chapter 3 will look at measures taken by the Japanese government to resolve the domestic banking crisis. At the root of Japan’s poor economic performance in the 1990s was a financial system teetering under the pressure of non-performing loans. This was a critical problem but successive governments failed to deal with it in a resolute manner. Chapter 4 will look at issues relating to corporate rationalization and Chapter 5 will consider administrative and regulatory reform. Regulatory reform has produced very modest results even though it is now seen as the key to resolving Japan’s economic malaise. In Chapter 6, I will look at the implications of the Asian crisis for Japan’s foreign policy and for the so-called network capitalism, linking Japan’s economic trajectory to the success and failures of regional economies. In this chapter, I will look at the proposal for the AMF and at recent developments in creating a financial safety-net for regional countries and safeguarding Japan’s regional economy. The concluding chapter will explain the domestic political and structural deficiencies that have impeded the reform process, and look at the prospects for Japanese regional diplomacy.

2 Economic Stagnation in Japan

Before the onset of Japan’s contemporary economic crisis, economic performance was unsurpassed in terms of growth rates, equity or resilience to external shocks. There were many factors that contributed to Japan’s bubble economy, including a determined official push to move the economy from excessive dependence on foreign demand to reliance on domestic demand. Foreign exports and increasing balance of payments surpluses frequently led to trade friction with the United States. As disputes emerged and were resolved after some acrimony, the only constant was a progressive worsening of the American trade balance with Japan. In the mid-1980s, American frustrations led to a growth in sentiment in favour of protectionism directed at Japan which at its worst could have undermined the foundations of international liberal trade in general. As a desperate measure to stave off threats to liberal trade, the Plaza Accord, an agreement among the Group of Five (G-5) countries in 1985, sought to restore the trade balance through exchange rate adjustments. A lagged decline in exports and fears of impending economic downturn prompted the Japanese government to stimulate domestic demand to compensate for slowdown in export demand. With the purpose of providing relief to domestic manufacturers, the government announced plans to inject an additional Y6 trillion into public works programmes. The Bank of Japan also cut interest rates from 5.0 per cent in 1985 to 3.0 per cent in November 1986 and to 2.5 per cent in February 1987. The interest rate cuts had the anticipated stimulatory effect on stock and property markets. High levels of domestic economic activity sustained the bubble economy, and indeed during this period Japan’s trade surplus actually declined, as was anticipated in the Plaza Accord. The economic bubble did not recreate the double-digit growth rates of the 1960s, but economic 17

18 Japan in Crisis

performance was still strong compared with other advanced industrial economies. Increases in the stock market index and in property prices exceeded all expectations and, buoyed by cheery expectations that the growth cycle would last, individuals and corporations engaged in speculative activities lured by cheap credit and the prospects of quick capital gains. The structure of corporate financing in Japan played a part in fuelling the boom in speculative activities. In general, the corporate sector can obtain financing either from equity markets or from banks and financial institutions. In Japan, unlike western countries, the corporate sector had relied on bank financing with little emphasis on equity financing. This had the advantage of freeing corporations from the tyranny of a short-term time horizons and immediate returns on investments that is demanded typically by equity investors. Instead, corporations were able to concentrate on long-term strategies for increasing market shares even at the expense of short-term profitability. Lending institutions ensured corporate responsibility in investment decisions through an active and intrusive management role. In this structure, the company’s main bank, the primary lending institution, exercised prudential oversight and ensured that investment decisions adhered to basic principles of financial responsibility and market rationality. However, in the mid-1980s, as a result of financial market liberalization, corporations were no longer dependent entirely on the domestic banking sector for their capital needs. Large corporations could obtain cheaper funds in global money markets and consequently became more independent of bank oversight. Their investment decisions too became more irresponsible. Unlike in western corporations, the absence of an external and independent board of directors in Japanese corporations meant there were few constraints of accountability on management.1 Accountability and protection from egregious investment and managerial decisions had traditionally been the purview of the main banks, but this constraint was weakened by the new-found financial freedom of corporations. It should be noted, however, that even in the best of times bank oversight was less than perfect and was compromised by a close relationship between lending and borrowing institutions built up over an extended period of time. The main bank was rarely in a position to exercise arm’s-length surveillance and control. In the bubble economy, corporate investment activity had few effective checks and controls and investment activity exceeded rational economic expectations. On a per capita basis the Japanese investment in new plant and equipment was nearly twice the American. Total Japanese capital investments in 1989, for example, were US$549 billion, compared with only US$513 bil-

Economic Stagnation in Japan 19

lion for the US. Japan was investing more than the US in new productive capacity despite having an economy that was only 60 per cent the size of the American.2 At one level, the high level of Japanese investment activity was potentially ominous for the West because new and presumably more efficient manufacturing facilities would inevitably enhance the export competitiveness of Japanese industries and the manufacturing sector. The relentless drive for modernization and expansion of plant capacity could be expected to trigger an export surge in future, to the detriment of US competitors. This scenario did not eventuate, and instead Japanese corporations were left with considerable excess production capacity. With many Japanese firms turning away from their main banks for investment financing, banks increased their lending to small and medium-sized businesses, to the real estate sector and to individuals. Just as the corporate sector escaped bank surveillance as a result of deregulatory policies, the financial sector too had increased autonomy of lending. In the early postwar period, the Japanese government had used administrative guidance to force financial institutions to expand lending to either the most productive or the potentially productive sectors of economy. However, starting in the 1970s, administrative guidance was slowly phased out in favour of the market mechanism. Interestingly, in the late 1980s, banks were lending to the some of the most unproductive sectors of the economy, such as real estate and property development. This was a radical departure from the early postwar years. According to a survey by the Ministry of Finance, total lending to the real estate sector at the end of 1991 stood at Y120 trillion. In terms of total outstanding bank loans, the property sector accounted for 11.6 per cent in 1991. This may not seem very high, but it had increased from only 5.6 per cent in 1980. Moreover, the annual rate of lending to the property sector increased very quickly, especially in the late 1980s. On average, lending to the property sector increased at an annual rate of 14.1 per cent in the late 1980s; in 1986 and 1989 it increased at 29.2 per cent and at 24.3 per cent, respectively.3 The flow of funds to the property sector led to sharp increases in property prices and in the share market. For example, while production increased 1.35 times between 1985 and 1990, the share market index rose 3 times and Tokyo property prices 2.5 times.4 The Nikkei share market index increased from 13 137 in early 1986 to 38 915 by the end of 1989 and total residential land value in Tokyo increased from Y139 trillion in 1983 to Y521 trillion in 1989.5 In 1988, capital gains in the real estate sector alone reached Y416 trillion or about 1.2 per cent of GNP. By comparison, in the US capital gains in the property sector in 1988 amounted to only 0.3 per cent of GNP.6

20 Japan in Crisis

Competition among Japanese banks was so intense that as long as property could be put up as collateral they were prepared to advance loans without questioning its use.7 Lending policies were so lax that loans were being made without regard to the crucial question of whether they could in fact be repaid at a later date. Such lending practices were not very different from those of western financial institutions in the 1970s, which led ultimately to the Latin American debt crisis. Japanese financial institution had obviously not internalized the lessons of that episode. But speculative bubbles invariably collapse, and when property prices fell in Japan the banks were left with a large number of non-recoverable loans. They found comfort in the knowledge that the government had a policy of not allowing the failure of any major financial institution. In general, popular euphoria and ‘irrational exuberance’8 (This was a term used by Chairman of the US Federal Reserve Bank, Alan Greenspan, to explain the surge in Dow Jones index in the 1990s) sustained the belief that the economic bubble would last if not indefinitely then for a relatively long period. The bubble produced a false sense of security but a crash was inevitable and the succeeding economic stagnation lasted considerably longer than the bubble economy. Although Charles Kindleberger had concluded, from an analysis of previous economic bubbles, that prudential monetary policies could moderate some post-bubble economic crises, he was also certain that ‘even optimal policies would leave a residual problem of considerable dimensions’.9 Still, Japan’s prolonged economic crisis was not inevitable and was a result mainly of government inaction and mismanagement. What burst the Japanese economic bubble was a decision by the Bank of Japan to increase discount rates in May 1989. The bank explained its decision as necessary to control inflationary pressures but in reality there were, apart from increases in asset prices, not many signs of inflation in the economy. Koichi Mera has speculated that the actions of the Bank of Japan were actually inspired by lack of faith in free markets and a consequent desire to regain control over markets that appeared to have escaped bureaucratic regulation. Moreover, he suggests that there was another, more selfish reason why the government chose to reverse the asset price inflation. According to Mera, spiralling property prices had made home ownership more difficult for public sector employees because they typically acquired property after retirement and could not therefore afford a long mortgage term that was inevitable if property prices continued to spiral or remained high.10 At the same time, the Ministry of Finance tried to halt asset price inflation with new restrictions on lending to the real estate sector. These

Economic Stagnation in Japan 21

remained in force until December 1991. However, the directives of the Ministry of Finance had little immediate effect as housing loan companies (jusen) continued to provide such loans. Real estate lending increased after the ban was lifted. In the year to March 1993, outstanding loans by the big commercial banks to the property sector increased by 8.8 per cent even though total lending over the same period increased only 0.3 per cent.11 Interest rates were increased again in 1990 following the Iraqi invasion of Kuwait. Conflict in the Middle East had an adverse impact on Japan’s economic outlook because it heightened uncertainties about oil supplies. Of all the advanced industrial economies, Japan is particularly sensitive to pressures on oil supplies because of its dependence on imported oil, mainly from the Middle East. Economic uncertainty, according to Cargill et al., prompted the Bank of Japan to further tighten monetary policy.12 By July 1991, the discount rate had been pushed up to 6 per cent before the Bank of Japan began to ease back on monetary policy. During the bubble, the Bank of Japan had progressively cut discount rates to only 2.5 per cent. The shift in monetary policy sparked the economic collapse and the Nikkei share market index, for instance, tumbled steadily from a peak of nearly 40 000 to below 15 000. Although the Bank of Japan hoped to engineer a soft landing of the economy, contractionary monetary policies produced the longest period of economic stagnation in postwar Japan. We must not be too critical of the Bank of Japan. It could perhaps have phased in tight monetary policy beginning in 1988, rather than in 1989, without causing any yen appreciation or hurting Japanese exporters, but such criticisms of the bank understate the difficulties of micromanaging economic cycles. It is unlikely that the Bank anticipated the consequences of its action, even if we accept suggestions put forward by Leon Hollerman that financial authorities in Japan used the crisis to pursue structural reforms and weed out less competitive firms, and by Karel Van Wolferen, in early 1993, that the recession in Japan was part of a planned restructuring of the economy to make Japanese manufacturing even more competitive.13 The post-bubble economic meltdown resulted in an asset price loss of Y1000 trillion. Corporations and individuals that had borrowed large sums based on inflated property prices were left with high total debt and declining asset prices. In turn, banks were left with a large proportion of unrecoverable debt. Exporters were affected by a rising value of the yen, which increased from Y145 to the dollar in 1990 to Y127 in 1992 and to Y100 in late 1994. In early 1995, the Mexican currency crisis rocked confidence in the US dollar and the yen appreciated sharply to Y79.75 to the dollar. The

22 Japan in Crisis

rising value of the yen through the early 1990s worsened the export outlook for Japanese corporations and encouraged a push to establish manufacturing facilities in East Asia where production costs were lower. In the past, Japan had always exported its way out of economic difficulties. That route was no longer available given the sensitivities of trade disputes with the United States, its major trading partner and export destination. As it is, Japan was continuing to amass large trade surpluses against the United States and further export growth could lead to more aggressive trade disputation. Indeed, the two countries did stumble towards the precipice of a trade war in the mid-1990s over alleged Japanese trade barriers that impeded the import of automobiles and auto parts. The American government insisted on numerical import targets from the Japanese government, but when it encountered stiff resistance the US judiciously decided to drop its demands rather than risk a protracted and bitter trade conflict. Such an event would have had enormous consequences for the global trade system and for the newly established World Trade Organization, which might have been called in to resolve the dispute. In terms of established international trade regulations the American case for numerical targets was weak, but whether the WTO would have been able to dictate terms to either one of the two leading economic powers is uncertain. In order to safeguard the credibility of the WTO at a time when it was in its infancy, the US was wise in not pursuing its demands and in stepping back from a full-blown trade conflict with Japan. In the context of American disenchantment with unbalanced trade relations with Japan, it was impossible for Japanese manufacturers to boost exports to revive domestic growth. Domestic demand also could not be relied upon to revive growth. In sharp contrast to the bubble economy years, Japanese consumers had increased savings in response to concerns that economic condition might worsen further. An ageing population, increased unemployment and the fiscal crisis of the state also permitted no certainty that public welfare and pension programmes would be adequate to cope with changing demographics and the post-retirement needs of the retirees. It is interesting that while unemployment did increase it did so by a mere two percentage points between 1990 and 1998.14 This was hardly a harbinger of tremendous social and economic dislocations, but in the context of earlier employment statistics it generated considerable uncertainties about future employment prospects. Coupled with the inadequacies and potential collapse of the national welfare system and its inability to cope with an ageing population, economic uncertainty was a strong incentive to save for the future. Thus, it would not be too much of an exaggeration to attribute weak domestic demand to the psychological makeup of the soci-

Economic Stagnation in Japan 23

ety and to worries about future economic prospects. Indeed, there were concerns also that Japan would end up as a second-class economy. Just as the bubble economy had been sustained by a pervasive optimistic outlook that the boom would continue indefinitely, Japanese consumers in the 1990s were gripped in the fear that economic stagnation would not only continue but might indeed become worse. This perception fed off itself and made economic recovery that much more difficult to engineer. In terms of consumer psychology, therefore, the 1990s might be described as a period of ‘reverse bubble economy’,15 with consumer confidence severely shaken. As individual and household demand collapsed, the government introduced numerous public works programmes and cut interest rates. Since 1992, the Japanese government has spent a total of US$800 billion in demand stimulus packages and public works expenditures, including the record biggest stimulus package of US$195 billion that was announced in January 1998.16 Critics, not without some justification, are convinced that the vast increase in public sector expense was more a result of a pork-barrel politics to benefit construction industries associated with the ruling LDP than an attempt to boost domestic consumption demand. Thus, the government invested in large construction projects and infrastructure developments instead of in programmes that could alter the gloomy psychological makeup of consumers and increase individual and household consumption demand. As a result, Japan realized the worst of both worlds: patchy growth and higher public sector debt. As a measure of the fiscal crisis of the state, it is worth noting that Japan has the highest levels of public sector debt relative to GDP among the OECD group of countries. In 1997, for example, total public sector debt in Japan was Y476 trillion or 92.6 per cent of GDP, compared with the United States’ public sector debt of 64.1 per cent of GDP, the United Kingdom’s 60 per cent and Germany’s 64.4 per cent. In 2001, public sector debt in Japan had increased to around 130 per cent of GDP. The only comfort was that the debt was owed at home, not to foreigners. In early March 2001, as the government prepared its thirteenth economic recovery package since 1991, Finance Minister Miyazawa acknowledged that Japanese public finances were at virtual collapse. The state of public finances meant that fiscal stimulus did not figure prominently in the package and instead the government emphasized tax relief to boost consumer spending and measures to support the stock market. Over the longer term, the reality is that ultimately taxes have to increase to pay off accumulated debt and to prepare for Japan’s demographic transition. Throughout the long period of economic stagnation, the government faced the dilemma of having to choose between pump-priming measures and tackling the fiscal crisis of the state. In this contradictory

24 Japan in Crisis Table 2.1 Official discount rates in Japan 30 August 1990 1 July 1991 14 November 1991 30 December 1991 1 April 1992 27 July 1992 4 February 1993 21 September 1993 14 April 1995 8 September 1995

6.0 5.5 5.0 4.5 3.75 3.25 2.50 1.75 1.00 0.50

Source: Economic Statistics Monthly, no. 615, Bank of Japan, June 1998, p. 22.

tussle, policies have alternated between the two. For instance, as well as expansionary fiscal policies the Japanese government felt it fiscally prudent to increase consumption tax from 3 per cent to 5 per cent in 1997. This, however, dealt a fresh blow to economic recovery. The fiscal measures were accompanied by progressive reductions in interest rates (see Table 2.1). The Bank of Japan undertook its first rate cut in July 1991 when the discount rate was cut to 5.5 per cent. Two additional rate cuts that same year lowered it to 4.5 per cent. By the mid-1990s, the Bank had progressively lowered its discount rate to only 0.5 per cent. As well, the Bank lowered reserve requirements for banks, a move that was expected to release more than US$15 billion in cash into the banking system for the provision of new loans.17 In Japan, progressive interest rate cuts were meant to stimulate domestic demand and economic growth but this failed to materialize. This was not very surprising, as investment activity during the bubble economy phase had already resulted in excess production capacity. Instead, the rate cuts only made it less attractive for investors to hold Japanese yen. This depreciated the value of the yen and yen-based loans to regional countries became more attractive. In the case of Thailand, the flow of capital to the private sector went up from US$12 billion in 1994 to nearly US$21 billion in 1995. While the exchange rate movement made yen-based loans more attractive for regional countries, there was also a down side.

From a Japanese bubble to an Asian bubble As mentioned above, collapse of Japan’s bubble economy left banks saddled with a high proportion of non-performing loans and few lending opportunities within Japan. In order to write off NPLs, they had to devel-

Economic Stagnation in Japan 25

op new markets and profit streams. It was this imperative that encouraged Japanese financial institutions to lend aggressively to East Asian countries, where investment opportunities were both promising and profitable. Loose lending practices had created the Japanese economic bubble and now Japanese banks became important players in generating an Asian economic bubble. The role of Japanese banks cannot be understood without reference to official government policies. The Ministry of Finance, according to Merton Miller, encouraged banks to offer loans in Japan and elsewhere to improve their profitability and cover bad debts remaining from the Japanese bubble economy. But since there were few lending opportunities within Japan, there was an acceleration of lending to East Asian countries. Hence, Miller argues, the roots of Asian financial crisis can ‘be traced ultimately to Japan’.18 In the process of overcoming their own domestic economic crisis, the actions of the Japanese Ministry of Finance and of the commercial banks recreated the same bubble economy on a regional scale and ultimately contributed to a regional crisis. Japan’s regional investment began initially with foreign direct investment (FDI), but progressively through the 1990s foreign indirect investment also increased. In Indonesia, for example, up until 1992 FDI was well in excess of investment in securities, but in the three years 1993 to 1995 short-term investment was either equal to or well in excess of FDI flows into the country. In Thailand, FDI investment exceeded short-term capital flows between 1987 and 1992 but this pattern was reversed in the next four years. A similar pattern prevailed also in South Korea. According to Callum Henderson, Japanese banks were keen to lend in Asia, mainly to the growing Japanese corporate sector in Asia, but were ‘not shy about making loans to the Asian corporate sector’.19 The exposure of Japanese banks to East Asia was not uniform, and at the end of 1996 ranged from US$37.5 billion in Thailand through $24.3 billion in South Korea and $22 billion in Indonesia to $8.2 billion in Malaysia.20 Most Japanese bank lending was to the offshore centres of Singapore and Hong Kong rather than to the five crisis countries of Indonesia, South Korea, Thailand, Malaysia and the Philippines. This is shown in Table 2.2. However, there was no reason to be sanguine, because these offshore centres had on-lent to the rest of Asia and confronted collapsed property prices in their own markets. While the EU countries had lent more capital, Japanese banks were more vulnerable because of their smaller capital base. For the crisis countries, the principal worrisome aspect was that much of the increased bank lending in the couple of years before the crisis was short-term. In Thailand, Indonesia and Korea the ratio of short-term debt to foreign

26 Japan in Crisis Table 2.2 Bank lending to emerging Asian markets at end June 1997 US

Japan

EU

Asian emerging markets 5 crisis countries China China Taipei Singapore, Hong Kong

43.3 23.8 2.9 2.5 14.1

(US$ billion) 271.4 97.2 18.7 3.0 152.4

353.3 98.1 28.1 14.4 212.8

Asian emerging markets 5 crisis countries China China Taipei Singapore, Hong Kong

12.4 6.8 0.8 0.7 4.0

(as percentage of bank capital) 109.5 39.2 7.6 1.2 61.5

48.5 13.5 3.9 2.0 29.2

Source: OECD Economic Outlook, June 1998, p. 21. Notes: The five Asian countries are South Korea, Indonesia, Thailand, Malaysia and the Philippines. The EU countries are Germany, France, Italy, UK, Austria, Belgium, Finland, Luxembourg, Spain and the Netherlands.

exchange reserves exceeded one and moreover, according to David Marshall, there was anecdotal evidence that much of the new lending had been invested in real estate rather than in productive activities.21 The flow of Japanese capital that sustained the Asian economic bubble did not simply result from pure market conditions but was due also to specific government policies that encouraged financial institutions to expand foreign operations and investment opportunities following the end of the Japanese economic bubble. In the United States, when a similar crisis confronted the savings and loans corporations, banks were encouraged to aggressively increase their loan loss reserves and quickly work their way out of their difficulties. In Japan, however, according to Christopher Wood, there was a ‘continuing collective attempt on nearly all sides to pretend the losses never happened’.22 A better explanation is that the Japanese government pretended that whatever problems were confronted by banks would be resolved in time through profits generated in East Asia and without resort to harsh restructuring programmes. In the process, the Japanese government allowed the domestic economic malaise to drag on and fester without any clear and decisive attempt to reverse economic stagnation. It was also at least partially culpable for implementing policies that fuelled the East Asian economic bubble and culminated in a regional economic crisis. A common criticism of the Japanese financial system was that it had not kept pace with financial globalization and was susceptible to crises. The

Economic Stagnation in Japan 27

weaknesses stemmed from low capital reserve ratios for Japanese banks and inadequate regulation and reporting requirements. Japanese banks operated with a very low reserve ratio, which, moreover, was inflated because banks included their shareholdings in their reserves. In 1988 when the major industrial countries agreed to establish minimum capital requirements for international banks, the Japanese government secured a concession that would permit Japanese banks to include latent capital gains on their stock portfolios as part of capital reserves. This was an important concession in view of the extensive shareholding of Japanese banks related to their respective keiretsu groupings. The same factor also worked to their advantage in the context of the bubble economy and a booming share market, which inflated their latent capital gains. The health of the financial sector was seriously undermined when the bubble burst and it is worth noting that in 1990, in a single calendar year, the Nikkei share market index declined to half the level it had reached in 1989. As Japanese economy continued to stagnate, the government attempted to lift growth through fiscal measures to stimulate domestic demand but without much effect. The problem was that business activity remained low and bank lending for new investment had also stalled. While banks were reluctant to add new loans to their books, their existing bad loans to the real estate sector meant that these bad loans had to be protected from default, and consequently loans to the real estate sector grew faster than overall business loans. Given existing bad loans and poor economic conditions, the Ministry of Finance planned to restore banks to profitability by encouraging them to generate profits through overseas investments. And the Bank of Japan, which had earlier tightened monetary policy and burst the Japanese economic bubble, eased monetary policy by lowering interest rates. The progressive reduction of interest rates brought rates down to nearly zero. As short-term rates tumbled, lending for marginal investment purposes became more worthwhile and it was this process that led to an accumulation of risky investments in East Asia. The bubble economy was restored, not in Japan but in East Asia. For Japanese banks, the risks must have seemed low because of the unwritten official policy of not permitting any financial institutions to fail. This government guarantee distorted lending policies that otherwise might not have occurred under purely commercial considerations. The nominal interest rates, of course, could only be lowered to near zero per cent and once that had happened the cycle of issuing marginal loans was bound to crash. In the process of solving one crisis, official directives paved the way for a second crisis, of a similar nature, and which further exacerbated the

28 Japan in Crisis

position of Japanese financial institutions. The crisis originated when Japanese authorities, in a bid to shore up the falling value of the yen, alluded to a potential increase in interest rates. The talk of an interest rate increase worried commercial and investment bankers about their investments in Southeast Asia and they ‘immediately began to sell Southeast Asian currencies, setting off a tumble not only in the currencies but in the local stock markets as well’.23 The threatened interest rate increase did not become a reality but had the same effect as the interest rate increase of the early 1980s which sparked the Latin American debt crisis of 1982. Most of the sovereign debts contracted in the 1970s and early 1980s were short-term under low interest rates, but when western countries embarked on an anti-inflationary policy by increasing interest rates it became the trigger for the debt crisis. There were other causes for the Asian crisis including slipping economic and export performance. For the regional countries, depreciation of the yen may have made yen-based loans more attractive, but since their currencies were linked to the US dollar their exports to the US, constituting a bulk of total manufactured exports, became less competitive, even allowing for the lower cost of imported parts and secondary products from Japan.

The Asian crisis and the Japanese economy The Asian crisis was a clear indication that Japan’s banking crisis could not be resolved by the preferred strategy of using an Asian economic boom to progressively write off non-performing loans. The Japanese government had to implement more direct measures to deal with NPLs and remove a key obstacle to domestic economic recovery and growth. The Asian crisis also heightened expectations that a sense of international responsibility would encourage the Japanese government to decisively act to restore domestic growth and use economic expansion to facilitate an export-led regional recovery. By contrast, the Economic Planning Agency (EPA) remained emphatic that macroeconomic policy measures should not be used to placate foreign critics or in response to foreign expectations, but should be used only for domestic policy objectives. According to Komine Takao, it was unfair to expect that Japan would accelerate economic growth simply to help other Asian countries. He insisted that Japanese macroeconomic policies should be used for domestic policy objectives, not to rescue foreign countries.24 The economic bureaucracy considered it more important to tackle the fiscal deficit in the belief that economic recovery was imminent and required no additional governmental measures. EPA officials insisted that the pace of

Economic Stagnation in Japan 29

recovery should be dictated by domestic factors rather than by regional considerations. Komine Takao also expressed the view that while demand expansion might assist regional economies, it was not the secret remedy or panacea for the Asian economic crisis which critics assumed it to be.25 In this early debate on Japan’s international role and responsibility, the Ministry of Foreign Affairs was less influential than the economic ministries because it lacked a powerful domestic constituency. Before the Asian crisis, successive Japanese governments had failed to address the real reasons behind economic slowdown. Even after the crisis, however, Prime Minister Hashimoto continued to ignore the banking crisis. Worse still, a commitment to fiscal austerity further weakened growth prospects. The austerity measures included an increase in consumption tax at a time when the government should instead have introduced measures to stimulate a depressed economy. When the negative consequences of fiscal austerity became apparent, the government announced a package of comprehensive economic measures (CEM) in late April 1998 to stimulate the economy. The government had been forced to acknowledge the gravity of the economic crisis when Yamaichi Securities, a leading stock brokerage, collapsed in late 1997. The CEM package involved a total of Y16 trillion (US$124 billion or 3.2 per cent of GDP) comprising mainly fiscal expenditures (US$93 billion) on social infrastructure development. At the time, Prime Minister Hashimoto declared this package of fiscal stimulus as ‘necessary and sufficient’ to restore confidence in the Japanese economy and halt the continuing economic slump.26 Instead, the economic situation continued to deteriorate. The problem was that economic recovery in Japan could not be achieved simply by increasing public works expenditures and other fiscal measures. This strategy had been tried through the 1990s and had produced no lasting benefit. Ultimately, Japanese economic malaise was a result of the adverse situation confronting banking institutions plus weak consumer confidence that had depressed domestic consumption demand. The lack of consumer confidence underpinned low consumption demand and high savings. To restore confidence it was necessary to offer substantial tax cuts to stimulate consumer spending, but the government promised only US$31 billion in tax cuts and that, too, only as a temporary measure. The Economic Planning Agency estimated that the impact on economic growth would be to increase it by 2 per cent after a year, but markets remained unconvinced. The temporary tax cut did not have the stimulatory effect the government might have expected, and this added to pressure on the government to offer permanent and meaningful tax

30 Japan in Crisis

cuts to stimulate domestic demand. As well, critics argued that the government had to adopt real and meaningful measures to tackle the bad debt situation of domestic banks. The Japanese government remained confident that no additional measures were necessary and that recovery was simply a matter of time. It chose to focus instead on its deficit reduction targets. When the economy plunged deeper into crisis, a popular backlash forced Prime Minister Hashimoto to resign from office.

Explaining the failure of economic recovery packages With a prolonged economic downturn and a failure on the part of the government to stop the haemorrhaging of the economy, several economists offered their own prescriptions to end the recession in Japan. For Paul Krugman the Japanese economy was in a ‘liquidity trap’ of excessive savings and the solution was to encourage and indeed force consumers to increase consumption levels. To achieve this he recommended a policy of managed inflation, 4 per cent a year for a period of 15 years, which would be a disincentive to save and also lead to currency depreciation. The key was to ensure that inflation stayed above existing low interest rates and since nominal interest rates could not be reduced to below zero, the logical solution was to target and generate higher inflation rates.27 Needless to say this was a controversial prescription and critics argued that it was foolish to assume that governments could induce and manage inflationary expectations without another crisis occurring if they lost control of the inflationary process. A policy of managed inflation makes a heroic assumption about the state’s capacity to control inflation. It is fair to say that when the Bank of Japan increased interest rates to control speculative activities, in late 1989 and thereafter, it had little inkling that its actions would lead to sustained economic stagnation. If post-bubble deflation had proved difficult to control and manage, there was no reason to assume that inflation could be managed any better. In January 1999, the governor of the Bank of Japan, Hayami Masaru quashed the idea of experimenting with managed inflation, saying that it was inappropriate to set an inflation target or raise prices to a certain level.28 Moreover, there was little certainty that even induced inflation would lower the propensity to saving among Japanese households. In the past, neither inflationary periods (after the oil crises) nor deflationary periods (after the collapse of the economic bubble) affected the savings rate. Thus, according to Ichimura, ‘Inflation does not seem to reduce savings rate in Japan.’29

Economic Stagnation in Japan 31

Others proposed that since the problem in Japan was the financial system the only remedy was to increase interest rates to strengthen the value of the yen and induce capital inflows to generate fresh capital injec-tion for banks and restore their financial viability.30 An even more ambitious plan to end the deflationary bout in Japan was the suggestion for currency reform. According to Brendan Brown, head of economic research at Tokyo-Mitsubishi International Plc, London, it might be possible to boost consumption and propel economic recovery if the Bank of Japan announced a plan to exchange old notes for new ones in five years’ time, but at a loss of, say, 10 per cent. Thus, for each Y1000 turned in, the Bank would issue only Y900 in new notes. A simultaneous imposition of bank charges on deposits and a cut in the discount rate to below zero would leave consumers with a stark reality of either increasing present consumption to minimize future exchange losses or else continuing to spend less and risk higher losses in future. Brown argued that such measures would give consumers a strong incentive to spend and provide the ‘spark for a miraculous recovery from a period of malaise’.31 These proposals were bold and innovative and tempting, therefore, to dismiss as impractical given the history of bureaucratic policy-making in Japan. Bureaucracies are generally committed to routine and standard operating procedures and unprepared to accept bold and risky policies. The reality, however, is changing, even if slowly. Elected politicians in Japan have steadily increased their influence in policy-making at the expense of the national bureaucracy. This shift in the balance of power has continued since the 1980s but the momentum of change has been particularly rapid in recent years and since the establishment of the Obuchi government. Politicians are beginning to assert themselves more and this is true of, for example, the minister for international trade and industry, in the Obuchi government, Yosano Kaoru. According to Yosano, ‘Politicians must bear the responsibility for what they do. In the past, many tended to avoid the onus of responsibility of their decisions. That was irresponsible. The final decision should be made by politicians. . .’32 Several factors explain relative decline in the powers of the bureaucracy in Japan. First, the standing and prestige of the national bureaucracy has suffered considerably following a series of corruption scandals. The Japanese bureaucracy had the reputation of being professional and scrupulous – unlike the political system, which was periodically exposed as corrupt and scandal-ridden – but in the 1990s the bureaucracy too was tainted by corruption scandals. Symptomatic of bureaucratic malfeasance was a finding that Ministry of Finance officials were guilty of having accepting bribes. The Health Ministry was also exposed for its role in a

32 Japan in Crisis

cover-up involving tainted blood transfusions. Until the mid 1980s, the Ministry of Health and Welfare did not require heat treated blood for transfusion despite knowing of potential HIV risks. Consequently, 1800 haemophiliacs contracted the AIDS virus but ministry bureaucrats continued to deny responsibility until forced to do so by Health Minister Kan Naoto in 1996. This was one of the rare instances in Japanese politics when an elected politician had forced bureaucrats to admit to their incompetence. To settle the affair, the Minister offered both an apology and a compensation package to the victims. More recently, in 2001, several senior bureaucrats in the Ministry of Foreign Affairs were implicated in financial scandals, again to the detriment of bureaucratic influence and prestige. Second, prolonged economic crisis was attributed by many to bureaucratic mismanagement and this worsened the stock of the national bureaucracy. The Ministry of Finance had the primary responsibility for regulating the financial sector in Japan, but it was slow to react to the debt problems of banks and initially expected a quick recovery in the real estate sector to restore the banks to profitability. According to Leon Hollerman, four factors explain the inaction of economic ministries in the post-bubble recession: 1. The Ministry of Finance was not accustomed to dealing with structural recession as opposed to cyclical recession. 2. The MOF traditionally has followed the dictates of austerity not only for the government but also for the average consumer. Even during the recession, it was convinced that Japanese lifestyle was ‘extravagant and profligate’. 3. The MOF realized that apart from deregulation there was no other long-term remedy to the problem, and unfortunately the ministry was not an enthusiastic supporter of deregulation. 4. Bureaucrats calculated that the structural recession would remove the less competitive, low-technology firms from the industrial stage and assumed this to be desirable in the age of globalization.33 Third, rather than allow the bureaucracy time to repair damage to its public standing, politicians turned up the heat and moved to pare down the bureaucracy to reduce its policy-making influence. In January 1999, in the process of negotiating a coalition government with the Liberal Party, the ruling LDP agreed to cut the size of the national bureaucracy by 25 per cent over the 10 years beginning in 2001.34 Reducing the size of the bureaucracy had been vigorously argued by the leader of the Liberal Party, Ozawa Ichiro, as a way of reining in bureaucratic influence and increasing the role of elected representatives in policy-making.

Economic Stagnation in Japan 33

The more conservative LDP had, in the past, resisted the push to cut the size of the bureaucracy by that much, but eventually agreed to do so in order to form a coalition government and obtain the support of the Liberal Party in the upper house of the Diet. The two coalition partners also agreed to introduce a bill in the Diet that would abolish the common practice of bureaucrats responding to questions during parliamentary question time. This practice not only was inconsistent with democratic principles but also was criticized as stifling debate in the parliament.35 The coalition partners agreed also to increase the number of parliamentary appointments in each of the bureaucratic institutions as a way of taking charge of the policy process. It appeared that politicians and political parties were willing to reform existing structures, but the coalition agreement did not last, and, besides, there are reasons to doubt the LDP’s capacity to implement genuine reforms (see Chapter 5). Genuine administrative reforms will inevitably take time and it still remains to be seen whether a clear demarcation can be made between policy-making by elected politicians and policy implementation by bureaucrats. Moreover, even if the Japanese bureaucracy holds less away than before, it still retains considerable influence, as well as expertise and specialized knowledge, in policy choices; and there is no doubt that like bureaucracies everywhere it is committed to cautious conservatism rather than to creative solutions to existing problems. The many attempts to stimulate growth had little effect on the sluggish economic conditions. Despite large public works spending programmes and fiscal stimulus, the economy remained depressed and this was unprecedented in postwar Japanese economic history. At the same time, however, some manufacturing sectors were still performing well and this reduced the urgency and need to act quickly to tackle the underlying problems within the economy. The sectors that were performing poorly were the financial and real estate sectors of the economy, but the lead manufacturing industries like automobiles and electronics appeared to be weathering the recession reasonably well. Of course, in blaming the bureaucracy for economic mismanagement we cannot exonerate political leaders. Elected politicians entrusted with economic management were unprepared for the task. There were, of course, no clear and unambiguous pressures on political leaders to act speedily to overcome the economic crisis. Had the weight of public opinion been strong there is little doubt that political leaders in Japan would have acted much sooner to resolve the economic crisis. The recession in Japan continued because of political indecision, due largely to lack of pressure from the voters. Through much of this period, the Liberal

34 Japan in Crisis

Democratic Party (LDP) was in power and it suffered little voter backlash over its handling of the economy. The LDP, therefore, was not very concerned that opposition parties could use the economic malaise to their political advantage. This was true until 1998 when poor results in the Upper House elections forced the ruling LDP to reconsider its policy priorities. For much of the 1990s, if political leaders felt any domestic political pressure, it was to revamp the political system and reduce the incidence of money politics and corruption. In the early 1990s the political system was shaken by a series of corruption scandals which led to demands for electoral reforms. Japan’s multi-member political districts were associated with the prevalence of money politics, and to placate voter anger Prime Minister Miyazawa promised electoral changes to reduce the costliness of elections and the incidence of corruption scandals. Miyazawa, however, failed to reach a compromise agreement with opposition political parties on the nature of reforms. This prompted a parliamentary no-confidence motion sponsored by the opposition political parties and passed when a sizeable number of reform-minded LDP politicians crossed the floor to vote with the opposition parties. This open breach of party unity was the first step to large-scale defections and the establishment of new conservative political parties. Weakened by defections and suffering voter backlash, the LDP, for the first time since 1955, lost its hold on political power in the 1993 elections. After a short interregnum, however, the party returned to government the following year. The loss of office did not necessarily represent a popular rejection of conservative politics. Indeed, the total conservative vote remained relatively intact and the LDP lost office only because that vote was now spread over several competing political parties. Defections and the formation of new political parties were the main reasons for the LDP’s electoral failure. At the same time, the 1993 elections offered no comfort to the main opposition party, the Social Democratic Party of Japan (SDPJ), which was also decimated. To the extent that voters were dissatisfied with the party in power, the same dissatisfaction extended to the opposition parties as well. The election result was not necessarily an endorsement of opposition policies. The election results were disastrous for the LDP as well. Throughout the postwar period, the LDP had provided political stability within Japan but its loss of the election plunged the political system into several years of instability and stalemate, as parties formed and re-formed. The period after the 1993 elections was a period of intense political turmoil and fluidity and, naturally perhaps, economic management suffered. In the

Economic Stagnation in Japan 35

absence of political direction, the bureaucracies remained in control and their management of the economy lacked the determination and decisiveness to tackle a worsening problem. Between 1991 and 1998, the economic stimulus measures of the Japanese government centred on increased public expenditure and interest rate reduction. These had little real impact on economic growth. There were few steps taken to deal with the plight of financial institutions in Japan and resolve the credit crunch by sorting out the bad debt of banks and financial institutions. The EPA belatedly acknowledged this, and in a report published in December 1998 it noted that failure of the economic stimulus packages was due to governmental neglect of the sorry state of the nation’s financial structure.36 In a sense this recognition was forced upon the Japanese government by the Asian crisis and by increased international pressures to play a positive role in managing the crisis by reflating the economy and increasing Asian imports. Failure to deal with the domestic financial and banking crisis was a main reason for the prolonged economic stagnation in Japan. Bad debt impeded bank lending capacity, which in turn held back economic recovery; moreover, given very low interest rates, it was natural that depositors fled the banking sector for other safer and more rewarding institutions. One problem here was the inadequacy of a depositor insurance system. Without an adequate insurance system and the known difficulties of the banks in Japan, it was to be expected that bank deposits were no longer regarded as completely safe. In Japan the Deposit Insurance Agency (DIA) had been established about twenty years earlier, but as Shimada has argued, this was done more to establish an international ‘alibi’ than to perform any real function.37 The DIA was placed under the jurisdiction of the Ministry of Finance and until recently had only 14 employees. More recently, the DIA has acquired a higher profile and increased its staff size to 280, but it still lags well behind the equivalent American agency, which has 21 000 employees, including 3000 inspectors. During years of rapid economic growth, the government was often credited for its sagacious economic policies. The post-bubble economic crisis altered that popular perception of the Japanese political system. The crisis did not necessarily expose government failures that had somehow escaped detection during years of high economic growth, but political instability added to economic woes. In the first half of the 1990s, the Japanese political system was rocked initially by a series of scandals and crises and later by uncertainties surrounding electoral and political reforms. However, when the opportunity for decisive and strong leadership presented itself the Japanese government proved singularly unable

36 Japan in Crisis

to rise to the challenge. Political mismanagement thus became an important source of prolonged economic stagnation in Japan especially during the administration of Prime Minister Hashimoto. In 1996, the Japanese economy appeared to be on the brink of economic recovery with a 3.9 per cent growth in GDP but the government, unintentionally, killed that with an increase in consumption tax from 3 per cent to 5 per cent in 1997. This ensured there would be no resurgence of consumer spending to sustain a fragile economic recovery. The government of the day was more concerned with repairing its fiscal health than with quick economic recovery. Admittedly, this was at the behest of the conservative Ministry of Finance and served only to discredit its ability to manage the economy. Moreover, political leaders and bureaucrats generally felt that time would inevitably produce recovery as asset prices recovered from their depressed state. They were convinced that property prices would eventually increase and resolve the bad debt situation of the banking sector. They were seemingly prepared to wait for that to happen, but in the process wasted nearly the entire decade of the 1990s, just as the decade of the 1980s had been a decade of lost developmental opportunities for the Latin American countries as a result of their own debt crisis.

Conclusion In July 1998 the Diet appointed Obuchi as the new prime minister and soon after taking office he announced fresh plans to revitalize the economy with an injection of Y6 trillion in permanent tax cuts and a supplementary budget of Y10 trillion. The new government also prepared various bailout strategies using public funds, but in mid-September 1998 the Diet for the third time rejected a plan to bail out Japan’s banking sector. Opponents argued that it was inappropriate and wasteful to use public funds to bail out banks, which should instead be forced to close.38 This went to the heart of the ‘moral hazard’ issue, according to which commercial enterprises that engaged in risk-taking behaviour for profit must not expect to receive public assistance to compensate for losses resulting from management errors. This is based on the view that since profits and losses are the opposite sides of the same coin, the market, unfettered by government bailout operations, should be the sole arbiter of investment outcomes. The moral hazard issue also suggests that governmental bailout of insolvent corporations will only heighten expectations of future bailouts and diminish corporate responsibility in managing risks. In reality, however, few governments are able to resist pressures to intervene to ensure the survival of strategic and major industries. In particular,

Economic Stagnation in Japan 37

democratic governments are extremely susceptible to domestic popular pressures and may find it harder to resist bailing out a troubled industry for fear of adding to unemployment and popular discontent. Thus, even in the US, where the government is more committed to free market principles than elsewhere, there was no choice but to bail out, for example, the Chrysler Corporation when it faced bankruptcy owing to its inability to compete with Japanese imports. In Japan, the difficulties confronting the Long Term Credit Bank (LTCB) prompted Prime Minister Obuchi to state in an interview that ‘Obviously, we cannot tell LTCB to quit operating simply because the management of that bank was incompetent.’39 Prime Minister Obuchi insisted that the government could not permit the failure of a large bank like the LTCB because of the effect this would have on the economy as a whole. The LTCB had liabilities exceeding 1.2 to 1.3 times the entire GDP economy of Indonesia and its liquidation would, argued the government, have enormous detrimental effects on the Japanese economy. These statements by the prime minister merely reflected a long-established Ministry of Finance policy of not permitting bank failures. By late September 1998, however, agreement had been reached between the ruling LDP and the opposition parties led by the Democratic Party of Japan to rescue the ailing LTCB and pave the way for a resolution both to the banking crisis and the general economic malaise. As mentioned above, the Japanese government has relied on extensive fiscal measures to revive economic growth. These have not had the desired impact, but it is possible that economic conditions would have been much worse without fiscal pump-priming. Certainly the growth outcomes would have been considerably worse and that would have led to high levels of corporate sector bankruptcies and unemployment. On the other hand, it is possible that the severity of economic crises, without fiscal intervention, might have been the necessary condition for meaningful reforms in Japanese political economy. These counter-factuals are impossible to assess and evaluate. After muddling through years of economic stagnation, Prime Minister Obuchi began the difficult task of banking and structural reforms. Prime Minister Koizumi revived the reform agenda in 2001, and declared also that sustainable recovery was unlikely without some short-term economic pain. As ‘pain’ began to look more like recession, the government also warmed to the idea of price stability, even inflation, to combat the deflationary spiral that had dampened consumer spending, in the expectation of cheaper prices in future. The government was desperate to change consumer spending habits and in the thirteenth economic recovery package announced in early March 2001 urged the Bank of Japan to lower interest

38 Japan in Crisis

rates and set targets for price stability.40 Interest rates were already hovering near zero and had failed to impact on consumption or investment decisions of consumers and corporations. However, in mid-August 2001, having previously rejected suggestions for managed inflation, the Bank of Japan agreed to inject additional liquidity into the Japanese economy to fuel inflation and end price deflation. It decided to increase its monthly purchase of government bonds and raised cash reserves available to the banking sector. The Bank of Japan, independent from the government, had been under sustained governmental pressure to play a constructive role and it ultimately succumbed to pressures to print money and fuel inflation. The move was calculated to absolve the bank from future blame for worsening economic conditions and Governor Hayami Masaru made it clear that only the government could be held responsible for any failure to achieve economic recovery.41

3 Financial Reforms in Japan

Economic growth in Japan in the 1990s was intermittent and modest. Recovery from the post-bubble crisis was complicated by the interplay of low consumer spending, regulatory inefficiencies and bottlenecks, nonperforming loans in the banking sector, corporate indebtedness and structural impediments. Of these, the crisis within the financial sector was a fundamental impediment to growth. A sharp fall in real estate prices had devalued the worth of loan collateral and borrowers also experienced difficulties in meeting their repayment obligations as a result of the economic downturn. Given the nature of relationship banking in Japan, banks were reluctant to move against debtors and to dispose of collateral at market value in order to recover outstanding loans. The rise in non-performing loans (NPLs)1 led to a contraction of new lending by financial institutions and this adversely affected business conditions. Japanese financial institutions were also undercapitalized and confronted other structural problems that did not bode well for their competitiveness in a deregulated financial market and under global market pressures. Insufficient capital reserves meant that banks could not write off bad loans and they also had no recourse to an institution such as the American Resolution Trust Corporation to dispose of non-performing loans. According to publicly disclosed figures, total loan loss provisions for all financial institutions in Japan was 2.11 per cent of total outstanding loans in March 1996, compared with total NPLs of 4.88 per cent of total loans.2 Analysts and policy-makers were not completely oblivious to problems that plagued the Japanese economy, but for much of the 1990s a policy of benign neglect characterized the government’s response to the banking crisis. The government assumed that, in time, bank profitability would gradually recover and enable them to retire their NPLs without the 39

40 Japan in Crisis

necessity of government intervention to resolve the crisis. The strategy was upset by the Asian crisis, which became a catalyst for a new approach to resolving the domestic financial crisis. The initial emphasis of government measures in the post-Asian crisis phase was to strengthen the financial position of the banks, but little was done to resolve the problem of non-performing loans and corporate indebtedness, whether by encouraging banks to forgive debt or by moving against debtors by confiscating and disposing of loan collateral in order to recover their losses. Resolution of NPLs within the banking and corporate sector received considerably more attention in the aftermath of a stock market crash in early 2001. In particular, Prime Minister Koizumi indicated that his government would seek a complete elimination of NPLs within the next two to three years. In this chapter, I will look at the nature of the banking crisis in Japan and relevant policy measures before and after the Asian financial crisis. I will focus mainly on efforts to recapitalize and restructure the banks in the late 1990s and in 2001.

Crisis in the Japanese financial sector There are several explanations why Japanese financial institutions were beset by a protracted crisis in the 1990s. For much of the postwar period, Japanese banks and financial institutions were regarded as part of the virtuous cycle that ensured continued economic growth and prosperity. They exercised due diligence over client firms and borrowing institutions, ensuring in the process profitability for the firms and for themselves. The system fell apart in the 1990s. Financial deregulation for example, had opened up new sources of capital for large firms, such as borrowings on capital markets. This forced financial institutions to broaden their client base, loosen lending criteria and increase lending to more risky customers, even for speculative economic activities. These practices of Japanese financial institutions were sustained by excessively inflated prices of real estate and other assets used as collateral for borrowed capital. When the bubble burst, asset prices also collapsed and lending institutions were left with a high proportion of unrealizable loans. The increase in NPLs had an adverse effect on bank lending policies, and the ensuing credit squeeze meant that even viable and profitable firms were denied access to investment and operating funds. In order to promote overall economic recovery, it was essential to first resolve the crisis confronting banks, but successive governments refused to commit public funds to assist in a bank-led economic recovery.

Financial Reforms in Japan 41

Instead, financial institutions were encouraged to increase lending to overseas markets, primarily in Asia, and use foreign profits to cover domestic losses. Unfortunately, NPLs accumulated faster than could be written off from profit streams, and even this avenue was foreclosed by the Asian financial crisis of 1997, which added to the non-performing loan burden of Japanese financial institutions and exacerbated their distress. The dire predicament of Japanese financial institutions, previously concealed by the limited availability of statistical information, became more apparent after the collapse of some domestic banks. The official policy of protecting banks from collapse now lay in tatters, and the government was forced to abandon its policy of benign neglect to intervene actively to resolve the banking crisis. The other underlying problem for Japanese financial institutions was that, apart from high levels of non-performing loans, they were also at a competitive disadvantage compared with large western financial institutions. In a global economy, relatively small Japanese financial institutions were at a distinct disadvantage, and to the extent that financial liberalization was unavoidable it was necessary also to reform and strengthen Japan’s banks to enhance their international competitive strength. As well as the size factor, regulatory processes also had to be brought into line with international practices to ensure the proper surveillance and monitoring of financial institutions. The lack of regulatory transparency and surveillance was similar to the situation in the 1970s and early 1980s, which had contributed to the Latin American debt crisis. At that time, western financial institutions were unaware of the total debts of borrowing countries and continued to offer loans beyond safe and prudential levels. The remedial tasks of financial sector reform in Japan, neglected through the 1990s, became a focus of attention for the government after 1997 when the Asian crisis exacerbated an already critical situation. In December 1997, Yamaichi Securities, one of the largest brokerage firms in Japan, was forced into bankruptcy. Likewise, the Hokkaido Takushoku Bank was also forced to file for bankruptcy. Lax Japanese banking regulations had led to a breakdown of market discipline during the period of the bubble economy and the task now for the Japanese government, according to the Bank of Japan, was to construct an efficient and stable financial system: With respect to efficiency, what is required of the new financial system is the full functioning of the market mechanism, incorporating the latest innovations and other developments taking place in the markets.

42 Japan in Crisis

With respect to stability, if the market check mechanism functions effectively, it should urge prompt review of the management of a financial institution to correct problems at an early stage, thereby averting the possibility of risk being amplified. Disclosure is a means to stimulate such a market check mechanism, and to thereby ensure financial system stability. Improved disclosure practices are necessary in view of rapid technological innovation in financial markets and the sophistication of risk management systems, they will strengthen individual institutions’ competitiveness in the global financial markets, and will also benefit the financial system as a whole.3 Even before the Asian crisis, Prime Minister Hashimoto had emphasized the imperative of reform in various sectors of the Japanese political economy. The government portrayed itself as reformist by highlighting its commitment to the so-called ‘six plus one’ reforms.4 The six areas targeted for extensive reforms and deregulation were the public sector, economic structure, fiscal policy, social welfare, financial structure and education. The ‘plus one’ referred to the declared objective of decentralization and relocating some administrative structures outside Tokyo in order to alleviate population pressures in the metropolitan Tokyo district. The reform agenda was ambitious but necessary to recreate the bases of economic growth and end the long period of stagnation. However, implementation of reforms suffered from lack of a clear sense of direction and from opposition emanating from various vested interests in the domestic society. While regulatory controls had the effect of reducing domestic competition, some sectors had emerged as beneficiaries and they were determined to resist deregulation. These recipients of economic rent attempted to undermine the reform agenda by suggesting that regulatory controls were essential not only for economic reasons but for social, cultural, health, safety and environmental considerations.5 These were arguments that the Japanese government had itself employed in the past to resist foreign demands for liberalization. Nonetheless, the Hashimoto administration can be credited with the socalled big-bang financial reforms. At the same time, however, the government faltered in the task of resolving the banking crisis and this continued to impede economic growth and recovery. This failure stemmed from a misreading of the economic situation and the consequent prioritization of deficit reduction policies. The Hashimoto government failed to alter its policy priorities even after the Asian crisis. Despite acclaimed Japanese ‘flexible rigidity’, the government was more rigid than flexible and at a critical juncture in the late 1990s was wedded to a policy of fiscal conser-

Financial Reforms in Japan 43

vatism and austerity. Policy flexibility is not a term that could be applied to describe the Hashimoto administration. Yet, the commitment to deficit reduction was understandable, as total public sector deficits were close to annual Japanese GDP. This was a figure considerably higher than for any other advanced industrial democracy and, coupled with the certainty that an ageing population would place greater pressure on public finances in future, meant the task of deficit reduction had to be taken seriously. Japan has a rapidly ageing population, which means there will be fewer people in the productive age groups to support the aged beneficiaries of social welfare programmes. Indicative of changing Japanese demographics is the fact that the number of individuals in the productive age bracket of 15 to 64 will decline from 86.5 million in the year 2000 to 73.8 million by 2020. Concomitantly, the number of individuals aged 65 and above will increase to 33.3 million by the year 2020, from 21.8 million in 2000. Interestingly as well, these changes are taking place in the context of a shrinking population base. The fertility rate in Japan, at 1.4, has fallen well below the replacement rate of 2.1 and as a result the total Japanese population, which was 127 million in the year 2000, will decline to 124 million in the year 2020 and to only 67 million by the end of the century.6 The ageing population profile will add to future demands on public welfare provisions, and prudent fiscal management dictates the generation of current surpluses in readiness for future deficits. During the Hashimoto administration, the malaise within the banking sector was allowed to fester, with no credible plan to restore the viability of financial institutions. The broad policy parameters remained unchanged and the government also approved a controversial increase in consumption tax. The magnitude of tax increase was not particularly large but the immediate outcome was to further dampen consumer spending and stymie an incipient consumption-led economic recovery.7 In mid-June 1998, to mark the close of the 142nd session of the Diet, Prime Minister Hashimoto acknowledged the urgency of tackling the banking and economic crisis. However, before he could chart a new policy direction, he was forced to resign following a disastrous setback in the Upper House elections in early July 1998 (Table 3.1). A large number of voters had deserted the LDP and dealt a severe blow to pre-election LDP hopes of regaining control of the Upper House.8 In the Upper House elections half of the 252 seats were contested and the expectation was that the LDP would win a few more than the 61 LDPheld seats being contested. These, together with the 58 seats held over, would still not give the LDP a majority in this chamber, which required it to win at least 69 of the contested seats. But analysts agreed that if

44 Japan in Crisis Table 3.1 1998 Upper House election results Party Liberal Democratic Party Democratic Party of Japan Komei Party Social Democratic Party of Japan Japan Communist Party Liberal Party Kaikaku Club Sakigake Niin Club Independents

Seats won 44 27 9 5 15 6 0 0 0 20

Seats held over 58 20 13 8 8 6 3 3 1 6

Total 102 47 22 13 23 12 3 3 1 2

the LDP improved its representation, even if marginally, then the results would permit the party to proclaim victory. In the end, the LDP won only 44 seats and the result was particularly poor in the urban centres of Japan. The party failed to win a single seat in Tokyo, Osaka, Aichi, Kanagawa, Saitama or Kyoto. The LDP’s electoral failure was due to a high voter turnout in the urban centres, which in turn reflected popular disenchantment with the policies of the government and its failure to deal with a mounting crisis. Unlike the previous Upper House election, three years earlier, when voter turnout was only 44.5 per cent, in the 1998 election voter turnout increased sharply to 58.8 per cent. High voter turnout was damaging to the LDP, and urban voters swamped the strong electoral support for the LDP among farmers in the rural districts of Japan. As is the norm in Japanese politics, Prime Minister Hashimoto accepted responsibility for LDP’s poor electoral performance and resigned from office. Hashimoto’s failure to deal decisively with the banking crisis belied his image of a dynamic politician intent on introducing sweeping reforms to restore the bases of economic growth. Following his resignation, the more powerful Lower House of the Japanese Diet, dominated by the LDP, selected Obuchi Keizo as the new prime minister. The policy activism of the new government was apparent from the beginning. The contrast between the two administrations was particularly striking because Hashimoto had cultivated an image as a charismatic and dynamic leader whereas Obuchi was berated as dull and uninspiring. When Obuchi became prime minister, he had the dubious distinction of being the least popular of new prime ministers. Indeed, he was also the least popular, in terms of public opinion, of the three candidates competing for the position of party presidency, which included Koizumi Junichiro and Kajiyama Seiryoku. John Neuffer, publisher of a political newsletter in

Financial Reforms in Japan 45

Tokyo, used the analogy of a ‘cold pizza’ to describe the new prime minister, who could offer only the lame rejoinder that a cold pizza could at least be warmed up. With an image as a weak politician and an uninspiring leader, few expected much from Obuchi. Apart from personality issues, expectations were low also because of the electoral success of opposition political parties, particularly the Democratic Party of Japan and the Japan Communist Party, which were better placed to obstruct government bills in the parliament and derail LDP’s policy agenda. Since both these parties had strengthened their parliamentary position by distancing themselves from the LDP, analysts expected that the LDP would face increased difficulties in passing bills through the parliament and in pursuing its economic agenda. Indeed, in late 1998 the Democratic Party of Japan was able to mount a serious challenge to LDP dominance and stymie the passage of a couple of bills in the Diet to restructure the financial institutions in Japan and provide capital injections to strengthen their capital base. Given the potential legislative impediments facing the Obuchi government, its achievements were striking and it proved intent and resolute in addressing the problems confronting the Japanese economy. With the benefit of hindsight, even John Neuffer was prepared to be more charitable to the prime minister, acknowledging that he had exceeded all expectations.9 Obuchi could not overcome the tag of a dull leader but he was still an effective politician. An Asahi Shinbun poll in April 1999 found that 37 per cent of those polled supported the Obuchi government. This was a record high for any Japanese prime minister in recent years, and certainly a sharp contrast with the approval rating of his successor Mori, whose popularity was in single digits in early 2001. In his public speeches as a candidate for the LDP presidency, Obuchi stressed the importance of domestic recovery by declaring it an ‘international responsibility’ and ‘duty’ that Japan had to fulfil. Upon taking office he pledged he would implement measures to stop the economy contracting for the third straight year. He took his cue from the July 1998 election results and political backlash against the Hashimoto administration. The focus on economic recovery was necessary also in order to prevent the newly established Democratic Party of Japan from mounting a credible challenge to the LDP at the next general elections. Elections were not due until the year 2000 but that still did not give the LDP much time to reverse either the course of the economy or the fortunes of the LDP. In their bubble economy period the East Asian countries, like Japan earlier, had invested in considerable additional production capacity. The 1997 crisis led to a collapse of both domestic consumption demand and

46 Japan in Crisis

export trade, and these countries were left with considerable underutilization of capacity. East Asian economic recovery depended on access to new markets to absorb surplus production capacity and, obviously, expectations were that Japan would step in to fill the breech. US President Bill Clinton, for instance, stated that it is difficult to see how any actions of the world community can be successful in restoring growth in Asia in the absence of growth in Japan, which would enable Japan to lead the region out of its present condition.10 The Japanese economy constituted 70 per cent of the region’s economy and it had substantial capacity to absorb surplus regional production. According to estimates, a 1 per cent expansion of the Japanese GDP would increase Asian (excluding Chinese) imports by 0.8 per cent to 2.94 per cent, with a resulting Asian GDP expansion of 0.04 per cent to 0.15 per cent.11 Clearly a robust Japanese economy could play an important role in an export-led regional recovery. The difficulty was that Japan was mired in its own economic crisis and surplus production capacity. At the same time, the Japanese government could not ignore the crisis in its region because of its potential to drag the Japanese economy into a deeper crisis. This became palpably clear when in late 1997 the Japanese economy was rocked by the collapse of Yamaichi Securities, one of the leading brokerage firms in Japan. Thus in 1997–98, apart from international pressures to reflate the economy to contribute to Asian recovery, there were legitimate reasons of self-interest for the Japanese government to stimulate economic growth.

Banking sector reforms in Japan After some marginal improvement in economic conditions in the mid1990s, the Japanese economy actually contracted in fiscal year 1997 (April 1997 to March 1998), the year of the Asian crisis. The contraction was small – 0.7 per cent below the previous year – but the outlook was worse for 1998. In late 1998 the Japanese government endorsed an EPA estimated economic contraction of 1.8 per cent for fiscal year 1998. It was the first time in the postwar history of Japan that economic contraction was predicted for two consecutive years. In the third quarter of 1998 the economy actually shrank at an annual rate of 2.6 per cent. This marked the fourth consecutive quarter of economic contraction in Japan and was the longest period of contraction in postwar Japanese history. Reflecting

Financial Reforms in Japan 47

the poor state of the economy, the Nikkei share market index, on 5 October 1998, closed below 13 000 for the first time since late January 1986. In forming his cabinet, Prime Minister Obuchi appointed Miyazawa Kiichi as minister of finance. Miyazawa, a former prime minister, was considered ideal for the position given his reputed expertise in economic management and market credibility. He had been the finance minister in the late 1980s at a time when the economy was beset by a sense of gloom brought on by the Plaza Accord of 1985 and the appreciation of the Japanese yen. To prevent excessive exchange rate realignment, Miyazawa authorized market intervention to shore up the value of the dollar and lower the value of the yen. He is also credited with the subsequent cuts to the official discount rate (to 3.0 per cent in November 1986 and to 2.5 per cent in February 1987) which were made to stimulate economic activity. His reappointment as finance minister in 1998 was intended to reassure markets that the government was serious about achieving economic recovery. After years of ignoring a problem, the Obuchi administration finally began the important task of resolving the bad debt problem that plagued Japanese banks. In October, the government secured legislative passage of a bank bailout bill that committed US$506 billion (Y 60 trillion) in financial assistance to banks burdened by bad and questionable loans. According to findings of the Financial Supervisory Agency (FSA),12 the total amount of problem debts, defined as loans whose recovery was either dubious or unlikely, of all national banking institutions, at the end of September 1998, was Y 73 trillion, an increase of Y 1.3 trillion since March that year.13 The amount the government committed to the bailout plan was five times the amount the US government had used to clean up the debt of savings and loans banks a few years earlier (see p. 49 below). As ever, opinion was divided, some critics claiming that the rescue package was still insufficient while others cautioned that the system was too weak to withstand restructuring. Previous governments had rejected the use of public funds to bail out banks because of perceived popular antipathy. Following an earlier bailout of housing loan corporations ( jusen) associated with the ruling Liberal Democratic Party, public opinion had turned against the use of public funds to assist companies in distress. The jusen had been established by banks and other financial institutions in the 1970s to provide loans to for housing and other purposes. The banks, by contrast, limited their lending largely to corporate clients. When the economic bubble burst and real estate prices collapsed they were saddled with large unrecoverable

48 Japan in Crisis

loans. In 1996 the government was forced to bail out the jusen with about Y 685 billion in public funds. The amount spent on the bailout plan was not large but still generated considerable public opposition. Noting the strong public distaste for taxpayer-funded bailouts of private enterprise, Cargill et al. predicted that ‘policymakers are likely to be very reluctant in the future to propose public funding as part of any solution in dealing with financial problems’.14 In 1998, however, the government and opposition parties finally reached agreement on the use of public funds to bail out ailing financial institutions. The agreement was made possible by changed circumstances and shifting public sentiments. The high-profile failure, in late 1997, of Hokkaido Takushoku Bank, Sanyo Securities and Yamaichi Securities eroded public confidence in the safety of their savings and deposits and there was now no great outcry against the use of public monies to help the banks. Popular opinion now favoured whatever measures were necessary in order to guarantee the safety of their deposits. In order to proceed with the task of resolving the banking crisis, the Japanese Diet approved the Financial Rehabilitation Law in late 1998. This also led to the establishment of the Financial Restructuring Commission (FRC) to oversee banks that were temporarily nationalized as part of the restructuring programme. The FRC was located in the Prime Minister’s Office and headed by a political appointee holding ministerial rank. Its chairman, Yanagisawa Hakuo, was a relatively obscure LDP politician who without this opportunity would have finished his political career without any noticeable achievement. He now had the chance to distinguish himself and quickly established himself as an important member of both the Obuchi and the successor Koizumi administrations. His reformist determination and rise to prominence became a source of tension between himself and his faction leader, Kato Koichi. Most unusually, in the context of Japanese politics, Yanagisawa subsequently left the Kato faction of the LDP to set up an ‘anti-Kato’ group. The appointment of a political figure to chair such a crucial institution and the decision to keep the FRC independent of the Ministry of Finance were indicative of the shifting balance of power between elected politicians and bureaucrats. However, the FRC was still written off as a lapdog of the Ministry of Finance since it was to be staffed by bureaucrats from that ministry. The FRC was also derided as yet another institutional response that would ultimately fail to effectively regulate the banking sector. Nevertheless, it demonstrated its independence and in six months had achieved more to strengthen the banking industry than had the Ministry of Finance since the onset of economic stagnation in Japan. The FRC proved its worth by insisting on genuine restructuring efforts in the banking sector based on informed

Financial Reforms in Japan 49

and accurate assessment of the problems. Christopher Mahoney, the managing director of Moody’s Investment Services, gave a strong vote of confidence to the FRC when he said, ‘The government rescue of the Japanese banking system has finally begun in earnest. It appears coherent and well conceived, and a full-blown banking crisis will be avoided.’15 Under the FRC rescue plan, banks which were near bankruptcy were to be nationalized and restructured with the assistance of a government injection of funds. Other banks with serious debt problems would be encouraged to apply for public funds to write off bad debts and would in return be required to undergo tough restructuring and cost-cutting measures. The model for the Japanese plan was the Resolution Trust Corporation (RTC) that existed in the United States between August 1989 and December 1995 to resolve the crisis in the savings and loans institutions. The American savings and loan crisis affected small institutions that were adversely affected by problems in the energy sector and the collapse of several major real estate markets. In terms of the magnitude of the crisis, between 1980 and 1994, nearly three thousand banks with more than US$900 billion in assets either were closed or received financial assistance from the Federal Deposit Insurance Corporation (FDIC). The resolution of the crisis had the following three components: 1. Purchase and assumption of transactions This involved the purchase by a healthy financial institution of all the assets of a troubled institution in return for assuming, at a minimum, all insured deposits and possibly all deposits. 2. Deposit payoffs When no purchaser could be found, the FDIC or RTC would pay depositors of the failed institutions the amount of insured deposits, and depositors with uninsured deposits and other creditors would receive a proportion of the proceeds from the sale of assets. 3. Open bank assistance The FDIC provided loans to financial institutions in return for restructuring and new management structures.16 In Japan, banks that were forcibly nationalized had their stocks and shares declared void and the FRC was given the powers to appoint a new management team to reorganize and run the bank. Interestingly, the process of public acquisition of private banks and the nullification of shares could possibly be seen as unconstitutional, as it violated individual property rights that are guaranteed under the constitution. The measures adopted by the government, however, were not challenged in the courts. The main task of the FRC was to separate the bad and the healthy assets of individual banks and to submit a plan for the disposal of bad ones.

50 Japan in Crisis

The Long-Term Credit Bank of Japan (LTCB), the tenth largest bank in Japan, was the first banking institution to be nationalized and placed under the rescue programme. The LTCB’s financial difficulties began with questionable loans to the EIE Group, an ambitious and high-profile international resort development firm. High exposure to the property sector was the undoing of the LTCB. Loans to EIE alone, at their peak, totalled more than US$3 billion and nearly a quarter of that loan ultimately became unrecoverable once the economic bubble had burst.17 In late October 1998 the government declared the LTCB insolvent and acquired all its shares. Earlier in that same month, the Financial Supervisory Agency had reported that the LTCB, as of 30 September 1998, had more liabilities than assets. LTCB shares, had in February 1998 been trading at Y 373 but slumped to Y 2 before share trading on the Tokyo stock exchange was suspended. The rescue of the LTCB came too late for one of its subsidiaries, the Japan Leasing Company, which was forced to declare bankruptcy in September 1998. Japan Leasing had total liabilities of Y 2.14 trillion and was the biggest postwar bankruptcy in Japan. In midFebruary 1999, the FRC decided that it would sell Y 2 trillion of LTCB’s Y 4.6 trillion in bad debts to the Resolution Trust Corporation (RTC),18 which had been established to dispose of the bad debt of the nationalized banks. The remaining bad loans were to be kept on the LTCB’s books because it was considered too difficult to dispose of them to the RTC. The FRC also announced that it eventually would sell LTCB to another financial institution after it had been returned to financial viability. The FRC appointed Goldman Sachs to find a suitable buyer for the LTCB. In mid-1999, Mitsui Trust & Banking and Chuo Trust and Banking, which were to merge in 2000, were reported to have begun talks to take over the LTCB. Later that year, however, the government gave US-based Ripplewood Holdings first right of negotiations to take over the LTCB, in preference to Mitsui and Chuo, because of the latters’ demand for additional government assistance to facilitate the takeover.19 Under Ripplewood, the LTCB was restructured and resumed trading as Shinsei Bank. When the FRC began the task of financial rehabilitation, it was commonly understood that of the 17 major banks in Japan, 5 were reasonably safe, 7 were in dubious shape and the remaining 5 could be nationalized and brought under the official rescue programme. However, only one other bank, Nippon Credit Bank, was nationalized. Obviously therefore, the government’s rehabilitation plan was only going to provide a partial solution to the crisis in the financial sector but it still reflected poorly on the unwritten policy of the Ministry of Finance that no major banking institution would be permitted to fail.

Financial Reforms in Japan 51

Another aspect of the bank rescue programme was the injection of public funds for the recapitalization of the capital base of banks. According to Bank for International Settlement guidelines, banks which maintain an international presence are required to maintain an equity ratio of 8 per cent of total assets, a stipulation negotiated in Basle, Switzerland, in 1988. At that time, the British and American governments expected that bank reserves would be in the form of equity capital. However, the Japanese government and banks obtained the concession that they could apply the unrealized gain on their equity (stocks and so forth) portfolio toward the minimum reserve requirement. Under the agreement, Japanese banks had to keep 4 per cent of assets as equity but could include unrealized gains toward the remaining 4 per cent. At the time of the bubble economy and a soaring stock market this suited their purposes, but once the Nikkei share market index crashed Japanese banks became non-compliant with BIS reserve requirements. As of 30 June 1998 the top 19 banks in Japan had outstanding loans of US$3.1 trillion but reserves of only 4 per cent.20 To return to compliance, banks could either reduce their assets portfolio or withdraw from international transactions. Only a few banks opted for the latter option because of a perceived danger that any de facto acknowledgement of the full extent of bad loans would jeopardize long-term survivability. That seemed to be the lesson of the failure of Hokkaido Takushoku Bank’s, which had withdrawn from international transactions but still collapsed under the weight of bad debt. Only Daiwa Bank and Mitsui Trust and Banking Company announced, in October 1998, that they would close international operations because of their inability to meet capital adequacy requirements. Most banks took the former option, which in turn led to a debilitating credit crunch that exacerbated deflationary pressures in Japan. By using public funds to recapitalize the banks’ equity base, the government hoped to enable banks to resume lending in Japan and ease the credit crunch.21 The funds were to be used to wipe out bad debt. The government encouraged major banks to apply for financial assistance, but in the initial stages only a handful of banks asked for public funds, the others opting to maintain the fiction that they could ride out their existing difficulties. There was also a fear that an application for public funds would lead to a disclosure of the true state of their financial position and that this transparency might only weaken them further. The reluctance of banks to apply voluntarily for public funds prompted the Financial Supervisory Authority to begin an examination of all banks in the expectation that a process of dialogue between banks and the FSA would lead to a restructuring programme for the banking sector. FSA activism was to ensure that more banks actually applied for funds from

52 Japan in Crisis

the government before the end of the fiscal year, once the restructuring plans had been finalized. In January 1999, the FRC urged the 17 banks to accept public funds to write off a substantial portion of their bad debt by the end of the fiscal year. The minister promised favourable terms for capital injections on condition that banks restructured their business and streamlined their management. By early 1999, banks had only taken up Y 5.8 trillion of the available funds, which represented a strengthening of capital base by only 1 per cent for the city and regional banks.22 The precariousness of financial institutions can be seen from the example of the Sumitomo Bank, which was considered healthy and, at one time, a good prospect to take over the LTCB prior to its nationalization. In November 1998 the Sumitomo Bank itself applied for public funds, though only for Y 500 billion, under the recapitalization plan to help it write off bad debt. For the fiscal year 1998, banks had to apply by 15 February to obtain public funds to write off bad debt. The FRC insisted that banks prepare and demonstrate a genuine commitment to reform. The determination shown by the FRC to resolve the banking crisis impressed financial markets and banking shares were among the best-performing stocks in the Tokyo market in early 1999. Confident that banks would acquire new capital through the FRC and undertake genuine reform, the vice-minister of finance, Sakakibara Eisuke, in early February 1999 declared that the Japanese banking crisis would be resolved in a week or two.23 This was unduly optimistic. Before the end of the fiscal year in March, only the Bank of Tokyo-Mitsubishi, the largest Japanese bank, felt confidence in its strength to ride out the bad loan situation confronting the Japanese banking sector in general. All the other major financial institutions were forced to apply for public sector funds and submit to a planned restructuring programme. With the injection of public sector funds, the major banks, in mid-March, announced that they expected to write off all nonperforming loans and end years of losses, at least for the next four years.24 The rehabilitation of the banking sector is essential to the recovery of the Japanese economy. The credit squeeze, which has crippled the Japanese economy, will ease only after banks have recovered from their bad debt, and similarly liquidity pressures facing banks will ease only after consumers have regained enough confidence in banks to trust them with their savings and deposits. The policies introduced by the Obuchi government addressed primarily the liquidity requirements of Japanese financial institutions. They left unresolved the other important issue of whether Japanese banks could survive competition in the global financial market. This became a more pressing issue

Financial Reforms in Japan 53

with the introduction of big-bang financial reforms in 1998. These reforms opened up Japanese financial markets to foreign competition and the worry was that Japanese banks, already saddled with bad loans, might not be able to withstand increased competition from foreign financial institutions. According to Morinaga Takuro, there are a number of internal management problems that impede the capacity of Japanese banks to compete successfully in the international market place. For instance, he has pointed out that Japanese banks were managed by individuals who had been trained as generalists rather than as specialists in international banking and finance. He concluds that such a management structure would disadvantage Japanese banks but acknowledges also that a transition to a more competent management system might take as long as 20 to 30 years.25 This, he argues, was because of the nature of the employment system in Japan and the ‘moral’ constraints in dismissing redundant employees. The lifetime employment system that was dominant in the large corporate sector of Japan is changing, however, and in the banking industry the changes are also being forced along by the demands of the restructuring required under the government assistance programme. In return for funding from the Financial Restructuring Commission, the banks have committed themselves by 2003 to eliminate 20 000 jobs, or roughly 14 per cent of the present workforce.26 The main impact of this rationalization will probably be felt more in the lower echelons of the banking industry but may also lead to a streamlined management structure. A summary of the amount of financial support of the 14 major banks and their restructuring objectives is shown in Table 3.2. For its part, the government encouraged mergers and tie-ups that would give banks an expanded capital and resource base to compete in the global economy. In 2000 Mitsui Trust Bank and the smaller Chuo Trust Bank merged their operations to create the largest trust bank in Japan with assets of Y 45 600 billion and 170 branch offices. Other banks also initiated merger discussions as part of a broader restructuring agenda to create large financial groups, in place of the 21 major banks, plus the dozens of insurers and countless number of brokerage firms. Mergers were facilitated by a decision, in take 1997, to lift the ban on holding companies that had been in place since the Second World War. In late August 1999, Daiichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan announced plans to merge operations in late 2000 creating, in the process, the worlds largest commercial bank with assets of more than Y 141 trillion.27 The merger, based on the establishment of a new holding company, was the ‘first effective use of the holding company framework for a large scale consolidation’.28 Two other Japanese banks,

54 Japan in Crisis Table 3.2 Bank support and restructuring goals, 1999 Bank

Asahi Chuo Shintaku Daiichi Daiwa Fuji Kogin Mitsui Shintaku Mitsubishi Shintaku Sakura Sanwa Sumitomo Sumitomo Shintaku Tokai Toyo Shintaku

Financial support (Y billion)

Executive cuts

Workforce cuts

Repayment date

500 150 900 408 1 000 600 402 300 800 700 501 200 600 200

39–31 55–32 35–25 31–20 41–34 35–18 – 34–30 51–21 40–15 43–38 32–18 15–17 30–18

12 800–11 800 9 980–8 900 16 130–13 200 7 640–6 300 14 250–13 000 4 776–4 482 – 4 932–4 695 16 700–13 200 13 600–11 400 15 000–13 000 5 900–5 200 11 125–9 731 4 100–3 400

7–9 9 8 12 6 5 9 5 10 5 6 5–7 10 7

Source: Shukan Toyo Keizai, 17 April 1999, pp. 32–3.

Sumitomo and Sakura, also agreed to merge. The resulting rationalization of cost structures should enhance profitability of the new banks, but these and other big banks will have to improve their network and global penetration to compete successfully with global financial institutions, like the Citigroup or Deutsche Bank. As a result of mergers in late 2000 and early 2001 the banking scene was radically transformed, and in place of a large number of financial institutions there emerged four large financial groupings. These were: Sumitomo-Mitsui Banking Corporation Composed of Sumitomo Bank and Sakura Bank (April 2001). Mizuho Group Composed of Daiichi Kangyo Bank, Fuji Bank and the Industrial Bank of Japan (April 2001). Mitsubishi Tokyo Financial Group Incorporated Composed of Bank of Tokyo-Mitsubishi, Mitsubishi Trust & Bank, and Nippon Trust Bank (September 2000). United Financial of Japan Sanwa Bank, Tokai Bank and Toyo Trust (April 2001).

Regulatory controls and surveillance Important though restructuring and recapitalization of the banking sector was to the rehabilitation of the banks, Akiyoshi Horiuchi points out

Financial Reforms in Japan 55

that the crisis in Japan’s financial sector was not unrelated to internal and governance aspects of the banking institutions. Banks, he says, were undisciplined in their operations because governmental supervision, potential capital market controls and competitive pressures were either inadequate or weak.29 A governmental safety net that ensured bank survivability during crises and regulatory controls on excessive competition within the financial industry and protection to weaker banks weakened prudential management within the financial sector. In the absence of outside disciplinary pressures, bank management became entrenched and, according to Horiuchi, entrenched ‘bank managers tended to take excessive risks under the comprehensive safety net during the latter half of the 1980s’.30 To install a better regulatory regime of surveillance and monitoring, the Hashimoto administration introduced the so-called bigbang reform measures. The prime minister announced the government’s reform intentions in November 1996 and instructed Ministry of Finance bureaucrats to prepare detailed measures, based on the principles of freedom, fairness and global standards. The big-bang reforms liberalized Japanese financial industry, ending the segmentation between, for example, banking, insurance and securities operations. To regulate the deregulated financial sector, the cabinet, in March 1997, approved a bill to establish a Financial Supervisory Agency and this was formally enacted by the Diet in June 1997. The FSA was established in late June 1998 with the task of licensing, inspecting and supervising financial institutions. These functions had previously been performed by the Ministry of Finance but given the failings of the ministry the government decided that it was inappropriate for one ministry to be responsible for both budgetary and taxation matters, as well as surveillance of financial institutions. However much MOF officials may have disagreed with these objectives, they were constrained in their ability to obstruct the devolution of authority because of their diminished reputation, power and influence. According to Stephen Harner: The MOF’s supervision and management of the financial sector was a particular focus of criticism. As Japan’s banks, securities companies, and insurance companies sank further towards insolvency, and in many cases, like the jusen housing loans companies, Hyogo Sogo Bank, the Hokkaido Takushoku Bank, required massive bailouts using taxpayer funds, it was correctly concluded that the MOF had failed in its prudential management role.31 Thomas Cargill points out that, among the many policy blunders of the MOF, although its officials knew of the magnitude problems facing the housing loan companies as early as 1993, they chose not to act until

56 Japan in Crisis

1996 when the problem could no longer be denied or ignored. According to Cargill, ‘There is every indication the nonresponse policy was based on the hope that land and equity prices would soon recover.’32 Under the new structure, the FSA had responsibility for supervisory and surveillance functions while the MOF retained taxation and budgetary functions. Like its sister institution, the FRC, the FSA inspired little hope of significant change largely because it too was to be staffed by MOF officials. However, it quickly established a formidable reputation for financial rectitude and arm’s-length dealing with financial institutions to the extent that inspectors ‘will not accept even a cup of tea or coffee from financial institutions’.33 Upon its establishment, the FSA also instituted a working committee to review financial inspection manuals. The final report of this committee was handed down in April 1999 and it established the basis for moves away from (a) regulator-led inspections to self-management-style inspections and (b) emphasis on the assessment of asset quality to inspection of risk management. Under the new guidelines of prudential management, banks are required to periodically self-assess their capital adequacy ratios, subject to external audit. In July 2000, the government merged the Financial Supervisory Agency and the Financial System Planning Bureau of the Ministry of Finance to establish the Financial Services Agency (FSA), under the leadership of Yanagisawa Hakuo, who had successfully led banking reforms as head of the FRC. The new agency has greater powers to exercise surveillance over financial institutions, including public disclosure of critical financial situations and the prescription of corrective actions. Banks have also been required to accept internationally accepted accounting practices and be more transparent in disclosing financial details so that markets can exercise greater controls over bank lending policies.

Bank reform and persisting economic weakness Despite the reform initiatives of the late 1990s, recovery remained weak with mixed signals about the trend line. The Obuchi administration had taken the first partial steps toward resolving the banking crisis but, as is often the case, partial solutions proved to be no solutions at all. Thus, even as banks disposed of some of their non-performing loans, they continued to accumulate new non-performing loans, leaving the overall problem intact.34

Financial Reforms in Japan 57

A quarterly survey of business sentiment in December 2000 revealed that businesses were no more optimistic than they had been in the September quarter, when economists had in fact anticipated an improvement. In early 2001, Japanese economic outlook was worse than it had been in recent months and years and the Nikkei share market index even dived below the 12 000 mark. The Tankan survey of business confidence by the Bank of Japan in September 2001 revealed continuing business pessimism. The survey polled 8 800 businesses and found the biggest drop in business confidence in three years. The Confidence Index registered a decline to –33 from –16 in the previous survey. Not surprisingly, the share market index also trended down, falling below 9 500 in February 2002. This decline meant that the stock market had given up all the gains of the bubble economy years. For the Japanese government, the major concern arising from the stock market crash was that the corporate sector was underpriced and an attractive target for foreign takeover. Worrisome though the collapse of the stock market was for the future of the corporate sector, it was not, however, expected to have a major impact on an already sluggish consumer demand. This is because shares are largely held in cross-share holding arrangements among companies and only a small proportion is held by individual investors. At the end of the 1980s the combined total of shares owned by financial institutions and ordinary businesses reached 61.7 per cent of the whole. The Mitsubishi Group of companies owned an average of 29 per cent of the shares of each member of the Mitsubishi Group.35 The purpose of mutual shareholding was to prevent attempts at hostile takeover of firms and to weaken the rights and influence of ordinary retail shareholders. The Mitsubishi Group, for example, had a controlling interest in each of its group of companies as the major shareholder, giving managers greater autonomy from shareholder pressures. The collapse of the stock market, according to Kiuchi Takashi, economic adviser to the Shinsei Bank (formerly the Long Term Credit Bank of Japan), was prompted by a scramble among banks and businesses with large share portfolios to unload their portfolios to free themselves from future capital losses and, in response to new requirements, in 2001, to accept international accounting practices and prepare consolidated accounts. In the past, corporate accounting standards allowed share portfolios to be listed at book value rather than market value, a practice not permissible under accounting standards new for fiscal years 2001 onwards. In the lead-up to the close of the fiscal year, firms scrambled to unload their equity holding while making as little financial loss as possible. In

58 Japan in Crisis

terms of divestiture, the process already had the effect of reducing bank holdings of stocks in the year 2000. For example, at the end of fiscal year 1989, the total bank holding of shares outstanding on the domestic stock exchange was 46 per cent, but at the end of fiscal year 1999 (March 2000) total the bank holding had dropped to 36.5 per cent.36 This led to a very volatile share market, which closed the fiscal year at slightly under the 13 000 mark. A closing level substantially below the 13 000 mark would have exacerbated the situation for banks. Given the nature of share ownership in Japan, the stock market collapse was unlikely to add to consumer pessimism, but it still presaged difficult times for the Japanese economy. According to Kiuchi Takashi, the sudden economic decline in 2001 was not directly related to the on-going malaise within the Japanese economy but was rather a reflection of a dramatic slowdown of American and other western economies, with adverse consequences for Japanese exports.37 In late March 2001, the Bank of Japan (BOJ) felt compelled to lower overnight call rates effectively to zero, less than a year after it increased interest rates confident that sustained economic recovery was imminent. The rate cut was to be achieved through expansionary monetary policy, and the Bank of Japan announced that it was prepared to purchase bills and government bonds aggressively as long as the deflationary spell continued. This was a significant concession by the BOJ that it was prepared to halt the deflationary spiral. Yet, rather than overtly confirm any merit to demands for controlled inflation, the BOJ only acknowledged the importance of price stability. In its statement the Bank said that measures being introduced would remain in place ‘until the consumer price index registers stably at zero per cent or an increase year-on-year’.38 This was only a modest shift in BOJ policy preference despite calls from Finance Minister Miyazawa and other Ministry of Finance officials for the BOJ to substantially expand money supply, to 5 per cent a year instead of 2 per cent, to halt the deflationary spiral and spur inflation. The governor of the BOJ, however, had been reluctant to follow this course of action, convinced that deflation was a healthy indicator that the economy was benefiting from innovations such as e-commerce, rather than a sign of fundamental economic problems.39 With interest rates at marginally above zero and expansionary monetary policy, the Bank of Japan also indicated that it might almost have exhausted its means to reflate the economy. In March 2001, as it effectively lowered interest rates to revive growth, it therefore added a warning that sustainable recovery was unlikely without ‘painful restructuring’.40 This was a signal that prospects for recovery were beyond the sole control

Financial Reforms in Japan 59

of the Bank. The Bank emphasized the importance of structural reform, including a sweeping and complete resolution of the bad debt problem even if it meant a large number of corporate failures and bankruptcies. In the aftermath of the Asian crisis banks were recapitalized and emerged as stronger institutions, but they still carried non-performing loans on their books. The alternative was that many of the debtor firms would be forced to declare bankruptcy and instigate a period of industrial dislocation. The BOJ was effectively telling the government that it was time to take the difficult decisions. In his review of Craig Freedman’s book on the collapse of the Japanese economy, Richard Katz points out that the Japanese government by pumping Y 46 trillion (US$434 billion) into recapitalizing the Japanese banks had essentially overcome the supply-side problem. To the extent, however, that there remained a large number of unprofitable, debt-laden firms, Katz added the dismal caution that the crisis was likely to be prolonged without decisive measures to eliminate the burden of nonperforming loans.41 Since the late 1990s, banks had been retiring some of their bad debt as part of their recapitalization process, but the pace of retiring bad debt did not keep pace with the accumulation rate. In fiscal year 1999 the 16 major banks in Japan wrote off about Y 4.5 trillion in bad loans and in fiscal year 2000 the amount of writeoff was Y 4 trillion, about Y 1 trillion more than profits for the year. However, as existing bad debt was being written off more was being acquired and the problem instead of diminishing in magnitude became progressively worse. There are several options that could be utilized to achieve the desirable reduction in levels of non-performing loans. The banks could, first, sell their bad loans to an American-style Resolution Trust Corporation, second, engage in debt forgiveness in exchange for corporate restructuring programmes and, third, call in their loans even if it meant forcing companies into bankruptcy. Market principles would require companies to be held accountable for accumulated debt and for past policy and investment failures and, indeed, in explaining its decision to return to a zero interest rate policy in March 2001 the BOJ also added its voice to the imperative of resolving the non-performing loans issue by calling for corporate reform and restructuring, even at the extent of forcing companies into liquidation. It emphasized that it had few other policy tools left to deal with the economic stagnation. Any invocation of market principles and responsibility would entail banks confiscating corporate assets and collateral and disposing of these at market prices to recover at least a part of their losses. Understandably, however, there are now concerns as well that the failure and bankruptcy of such large corporations as Kumagai Gumi would

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do more harm than good in exacerbating market sentiment and impeding economic recovery. The government certainly is not keen to see a repeat of late 1997 and the failure of, for example, Yamaichi Securities. Instead, the government appears to favour debt forgiveness and waiver, a strategy that forces lending institutions to accept partial responsibility for loose lending policies in the 1980s. Still, rather than penalize banks, Takeo Hiranuma, in charge of the Ministry for Economy Trade and Industry (METI, formerly the Ministry of International Trade and Industry, or MITI) suggested that it might even be possible for banks to deduct the cost of debt waiver from pre-tax profits. He explained that a formal plan for resolving the debt problem was likely to be announced early in fiscal year 2001.42 In early April, the government announced a set of measures to facilitate the disposal of existing bad loans within the space of two years and new bad loans within three years, through debt forgiveness, or by enforcing loan conditions to force borrowers into bankruptcy. Expectations, of course, were that banks would engage in debt forgiveness in return for corporate restructuring to avoid the social costs that would accompany large-scale bankruptcy. To the extent that corporate restructuring might entail involuntary redundancies, the government announced plans to provide better jobless allowances to those forced into involuntary retirement than were available to the unemployed.43 However, considering that banks, in fiscal years 1999 and 2000, had managed to write off only Y8.5 trillion in bad debt, it is excessively optimistic to assume that banks will somehow manage to retire the remainder of bad debt in either two or at most three years, without considerable financial support from the government. Even then, there may be serious deflationary consequences through rising unemployment as a result of forced and rapid elimination of non-performing loans. Credible estimates of the unemployment effect of any rapid disposal of non-performing loans are that the number of unemployed will rise by 2 to 3 million.44 This will no doubt be a severe drain on the public purse and it is uncertain, as yet, how the government can marry its social safety net obligations with the other objective of reducing public sector debt. Renewed pressure on banks to dispose of non-performing loans within a short period has other implications for the future of the corporate sector. Client firms that are cast aside by protective banks will become targets for foreign takeovers, and the concern is that many Japanese industries could pass into foreign ownership. For example, Ripplewood Holdings of the US which acquired the Long Term Credit Bank of Japan (now renamed Shinsei Bank) for US$1.2 billion has also set up Ripplewood Holdings

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Japan (RHJ) with a capital base of US$1.2 billion to acquire distressed corporations. It has already made three acquisitions and plans to acquire another six or seven Japanese companies by 2005, to be disposed of at a profit after rehabilitation in another 5 to 7 years. The policies of the Koizumi government have created opportunities for foreign investment funds, which are seen as vultures circling over the weakened Japanese corporate sector as they wait to acquire companies in short-term distress.45 After many decades of holding off foreign investors, the Japanese corporate sector is likely to undergo a major traumatic upheaval as a result of foreign acquisitions.

Conclusion The prolonged economic crisis, despite positive reforms in the banking sector and massive injections of public funds into new infrastructure and construction projects, suggests that problems go beyond supposedly simple solutions. Until the outbreak of the Asian crisis, however, the main measure for economic recovery constituted of large public works programmes to compensate for sluggish consumer demand. In the process the government added to its overall debt levels but failed to purge the impediments to growth. In the aftermath of the crisis, government measures have been more varied, and have included a serious and successful attempt to resolve the banking crisis through recapitalization and reform. According to Kiuchi, while most big banks in Japan were on sounding financial footings, it was still possible for small and regional banks to experience fresh difficulties in the recurrent phase of economic slowdown in 2001. Reform and recapitalization of the financial sector may have been a necessary precondition for sustainable growth, but without a resolution of the bad debt situation banks have continued to hold back on new lending, which has continued to post year-on-year decline. Many analysts have been convinced that it is essential to undertake significant structural reforms before growth can be sustained, but to date actual reform efforts have been modest.

4 Corporate Reforms

Apart from the well-known explanations of Japan’s economic success offered by mainstream economists (sound fiscal, monetary and taxation policies) and by developmental state theorists (state intervention in the economy), many analysts also regard the particular organizational and governance features of the Japanese corporation, the J-firm, as important determinants of economic success. Japan, however, has a bifurcated industrial structure and there are considerable organizational differences between the two types of firm. The first category is composed of a small number of large, modern corporations, many of which are interlinked into keiretsu groupings1 that are held together by cross-ownership of shares and by links to a main bank. The second category is made up of a large number of unaffiliated small- and medium-sized enterprises. The focus in this chapter will be on the former, which have driven Japan’s export success and international competitiveness. Because the keiretsu structure is specific to Japan, these are conveniently labelled ‘J-firms’, and there is an extensive literature on the main characteristics of the J-firm and its differences from western or American firms or ‘A-firms’. In the keiretsu-linked corporate structure, the central position is usually occupied by a ‘main bank’, so called because of its primary lending responsibility to keiretsu members. The position of the main bank was enhanced by a relatively high level of corporate dependence on bank finance for capital activities and investments. The main bank system had specific advantages for Japanese companies because relational, rather than arms-length, banking had the practical effect of liberating management from short-term profit considerations to focus instead on increasing market shares, both domestically and overseas. This proved particularly useful in ensuring the long-term success of Japanese firms in overseas markets where they were engaged in head-to-head competition 62

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with western firms. This was, of course, not the only source of Japan’s international competitive advantage. The industrial relations practices of large Japanese firms, with an emphasis on cooperative labour–management relations rather than the adversarial relationship found in western corporations, also contributed to their success. Western firms had few answers to the Japanese onslaught, but the resultant protectionist sentiment in western countries was based on other assumed or real factors, such as unfair Japanese trade practices, government support and subsidy, dumping, and denial of access to the Japanese market. Another ‘coping’ strategy was to try and emulate the Japanese model. Largely because of the many successes of Japanese corporations and their competitive strengths, Japanese management structures became a model for study and for emulation by western corporations seeking to derive the synergies of, for example, a more cooperative and less hierarchical work environment.

Main features of the J-firm The J-firm differed from western corporations and from ideal-typical models of corporate efficiency, as embodied in Taylorist principles. At the turn of the twenteenth century, Taylorist models of production efficiency emphasized specialization within the firm such that the entire production process was segmented into simple motions and specialized tasks. A high degree of specialization meant little sharing of knowledge and information across job classifications, and production workers operated as relatively atomized entities. This was a process of de-skilling the workforce and of replacing the craft and artisanal basis of commodity production with a production process that was simpler and highly specialized. But the absence of shared understanding of complex production processes contributed to a relative incapacity to cooperatively resolve periodic production problems and shop floor emergencies. By contrast to the way production was organized in A-firm, the J-firm relied less on specialized mechanical activities and more on cooperative skill-sharing. This was achieved by frequently rotating employees to perform different tasks in order to equip them with a better grasp of the total production process. This allowed for horizontal cooperation and such innovative strategies as shop floor quality control circles. This difference between the J-firm and the A-firm was reflected also in the nature of labour unions, which in Japan were organized across functional job classification within a specific company, rather than across company structures but around a specific functional task, as in the West.

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Although the quality control circle was a western innovation, it was most enthusiastically embraced first by firms in Japan. The introduction of quality control circles on the shop floor empowered production workers to deal with specific problems and issues. It also led to significant quality improvements and enabled Japanese manufacturers to discard their image as producers and exporters of cheap but low-quality products. This prompted some US firms, like the Lockheed and Honeywell corporations, to try and replicate the Japanese success story in the early 1970s. Each was able to generate substantial savings by introducing quality control circles. Large Japanese corporations also maintained a system of long-term employment and seniority-based wages. Under long-term employment, employees were retained across business cycles and a seniority-based remuneration system discouraged labour mobility and promoted loyalty to the company. It was beneficial for companies to try and retain workers because of the high costs of in-house training, and similarly workers found it beneficial to remain with one employer rather than lose seniority in a new position. Neither practice was, rigid, however, nor were all employees of the same company accorded the privileges and certainty of long-term employment. Seniority also was only one factor in determining wages, and Arne Holzhausen has pointed out that qualifications and competence were not overlooked. According to Holzhausen: As employees get older and obtain higher positions . . . the level of qualifications and competence . . . gains more influence on compensation and promotion decisions. Regular annual wage increases according to age and tenure continue, but their impact on overall income growth diminishes.2 A key difference, as noted above, was that J-firms relied heavily on bank financing, rather than on equity or capital markets. This, consequently, led to the development of strong organizational and contractual linkages with the primary lender, the main bank. By law, banks were restricted to share holding of no more than 5 per cent in any one firm, and a main bank usually held close to 5 per cent of outstanding shares of its client firm. The banking sector mediated the flow of funds from the household sector to the corporate sector and this was facilitated by government regulations to prevent banks from underwriting and brokering bonds, restrictions on bond issuance, and artificially low deposit rates that gave banks de facto subsidies.3 The banks were at the centre of the keiretsu-based industrial structures that emerged in the postwar period, following the

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dissolution of the prewar zaibatsu with family-owned holding companies as their core. In Japan, the main bank also had a role in monitoring firms and in ensuring prudential corporate governance in the absence of an external board of directors, a common feature of western corporate governance and management. In the J-firm, boards of directors were made up largely of individuals promoted from within the firm. The external members included former government and public sector employees (a practice known as amakudari, or descent from heaven), representatives of large block shareholders – often other firms within the same organizational grouping – and an executive from the firm’s main bank. The bank representative on the board of directors was not formally or technically an ‘outsider’, because the nominated individual would usually resign from the bank to become a ‘permanent employee’ of the firm. Even as an employee of the firm, the bank representative was still a useful source of information for the main bank and an important part of its monitoring and surveillance structure. When a firm encountered serious financial difficulties, however, the main bank often dispatched a current employee to act as director.4 The prevalence of relationship banking, as opposed to arm’s-length and rules-based banking, was often pointed to as a strength of the Japanese industrial structure, accounting for the superior competitive strength of the J-firm over the A-firm. Between 1945 and 1952, holding companies that held the zaibatsu together were disbanded so as to end their monopolistic grip and create a competitive industrial structure. Under Occupation directives, share ownership was widely dispersed among ordinary citizens, reaching a peak of 70 per cent in 1949. This period of shareholder democracy did not last very long, and share ownership quickly became concentrated in banks and other companies, as a result of mutually agreed cross-ownership of shares. By the late 1980s, individual ownership of shares in Japan had declined to about 25 per cent, compared with 60 per cent in the United States. There are various explanations for this shift from dispersion to compression of share ownership, one being that concentration of share ownership was prompted by fears of foreign takeover at a time when equity prices were low and Japanese companies an attractive target for acquisition; cross-ownership of shares, according to Miyajima Hideaki, emerged as the dominant strategy to block the foreign acquisition of shares and takeover of companies. Another explanation, suggested by Yishay Yafeh, is that the emergence of ownership concentration was related to efficiency considerations, since dispersed ownership allowed shareholders no means to control

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managers and ensure good governance. He has questioned the threat of hostile takeover as a credible explanation and argues that the reason individual and small holding lasted only briefly was simply that it left management unchecked and inefficient.5 To support his conclusion, Yafeh finds evidence that, other things being equal, ‘the greater the percentage of a firm’s outstanding shares expropriated and resold by the American authorities, the worse was the firm’s performance in the early 1950s’.6 A third explanation for the prevalence of share cross-ownership is that it was a deliberate strategy to protect companies from demands for ‘shareholder value’ and demands on their earning from outside interests. This, according to William Lazonick, prompted banks and industrial companies to take equity off the market by holding each other’s shares.7 Maximization of shareholder value is the essence of contemporary western capitalism, but Japanese firms colluded among themselves to enhance managerial autonomy from shareholder demands and to concentrate, instead, on increasing market shares. Whatever the specific advantages and strengths of the J-firm, it is not surprising that prolonged post-bubble economic crisis and corporate sector weaknesses raised doubts about the efficacy of main bank monitoring of business and investment decisions. Certainly, the industrial landscape of Japan still contained many examples of internationally competitive firms, such as Sony and Toyota, but a dramatic reversal in the fortunes of many other companies that had previously been successful raised inevitable doubts about prevalent management structures and practices. One of the basic weaknesses was that bank oversight of management and investment priorities was neither strict nor independent. The main banks could not exercise arm’s-length control because of their long association with client firms and the common practice of business-related socialization, such as drinking and entertainment. Banks were also perhaps less diligent because of an established government policy not to permit any of the major banks and financial institutions to fail. The ‘convoy strategy’ of the Japanese government was designed, first, to ensure that no single bank became so powerful as to undermine the viability of another financial institution and second, to ensure that ailing financial institutions were assisted by others to recover. The main banks were lax in ensuring prudential governance but, at least in the early postwar period, relationship banking had the advantage of releasing firms from the pressures and demands of a short-term profit horizon that confronted managers of A-firms, which relied extensively on equity markets for investment capital. Managers in Japan were not constrained by the imperative of having to declare profits and dividends

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on an annual basis. As discussed earlier they concentrated on strengthening market position, a long-term strategy of survival, rather than on profitability to satisfy shareholders’ demands for annual dividends. Also, because of the common practice of cross-shareholding among a group of firms (as discussed in the previous chapter), managers of corporations had considerable autonomy. Smaller but independent shareholders could not be relied upon to ensure prudential management. Indeed, cross-shareholding was intended to ensure that retail and small shareholders would have no managerial influence. Over time, and especially as a result of financial liberalization, the firm–main-bank relationship tended to weaken, and firms progressively increased their reliance on low-cost equity markets and international capital markets. This was true mainly for large successful firms with international brand image and presence. As a result, bank debt in corporate finance declined from 39 per cent in 1972 to about 13 per cent in 1997 for large Japanese companies, the latter figure not substantially more than the 9 per cent for large American firms.8 The erosion of main bank linkages, according to Hoshi Takeo, was particularly prominent for firms with large amounts of collateral, which sought other avenues of raising capital, such as bond and equity markets.9 In the 1990s, relationship banking was strained also by economic stagnation, which made it harder for banks to continue to stand by and support struggling corporations. These changes to relationship banking were clearly manifest in the collapse of Sogo department store in 2000, as a result of its main bank’s refusal to bail out a large client. In general, according to Lazonick, the increase in the number of bankruptcies in 1997 and 1998 among large Japanese companies was a result of the unavailability of bank credit.10 In earlier periods, banks could be expected not to push a large client firm into bankruptcy, but now they were constrained by a rising proportion of non-performing loans. Still, the collapse of Sogo was probably an exception rather than a harbinger of immediate changes in the nature of main bank and firm relationship. Negating the symbolic value of Sogo’s collapse, the reality was that many banks continued to hold onto non-performing loans, preferring to preserve the firm–main-bank relationship rather than allow market rationality to determine the fate of unprofitable firms. In 2001, this re-emerged as a focus of attention as Japan reversed into recessionary conditions amid concerns that non-performing loans and bank willingness to carry such loans on their books were impeding recovery. In early April 2001, the government declared its intention to push for a complete resolution of non-performing loans within a short period of

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two to three years. Japanese banks had progressively tackled the problem of non-performing loans, writing off about Y59 trillion in such loans over a nine-year period since fiscal year 1992, but this had been achieved within the framework of main bank relationships. It is estimated that problem loans amount to Y150 trillion and their resolution, based essentially on balance sheet considerations as is being suggested, will likely have a serious impact on bank–client relationships.11 Despite government assurances of financial assistance, a quick resolution of remaining problem loans will no doubt lead to major bankruptcies but also have a flowthrough effect on small and medium-sized corporations. In future the firm–main-bank relationship is certain to change very significantly as a result of the proposed resolution of NPLs. As mentioned above, financial liberalization had expanded the menu of choice for managers. Access to new sources of corporate finance understandably affected the behaviour of firms, but there was little fundamental change in the way their production was organized, in their cooperative labour–management relations or in their employment practices.

Corporate reforms and convergence As was to be expected, the long period of economic stagnation in the 1990s cast fresh doubts about the merits of the Japanese model of corporate governance in the era of economic globalization. Japanese management practices became associated with loss of creativity and competitiveness firms, since remuneration was based not on excellence and merit but on seniority and corporate loyalty. Almost imperceptibly but with enormous economic consequences, the so-called strengths of Japanese industries were recast as weaknesses to be avoided rather than emulated. Increasingly, the J-firm came to be seen as part of the overall problem plaguing the Japanese economy. The new understanding was that J-firms had become too ossified and unable to respond quickly to changing market conditions, no small disadvantage in a globalized world economy. Consequently, there emerged a robust debate on the importance of restructuring the basic organizational principles of the J-firm. Interestingly, however, this debate was more a feature of western analysis of Japanese management and less in evidence within Japan itself. At a more subdued level, corporate rationalization and reform has been debated in Japan since the early 1990s as being essential to overcoming lingering economic malaise and to improve company outlook. Actual initiatives were incremental and adaptive rather than radical. This

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prompted the former chair of the Financial Restructuring Commission, Yanagisawa Hakuo, to lament the absence of a bold and decisive leader to reform an ailing Japanese economy, like John Reed who had successfully turned around Citicorp and saved it from collapse in the early 1990s.12 The slow pace of reform belied the worsening state of some of the leading manufacturing sectors, such as the automobile industry. This industry, an outstanding success in the postwar period, was beset with problems arising from excess capacity. Two of the leading manufacturers, Nissan and Mitsubishi, were hit particularly hard by the slump in sales. The difficulties facing some auto manufacturers also affected other industries. The pain was not uniformly shared, however. Toyota Motor Corporation was a prominent exception and able to maintain its international competitiveness and profitability into the 1990s. Likewise, Sony Corporation too remained strong and profitable and defied the gloomy conditions facing others. Nonetheless, the general picture was one of poor performance and declining profitability. Stagnant and declining domestic consumption levels added to the woes of Japanese corporations. In the US, the decline of net after-tax profit of non-financial domestic firms from 10 per cent in 1965 to less than 6 per cent in the late 1970s13 was a signal for large-scale corporate restructuring and rationalization, but declining profitability in Japan produced no similar outcomes. In Japan the ratio of operating profits to operating capital for small and medium-sized companies in the manufacturing sector declined from 3.9 per cent in 1990 to –0.3 per cent in 1998, and in chemical industries the decline was from 5.8 per cent to 2.2 per cent.14 But, as noted above, the Great Stagnation did not affect all industrial sectors equally. Some industries, such as electrical machinery, continued to post good growth through the 1990s, but in iron and steel, for example, the production index declined from 109.8 in 1990 to 88.7 in 1998 (1995 = 100). The fall in general machinery was from 116.0 to 89.1 and in the transport equipment industry from 113.5 to 103.8.15 The crisis in the Japanese corporate sector was plainly manifest in failures and bankruptcies. Compared with 1990, when there were 6468 cases of bankruptcy, in 1997 and 1998 the number reached 16 365 and 19 171, respectively. The number of corporate bankruptcies was also high in 1985 (18 812) but the total amount of liabilities owed by these firms was only Y4.2 trillion, compared with Y14.0 and Y14.4 trillion in 1997 and 1998, respectively (see Table 4.1). It should be emphasized that the rise in bankruptcies in Japan in the 1990s was not a result of reckless management, which was a contributing factor in a relatively small percentage of total bankruptcies. Instead, poor economic performance and the stagnation of

70 Japan in Crisis Table 4.1 Corporate failures in Japan Bankruptciesa

Amount of liabilitiesb

Cause of bankruptciesa Reckless management

1980 1985 1990 1995 1996 1997 1998

17 884 18 812 6 468 15 086 14 544 16 365 19 171

2 707 4 186 1 945 9 033 7 994 14 021 14 381

5 778 5 336 2 851 3 085 2 728 2 802 2 785

Stagnation of sales 5 230 6 416 1 613 7 745 7 546 8 716 11 229

Source: Japan Statistical Yearbook 2000, Statistics Bureau, Management and Coordination Agency, Government of Japan, Tokyo, 1999 (November), p. 204, table 5–14. Notes: (a) = number of cases; (b) = yen in billions.

sales were responsible in a high proportion of cases. In 1990 reckless management practices had contributed to 44 per cent of corporate failures, whereas stagnation of sales accounted for 30 per cent of all bankruptcies. By contrast, in 1997 and 1998, stagnation of sales accounted for 53 per cent and 58 per cent respectively of all bankruptcies, whereas reckless management was responsible for only 17 per cent and 14 per cent of total failures.16 It appears, therefore, that management practices and the muchvaunted Japanese model were not directly to blame for corporate failures in the 1990s, but these statistics do not provide a full understanding of the complex corporate situation in Japan. As mentioned in the previous chapter, there are a large number of unprofitable and debt-laden firms (confirmed, as noted above, by the higher liabilities of firms that were forced into bankruptcy) which have somehow avoided foreclosures because lending institutions have been prepared to carry the nonperforming loans on their books. It is clear that many corporations have been allowed to continue trading which under full market discipline would face liquidation and bankruptcy. The full extent of problems within the corporate sector is unascertainable, and statistics do not provide a complete picture. During the bubble economy years Japanese corporations were guilty of profligate spending and unwise capital investment decisions, but aided and abetted by their main banks avoided the consequences of their inappropriate decisions. At the same time, it needs to be emphasized that good management assumes an ability to respond to changing market conditions. In Japan, a sustained sales slump should have prompted firm-level rationalization

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and restructuring, but that did not eventuate to any significant degree. There is no suggestion that corporate reform and rationalization is a solution to the macro-level problems confronting the Japanese economy, but corporations were slow to admit to their own weaknesses and overcome hindrances to international competitiveness. Crises and adverse economic conditions confront many firms across the world, but what was unusual about the Japanese crisis was that firms opted not to undertake necessary reforms for an inordinately long time. The crisis had more complex causes and it represented uncharted waters for Japanese managers and for a management model that was universally acclaimed as superior. As mentioned, there were crises before, but corporations had dealt with them more successfully than in the 1990s. For instance, after the oil crisis of 1973 Japanese corporations quickly adapted to changes in manufacturing outlook and resumed their normal growth trajectory after a short setback. The yen shock of the mid-1980s, resulting from its rapid appreciation, was also quickly overcome with minimal disruptions to economic prosperity. Corporate response to the crisis in the 1990s was, as before, to try and adapt rather than submit to a regimen of radical and uncertain changes. In a similar situation in the 1980s, western firms had engaged in extensive corporate rationalization and exited their economic crisis in a much stronger position. Clearly however, reform is over-due in Japan. It is tempting to attribute the irresolute nature of reforms to labour market rigidities and a longterm employment system that denied individual firms the capacity to rationalize production and shed excess workers or to treat labour costs as a variable. The reality is that long-term employment in the large corporate sectors is less rigid than it may appear, and historically firms were able to manage and manipulate labour costs by shifting surplus workers to subsidiary corporations and subcontractors. Japanese enterprise unionism also meant that employees could be redeployed within a firm across functional skills, and in the past firms had relied on this to manage ‘permanent’ employees and in response to shifting market conditions. Another source of flexibility for corporations was the wages structure, composed of fixed monthly salary and half-yearly bonuses. Even though the base monthly wage was fixed and linked to employee seniority,17 firms had considerable latitude in adjusting bonuses to reflect operating conditions and profitability. These measures could assist firms in coping with only short-run difficulties rather than a prolonged recession. Consequently, observers and analysts have puzzled at the timid nature of response from Japanese managers. One explanation may be that, despite poor performance, there was no perceived need within Japan for

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radical corporate reform in the expectation of economic recovery. Conversely, the need for reform may simply be a manifestation of western expectations of a desirable convergence on western management strategies. Indeed, it might be argued that much as the West, in particular the United States, expected Japanese reform, Japanese executives themselves seemed determined to avoid it. American expectations may perhaps be traced to the history of US sponsored reforms during the American occupation of the country, and influenced, in the contemporary period, by reforms in East European countries and elsewhere. It may have been patently obvious to many outside observers that Japanese management practices were compounding existing economic difficulties, but within Japan the imperative of reform was neither uncritically nor commonly accepted. Within Japan there was still a considerable body of opinion that minor adjustments and modifications of the acclaimed Japanese management model, rather than wholesale reform, would suffice to overcome present difficulties. The absence of urgency might be attributed to the fact that average annual GDP growth rate in the 1990s remained positive, even if it was low by historical standards or in relation to other advanced industrial economies. In the 1990s, GDP grew by an average of about 1 per cent per year and while this was a far cry from the heady days of the 1960s, it did not necessarily point to a massive breakdown of the system in place. Certainly, unemployment in Japan had reached record high levels, but at 5 per cent in 2002 was not a critical social problem. In reality, despite sluggish economic performance, there was no critical or vocal majority that demanded radical reform. Moreover, Japan’s changing demographics meant that the unemployed would ultimately be absorbed into the workforce as a result of the labour shortage anticipated in the not too distant future. It is for this reason that the chairman of Toyota Motor Corporation, Okuda Hiroshi, expressed the view that corporate rationalization was unnecessary, and might even damage company prospects of retaining and recruiting workers in future if it resulted in a loss of workers’ trust in the company. In place of corporate rationalization, he argued, management had a responsibility to retain and retrain workers, and to redeploy them in new business activities. According to Okuda, the real task confronting Japan was to transform an ‘economy of worry’ into an ‘economy of confidence’. He suggested that this could be achieved by dropping the obsession with ‘income equality’, as reflected in the seniority-based wages structure, and instead by generously rewarding successful entrepreneurs and innovators, through a system of incentive pay. This, according to Okuda, would create a culture of creativity and enable Japan to regain the lead in inter-

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national competitiveness.18 In effect, this was an argument against economic rationalization and in favour of adjustment, even abandonment, of only one component of Japanese labour—management practices. There have been many arguments in favour of reform, including suggestions that technological creativity increasingly demands a more individual-centred structure rather than the cooperative, group-oriented management style prevalent in Japan. It is not uncommon to find suggestions that the bias in favour of rewarding conformity rather than individual excellence is self-defeating in the new phase of competition in information technology and globalization, and that Japan faces an important task of repositioning itself to compete at the frontiers of modern technology. As with any transformation, emulation of western management practices will entail costs and for that reason proposals to that effect have not generated overwhelming support. Ronald Dore, for example, has rejected any need for Japan to move towards a more individual-centric system and away from cooperative structures.19 According to Dore, radical reform would only undermine the valuable gains of the postwar period. He argues that Japan has developed a better form of capitalism, compared with the American type of individual-centric capitalism, based on social solidarity, cooperative employee–management relations and respect for egalitarianism. He expresses the concern that the push for rationalization would erode the bases of Japanese capitalism, namely on equality and social justice. Even if we discount the technological imperative as a factor necessitating changes, the rationalization of Japanese industry is an imperative of economic globalization, which demands an ability to respond flexibly to global economic forces. Rationalization does not necessarily imply that Japanese practices will converge on western practices. The main advantage of Japan’s consensus oriented, knowledge-sharing and inclusive industrial relations is that these practices tend to erode artificial barriers between management and workers. By contrast the western style of sharing knowledge only on a ‘need-to-know’ basis limits the flow of information from management to production workers and maintains a divide that has had many deleterious consequences. For example, in the West, globalization is perceived by workers as a threat to employment and job security and have led to conflict and resistance, as when the World Trade Organisation or the World Economic Forum, institutions seen as instigators of globalization, have held meetings in the US, Australia and Europe. Each meeting was disrupted by pitched battles and demonstrations to convey the message that globalization was unacceptable to many sections of the population.

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On the other hand, globalization has not raised the same concerns in Japan. In Japan employment may be more secure because of the anticipated labour shortage, but it is so also, at least partially, because of a management style that is inclusive and empowering. Even as Japanese firms embrace rationalization and streamline their production processes, there is no evidence to suggest that the cooperative and sharing style of industrial management is being abandoned. Managers are likely to give greater emphasis to the bottom line and shareholder interests, largely because of increased sensitivity to market discipline as a result of weakened ties with main banks and increased reliance on non-bank finance arrangements, but there is no reason to assume that this must be at the expense of stakeholder (employee) interests and the cooperative features of Japanese labour–management relations.

Corporate reform in Japan According to Pempel, contemporary pressures for reform in Japan stem also from the series of adaptive changes in the 1970s and 1980s that had introduced contradictions into the system which can be resolved now only through major reform, not adaptive change. Some of the series of adaptive changes T. J. Pempel cites as having led to the need for major reform, or regime shift, include overseas investment, which weakened organized labour, subcontracting firms and main bank relationships; deficit financing, which produced a backlash within the business community and the Ministry of Finance against following western-style welfare politics; and the politicization of policies which initially was beneficial for the ruling LDP but ultimately produced the demand for change when it was blamed for rising corruption in politics.20 Through it all, the rise of conservative forces and demise of left-of-centre and socialist interests may be seen as providing the context for economic reform and rationalization. Socialist politics and stagflationary pressures in the 1970s were part of the forces that produced the Japanese style of capitalism through a series of adaptive changes. The process of adaptive change was similar to what Imai described as kaizen, the progressive improvement of existing processes and structures. According to K. Imai, Japanese-style capitalism and management are typified by a commitment to improving existing technologies. He argues also that this differs from western emphasis on innovation and major reform, which is concerned more with replacing existing technologies with superior forms.21 It is possible, as Pempel has argued, that the cumulative effects of adaptive change had produced a

Corporate Reforms 75

situation that was more dysfunctional than productive, and that it was this realization that was driving the pressure for comprehensive rationalization and restructuring. As well, declining profitability of previously competitive industries is a powerful incentive for reforms to regain lost international competitiveness. It is understandable that the reform movement has gathered momentum since the Asian crisis and banking reforms. According to Sato: If Japan is to remain viable in the new era, there must be systemic change as fundamental and momentous as the 1868 Meiji Restoration and the 1945 postwar reform. However, the current change must come from internal sources and in peaceful conditions. This will certainly be difficult to achieve.22 Unlike in 1868 and 1945, the impetus for reform and rationalization at the turn of the century has to come from inside. This makes the current task more difficult to achieve. Moreover, even as reforms are initiated, there can be no expectation that this will produce some kind of convergence. It is likely that corporate rationalization will change the topography of Japanese capitalism, but it requires a considerable leap of imagination to assume that there will be a comprehensive convergence on western patterns or that issues of social justice and equity will be completely subsumed by western-style competitiveness. The Japanese corporate sector in the late 1990s appeared to be taking its cue from financial sector reforms to restructure and rationalize domestic production. These were forced upon businesses in order to reduce production costs and enhance international competitiveness. As noted above, the chairman of Toyota Motor Corporation cautioned against downsizing, urging instead that firms should deploy redundant workers into new activities. At the same time, he noted also that Toyota had survived the 1990s better than other car manufacturers in Japan by assiduously concentrating on its core business rather than following the trend of the late 1980s and becoming involved in new activities and zaiteki (financial technology). And he conceded that in the final instance he too would be prepared to shed workers but that he would also tender his own resignation to accept responsibility for mismanagement. For many Japanese companies faced with stiff international competitiveness and declining profitability there is no option but to concentrate on core activities and shed redundant workers. Porter et al. argue that in order to survive in a competitive global environment, Japanese firms must rediscover ‘strategy’, the ability of making

76 Japan in Crisis

hard choices about what not to do and what not to produce. Instead of simply converging on their competitors, Japanese firms have to seek out a distinctive and unique product niche as have American firms where, for example, Dell, Gateway and Apple ‘have each had distinctive strategies and been highly profitable in most years . . . ‘23 These authors suggest that the real problem confronting Japanese firms has been that they have become too broad-based rather than concentrating on their specific competencies. This may be attributed to the penchant for imitation and for becoming more like others rather than standing alone and focusing on doing what they do best. Thus, instead of concentrating ‘on certain products or groups of customers, Japanese companies succumb to the temptation of pursuing broadly based strategies . . . By doing everything, though, Japanese companies become unique at nothing.’24 This ‘me-too strategy’ of imitation and excessive product and consumer diversification was a product also of an obsession with market shares, which led to excess capacity25 and exacerbated profitability problems. Companies worried more that their market share was slipping instead of being concerned about sliding profitability. The strategy of prioritizing market shares over profitability was underpinned by low levels of reliance on equity capital and was acceptable to the main banks, the main source of investment capital, which had a longterm outlook of their relationship with firms. However, following financial deregulation in Japan, firms were able to diversify their capital sources to equity and money markets. For example, bank borrowings ‘made up nearly 77% of total corporate finance in 1965–69; by 1990–91, this had dropped to 42.5%. Bond issues that had been below 10% jumped to 42% during the same period.’26 One consequence of this development is the imperative of focusing more on profitability in order to satisfy shareholders. In previous years, the profit motive could be played down as long as recessions were short in duration and did not require drastic measures, such as layoffs, to improve corporate cost structures. Banks too, given the magnitude of bad debt, are more sensitive to the profitability of borrowing institutions. In the depressed economic conditions, a newly discovered profit motive has forced firms to consider corporate rationalization, plant closures and layoffs in order to reduce the surplus production capacity that was added during the bubble years and not withdrawn even after production had shifted to cheaper production platforms in East Asia. Rationalization may have become imperative, but it has not easily been undertaken for reasons of tradition and social responsibility. However, financial sector reforms, forced on banks by the government, has had a

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profound learning effect on the corporate sector as well, although it is unlikely that rationalization will go as far as it did in western countries in the 1980s. Rationalization has come to Japan a decade after western firms began downsizing and restructuring their operations, but it is unlikely that Japanese firms will copy the western model. Instead, we are likely to see a middle ground between ruthless restructuring and corporate social responsibility. Corporate reform in Japan is being introduced with considerably more vigour now, after nearly a decade of poor economic conditions and more than a decade after rationalization and reform had become the norm for corporate success in the West. The initial response of Japanese firms to the contemporary economic crisis was not unlike their response to previous economic downturns, namely measures such as limiting overtime work, reducing and/or suspending the recruitment of mid-career workers and graduates and transferring and/or loaning out workers to subsidiaries and other affiliated corporations.27 Such measures helped but could not resolve the problem of surplus production capacity. There are other explanations for the slow acceptance of the need for corporate rationalization to deal with the post-bubble economic crisis. In a recent study, Richard Katz has explained the absence of reforms in Japan in terms of a closed Japanese economy. According to him, trade liberalization is an essential requisite for successful reform, but in Japan the tendency within the corporate sector, and one sanctioned by governments, has been to buy the foreign producer rather than foreign products. Katz finds evidence for this in the increase in ‘captive imports’, i.e. imports into Japan by Japanese firms producing overseas (either through foreign acquisitions or in new plants). For example, in the period 1990–95, captive imports more than doubled, but because of their very nature had failed to produce reforms and productivity gains. He argues that What Japan really needs is a tidal wave of imports from non Japanese companies. Where even a small amount of imports can get their foot in the door, the effect on bringing down monopolistic prices . . . has been phenomenal. Tuna prices dropped 63 per cent during 1995, beer fell 32 per cent, whiskey 17 per cent, PCs 30 per cent and gasoline 20–25 per cent.28 The reality, as mentioned above, is that not all sectors of the Japanese economy suffered during the poor economic climate during the 1990s. Individual industries remained competitive and the case for reform was not as compelling for all sectors. Moreover, Japanese industries still

78 Japan in Crisis

retained their technological and manufacturing excellence. Even so, reform in the banking sector demonstrated that built-in obstacles to reform, such as the practice, of lifetime employment, could be overcome to secure greater productivity gains. It cannot be denied that Japanese firms have laboured under unfavourable cost structures, especially in the 1990s. The example of banking reforms, in conjunction with progressive deregulation, openness and withdrawal of protection to industries, provided a strong incentive to implement necessary reforms in the corporate structure. Compared with those of other advanced countries the Japanese economy had been one of the most tightly regulated, and the regulatory structure benefited certain industries, which did not have to cope with the rigours of the market place.29 Regulatory protection permitted industries to derive economic rent and operate successfully even with a high cost structure. In the absence of competitive pressures to maintain a lean operating structure, firms became bloated with excess workforce. That luxury, however, was no longer available to the corporate sector because of slow growth and deregulation. However, as mentioned in Chapter 3, the pace of deregulation has been slower than might have been expected and has been hampered by resistance from protected industries. Rationalization in Japan also is unlikely to be as far-reaching as it was in the West, and that is largely because of a taboo against layoffs. In the postwar period, the large industrial sector guaranteed employees lifetime employment as part of an earlier compromise in return for industrial peace. Lifetime employment has achieved the status of long tradition and there is a strong aversion to workforce reduction. To some extent, the practice of lifetime employment served as a privately funded welfare mechanism, in which a redundant workforce was retained on the company payroll rather than being transferred to an inadequate and poorly funded public welfare system. It was also essentially an instrument for ensuring social justice and a reminder to firms that their responsibilities extended beyond the corporate bottom line to the welfare of their employees. When overall economic conditions were robust, surplus workers were often retrained to perform other functions. This ability to redeploy workers was an important counterpart to lifetime employment and facilitated by enterprise, rather than functionally based, unionism. Often, however, many surplus employees were retained even when they made no contribution to the company at all. With limited options for rationalizing production, labour costs continued to balloon out of proportion. A study by Lehman Brothers on unemployment in Japan in June 1999 has revealed that labour costs had

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increased to 57.5 per cent of gross domestic product over the previous ten years from the recent average of 55 per cent. It calculates that if industries were to restore labour costs to recent averages by retrenching surplus labour then the resulting unemployment rate would be around 8.3 per cent, well above the 1999 high of 4.6 per cent. More sombre was the assessment that if labour costs were reduced to the US level of 48 per cent then Japan would have an unemployment rate of 19 per cent.30 All these suggest a high level of hidden unemployment in Japan and the situation is not unlike that in China, where state-owned enterprises (SOEs) retained excess workers despite poor profitability in order not to create large- scale social dislocations. With prolonged economic recession in Japan, firms increasingly found it difficult to continue with the established tradition, but still there remained for a considerable period a general reluctance to take the necessary steps to streamline and rationalize operations. Reform in the banking sector and a further worsening of economic conditions in the late 1990s became catalysts for increased acceptance and inevitability of rationalization. Even so, while Japanese banks have committed themselves to substantial reduction in their workforce, the same degree of rationalization cannot readily be expected from other Japanese industries. Restructuring of the banking industry was inevitable because of a dependence on public funds, but other industries are not compelled to follow restructuring with the same urgency. Nonetheless, even if rationalization in other sectors of the economy does not match the scale of the western rationalization in the 1980s, some rationalization is inevitable, and not only because ownership and control of some of the leading Japanese corporations, such as Mitsubishi, have passed to western interests. According to estimates, Japanese firms employ about 4 to 5 million surplus workers. While the imperative of reform is well understood, management has been unable to deviate substantially from traditional practices of lifetime employment and seniority-based wage rates that have dampened profitability. Restructuring would be an acknowledgment of management failures and tarnish the image of large corporations. Still, difficult as it was, Sony Corporation, in early March 1999, announced that it would reduce its workforce by about 17 000. Likewise, Mitsubishi Electric announced job cuts of 6 000. Similar job cuts will be necessary in many other large corporations, which are burdened with surplus workforce. However, some corporations, in deference to traditional work practices, have opted to reduce their workforce through natural attrition. In early 1999, for example, Hitachi Metals Limited announced that it would reduce its workforce by 13 per cent, but

80 Japan in Crisis Table 4.2 Company restructuring in Japan Company Sony NEC Toshiba Mitsubishi Electric Mitsubshi Chemicals Toyo Engineering

No. of employees

Layoffs

Completion date as at September 1998

170 000 150 000 66 500 45 440 11 545 1 438

17 000 15 000 6 500 6 000 2 000 350

March 2003 March 2002 March 2000 March 2002 March 2001 March 2000

Source: Shukan Toyo Keizai, 17 April 1999, p. 22.

through a process of attrition. This timid approach is unlikely to produce a streamlined workforce in the immediate future, and this will continue to impede international competitiveness, even with the technological edge of Japanese firms. Table 4.2 lists some of the declared cuts in workforce by major Japanese corporations and their completion schedules. Corporate rationalization, however, is more than job reduction and corporations that had acquired new assets and activities in the 1980s are expected also to slough off the ancillary activities and concentrate more on the core businesses. Mitsubishi Electric, for example, announced that it would begin disposing of unprofitable subsidiaries and reduce the total number of subsidiaries from 180 to 140 by March 2001.31 Similarly, Sumitomo Corporation announced that it would reduce the number of its subsidiaries from 300 to 150. In late October 1999 Nissan Motors announced that it would reduce its global workforce by 21 000 (14 per cent) as well as close three assembly plants in Japan. Similar reductions in workforce were announced by a number of other Japanese car manufacturers in mid–2001. The problems confronting Nissan can be traced to its challenge to Toyota’s supremacy in the 1980s, the plan having come unstuck when the Japanese economic bubble burst. Amid declining sales, the entire auto industry, in particular Nissan, was left with a large unused capacity, but plant closures were not an easy option. At its peak in 1990, total auto production in Japan was about 13.5 million cars, but by 1997 it had declined to about 11 million cars, leaving a surplus production capacity of at least around 2.5 million units.32 Nissan ultimately announced a decision to shut some manufacturing facilities, but symptomatic of the difficulties in reducing employment within Japan, the company also offered assurances that workers in closed assembly plants would be deployed to other sectors within the company.

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Industrial restructuring in other sectors was also necessitated by a pool of excess workers, poor domestic demand and the excess capacity created during the bubble economy years in the 1980s. Figures for 1998 show that capacity utilization in most industrial sectors was down to around 70 per cent or less. The problems for industries in Japan are compounded by weak domestic demand, as evidenced by falling sales in the retail, housing and car markets. Mergers and acquisitions, under the euphemism of corporate rationalization, were a feature of western economies for a number of years and had now also arrived in Japan. According to The Economist, there were ‘908 deals involving Japanese companies last year [1998], nearly 30 per cent more than in 1997, and more than double the number of deals in 1993’.33 The government did not, indeed could not, take a completely laissez faire attitude toward troubled companies. In 1999, it decided to provide subsidies to the troubled Nissan Motor Co. to assist its recovery. The minister for international trade and industry stated that the government had the responsibility to assist a leading industry. Government assistance for a troubled but important domestic industry was not unprecedented, even in the West. There are many examples of government subsidies to declining firms, such as the Chrysler Corporation in the US, which averted potential bankruptcy with the help of government protection and a rescue package. Assistance to Nissan would be incontrovertibly counterproductive only if it used the breathing space to stave off internal restructuring rather than taking the opportunity to improve its product line and performance. Given the imperative of rationalization, a dilemma for Japanese firms was that signs of tentative economic recovery and growth only made it more difficult to maintain the momentum of reforms. However, complacency would only temporarily delay the inevitable day of reckoning. At the same time, rationalization and layoff of workers in the middle of economic stagnation only exacerbated a worsening unemployment situation. In February 1999, unemployment in Japan stood at a record 4.6 per cent, increasing to 4.8 per cent in May 1999. These figures were not very high in comparative terms but represent an entirely new development in Japan, a country used historically to very low levels of unemployment. Rationalization, however, was essential to long-term recovery and to the international competitiveness of some of the key manufacturing sectors in Japan. To date, however, the record of achievement is mixed and many large firms remain generally supportive of traditional practices, including longterm employment. In order to preserve lifetime employment practices there have been only limited retrenchments, and seniority-based wages also

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remain an important determinant of wages despite an increased focus on merit-based pay. Chris Pokarier suggests there are important consequences of this tardy response from Japanese management, and that by retaining senior employees and scaling back the recruitment of fresh university graduates firms have been disadvantaging themselves in terms of future flexibility, efficiency and dynamism.34 It should be emphasized that industrial competitiveness cannot be achieved through rationalization strategies alone. One of the key features of Japanese industrial structure was a heavy reliance on intra-keiretsu contracting. Subsidiaries and affiliated corporations played an important role in supplying parts and materials, and in turn these subsidiaries were relied upon to park ‘surplus workers’ transferred from head office or to lower the cost structures for the parent corporation, as happened during periods of yen appreciation. Major corporations, in their attempts to retain export competitiveness, put pressure on their subsidiaries to reduce prices,35 a strategy that essentially transferred the pain of competitive adjustment to subsidiaries and affiliated firms. These networks have become less important as firms reduce intra-keiretsu contracting to source parts and materials in a competitive market environment and as the rationalization of workforces reduces the importance of keiretsu firms to offload surplus workers. Decreasingly, as noted above, large Japanese firms are in the process of reducing their subsidiaries and affiliates. As mentioned before, the deflationary consequences of rationalization are significant. Highlighting this danger, Paul Krugman urged the Bank of Japan to adopt ‘irresponsible policies’ and set an inflation target to counteract economic deflation and to stimulate consumption demand.36 The importance of encouraging consumer spending cannot be overemphasized because banking reform, necessary as it is, will not by itself lead to economic recovery. The Japanese government confronts a dilemma in that sustained economic recovery will depend on Japanese consumers changing their consumption and savings patterns, but a willingness to forgo savings for consumption can happen only when they regain confidence in the economy. Indications are that the mood of Japanese consumers in 1999 was much less confident than in 1998. An Asahi Shinbun survey in March 1998 had found that 77 per cent of respondents were worried that recession would impact on their household’s future income or employment prospects, but in April 1999 a similar survey revealed that 82 per cent of respondents were either highly or somewhat concerned that recession would have adverse effects on income or employment prospects. Until and unless consumer confidence is restored, it is likely that full economic recovery in Japan will be a lengthy process. When in

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the April 1999 survey consumers were asked to identify the necessary conditions for restoring confidence in the economy, the most common response was a reliable welfare system (36 per cent) employment stabilization (35 per cent), tax cuts (13 per cent) and elimination of fiscal deficits (12 per cent).37 In a sense, the Japanese economy was gripped in series of vicious cycles that impeded recovery. For instance, lack of consumer confidence had resulted in low consumption and poor economic performance and was itself a result of rising unemployment and economic uncertainty. It is important to reverse this trend to restore consumer confidence. Yet the rise in unemployment levels is not unrelated to industrial restructuring within Japan, without which Japanese industries are unlikely to recover their international competitiveness. At the same time, it should be understood that restructuring programmes to date remain rather modest, compared with the restructuring and rationalization implemented by western firms in the 1980s to improve their international competitiveness and productivity. Most of the job losses that were announced targeted overseas operations rather than in Japan, where the size of the workforce was to be reduced gradually through attrition and reduced annual intake.38 These were very tentative attempts at restructuring, and Japanese management has yet to demonstrate its willingness and capacity to radically overhaul operations in Japan. Until the late 1980s, Japanese management practices were held up as a model for emulation for their success in, for example, achieving high levels of worker motivation and team spirit. This style of management had built-in rigidities but was suited for hard manufacturing of products and components. Japanese management now has to prepare itself for the softer side of production, such as intellectual property and software, and this requires a more flexible approach to workforce levels. It is not easy to abandon a set of structures that worked well for half a century, but the ability to adapt to changing requirements will ultimately determine Japan’s future economic success.

Conclusion Japanese corporate structures and governance features had contributed to economic success, but some of the earlier sources of strength have become weaknesses holding back economic recovery. As noted above, government-sponsored financial sector reform has had a ripple effect through the Japanese industrial structure. Corporate rationalization became a feature of corporate culture in Japan, but of course rationalization is nothing new. The Japanese government had been intricately

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involved in rationalizing and strengthening Japanese industries in the heydays of industrial policy controls, especially in the 1960s when mergers were encouraged to ensure that Japanese firms did not become easy targets for foreign takeovers. Miyajima points out that a majority of reorganizations and mergers that occurred were predominantly ‘among firms related to one another in terms of personnel or capital; that is, those in a parent–subsidiary relationship before the merger, or firms within the same bank-centered keiretsu’.39 It is ironical that while some of the earlier restructuring efforts were intended to stave off foreign acquisitions, necessary reform and restructuring of corporate structures is now being facilitated by foreign presence in the corporate landscape of Japan. The foreign presence has increased significantly in the period of the Great Stagnation. For example, foreign investment in Japanese stocks in fiscal year 1994 was Y16.4 trillion but had increased dramatically to Y99.6 trillion in fiscal year 1999.40 Foreign owners of Japanese corporations have aggressively pushed the reform agenda, and it is likely that as banks are forced to resolve their nonperforming loans more Japanese firms will become targets of foreign acquisition. This can be only a positive influence on the restructuring process. In the contemporary period, most of the emphasis has been on rationalization of excess staff, but the agenda for reform extends to a review of the keiretsu networks and their continued relevance in a more competitive global environment. There is also evidence of a shift in focus on core activities and some firms have divested their non-core businesses. Industrial rationalization and restructuring programmes are being adopted by many Japanese firms, albeit with a considerable lag after similar efforts in western countries. Some of the pillars of Japanese labourmanagement relations, including lifetime employment, are being gradually eroded. According to Matsumoto Shinsaku of the Japan Institute of Labour, ‘It isn’t showing up clearly yet in the rate of people changing employment or the other statistics, but on the conceptual level at least, the lifetime employment system is breaking down.’41 At a superficial level, ongoing reforms give the impression that Japanese industrial and management practices are convergent, but it is unlikely that Japanese firms will follow the western lead in ‘rationalization’ with the same zeal and purpose. Layoffs and downsizing still remain difficult subjects, and inevitably Japanese practices will converge on an equilibrium point different from western concepts of best practice. In the West, corporate rationalization increased the flexibility of managers to respond to global competitive pressures, but that flexibility was earned at the expense of insecurity for employees. It is unlikely that Japanese firms

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will move quickly to shed their ‘employee-friendly’ image and become more ‘shareholder-friendly’. Indeed, it is remarkable that after more than a decade of stagnant growth and profitability for many corporations, there is no great movement in favour of adopting the western strategy to downsize (the workforce) and distribute (profits to shareholders). Instead, management practices continue to build on the traditional Japanese practice of retain (the workforce) and reinvest (profits back into the company).42 One interesting feature of changing industrial relations and rationalization in Japan is the role of foreign managers and executives driving the process of changes. The long period of economic stagnation, poor corporate results and depressed stock markets made some Japanese firms, like Nissan, easy targets for takeover by foreign firms. Foreign acquisition of iconic Japanese firms is all the more interesting given a long-standing government policy to protect Japanese firms from takeover bids, especially after liberalization of capital controls in the 1960s. This concern to protect companies from foreign takeover had prompted the government to try and consolidate firms into larger conglomerates so that they could better withstand foreign pressures. In reality, appointment of a foreign chief executive officer has allowed for a more substantial rationalization programme than might have been possible without the foreign input. The present period may not parallel past periods of foreign borrowing, but there are certain similarities in the way foreign pressure and foreign executives have been at the forefront of industrial and corporate reforms in Japan. Firms more committed to reform and rationalization have emerged as more flexible players on the corporate stage, but of course there have been negative consequences as well, primarily in terms of loss of job security and tenure of employment. The social pain and costs have still been much less than those resulting from rationalization in the West. For example, unemployment in Japan, while high by past standards, remains remarkably low by international standards. Also, while there may be a greater sense of uncertainty about future outcomes, there is little direct evidence that Japanese consumers and workers are excessively pessimistic about the economy. One reason why Japan might manage its reforms better could be the particular demographics and expected future labour shortage. In the West there has long been an expectation that Japan would converge on western ideals, but it was unrealistic in the past and remains so in the contemporary period. If American history reveals a tendency towards either isolationism or engagement, Japanese history reveals periods of incorporation of foreign ideas and practices followed by lengthy periods

86 Japan in Crisis

of indigenization. Foreign borrowing in the past failed to produce convergence in, say, the way the principle of ‘mandate of heaven’43 was borrowed from China and indigenized but did not lead to convergence on Chinese practices. There is no reason to assume that Japanese management practices will converge on American or other western models. Arne Holzhausen, for example, looks at changing Japanese employment and management practices but concludes that Japanese practices will remain distinct and non-convergent. He notes that employment practices have been evolving, at least since the first oil crisis, to emphasize ability rather than seniority and that it is mistaken to believe that events of the 1990s are prompting a convergence.44 By contrast, Yishay Yafeh looks at corporate finance system and governance issues, and concludes that Japanese management practices will inevitably become similar to that in the United States. He writes that Japanese practices were time-bound and inconsistent with contemporary pressures on corporations, and that only by convergent strategies can Japanese firms remain internationally competitive and prosperous.45 We know that historically Japan has shown a great capacity to learn from the experiences of other countries, but foreign learning has always been indigenized to suit domestic purposes and requirements. One reason why it is unlikely to follow the West in downsizing is because of changing Japanese demographics. While present economic difficulties suggest a need for reducing the workforce levels in many Japanese corporations, the shrinking population means that, in the not too distant future, the bigger problem will be to recruit and retain workforce.

5 Regulatory Reforms

Crises inevitably force governments and policy-makers to review prevailing doctrines and practices. The Great Depression of the 1930s resulted in considerable social distress and had an enduring impact on accepted economic wisdom and on the role of states in economic management. It shattered the myth of self- correcting markets and legitimized state intervention in regulating national economies. Over time, this became institutionalized in regulatory structures. The logic of regulatory intervention in economic activity was premised on the simple notion that market failure, a periodic occurrence, could be remedied or mitigated by an activist state imposing a structure to overcome market uncertainty and instability, and enhancing confidence in long-term contracting. Armed with this basic assumption, states increasingly became legitimate players in regulating behaviour, market entry standards, health and safety standards, quality controls and an array of other market activities. In the 1970s, sustained economic stagnation and high inflation in the West undermined faith in state capacity to effectively regulate economic processes. The triumph of conservative governments in the US and the UK began a process of regulatory decontrol in order to reduce the burden of compliance on businesses. Regulatory restrictions were recast as a negative influence on market freedom and competition and as an impediment to corporate flexibility. This paradigm shift incorporated a firmly held belief that markets were more efficient at regulating business activity. In these governments’ world-view of minimalist state intervention, deregulation not only improved short-term economic efficiency but also had more dynamic long-term benefits by stimulating business activity and innovation.1 The negative externalities of state regulatory policies included government failure and the high cost of compliance that disadvantaged producers 87

88 Japan in Crisis

in the international marketplace. Robert Rogowsky has summed up the negative consequences of regulation by stating that the ‘more thoroughly a market is governed by regulatory bureaucracy, the more likely it will perform with the characteristic inefficiency of a large bureaucracy’.2 To the extent that this was true, there were obvious implications for national competitiveness. Another assumed negative externality of government regulation was that it inhibited risk-taking behaviour and private sector creativity and innovation, factors considered essential in a global economy driven by a revolution in information technology requiring rapid adjustment to shifting market conditions.

Regulatory politics in Japan and the United States In the United States, the first major area of deregulation involved the aviation industry, and this immediately ushered in an era of cheap flights, ‘proving’ the virtues of deregulation to market competition and consumer benefits. Proponents of deregulation also cited statistical evidence to show that in the post-deregulatory period, the 1970s to the 1990s, airline fatalities had declined by about 70 per cent. This was enthusiastically but misleadingly construed as confirmation that market discipline had improved air safety, when in reality safety had improved largely as a result of technological innovation and computerization in the airline industry.3 However, even discounting that improved air safety was related to deregulation, proponents were convinced that the economic advantages alone were sufficient to justify market-based, rather than state-based, regulatory structures. The economic benefits of deregulation, to producers and consumers, were clear from comparative price movements in regulated and unregulated sectors of an economy. In the US, according to Paul MacAvoy: The four deregulated industries – rail, trucking, airline and petroleum products – experienced price declines of the order of twenty-six to fifty percent after controls were ended. The three regulated industries – natural gas, electricity and telephones – continued to experience price increases except in markets specifically subject to decontrol.4 While the US and British governments introduced substantial deregulatory policies, the Japanese government did not deviate from its path of strong market presence to ensure orderly rather than chaotic market competition. Japanese state preferences were a continuing legacy of the developmental state, which in the 1950s and 1960s took the lead in rebuilding

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industry, targeted specific industrial sectors for promotion and used its credit allocation capacity to discriminate between different types of investment activity. The Japanese state performed its interventionist role through a series of legislative measures as well as the more informal yet pervasive practice of administrative guidance. While some attribute early Japanese economic successes to enlightened state intervention in the economy, Porter et al. have been critical of Japanese bureaucratic capitalism, or state-led capitalism, as having impaired corporate entrepreneurship and innovation. They reject as spurious suggestions that bureaucratic capitalism contributed to Japan’s economic success in the early postwar period, and argue instead that bureaucratic intervention is the main problem confronting the contemporary Japanese economy and has harmed the nation’s productivity and prosperity.5 Of course, despite heavy-handed regulatory controls, it is well known that innovation and entrepreneurial spirit were not necessarily absent among Japanese industrialists even at the height of pervasive state intervention and regulatory control. There are several well-known examples of new and innovative enterprises, like Honda and Sony, which successfully carved out their own competitive niches within a highly regulated, even a hostile economic structure. Porter et al. willingly concede that there were pockets of innovation, but insist that these were exceptions to the general rule and that only a handful of industries had carried the entire Japanese economy forward during the high-growth period. Most sectors of the economy, such as retailing, wholesaling, transportation, construction, energy and health care services remained highly inefficient, even though they generated significant employment outcomes. The employment generation capacity of these inefficient industries was a form of ‘social welfare system’, a responsibility that had been imposed on them by a regulatory state that was distrustful of market competition. The non-competitive sectors were shielded from foreign competition by protectionist policies and only the few competitive industries had a prominent export profile. The export success of the competitive industries underpinned the miracle of Japan’s high growth and equitable income distribution. Throughout the postwar period, however, domestic consumption remained low compared with that in other advanced industrialized countries. The continuation of low domestic demand was an important factor impairing economic recovery in the 1990s. Advocates of deregulation in Japan, logically enough, point to regulatory inefficiencies that impede corporate competitiveness in a global economy. They argue that deregulation is vital to establish the basis for

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sustainable economic recovery in Japan, after more than a decade of economic stagnation. A dissenting view is that deregulation, however worthwhile, should not be the focus of state policy since it was unlikely to resolve an economic crisis brought on by falling consumption demand and deflationary price movements, rather than by regulatory inefficiencies. Deregulation could have only a supply-side effect and was unnecessary to fixing inadequacy of consumption demand. According to Paul Krugman, the central dynamics of the contemporary Japanese economic crisis are insufficient consumption demand and deflation. He argues, as we have seen, that crisis resolution demands an inflationary target to curb savings and encourage domestic consumption demand. Deregulation, in the current economic climate, may simply be misguided policy and likely to distract the attention of policy-makers from the more important task of economic recovery and growth. Deregulation may even exacerbate the economic crisis if it adds to a deflationary spiral and inhibits consumption. However, rather than downgrade the importance of regulatory reform, it is, I argue, essential to pursue simultaneously both the supply- and demand-side solutions. The Japanese economy is highly regulated with extensive state regulatory and interventionist policies. Under these conditions, it is reasonable to assume that Japanese firms have a competitive disadvantage compared with firms operating in a less regulated environment and which consequently do not have the same high cost of regulatory compliance. To the extent that firms have to comply with regulatory requirements, the more stringent the requirements the greater is the cost of regulatory compliance. And the regulatory gap between Japan and western advanced industrial countries has widened considerably since the early 1980s. As national economies have become more integrated, discrepant regulatory burdens have acquired considerably more economic significance. Thus with the advent of globalization there is now greater interest in regulatory harmonization to ensure a level playing field for firms across national jurisdictions as well as in deregulation, to ensure that firms retain maximum flexibility in coping with environmental changes. In the past, American and other western businesses complained that Japanese regulatory structures impeded their capacity to compete in the Japanese market, but these days Japanese firms may legitimately complain of being disadvantaged by excessive and more onerous regulatory requirements. The issue of regulatory reform and deregulation in Japan has received considerable attention from both within and without the country. Outsiders, especially Japan’s trading partners, have focused on the trade-

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distorting consequences of regulations that impede foreign imports and act as non-tariff barriers to limit access to the Japanese market. Japanese regulatory structures, such as those governing distribution and restrictions of large stores, have been a frequent source of friction with trading partners on grounds that these are strategies to exclude imports from the market place. Domestically, proponents of deregulation emphasize the anti-competitive aspects of higher regulatory standards. They claim that regulatory structures in Japan have contributed to the persistence of economic stagnation and malaise, despite large public works programmes to boost economic growth. Advocates of deregulation are convinced that the competitive strength of Japanese corporations and growth prospects of the Japanese economy will depend on the willingness and ability of the government to introduce regulatory reforms and reduce the burden on private sector activity. The Japanese government, too, accepted the importance of regulatory reform, but, as always, the rhetoric of deregulation was more impressive than actual achievements. Still, there were some significant achievements, such as the privatization of the Japan National Railway (JNR), the telecommunications giant NTT and the Tobacco and Salt Monopoly Corporation. There was as well some deregulation of the financial sector, which opened up new avenues for Japanese corporations to secure investment capital from non-bank sources. This lowered the cost of investment capital for Japanese firms, which had previously relied on bank financing at higher interest rates. As a result there has been a marked weakening of main bank linkages, and instead a growing reliance on equity capital and on foreign capital markets. A negative consequence of financial deregulation, as noted in Chapter 2, was that it encouraged speculative activities and was, at least partially, responsible for the bubble economy, as firms were no longer constrained by main banks’ oversight and surveillance of investment activities. The shortcomings of market-based regulation are now being addressed through requirements of greater transparency, improved accounting practices, independent boards of directors and other measures to ensure accountability. Compared, however, with regulatory reforms that have been introduced in Japan so far, there remains much more to be accomplished before Japanese firms can compete internationally without being burdened by high costs of regulatory compliance. Japan has yet to experience the same deregulatory phenomenon that occurred in the US, the UK and other western countries in the late 1970s and 1980s. In Britain, the bigbang financial deregulation of the mid-1980s was a result of a number of

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factors, including the challenge of foreign competition, new technologies in financial transactions and an ideological commitment to market principles.6 In the US, President Carter in the late 1970s introduced policies to abolish or phase out regulatory controls on a number of industries and President Reagan in the 1980s made deregulation one of the four pillars of his New Economic Programme. Since the 1980s the regulatory gap between Japan and its competitors has widened since western countries began a programme of deregulation in the 1980s. In general, deregulation and regulatory reforms are ways of recalibrating state-society relations in order to find an appropriate balance between producers, consumer, and national interests. At the same time, regulatory reform should not be interpreted to mean deregulation only, and may include regulatory initiatives in new areas of economic activity. In Japan, the force of regulatory authority is based either formally on enacted legislative measures or informally on administrative guidance measures that have no legal standing. According to estimates of the Economic Planning Agency of the Government of Japan, the total weight of the regulated sector of the economy was approximately 53 per cent of the GNP in 1980. This compared with 23.7 per cent for the US in 1975. It is clear that even before deregulation began in earnest in the United States in the late 1970s the Japanese economy was already more heavily regulated and it can be assumed that the differential would have widened in the 1980s.7 Deregulation and regulatory reform became important keywords in Japan in the 1990s and there has been important progress, but according to Miyauchi Yoshihiko, chairman of the Regulatory Reform Committee in Japan, even in the late 1990s approximately 42.3 per cent of all Japanese industries continued to be subject to government regulation in some manner.8 One of the main objectives of Japanese regulatory structures was to create a system of orderly markets. Regulatory frameworks were consequently both extensive and intrusive, focused on creating ordered markets rather than competitive ones that were regarded as chaotic and undesirable. Competition, however, is increasingly the essence of the modern market economy and Japanese regulatory structures have the effect of frustrating its progress. Regulation, as indicated above, is an impost on business activity since it adds to the compliance costs of doing business. As such pressure for regulatory reform has come not only from trading partners who see regulation, especially of the administrative guidance variant, as a form of nontariff barrier, but also from peak domestic business groups, like Keidanren, which see regulatory controls as adversely affecting the com-

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petitive strength of corporations. Lonnie Carlile has suggested that the focus on deregulation in Japan can be traced to developments within the business community and Keidanren. According to him, Keidanren leaders, in the mid-1980s, began to perceive deregulation as an approach that would simultaneously address several economic challenges confronting Japan: trade frictions, recession, appreciation of the yen, and rapid technological change . . . Internally, the Keidanren leadership appears to have also begun around this time a campaign to foster a proderegulation, antibureaucratic climate among its membership.9 To the extent that regulations are an impost on businesses, consumers ultimately have to pay higher prices for goods and services. In principle, deregulation benefits both producers and consumers and can significantly boost economic growth to bring Japan out of economic stagnation in a way that fiscal stimulus packages failed to do in the 1990s. Since the collapse of the bubble economy the Japanese government has spent Y120 trillion in economic stimulus packages to little real effect, and the 1990s are regarded as a decade of lost economic opportunities. At the same time, as a result of deficit financing programmes total national and local government debt had ballooned to Y645 trillion at the end of financial year 2000 (FY2000). This amount was roughly equivalent to 130 per cent of GDP. It is possible that without deficit spending economic conditions in Japan in the 1990s would have been significantly worse, but according to Miyauchi the only real route to recovery was through extensive regulatory reform. Miyauchi, chairman of the Regulatory Reform Committee and a director of Keidanren, an organization whose membership included the large corporate sector in Japan, has also suggested that some of the celebrated examples of reform were actually less than exemplary. He has even maintained that there will be no genuine financial big bang reform until the government relinquishes control of the massive postal savings system, with savings and deposits equivalent to about 20 per cent of total private financial assets.10

Regulatory reforms in Japan In Japan, reform has been debated since the early 1980s, and the reform initiative gained momentum in the 1990s with the establishment of an Administrative Reform Commission (ARC) in late 1994. In April 1995, a Deregulation Subcommittee was set up under the ARC. The ARC was

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dissolved in December 1997, however, and replaced with a Deregulation Committee in January 1998. This was subsequently renamed the Regulatory Reform Committee (RRC) in April 1999. The decision to rename the Deregulation Committee as the Regulatory Reform Committee is instructive of the government’s approach to deregulation. Deregulation, in its strictest sense, means the abolition of restrictions and regulations, whereas the Japanese equivalent of the term, kisei kanwa, implies simply the easing or relaxation of controls rather than their abolition. The name change may have been prompted by concerns not to inflate western expectations only subsequently to frustrate them when the approach of the Japanese government turned out to be markedly different from the policies of governments in the US or the UK. The revised nomenclature confirmed that Japanese objectives were not to follow the path of western governments and that the Japanese bureaucracy would retain regulatory authority, even if diminished. As G. P. McAlinn writes, ‘This difference illustrates the profound gap that separates people in the West and Japanese in their vision of what constitutes the ideal relationship between government and business.’11 The Japanese government remained unconvinced of any need to fundamentally reshape statesociety relations, for fear it might, as it had allegedly in the West, lead to a decline of social morals, national cohesiveness, fairness, and equity. There are many government studies touting the progress of regulatory reform and deregulation, and one study by the Economic Planning Agency (EPA) estimated that in FY1998 the consumer surplus, or the net benefit to consumers, as a result of deregulation in various sectors of the economy such as telecommunications and air transport, amounted to a total of Y8.6 trillion or 2.3 per cent of national income.12 Despite such self-congratulatory assessments, most analysts agree that progress has been modest at best. This is obvious at least from estimates of the weight of regulatory requirements on Japanese industry. Indeed, compared with reform in financial sectors and other reforms, regulatory reform has lagged behind others, partly because of bureaucratic obstructionism and the opposition from vested interest groups in Japan, and even owing also to the concern of consumers that deregulation might result in lower product health and safety standards. There is no suggestion that Japan should replicate western and the American regulatory framework, and inevitably Japan will retain its distinctive features. Predictions of a convergence on western ‘best practices’ ignore Japan’s own historical evolution and the socially embedded nature of regulatory policies and institutions. As Kozo Yamamura has pointed out, different people will give different weighting to issues of economic

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efficiency or distributional equity, and the balance between regulation and the market will be determined by divergent values of each societal constituency, history and institutional inflexibility. He also argues that the convergence theory suffered from self-induced amnesia about all that was written only a short time ago on the ‘decline’ and the ‘deindustrialization’ of the United States and the United Kingdom and the distributional woes and social malaise that afflict American and British capitalism.13 He then concludes that Japan would ultimately evolve a hybrid model that reflected broad societal considerations rather than simply those of producers. It would be futile and simplistic to expect the Japanese government to try and catch up with western regulatory standards, in a way similar to those followed in earlier periods of ‘catch-up industrialization’. As far as opposition of vested interests is concerned, the situation is similar to problems of trade liberalization, which always have an adverse impact on protected sectors and which can be expected to lobby for continued protection. According to Miyauchi: people often blame bureaucrats for dragging their feet. I think, however, that it is not so much bureaucrats that oppose deregulation, but rather vested interests in the private sector . . . One example is the issue of liquor sales . . . in March 1998, a Cabinet decision was made to abolish restrictions on supply and demand related to population density and distance from store to store. However, there suddenly arose strong opposition from a few vested interests and the implementation became more complex.14 Despite known price advantages for consumers, it should be noted that consumer groups in Japan have been hesitant about embracing deregulation. In a sense, however, this was no different from the opposition to globalization and trade liberalization from the prominent American consumer rights advocate Ralph Nader, who campaigned tirelessly against liberalization and the establishment of the World Trade Organization, despite obvious benefits to consumers, as bringing undesirable employment and other consequences.15 Likewise, Japanese consumers have agitated against the liberalization of agricultural products because of the fear, whether real or not, that foreign products, such as rice, may carry health risks emanating from use of pesticides and other chemicals. Similarly, to the extent that many regulatory statutes are ostensibly

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designed to ensure product safety standards, consumer groups in Japan have been reluctant to support deregulation, regardless of the associated welfare gains. Still, as the White Paper on Regulatory Reform estimated, the consumer benefit of relaxed regulatory standards amounted to an average Y6.6 trillion a year between 1990 and 1997. In the same period the producer benefit amounted to an average of Y8.2 trillion a year.16

Bureaucratic opposition to deregulation and reform in Japan Successful economic and administrative reform will depend to a considerable extent on political activism and leadership. As expected, the bureaucracy and other vested interests have attempted to slow down or to derail the reform process. Of course, the bureaucracy can hardly be expected to support and implement deregulatory policies that ultimately must reduce their sphere of influence. The bureaucracy is by its nature an institution that is committed to stability rather than change and uncertainty. This, as Max Weber observed, is true of all bureaucracies, which are well adapted to deal with routine and mundane issues through so-called standard operating procedures but quite deficient in responding to new issues. To preserve the integrity of reforms, the task must be the responsibility of political leaders, but the reality is that Japanese bureaucrats exercise considerable influence. Not surprisingly, reforms have delivered much less than promised, and administrative reforms that have been approved have been more superficial than substantive. The Japanese bureaucracy has been very influential in postwar Japanese politics and policy-making processes. There are various reasons for its inordinate influence, but one practical explanation for bureaucratic involvement in policy-making is that it ensures suitable amakudari options for retired bureaucrats. Senior bureaucrats retire early in Japan to begin a new career in the private sector, a practice sustainable only because the bureaucracy has a policy-making function and because of the extensive regulatory structures. Firms and corporations accept senior retired bureaucrats on corporate payroll largely to gain access to the political and policy-making process. Evidence shows that amakudari (see Table 5.1) is a more prevalent practice in regulated industries and for this reason the bureaucracy can be expected to vigorously oppose extensive deregulation. A significant diminution of bureaucratic influence in policy-making will erode amakudari prospects and may in turn require compensating measures to retain senior bureaucrats within government ministries longer. This will of course have implications both for government budgets and for promotion prospects within ministries and agencies.

Regulatory Reforms 97 Table 5.1 Amakudari in selected Japanese industries Industry Regulated Construction Second regional bank Telecommunications Air transport Regional bank Electricity and gas Unregulated Steel Automotive

No. of firms

No. of amakudari board members

% of board members

30 30 4 5 30 20

150 60 13 11 36 20

12.8 11.4 9.7 8.2 5.7 3.9

30 30

6 6

0.9 0.9

Source: Kawamoto, A., ‘Unblocking Japanese Reform’, OECD Observer, March 1999.

Bureaucrats, however, are more likely to rationalize their resistance to large-scale deregulation on the grounds that any move to replicate the American example will lead to the same social dysfunctions and inequities. One pre-eminent Japanese Finance Ministry bureaucrat, Sakakibara Eisuke, also known as ‘Mr Yen’ because of his alleged influence over exchange rate movements, argued that many of the existing social ills in Japan could be traced to the bubble economy of late 1980s. The bubble economy, according to him, had spawned excessive freedom, an ideology of ‘me-ism’, and a decline in morals at the personal and corporate levels, producing maladies like the Recruit and Sagawa-Kyubin scandals of the 1990s. This problem, he argued, would be exacerbated if Japan followed the path of the US.17 Corruption scandals have also implicated the Japanese bureaucracy and resulted in a reduction of its influence and clout within government. The bureaucracy no longer has the exalted position it held during the 1960s when it was credited with engineering the Japanese economic miracle. The bureaucracy used to be held in high esteem and considered free of the rampant corruption that plagued Japan’s political parties, but in recent years it has been found to be just as susceptible to financial temptations and other misdemeanours. For all the bureaucrats’ sniping and attempts to discredit reforms, it is unlikely that they will be in a position to significantly derail the reform process. The real constraint on reform lies in the nature of party politics in Japan and the absence of political will.

Structural reform in the context of Japanese party politics The Liberal Democratic Party has monopolized government for much of the postwar period and while some individual zoku politicians (politicians

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who have grouped themselves into policy tribes to assert their policy leadership) have used longevity in the Diet to influence policies, the party has largely abnegated its policy role. Thus the rhetoric of reform has far outstripped any genuine commitment to it, especially in the 1990s after earlier liberalization measures under foreign pressure (gaiatsu) were blamed for electoral disasters. Instead of developing clear and coherent policies on reform, the party relied where necessary on ‘reformist’ and ‘dynamic’ politicians to project an image of policy activism. The cabinet of Prime Minister Mori, for example, included two politicians, Hashimoto and Yanagisawa, who supposedly had the requisite reform credentials and capacity. The party itself remained sidelined as a policy instrument. The same principle repeated itself in the challenge to Prime Minister Mori by Kato Koichi in November 2000. Kato legitimized his challenge on grounds that the Mori administration had stalled on reforms and that only he was capable of advancing the agenda introduced by Prime Minister Obuchi. As mentioned, in Japan the Liberal Democratic Party as a political party has failed in its role as a policy-making machine, and instead postwar politics have been personality-oriented politics, where a government’s reform credentials depend not on concrete policies but on the composition of the cabinet. The abnegation of policy responsibility by the party in power has a historical analogy in the usual separation of political ‘rule’ and ‘reign’ in imperial Japan. The contemporary pattern of devolving policy responsibility to an ‘outside’ agency is replicated throughout Japanese history,18 as during the Tokugawa period when formal political authority resided in the emperor based in Kyoto but the shogun actually governed the country from Edo (Tokyo). Again, in Meiji Japan, the Meiji emperor was the nominal ruler of the country but it was a small oligarchy from Satsuma, Choshu, Tosa and Hizen (Sat-Cho-Do-Hi) that held the reins of power. The Sat-ChoDo-Hi clique had been instrumental in deposing the Tokugawa shogun, and while their campaign had been legitimated in terms of the Meiji Restoration they refained political power and ruled Japan on behalf of the emperor. The practice of devolving power was useful in quarantining the emperor from blame for policy failures and explains why Japan, unlike imperial China, was able to maintain an unbroken line of imperial descent. In the contemporary period, this continuity in historical pattern may perhaps be attributed to the absence of a viable opposition political party. Political leadership is essential and the success of reforms will depend on a convergence rather than a separation of political authority and governance. In order to ‘normalize’ Japanese party politics and policy process, the importance of a viable opposition party cannot be overstated.

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In 1955, following the establishment of the Liberal Democratic Party and the Japan Socialist Party (JSP), it appeared that a two-party structure might take shape in Japan and that political power might alternate between these two political parties. A split in 1960 that led to the establishment of the moderate Democratic Socialist Party, however, permanently weakened the JSP. In that decade, the emergence of other smaller political parties further split the opposition vote and strengthened the dominance of the LDP. The LDP added to its electoral appeal by deliberately eschewing policy principles and by broadening its appeal beyond its traditional support base in the countryside. The party reinvented itself as a catch-all, or catch-almost-all, political party. Thus, even though it would have been logical for the JSP, for example, to mobilize the emerging environmental movement of the late 1960s, it was actually the LDP that responded to environmental concerns by legislating tough environmental measures in the 1970s. The post-split JSP was, and remained until the mid-1990s, the largest opposition party, but it was practically reduced to half a political party, with little prospect of winning government. The longer it stayed in opposition, the further removed it was from government and from formulating an alternative policy platform. With a policy vacuum among the opposition political parties there was little incentive for the LDP to be more policy-assertive. The JSP, relegated to political backwaters for much of the postwar period, became even more anachronistic and irrelevant to the political future of Japan following the collapse of most Marxist regimes in the 1990s. This may have been a factor in the decision in 1993 by Ozawa Ichiro, Hata Tsutomu and others to defect from the LDP and create what they hoped would be a viable and alternative, conservative political party in opposition to the LDP. The establishment of splinter parties followed an earlier example of LDP politicians who in the mid-1970s defected to set up the New Liberal Club (NLC). The NLC had very small beginnings, with only four politicians, and was unable to boost its numbers to pose any serious threat to LDP longevity. In the end, after about a decade of inconsequential existence the NLC returned to the fold of the LDP. In 1993, a large number of LDP politicians defected to establish new political parties. The first political party to emerge, in late June 1993, was Shinto Sakigake (New Harbinger Party) established by Takemura Masayoshi and nine other politicians. A few days later, Ozawa Ichiro, Hata Tsutomu and more than 40 other former LDP politicians established Shinseito (Renewal Party). Over the next few years, the party system continued to change. In December 1994, Shinseito merged with a number of other political

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parties and this led to the emergence of Shinshinto (New Frontier Party). This new party had 178 members in the Lower House of the Japanese Diet and could have posed a serious challenge to the LDP but internal dissension and defections weakened its unity and resolve. In December 1997, Shinshinto was dissolved, and in its place Minshuto (Democratic Party of Japan or DPJ) assumed the mantle of the leading opposition party. Ozawa remained independent of the DPJ and together with his closest allies established the Liberal Party in 1998. The establishment of splinter groups in the 1970s and 1990s followed major financial scandals implicating the LDP, and the splinter groups explained their actions as necessary to restore the faith of the electorate in the party system and to force through effective reforms, good governance and policy-oriented politics. Ozawa a key player in the political turbulence of the 1990s, certainly intended his actions and that of his group to become the basis for establishing a party structure in which politicians bore the responsibility for policy formation and which gave the voting population real choices about Japan’s political development. The risks were minimal because the ideological divide in Japanese party politics had practically disappeared and there was no chance that an LDP split would benefit the socialists. Ozawa’s defection from the LDP, the establishment of new political parties and the formation of a non-LDP government following elections in 1994 did have the important consequence of reforms in the electoral system. The maladies of a multimember electoral system had sparked the crisis in Japan and in its place the government of Hosokawa Morihiro brought in a combination of 300 single-member districts and 200 proportional representation seats. In terms of creating a genuinely competitive party structure, similar reforms had, in France, ushered in an ideological ‘bipolar quadrille’,19 but Ozawa’s actions were motivated by a desire to create a non-ideological bipolar party structure or coalition of political parties. Given our knowledge of electoral systems and party structures, a two-party dominant system is inevitable, but the immediate result of electoral reforms was to introduce a very fluid structure of political parties. It was difficult to predict not only the possible coalitions but also whether parties would survive, merge or disappear over a short period. In the current parliament, the rival blocks seem to be a three-party coalition led by the LDP on the one hand and the Democratic Party of Japan on the other. Ozawa’s own reconstituted Liberal Party has been reduced to the role of a minor coalition partner of the LDP. If he ever had any hopes of heading an alternate government, this is no longer in the realm of possibility.

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The two previous attempts at reforming the LDP utilizing defections and external pressure had failed to produce any appreciable change in electoral politics or in terms of the policy responsibility of the LDP. Past failures may explain Kato’s strategy of introducing reforms by working within the party structure. Within the LDP, Kato Koichi had been vocal in advocating reforms and envisioned himself, like Margaret Thatcher in Britain, as helping to reshape the structure of the Japanese political economy.20 It meant wresting control of the party from a leadership that had failed to meet the necessary requisites. This set the scene for a clash within the party between a group of reformers led by Kato and another group of traditionalists led by Mori. The outcome of a leadership challenge appeared to favour Kato because he had a popular approval rating of 54 per cent compared with just above 12 per cent for Mori, who was seen as inept. Mori’s sins of omissions and commissions had also lowered his stock within the party. Even the leader of his own faction, Koizumi, criticized his performance as party leader and prime minister. Koizumi insisted that the government had to press ahead with administrative and structural reforms, even at the risk of negative economic growth for a few years, in order to revitalize the country for the longer-term.21 In Mori’s defence, it should be added that it would have been inordinately bold for any prime minister to risk the fledgling economic recovery that had just become discernible. However, a longer-term perspective would have convinced any political leader that reform could only be deferred, not avoided, and that it made more sense to act decisively than to vacillate. If resistance to reform is not entirely attributable to concerns for economic recovery, then it is more likely that the LDP, as a political party, was not the party to introduce major reforms. Kato was brought down by this fundamental contradiction between his advocacy of reforms and the party’s unwillingness to embrace them. Kato threatened a no-confidence motion in order to depose the incumbent, but was also determined to work within the party rather than defect. Past defections had done little to change the internal workings of the LDP. But when it looked like his no-confidence motion might not succeed, he quietly decided to withdraw his challenge. Unlike Ozawa, he had decided that it was better to work within the party to bring in reforms, but he failed like others before him. The abortive challenge has, according to some observers, sealed Kato’s fate and made it nearly impossible for him to ever achieve leadership of the party when before it was seen as there for his taking. Critical of Mori for lacking vision and conviction, Kato has however demonstrated his own weaknesses and poor judgment. Both Kato and Ozawa were widely regarded as talented and ambitious politicians on track

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to become future leaders of the LDP but each has had his political career brought to a sudden halt by taking on the controversial task of political reform. Regardless of past failures, the nature of party politics is undergoing changes and the end result may be an injection of genuine policy competition that may, subsequently, facilitate the process of reform and deregulation. It is unclear whether the LDP will spearhead reforms, because while Prime Minister Koizumi has emphasized reforms other LDP party leaders have a vested interest in preserving the status quo. Within the parameters of an emerging competitive party system, the Democratic Party of Japan has better potential for introducing fundamental deregulatory reforms. Since so much depends on emerging competitive politics, it is necessary to identify some of the factors that could facilitate such a transformation of Japanese politics: 1. Responsible politics and a move away from money politics is premised partly on new legislation to provide political parties with public funds for campaign finance purposes. As recipients of taxpayer funds, political parties will inevitably be obliged to justify their expenses by putting forward responsible policy alternatives. That would be a logical outcome of the new arrangements, but of course consumers and taxpayers everywhere, and particularly in Japan, are poorly organized to articulate their demands. 2. Another reason to expect change is that the revamped electoral system will lead to a two-party-dominant system with each major political party deriving its support from distinct electoral communities. The LDP has derived its electoral strength from rural districts and a rough analysis of the representative base of the DPJ reveals its strength to be in the urban districts, much like the disbanded Shinshinto (New Frontier Party). If we consider only the single-member districts, the LDP has a parliamentary representation of 175 Lower House seats, compared with 82 for the DPJ. In terms of the proportion of rural and urban districts, the LDP representation is concentrated in rural districts, at nearly 70 per cent, whereas DPJ representation is concentrated in urban areas, at about 55 per cent of total. The demographics of the DPJ are similar to that of the defunct Shinshinto, and it is in a position to assume the mantle of bringing about regulatory reforms, either through political pressure while in opposition or as a party in government. The same had been expected of the Shinshinto, and a poll in August 1996 revealed that Shinshinto members were more favourably inclined towards deregulation than LDP politicians.22 Of the 81 Shinshinto politicians

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polled 61 indicated their preference for ‘aggressive deregulation’, whereas of the 46 LDP politicians polled only 19 supported a programme of aggressive deregulation. The reality is that just as Japan has a bifurcated industrial structure so there also exists a sharp urban and rural political divide. There are, in effect, two nations, an ‘urban Japan’ and a ‘rural Japan’, with divergent interests. The LDP had for a period managed to bring these two under an integrative umbrella but the differences became too great to be maintained over the longer term. The catchall electoral strategy may have facilitated the LDP’s political dominance in the 1960s and 1970s, but it also produced a political party that was so split in its pro-urban and pro-rural divisions that ultimately this produced a series of crises for the party’s coherence in the 1990s. The result was a split in the mid-1990s, as some but not all of the proreform and pro-urban members defected to establish new political parties. This was only a partial resolution of internal party contradictions, and the balance of power within the party has alternated between the progressive and conservative wings. In the July 1998 Upper House elections, the LDP suffered a major setback because of economic mismanagement and consequently its priorities shifted to resolving the banking crisis rather than economic liberalization. Deregulation was no longer considered politically desirable by many LDP politicians. This appeared to vacate the ground to the DPJ, but the problem for the more recently established DPJ, as noted by Steven Vogel, was that while the DPJ included many former Shinshinto politicians it also included former SDPJ politicians who derive support from public sector trade unions and are also more ambivalent about deregulation. 3. The reality is that with the LDP looking after mainly agricultural and producer interests Japan’s urban consumers have, suffered in silence in the past and continue to do so today; the party has subsumed many societal interests as part of its catchall electoral strategies but it has not supported substantial deregulation, which would erode the privileged position of Japan’s protected minority interests. As a catchall political party, the LDP did not unify the two Japans but itself became a fragmented party, with some members representing urban voters and interests while the rest remained committed to the party’s rural roots. This bifurcation was not irrelevant to the later difficulties and splits experienced by the party. If the DPJ consolidates its position in urban centres, it could eventually pave the way for policy-oriented electoral contestation. The crucial question is whether the LDP will remain a unitary political party at all or go the way of the NFP. A fractured opposition handed easy victories to the LDP through much of the

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postwar period, and more so in the period following electoral reforms in 1994, so the obvious lesson for an aspiring opposition political party is to maintain party unity. Leadership contests within the DPJ brought the party near to collapse in 2000 but it managed to weather the storm. Whether it will build on that to strengthen unity of purpose remains still to be seen. As an urban-based political party, the DPJ can be expected to advocate liberalization and deregulation to reduce the cost of living for Japanese consumers and workers. This strategy will also benefit the export sector and lower the wages pressure within the economy. Liberalization and deregulation are economic imperatives from a globalist perspective and have been advocated by Keidanren. It is a policy position that resonates with Ozawa’s Liberal Party. 4. Policy-oriented politics assumes that the LDP will abandon its strategy of representing a diverse set of interests and its attempt to be a catchall political party. T.J. Pempel argues that the LDP will be forced to abandon its inclusionary, all-embracing and unprincipled political stand as a result of the negative fallout following liberalization of the agriculture sector in the 1980s, which alienated the core electoral supporters of the LDP. Moreover, in late 1988 a government advisory committee proposed changes to laws that had long provided protection to small shopkeepers, and in 1989 the government introduced a consumption tax, which added to the burden of small business and shopkeepers. The cumulative effect of these policies was to erode the LDP’s electoral strength and, according to Pempel, reversing the backslide in electoral fortunes will require the party to rediscover its primary roots and cultivate support more actively in its traditional base, especially within the rural community.23 The catchall electoral strategy emerged at a time when the Japan Socialist Party (JSP) played the role of leading opposition political party. As stated above, the JSP was formed in 1955, but expectations that it would be one of the poles of a bipolar party system quickly proved false. In 1960, the moderate wing of the JSP broke away to form the Democratic Socialist Party (DSP), and in the decade of the 1960s a number of smaller centrist political parties emerged to erode the support base of the JSP. By the late 1960s the JSP was already a party in secular electoral decline, and when in the 1970s the LDP began to reposition itself as a catchall political party this was to be the final nail in the coffin of the JSP. A common assumption about competitive two-party political systems is that there is an inevitable race to capture the middle ground, or become a catchall political party. This had been observed in Britain, Germany and several

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European countries, but in Japan it was only the LDP that was successful in broadening its support base to what might be considered nontraditional conservative voters. While it became a catchall political party the LDP did not turn away from its traditional supporters in the rural districts and maintained protection for the farm industry until it was forced to bring in liberalization under pressure from Japan’s trading partners. The JSP, by contrast, was prevented from adopting a more moderate line by its association with the radical left-wing labour unions and by the emergence of moderate, left-of-centre political parties, such as the DSP and the Komeito. The JSP derived its core support from the members of the Sohyo-affiliated labour unions, and the militancy of Sohyo prevented it reaching out to the growing middle class or to non-unionized labour. In the overall party structure the centrist political parties became the spoilers of a two-party political system. These were, at the same time, too small to capitalize on emerging social forces and interests, such as environmental and welfare concerns. Logically, the JSP should have been the party to respond to progressive issues and interests, but it remained ideologically rigid and incapable of capturing new societal interests. Unlike the JSP, the LDP according to one interview respondent was an ‘ideological zoo’, host to many different persuasions but home to none. The success of the LDP strategy effectively marginalized the JSP and ensured long-term conservative rule in Japan. There were many other factors that contributed to stable conservative rule, such as an electoral gerrymander and its economic management, but the LDP’s success can be attributed largely to its own pragmatism and the irresponsibility of the opposition political parties. The LDP was politically successful, but inevitably its majority position in the Diet was progressively whittled away by voter disenchantment, apathy, political corruption and a number of maladies in the Japanese electoral system. As the LDP lost its majority in the Diet the smaller parties became logical alliance partners, resulting in a transition from government by catchall political party to government by catchall coalitional alliance. Following the collapse of global socialism, the JSP, now renamed the Social Democratic Party of Japan (SDPJ), was reduced to minor status. The 1990s were a period of rapid change in the political landscape of Japan, as parties splintered, merged and formed with great rapidity. In the end, the role of leading opposition party devolved to the Democratic Party of Japan (DPJ) – a conservative political party formed around a core of former LDP politicians. Its former leader and the current chair of the Policy Research Committee, Kan Naoto, was a health minister in the Hashimoto government and distinguished himself by

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taking on the health bureaucracy to expose bureaucratic corruption. Despite his reformist credentials, the path to reforms lies in initiatives by the ruling LDP that clear the path for a competitive bipolar party structure. In a conservatively oriented, non-ideological party structure such as exists at the moment there may still be some incentive to appeal to a wider section of the community but there can be no advantage in alienating core party supporters. It is clear that neither the LDP nor the DPJ can expect to secure parliamentary majorities by relying solely on core supporters, but there are no clear advantages of a shift to the middle ground if such a strategy also alienates core supporters. A successful electoral strategy must involve coalitional arrangements where centrist political parties, like the Liberal Party or the New Komeito, are genuine keepers of a balance of power, rather than spoilers of the ideologically based party structure of the period before the 1990s. To the extent that this becomes a political reality, we can expect the LDP and the DPJ to consolidate their specific electoral roots and rely on successful coalition strategies to win government. This will also be conducive to policy-based electoral competition. The LDP may therefore become more principled and less catchall, but it is not the party that can be expected to lead with regulatory reforms. There are reform-minded individuals within the party – obviously Kato and Koizumi – but the party hierarchy is suspicious of radical change that could potentially harm their own electoral prospects. Nonetheless, in 2001, it appeared that the LDP was prepared to accept the inevitability of reform. Appearances, can be deceptive however, and Koizumi’s good intentions are likely to be thwarted by a triumph of institutional prerogatives. If nothing else, Koizumi has created interesting dilemmas for traditional LDP leaders.

Prime Minister Koizumi and Japan’s reform agenda In early 2001, the LDP appointed Koizumi Junichiro party president, and as the leader of the largest coalition partner in the Diet he automatically became the new prime minister. Koizumi became the ninth prime minister in the post-bubble period and his ascendancy marked a revolution in Japanese politics, as he became Japan’s first ‘urbanoriented’ prime minister in 45 years, since Ishibashi Tanzan.24 Koizumi represented the highly urbanized Kanagawa 11th District and his reform orientation reflected the interests of his own electorate, but it placed him at odds with the traditional party elders, who represent primarily rural districts.

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The elevation of Koizumi to the party presidency and prime ministership was unusual in that it was forced upon the party hierarchy by strong support from the respective party branches and the general public. The contrast between Koizumi and his predecessor, Mori, was reflected starkly in their respective amounts of popular support – less than 10 per cent for Mori and more than 80 per cent for Koizumi. Koizumi’s support outside the Parliamentary wing of his party was based on his determination to reform the political and administrative structures of government and a carefully cultivated image as a politician different from all his predecessors, dynamic and reformist. He also promised to resolve the still outstanding issue of non-performing loans in the banking sector, even if it meant widespread corporate failure. Koizumi had contested the party presidency earlier in 1998 but had lost to Obuchi, who was safer and more acceptable to the party hierarchy. In that contest, a year after the Asian financial crisis, structural reforms were a major campaign issue and while Obuchi did introduce much-needed reforms in the banking sector his leadership style did not breach party norms of consensus. Koizumi was unacceptable in 1998 because of his disregard for the establishment and his reputation for being a loose cannon. When he became prime minister in 2001, his emphasis was on policy integrity and ‘reforms without sanctuaries’. His presidential and forceful style of leadership did not endear him to all sections of his party but it earned him strong popular support, especially among urban voters and consumers who stood to benefit from deregulation and reforms. He was seen as a sincere and honest politician battling against a hierarchy that was intent on destabilizing his policy agenda. There had been ‘new leaders’ in the past, representing a new generation, but Koizumi was a new leader in both substance and style. He won the support of voters despite open admissions that reforms would impose further hardships on the people. The measure of public support may be gauged from the comment of a 70-year-old man that ‘If we don’t move ahead with financial reforms now, then Japan will collapse. Koizumi will do it for us.’25 Similarly, when Koizumi began campaigning for the July 2001 Upper House elections with a strong message for reforms, a businessman remarked afterwards that ‘I understand the need for structural reforms and the general public must share that burden. I will vote for the LDP in the election.’26 The government’s message of structural reform was also well received outside Japan. During Koizumi’s first visit to the United States in late June 2001, President Bush endorsed him as the one person to initiate, introduce and implement necessary reforms to revitalize politics and a stagnant

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Japanese economy. Others had promised but failed to deliver on reforms. Interestingly, American endorsement of Koizumi was made essentially on the promise of reform rather than demonstrated capacity and achievement. It was directed essentially at opponents of reforms within Japan in order to dissuade them from derailing the reform agenda. In the first few months of the Koizumi administration, reform achievements were minimal. One innovative measure was cabinet ‘town meetings’, the first of these being held in mid-June 2001 in Aomori and Kagoshima to bring government closer to the people and end the alienation of voters from their elected representatives in government. Clearly, though, the government had to deliver much more in order to maintain high public support, and Koizumi was aware that if the government failed to make significant progress then his popular support base would quickly evaporate and this would ruin his political career. The expectation and support for reform was such that analysts labelled the Koizumi administration as marking the beginning of a ‘Koizumi revolution’. They saw as revolutionary not only the way the prime minister’s appointment had become the catalyst for a sharp increase in political awareness and interest among the people, especially the female voters, but also how it seemingly heralded the end of the long domination by LDP machinery and bosses. It was not clear, however, that Koizumi would ultimately succeed in fulfilling his campaign promises. Successful reform required that he overcome resistance within his own party as well as saboteurs inside the bureaucracy. For all Koizumi’s personal popularity his appointment exposed divisions within the LDP, with some politicians supportive of reforms in order to reconnect with alienated voters, and others opting to maintain the essential stability of the system, fearful that reforms would be detrimental to their own and to the party’s political future. As N. Asaumi has pointed out, the push for reforms was a doubled-edged sword, and by ‘prioritizing urban over rural . . . the LDP risk[ed] losing its traditional core of support’.27 In the first three months in office, Koizumi was cautious in pursuing the reform agenda, concentrating instead on consolidating his support base and in ensuring victory in Upper House elections scheduled for 29 July 2001.28 The challenge for Koizumi was to translate his personal popularity to increased voter support for the party in the elections. This could not be taken for granted, because even though Koizumi enjoyed a popularity rating in the high 80s, support for the party in mid-June 2001 was only about 37 per cent, no higher than that during the earlier Hashimoto government. Results of the Upper House elections, the first real test for Koizumi, would determine his standing within the party and

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whether or not he was in a position to demand loyalty from the antireform group within the party. In the elections, the LDP performed exceptionally well and increased its Upper House representation, winning 64 of the 121 seats contested. Together with New Komeito and the New Conservative Party, the ruling coalition won 78 seats, which gave it an overall majority in the Upper House. Clearly, Koizumi had come through his first test better than expected and he immediately declared that he was ready to move on to the next stage of implementing structural reforms. To lay the groundwork for reforms a government committee, the Council on Economic and Fiscal Policy (CEFP), unveiled in June 2001 the government’s reform agenda, which included the privatization of the postal savings system29 and the resolution of non-performing loans within a period of two to three years. The CEFP recommended that all NPLs remaining after the allocated time be sold to the Resolution and Collection Corporation. It is widely accepted that NPLs are a drag on the Japanese economy and that their resolution is essential to recovery and sustainable growth. It is clear also that rapid disposal of NPLs will inevitably trigger a chain of bankruptcies and lead to higher unemployment. To mitigate the negative fallout from structural reform, the CEFP identified measures to deal with the social impact. The government’s capacity to provide relief, however, was limited by an earlier pledge to maintain fiscal discipline. Structural reforms within the constraints of balanced budgets, caps on issuance of new government bonds and poor economic performance will not be easy. And past experience did not offer much hope. For example, the administration of Hashimoto Ryutaro had failed to maintain the reform momentum because of worsening of economic conditions. Important as these concerns are, the ultimate fate of reforms will depend on political leadership and the support of senior politicians within the LDP. In deference to the high approval rating of the prime minister they did not openly declare their opposition in the initial few months of the Koizumi administration. But, their deep-seated antipathy to reform was an open secret. Within the party the zoku giin, politicians with special interests and links to the bureaucracy, could be expected to stridently defend the bureaucracy’s privileged position against threats posed by large-scale reforms. One member of the postal affairs zoku giin equated the push to privatize the postal savings system to a form of fascism, and added that it was wrong to believe that Koizumi’s high approval rating translated ‘into unqualified popular support for the privatization of the postal services’.30 Other zoku giin, particularly those belonging to the powerful construction zoku, were apprehensive of suggestions that

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revenue previously earmarked solely for construction projects might no longer be quarantined and might be moved to other priority areas of public expenditure. Even the cabinet included members such as Education Minister Toyama Atsuko who were hostile to Koizumi’s reform agenda. Following recommendations by the CEFP that the government review existing public corporations and agencies and consider the possible privatization of state-run universities, the education minister, a former Education Ministry bureaucrat, rejected any change to the status of universities and was reported to have traded verbal punches with the prime minister, prompting Koizumi to chide the minister to ‘turn around [her] way of thinking’ and to ‘outgrow [her] preoccupation with conventional approaches’.31 As well as these special-interest politicians, others from rural electorates are also apprehensive of reforms that inevitably threatened the particular interests of their constituencies. With the LDP’s core electoral support in rural districts, there are many within the party who are uneasy about reforms, including liberalization and deregulation of the farm sector. The zoku giin and other opponents of structural reforms can use internal party machinery and their membership of the Policy Research Council, the LDP’s policy-making body, to dilute and frustrate the reform objectives of the Koizumi administration. They constitute the main danger to the fulfilment of the Prime Minister’s pledge to carry out ‘reforms without sanctuaries’. Proponents of reforms in the cabinet include the minister for economy and trade, the minister for financial services and the minister for foreign affairs. The last, Tanaka Makiko, departed from normal protocol of not interfering in bureaucratic policy-making processes and this immediately attracted the ire of bureaucrats, who subsequently engaged in a campaign to discredit her performance through calculated leaks designed to embarrass her and the government. The leaks implied that she was hostile to US interests and prepared to jeopardize close US–Japan relations in favour of better relations with China. US–Japan relations are the bedrock of postwar Japanese foreign policy, and insinuations that Tanaka was not committed to the United States were intended to discredit her position as the chief international diplomat. Tanaka was also subject to intense and hostile questioning in the national Diet by members of her own party over appointments in the Ministry of Foreign Affairs. Like her father and former Prime Minister Tanaka Kakuei she refused to bow to the bureaucracy, and her open political skirmishes with the bureaucracy and LDP politicians also endeared her to the public and strengthened her own political

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position. She also continued to enjoy the confidence and support of the prime minister32 despite suggestions that she had become a liability to Japan’s foreign policy and that her controversial statements had become a distraction to the main task of domestic structural reforms and deregulation.33 Although there are individuals within the LDP who wish to advance the deregulatory agenda, it is uncertain that they will be able to convince the traditional elders about the imperatives of reform. This is despite the fact that the LDP, under the leadership of Prime Minister Koizumi, did surprisingly well in the July 2001 Upper House elections, a result that could be attributed largely to the popularity of the prime minister. Indeed, in campaigning for Upper House elections in July 2001, the prime minister appealed to voters to give him a large mandate so that he could overcome resistance within the party and implement structural reforms. By contrast, Ozawa Ichiro, leader of the minor, urban-based Liberal Party, reminded voters that the Koizumi government was still an LDP government and told them that the only difference between Mori and his successor, Koizumi, was that the latter was better at manipulating the public and the media and that he would ultimately fail in delivering the necessary reforms.34 The anti-reform forces are well entrenched within the party. The LDP, notwithstanding the earlier defection of pro-reform politicians, remains a divided political party, not simply along factional lines but, more importantly, between the pro- and anti-reform groups. This divide pointed to several possibilities as to how the politics of reform might unfold. One possibility is that party elders within the LDP will defer to Koizumi’s popular appeal and support, the so-called ‘Koizumi revolution’, accepting both that the nature of politics has been fundamentally transformed and the inevitability of change in state–society relations. They may refrain from obstructionist tactics even if, in the long run, reforms produce a rural backlash against the LDP and make their own political future less secure. If they become reconciled to the inevitability of change, a logical strategy would be to concentrate on building a strong support base for the party in urban centres to ensure its continued domination in government. This is the most reform-friendly scenario and will automatically ensure that there are no other political impediments, as the opposition Democratic Party of Japan has already committed itself to support the prime minister’s reform agenda. Another possibility is that LDP leaders and the zoku giin will refuse to give in to reform measures that could destroy their own political careers and alienate core LDP supporters. In early 2002, their cause was strengthened

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by events that forced the Prime Minister to dismiss his controversial but popular Foreign Minister, Tanaka Makiko. She had become embroiled in yet another tussle with ministry officials and LDP politicians over issues of reform of the Ministry of Foreign Affairs and over a decision to exclude some NGOs (non-governmental organizations) from a conference in Tokyo to organize financial support for the reconstruction of Afghanistan. Amid allegations of deceit and coverups, Koizumi dismissed Tanaka, an act which did not resonate well with her adoring public. The Prime Minister suffered another blow when his preferred candidate to replace Tanaka declined the invitation to join the cabinet. The result was politically damaging to the Prime Minister, whose approval rating collapsed from above 70 per cent to below 50 per cent, in early February 2002. With falling popular support and limited support within the Party, most observers see little likelihood of significant reforms in the near future. It is possible that the window of opportunity that had opened in the early months of the administration is gradually closing and that this will undermine any reform initiative. Worse still is the prospect that the few changes that have been introduced will themselves work to the detriment of further reforms. For instance, the newly introduced system of cabinet town meetings have increasingly become forums for disaffected groups to vent their frustration and opposition to reform. These were intended to bring the government closer to the people but meetings in regional cities, where the reform message is less well understood or supported than in the urban centres, have attracted many who feel anxious about reforms. At one meeting in Ogaki, Gifu Prefecture, a company employee condemned the government for embarking on policies that would lead only to an increase in corporate bankruptcies.35 Workers in industries that will carry the brunt of the reform burden, such as general construction, retail and the services industries, have also begun to agitate against reforms in these forums. The laudable initiative of town meetings may ultimately undermine the very process it was meant to facilitate. A recent survey by the Asahi Shinbun found that the percentage of people opposed to reforms had increased from 6 to 12 per cent over one month.36 The government estimates that about half a million workers stand to lose their employment as a result of structural reforms, and as the reality of job losses dawns on the people opposition can only become stronger. Delay in the introduction of reforms means that the anti-reform forces have more time to organize and demand concessions and this can only make the government’s task that much more difficult.

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The lengthy delay in finalizing, articulating and implementing reforms works not only to the advantage of the anti-reform forces but also against the generally short tenure of Japanese prime ministers. Since the early 1990s, Japanese prime ministers have had an average term of office of less than 24 months. Given such a history of rapid turnover, it would have been opportune for Prime Minister Koizumi to take advantage of his high popularity standing and embark on the reform agenda early. He opted to wait to strengthen his position within the party, but the wait could prove ultimately to have been detrimental to reform prospects. If the Koizumi administration fails to live up to expectations this may strengthen the electoral appeal of the DPJ. It is ironic however that although the DPJ has been a consistent advocate of extensive reforms in the past it has failed to win popular support for its policies while instead Koizumi, with the policies of the DPJ, has managed to achieve what has eluded the DPJ. Increasingly, however, it appears that Koizumi will be unable to translate his popular success into government policies as a result of LDP intransigence and growing resistance in the regional areas of Japan. It seems inevitable that structural reform and deregulation will have to await a party that is more comfortable with a reformist position, based on its electoral support base and strengths. The LDP, with strong appeal in the rural districts, is not the logical party to bring in reforms. The DPJ has stronger roots in the urban centres, and since reforms will ultimately benefit urban consumers we may have to wait for its electoral success before there is genuine structural reform in Japan.

Conclusion The emphasis in this chapter has been on issues of deregulation to reduce the costs to businesses of regulatory compliance and to ensure their international competitiveness. The Japanese government has been relatively slow to embrace deregulation compared with other advanced industrialized countries. The focus on deregulation should not be interpreted to mean that reform agenda is unilinear, because while western countries have deregulated many aspects of their economy, there are also many instances of new regulation and reregulation, especially in the areas of environment and health-and-safety. As J. Francis has pointed out, ‘In the United States, the rate of new regulation during the Bush administration [early 1990s] matched that of the Carter administration – a fact made all the more ironic by the realization that President Bush had been in charge of the deregulation programme when he was Vice President during the Reagan Presidency.’37

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The reform measures currently under discussion in Japan are aimed at removing and eliminating supply-side bottlenecks and should improve potential growth prospects over the longer term. At the same time, however, government commitment to scale back on fiscal measures and aim for balanced budgets will put a dampener on growth conditions, at least in the short term. Clearly, therefore, structural reforms will entail substantial short-term pain and hardship on the people, and the government is still pushing ahead on its reform agenda solely on the basis of high approval rating for the Koizumi administration. The prime minister and other cabinet ministers have tried to explain carefully the need for adjustments and to ensure continued popular support for their ambitious agenda. The state minister in charge of economic and fiscal policy, Takenaka Heizo, has explained that ‘We cannot delay the reforms. The public understands that if we do not carry out reforms now, the pain will be even greater in the future. That is why they are supporting the Koizumi Cabinet.’38 The problem is that the Koizumi administration may have waited too long to implement the reforms and lost the narrow window of opportunity given it by high public approval. Prime Minister Koizumi has staked his government’s reputation to the reform agenda, but at best he can only be expected to deliver modest outcomes, most likely in the area of budgetary cutbacks and constraints. If Koizumi fails to deliver on his broader campaign promises of structural reforms this may enhance the political fortunes of the opposition DPJ, which, given its electoral orientation, would appear to be in a better position to introduce structural reforms and deregulation. There is no likelihood, however, that Japan will adopt the western deregulatory package in its entirety and pursue a policy of convergence. Catching up to the West, in terms of deregulation, does not seem to be on the Japanese government’s agenda. Kozo Yamamura argues that what is more likely is the emergence of a hybrid Japanese model that combines Japanese best practices and western best practices.39 Yamamura correctly points out that different people give different weight to issues of economic efficiency and distributional equality, and that Japan is unlikely to blindly commit itself to economic efficiency and ignore other issues of value, such as income equity. Indeed, even if wanted to it could not, because of institutional inflexibility.

6 Japan’s Regional Economy and the Asian Monetary Fund

As discussed in earlier chapters, the Asian crisis had a noticeable impact on the domestic policy agenda in Japan. After years of irresolute and aimless policy drift, the Obuchi administration in 1998 initiated measures to resolve the banking crisis and improve surveillance and regulatory transparency. However, before much more could be achieved, change in government had dissipated the pressure for reform. The government of Prime Minister Mori marked time and the economy continued to stagnate. Mori’s replacement by Koizumi in 2001 rekindled the government’s commitment to reform, especially in terms of deregulating the Japanese economy. As we have seen, there is of course no certainty that Koizumi will be able to translate his policy rhetoric into action, given the significant antireform forces within his own political party. As well as being a catalyst for domestic economic reforms, the Asian crisis was also an opportunity for the Japanese government to enhance its regional identity and influence by taking an active role in crisis resolution and in assisting the regional countries. The crisis was in Japan’s backyard, and it was logical that the largest regional economic power should assume leadership just as the United States had assumed primary responsibility for managing the Mexican crisis of 1994–95. By contributing to crisis resolution, the Japanese government could expect to enhance its regional status and erase lingering negative images of Japan. In the postwar period, the Japanese government has consistently issued mixed signals about its desire for regional rehabilitation, and yet it has been unable to reach a final settlement of its prewar and wartime Asian involvement. The government found ingenious ways to express its remorse without offering a formal apology to the victims of Japanese 115

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atrocities, including the so-called ‘comfort women’. School curricula continued to play down the full extent of Japan’s aggression in history textbooks and this has poisoned relations with its closest neighbours, China and South Korea. Regional anger was further inflamed in August 2001 when Prime Minister Koizumi visited the Yasukuni Shrine against even the advice of some cabinet colleagues. The shrine to Japan’s war dead, including perpetrators of war crimes, has been a no-go zone for Japanese officials, and Koizumi’s visit resulted in violent protests in China and South Korea. The visit was ostensibly to pay homage to the many forgotten war dead, but in the absence of comprehensive regional settlement served only to rekindle anti-Japanese feelings. The reality is that decades after the Second World War the regional countries remain suspicious of Japan, even if, on another level, they have themselves emulated the Japanese economic model to replicate its high growth and industrialization. In this context of lingering antipathy towards Japan, the 1997 Asian financial crisis was an opportunity for Japan to make a positive impression and establish its credentials of good regional citizenship. The crisis demonstrated the basic fragility of regional economic interactions at a time when the Japanese economy was becoming increasingly dependent on regional countries. The regional countries depended on Japan for the import of parts, capital goods, investment and so on, but by the same token Japan was dependent on them. Indeed, if we consider export penetration as a measure of dependency then the overall picture is one of asymmetric interdependence, with Japan more dependent on its Asian trading partners. At the end of the 1990s, roughly 40 per cent of Japanese exports went to the Asian countries, whereas only 20 per cent of Asian exports were destined for Japan. The Japanese economy had clearly become increasingly enmeshed in its own region where before it was inordinately dependent on the US market for exports. Japan’s trade and investment links with regional countries had become more prominent in the decade before the crisis. Japanese manufacturers had invested in plant and machinery in the region following the appreciation of the yen in the mid-1980s and the Plaza Accord. For Japan, the importance of Asian countries was initially as cheap production platforms when the yen began to appreciate, but Japanese investments in Asia continued to increase even after some of the excessive yen appreciation had been corrected. This, according to a survey by the Industrial Bank of Japan, may be read as an indication that Japanese companies were ‘beginning to look to Asia not only as a place to locate low-cost production bases but also for its growing markets’.1 Similarly, Japanese financial institutions had accumulated extensive loans portfolios in the region

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following the collapse of the Japanese economic bubble in the early 1990s. Japanese investments in the region and the growth of intraregional trade, created a network of economic linkages, which tied each individual country’s economic fortunes to those of others in the region, such that Asian countries, including Japan, were more likely to suffer or prosper as a group rather than as separate entities. The Asian crisis was not simply a crisis for the countries immediately affected but also strained the commercial viability of many Japanese manufacturing and financial institutions. The Asian crisis was an indication of the ease with which relationships of dependence and prosperity could be undone by adverse global market forces. Just as domestic institutional weakness and incapacity to deal with the pressures of economic globalization affected and overwhelmed individual East Asian countries, a similarly underdeveloped institutional base for regional economic interdependence helped fuel the regional conflagration. Economic interdependence in East Asia had evolved along markedly dissimilar lines to, for example, regionalism among European countries. According to Peter Katzenstein, while European regional integration had strong institutional foundations, East Asian regionalism was based instead on a multiplicity of networks, such as trade and investment and a multiplicity of centres of influence, such as Japan, China and the United States.2 Katzenstein is careful to explain that the difference should not be interpreted simplistically as signifying European ‘success’ and Asian ‘failure’, because the divergent developmental paths were a result of different circumstances and objectives. Most noteworthy is the fact that Asian countries, led by Japan, Australia and the United States, had deliberately eschewed institutional development in order to avoid the possibility of closed institutionalism favoured by countries like Malaysia. The Malaysian government had been a strong advocate of an East Asian Economic Caucus (EAEC) that would be composed only of the East Asian countries and exclude Australia, New Zealand and the United States. Not surprisingly, this was rejected by Australia and the United States as well as by Japan, which had extensive extra-regional economic linkages. Instead, they developed their parallel vision of East Asian regionalism and, supported by some other East Asian countries, pursued instead the objective of ‘open regionalism’. This became the basis for establishing the Asia Pacific Economic Cooperation (APEC), which deliberately relied on informal processes rather than formal institutional rules and linkages. Japan also took no interest in institutional development because, according to Alan Rix3 and Richard Doner,4 its foreign leadership style was one of

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‘leadership from behind’, which entailed not foreign policy activism or institution-building activities but rather an attempt to solve coordination problems among the regional countries through an on-going process of bargaining to ‘harmonize’ diverse national interests. According to Doner, coordination problems are solved not by asserting central authority or leadership but rather by providing incentives to ensure compliance with established rules and norms.5 The Asian crisis, however, demonstrated the fragility of ‘network power’ and the dilemma of not having an institutional ‘firewall’ against regional conflagrations. Following the Asian crisis, the Japanese government attempted to give East Asian ‘network power’ an institutional edge, by proposing the creation of a new regional financial institution and a more robust regional financial architecture. The old modus operandi of informal and weak institutional bases no longer seemed adequate to protect the network of relations that had developed between Japan and the regional countries, and this prompted the search for new solutions. In the process, the Japanese government also provided a useful counterpoint to common assumptions that Japanese diplomacy was reactive and passive. The Japanese government proposed the establishment of an Asian Monetary Fund (AMF), and most analysts agree that had a similar institution existed prior to the Asian crisis then the latter would have been easier to manage. However, the proposal of a regional financial institution had to be shelved because of American opposition. In any event, Japan’s post-crisis foreign policy initiative, especially the AMF, revealed an attempt to play a positive role in crisis management while responding also to a perceived need to strengthen the bases of regional integration and regionalism. The proposal for an Asian Monetary Fund, to be established with a substantial Japanese financial contribution, was a clear signal of Japan’s readiness to help regional countries overcome the crisis, and to help establish foundations for regionalism based on institutional development. At the same time, it was also a sign of political maturity and leadership that was unlike earlier instances of pressure-seusitive and reactive foreign policy. For example, Japan contributed US$13 billion during the Gulf War campaign, but only after intense American pressure on the Japanese government to share more of the burden of ejecting Iraqi occupation forces from Kuwait. In addition to being reactive, Japanese foreign policy initiatives were also characterized by Michael Blaker as leaning toward a strategy of ‘coping’ with external circumstances. The response of the Japanese government to the Asian crisis, however, marked a break from past diplomatic

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strategies, and instead of reacting to external pressure and avoiding entanglement, it proposed an institutional strategy for crisis resolution. The initiative failed to win the approval of the United States, but it was still important in signalling Japan’s willingness to play a more positive and helpful role on the international stage.

The Asian crisis as a foreign policy opportunity Crises are, as noted earlier, opportunities that can be exploited for positive gains. This is true for both domestic and foreign policy issues. For example, the Chinese government responded to the Asian crisis by announcing a decision not to engage in competitive devaluation, even if it meant losing export advantage to regional countries that had experienced sharp currency devaluation as a result of capital flight. This gesture had considerable symbolic significance because it was interpreted as an act of self-sacrifice in the interest of assisting regional countries to engineer an export-led economic recovery. The Chinese government won considerable international and regional praise for its restraint, even though there were no immediate costs associated with the policy decision. The financial crisis had disrupted the real economies in affected countries to such an extent that there was no immediate danger of Chinese exports being undermined by a surge of exports from the regional countries. Moreover, if an earlier Chinese devaluation of the yuan in 1994 had contributed to the onset of the Asian financial crisis, China’s response in 1997 ensured that its government was perceived as both responsible and helpful and consequently emerged from the crisis with heightened regional stature at minimal cost to itself. Likewise, the crisis was an opportunity for Japan to use its considerable economic resources to help regional countries recover from the meltdown and, in the process, enhance its standing within the region. We ought not to dismiss Japanese generosity as a cynical exercise in selfenrichment, but clearly positive gains were expected to flow from contributions to crisis management. In this chapter, I will focus primarily on the financial support measures of the Japanese government as well as initiatives to establish new institutions to deal with the Asian crisis. The immediate requirement of the regional countries was for financial assistance to pay for foreign loans and to rebuild national finances that had been depleted in the failed attempt to defend currency values prior to the onset of the crisis. Japan was the only likely regional source for the largescale financing needs of the crisis countries. In turn, a positive Japanese response would no doubt counteract some of the lingering suspicions and

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hostility towards Japan within the region and help also to consolidate its regional role. In the past, Japan had often been criticized as being unwilling to bear the costs associated with the maintenance of international economic stability. The impression of Japan as a self-interested international free rider had been formed in the 1970s following Japan’s rapid economic transformation and emergence as a major economic power. In particular, it was criticized for exploiting open markets overseas to boost export revenue while denying foreign exporters opportunities to enter the Japanese market through various formal and informal trade barriers. Later, as the Japanese government loosened its purse-strings to emerge as a leading source of international aid and financial assistance to other countries, it was criticized for an uninspired ‘chequebook diplomacy’. Rather than play a sustained and active international role commensurate with its economic standing, the Japanese government acquired a reputation for passivity and for limiting its international engagement to financial contributions. The main critics of Japanese foreign economic and security policies have included revisionist scholars like Chalmers Johnson and Karel van Wolferen,6 who have argued that Japanese free riding have been detrimental to international stability and to the American economy. They argue that by failing to share the burden of, for example, international security and economic regimes, Japanese actions had transferred costs to other countries, to the detriment of their economic performance and competitiveness. To remedy this lopsided situation, revisionist prescriptions have been to force Japan to assume greater responsibility for the provision of international public goods both in normal times and during crises. Though slowly at first, the idea of burden sharing also gained wide acceptance within Japan, both among public officials and analysts. Tachi Ryuichiro, for instance, has stated that Japan has to make contributions commensurate with its economic standing and provide more international public goods.7 In the Gulf crisis of 1990, Japan was criticized for its hesitation and ambivalence. The Japanese government attracted the ire of western governments for not taking a determined position in condemning Iraqi aggression against Kuwait. As stated earlier, Japan eventually provided considerable financial assistance to the western military campaign, but it still attracted criticism for limiting its contribution to financial aid. Moreover, initial Japanese ambivalence followed by western pressure and Japanese response seemed to add weight to revisionist assertions that the Japanese government must be compelled to behave in a manner that is internationally responsible, and that left to itself it will opt to free ride.

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In all fairness, however, Japan was limited in its contribution to western military efforts by a pacifist constitution. The constitution had been authored by the Allied forces that occupied Japan after the Second World War, and article 9 clearly proscribed war as an instrument of foreign policy. Despite its foreign origins, the constitution has achieved a high degree of domestic legitimacy that has confounded attempts to rewrite or to amend it. The Japanese government has also had to consider regional sensitivities because countries like China and South Korea are vociferously opposed to suggestions that Japan complement its economic potential with military-power status. This has led to a taboo on open discussion of sensitive military issues, especially by members of the government. In March 1999, Justice Minister Nakamura Shozaburo was forced to resign partly because of statements that Japan should abandon its pacifist constitution and establish a fully fledged military. Despite seemingly strict injunctions against war and the maintenance of a military establishment, article 9 has been interpreted to permit ‘selfdefence forces’ to protect the country from foreign aggression. Even then, such forces were denied any overseas role, whether for relief activities or even in support of international military operations sanctioned by the United Nations. Under the circumstances, the only recourse available to Japan during the Gulf crisis was financial contribution to the expense of the allied military operations. Nonetheless, jolted by the severity of western criticisms, the Japanese government subsequently secured the passage of Peace Keeping Operations (PKO) legislation through the parliament. The PKO law legitimized Japanese participation in international peace-keeping operations of the United Nations, although only in a noncombat role. Apart from that, the Japanese government has for a number of years asserted and expressed a desire to play a positive leadership role in the Asia-Pacific region. This manifested itself in processes that led to the establishment of the Asia Pacific Economic Cooperation (APEC) forum to achieve open and non-discriminatory trade liberalization. The Japanese government, along with the Australian, was an early advocate of the APEC mechanism, although APEC emerged as a viable association only after the US government decided to support it and convened a summit meeting of APEC leaders in 1993. Japan could also be expected to play an active role in managing the Asian financial crisis because of its potential flow-on effect on the Japanese economy. According to estimated costs of the financial crisis for Japan, a significant drop in Asian imports from Japan would reduce Japan’s GDP growth by between 0.3 and 0.4 per cent.8 The flow-on effect was admittedly not large, but for an economy that had

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contracted 2.9 per cent in the second quarter of 1997, and was unlikely to grow more than one per cent for the whole year, even the modest losses were serious for Japan and for the rest of the world. Moreover, the drag of the Asian crisis was likely to be felt most by the car manufacturers and makers of electronic machinery, which had considerable exposure in Southeast Asia. From a Japanese perspective, therefore, an early resolution of the crisis was important for its own economy as well as for the global one. Although it was not recognized initially that this was a global crisis, as evidenced by statements from the American president that it was a small glitch in the overall economic performance of Asian countries, it soon became apparent that the crisis had the potential to trigger a global economic downturn, through the domino effect of exacerbating first the fragility of Japan’s economic stability. The withdrawal of capital and loss of foreign exchange reserves jeopardized the ability of East Asian countries to service debts and also to finance their imports. The crisis, which began in capital markets, had an immediate adverse effect on the real economy. The sharp slowdown in economic activity affected government revenue and the ability to finance social welfare and infrastructure development programmes. To replenish state coffers, the international community responded with promises and commitments of financial assistance. In this respect, the international response was no different from earlier crises involving developing countries in Latin America. In channelling and coordinating financial assistance to the East Asian countries the International Monetary Fund (IMF) assumed the lead role, one that its founders had not intended. Under the Bretton Woods agreement, the International Monetary Fund was established to maintain a regime of fixed exchange rates and to provide assistance to countries experiencing long-term structural balance of payments difficulties. The IMF’s involvement in international debt and financial crises was a departure from its intended schedule of activities, but it filled a void for it when its role and relevance were inevitably put into question following the collapse of the Bretton Woods system in the early 1970s and once fixed exchange rates had been abandoned in favour of flexibility and its promise of automatic trade balancing. Amid the IMF’s crisis of relevance and legitimacy, the Latin American debt crisis of 1982 opened up an opportunity for it to reinvent itself as the guardian of international financial stability. The Latin American crisis was the first serious threat to international financial stability, given the high levels of exposure of major western banks. The concern was that large-scale debt servicing failure would inevitably lead to a collapse of

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western banking institutions and undermine global financial stability. IMF assistance to the debtor countries, in this instance, was designed to assist in the recovery process as well as to ensure orderly repayment of existing loans and prevent debt repudiation. In so far as debt servicing was the source of the crisis, the IMF introduced strict structural adjustment and austerity measures designed to generate exports and facilitate debt servicing. The Latin American countries, which had generally pursued import substitution industrialization, were encouraged to become more open and export-oriented, in order to enhance foreign exchange revenue to service debt. In the early stages of the Latin American debt crisis, debt relief was not given any serious consideration. Consequently, the burden of adjustment fell entirely on the debtor countries. Only in the late 1980s, after prolonged economic instability in the debtor countries, did the West and the IMF venture into debt relief. The mechanism for debt relief was the ‘Brady bonds’ scheme whereby the ‘IMF contributed to a pool of money used to retire non-performing bank debts’9. Before the Brady Plan initiative, debt relief had been dismissed as damaging to the debtor countries in the long term because creditors would refuse to advance fresh loans in future. However, this was a specious argument because, as pointed out by Jerome Levinson, ‘In fact, it was only after the Brady debt reduction initiative in 1989 that Argentina, like other Latin American debtor countries, regained substantial voluntary access to the international financial markets, although not the syndicated bank loan market.’10 In East Asia, the IMF again devised a programme of action to help restore investor confidence and prevent a contagion. The main emphasis of the IMF was to restructure and strengthen the financial system in the crisis countries, help preserve fiscal balance in them and assist with their balance of payments difficulties. Since the crisis was in large measure a result of financial sector weaknesses, the IMF programme arranged for the closure of non-viable financial institutions, for recapitalization of undercapitalized institutions and for a better system of supervision of weak financial institutions. In support of the structural adjustment programme, the IMF, its member countries and other multilateral institutions (the Asian Development Bank and the World Bank) committed approximately US$120 billion in financial aid. In return, the recipient countries signed letters of intent, which spelled out their commitment to the structural adjustment programmes. The IMF also grasped the opportunity to reform other sectors of the economy not directly relevant to the management of the crisis. IMF structural adjustment programmes have been criticized for their social

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consequences and for their inappropriateness to crisis resolution. It could be argued that the IMF conditionality exacerbated the political crisis in Indonesia that led ultimately to the fall of the Suharto government and to widespread ethnic and social conflict. Similar criticisms were made during the Latin American debt crisis and about IMF loans to debtor countries in Africa. Structural adjustment programmes have also been pilloried as formulaic and insufficiently reflective of actual requirements. For instance, while the East Asian crisis was financial, the structural adjustment programs included trade liberalization measures that had little direct relevance to the unfolding crisis. Worse still, IMF conditionality may even have exacerbated rather than alleviated the crisis. For instance, measures to close banks in East Asia and restructure the financial system may have actually further undermined investor confidence rather than repairing it. The IMF forced bank closures, which induced financial panic because no steps had been taken to protect depositors and to maintain the flow of liquidity to healthy sectors of the economy. The IMF also demanded fiscal cutbacks, despite healthy public sector finances. In Indonesia, it forced the government to raise fuel prices and end food subsidies. This resulted in violence directed at the government, which claimed the Suharto regime. Acknowledging the truth in some of the criticisms, Hubert Neiss, the Asia-Pacific director at the IMF, stated that ‘Had we correctly anticipated the severity of the recession, fiscal policy would not have been tightened at the outset of the programme. But this error was adjusted fairly quickly.’11 This admission of policy failure was little comfort to the affected countries, however. In defence of the IMF, it should be noted that IMF involvement begins only when a situation has deteriorated to a crisis point and when, presumably, strong measures are necessary and unavoidable. Moreover, the IMF has not only the immediate perspective of containing the crisis but a longer-term perspective of ensuring sound economic footings to facilitate economic recovery. The burden of IMF adjustment programmes fell on the debtor countries, with nothing onerous demanded of the creditor countries. In this, the rescue programme was a replica of previous IMF involvement in earlier debt crises. What the IMF did achieve, in the case of South Korea, was to renegotiate the terms of the commercial loans and convert short-term debt to long-term debt, which of course lightened the burden on the debtor countries. But the commercial banks exacted a stiff price for this: the conversion of unsecured credit to debtors of dubious financial capacity into one guaranteed by the government of South Korea ...

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there was no reduction [moreover] in the nominal amount of the Korean debt. No provision was made in the IMF-organized financial rescue operations with Thailand and Indonesia for the foreign creditors to reduce the nominal amount of the debt or to extend the maturity of their loans.12

Japanese aid to crisis countries In the Asian crisis, Japan was quick to offer financial assistance to the affected countries and again, as in the Gulf crisis, aid commitments were very generous. While the IMF coordinated the international assistance efforts, the Japanese government was the main source of financial assistance provided to the East Asian countries. The Japanese government was the largest source of funds channelled to these countries through the International Monetary Fund and other international agencies, and it also provided export credit through the Export–Import Bank of Japan. Overall, Japan provided approximately US$42 billion in assistance through various channels. Japan’s financial generosity was to be expected not simply because the crisis was in its backyard (just as the United States was the main source of financial assistance to Mexico in 1995) but also because Japan had amassed large international reserves, which it could use for that purpose. Japan provided US$4 billion to Thailand, US$5 billion to Indonesia and US$10 billion to South Korea. Japan led the donor countries and was perceived as having acted responsibly by the regional countries. However, western governments and international agencies like the IMF and the World Bank put considerable pressure on Japan to do much more. This occurred even as the Southeast Asian governments themselves criticized western governments and the US for their own cool response to the crisis. As noted above, President Clinton had initially described the crisis as a mere glitch in the economic performance of Asian countries. A senior US diplomat in Southeast Asia admitted that the US was on the defensive in Asia for failing to take initiatives, insisting simply that the interests of the crisis countries were being well served by the IMF and by the World Bank. Some have attributed US inaction to an “Asian allergy,” a defensive reaction resulting from allegations that Asian countries had made illegal donations to the Democratic Party in the US.13 Later, over the course of the crisis, the US transformed the economic crisis into a political crisis as well, insisting that one of the problems was the absence of real democracy in the crisis countries, particularly Malaysia. In November 1998, at the annual APEC summit in Kuala

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Lumpur, Vice-President Gore, standing in for Clinton who was otherwise preoccupied with the Iraqi crisis, lambasted his host, criticizing the lack of political freedoms in Malaysia. He praised the ‘brave people’ of Malaysia for pushing ahead with their democratic demands but Malaysian Minister for Trade Rafidah Aziz dismissed the speech as disgusting. The Malaysian reaction to it was to be anticipated, but even the Australian prime minister criticized the American vice-president for unproductive hectoring.14 Worse, the speech derailed the summit from the real agenda of trade and economic liberalization and probably did not win the US many friends in the region. Peter Petri has characterized the rift across the pacific as the outcome of a ‘philosophic divide’, which not only had led the Malaysian prime minister to blame the West for the crisis but also prompted the US to reject an early Japanese proposal for an Asian Monetary fund. Petri suggests that such a fund ‘might have contained the contagion last fall [1997].’15 If crises are an opportunity to further enhance national potential then American diplomacy in the Asian crisis was exemplary in its ineptness. Apart from financial generosity, the Japanese government took the unusual step of proposing the establishment of a regional monetary fund to be the lender of last resort for countries within the region. The proposal for an Asian Monetary Fund (AMF) underscored Japan’s desire to embed regional interactions in formal institutional structures and was an uncharacteristic move because the establishment of formal structures had not been supported, in the past, either by the United States or by the regional countries. The Asian region is among the least institutionalized of all regions and the Japanese proposal would have helped redress the institutional imbalance. Existing regional institutions such as the Association of South East Asian Nations (ASEAN), the Asia Pacific Economic Cooperation (APEC) and the East Asian Economic Caucus (EAEC) are all examples of soft institutions and, arguably what is required are more formal institutional structures that can withstand periodic pressures and crises. Formal institutions would not necessarily prevent crises but could presumably strengthen cooperative behaviour based on common expectations, norms and rules of conduct. The post-crisis tension within ASEAN was symptomatic of the inability of soft institutions to sustain interstate cooperation under adverse circumstances. ASEAN had been established in the 1960s as a loose regional association, and by all accounts was reasonably successful in muting regional antagonisms and conflicts. Japanese foreign policy acknowledged the importance of ASEAN as the main regional forum, and officials of the Japanese government were careful to emphasize that Japan would act in

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concert with ASEAN. The Asian crisis reopened divisions within ASEAN, however, and this prompted Prime Minister Mahathir to describe it as ‘split up’.16 The Asian crisis reduced ASEAN to a position of impotence as a result of internal bickering and growing tensions between some of the key ASEAN countries. An unwritten but obvious principle of ASEAN diplomacy was non-interference in each other’s domestic affairs. That principle became a casualty of the crisis as countries voiced criticisms of each other’s domestic political and social violence, due partly to ethnic divisions, and of their economic policies. In particular, acrimony and tension are highest in relations between Indonesia and Singapore and between Singapore and Malaysia. These are all ethnically divided societies and the Singapore government especially is worried that ethnic violence will spill over to engulf it in the crisis. Japan’s regional diplomacy had emphasized close partnership with ASEAN, but it seemed uncertain whether ASEAN would continue to hold the same position of importance. Moreover, the unfolding events in Southeast Asia have also made clear the weaknesses of loose associational groupings like ASEAN. The shortcoming of ASEAN was that it not only failed to be an agent for crisis resolution but also could not prevent deterioration of relations among its key members. In that context, the Japanese push for a more formal institutional structure was understandable. ASEAN disarray may also be an opportune moment for Japan to pursue its regional agenda with more assertiveness than in the past. ASEAN may again become more coherent once the crisis is resolved and political settlement reached in Indonesia and Malaysia, but in the interim there is considerable scope for Japan to take the initiative. The only limiting factor, and not a minor one, is the residual resentment towards Japan. Whether or not such an end was intended, the proposed AMF would have ensured a form of regionalism that did not take the more xenophobic route advocated by the Malaysian government, when it had championed the cause of an East Asian Economic Caucus (EAEC) as an exclusive institution, with membership restricted to the Asian countries. To attract support, the Malaysian government emphasized its potential for increasing Asian unity, which would presumably enhance the role and influence of the Asian region in global affairs. Malaysia expected Japan to play a leading role in establishing such an exclusionary institution, but Japan refused to support the idea because of its close links to the US and because of American hostility to the concept. The Japanese proposal for the AMF did not contain any membership restrictions, although it was primarily for the benefit of the East Asian

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countries. Unlike the EAEC, there was no suggestion that Australia and New Zealand, or even the US, would be denied membership. Presumably, similar institutions could also be established for other regions to act as a lender of last resort and to contain financial and currency crises. Perhaps the proposal should have been framed as an Asia-Pacific Monetary Fund, but to all intents and purposes that was essentially what it was envisaged as being. This is clear from Japan’s own national interests in maintaining good relations with both the US and Asian countries. A cynical explanation could be that it was an opportunistic move to institutionalize Japanese dominance within the region, since the AMF would be funded by Japan and presumably also led by Japan. More considered analyses, however, suggest that the proposal had considerable merit on its own. Nevertheless, even before the merits and demerits could be explored and evaluated, the idea of the AMF was rejected by the United States as unnecessary and even detrimental to international financial stability, which prevented any progress toward its establishment. However, despite this the AMF still is an interesting and important topic for study. Not only does it represent an example of a ‘dog that didn’t bark’, but also it is clear that the Japanese government had not completely abandoned the project, despite criticisms from the United States and from international institutions like the IMF.

The Asian Monetary Fund As we have seen above, the Asian Monetary Fund was proposed by the Japanese government to inject fresh capital into the troubled economies of East Asia in an attempt to restore international confidence in these economies and lure investors back, but it was rejected by the United States and consequently abandoned by the Japanese government, at least formally. Nonetheless, it is important to understand the thrust of the proposal and why it was rejected in order to derive some lessons for crisis management in future. As already mentioned, President Clinton had, early in the crisis, declared it a mere glitch in the overall economic progress of Asian countries. When the Japanese government proposed to include the East Asian financial situation on the agenda of the G–8 summit of the industrialized countries, to be held in Denver in late June 1997, the United States rejected this as unnecessary. Instead the joint communiqué issued by the summit leaders expressed the hope that the IMF and the World Bank would continue to make progress in promoting further capital market liberalization in the emerging developing countries.

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The Japanese government reacted early, but its focus was on the provision of financial assistance. This was clearly a situation where the immediate requirement was for financial aid and Japan, despite its own economic stagnation, was in the best position to respond positively. This was also – importantly – an economic crisis and the Japanese government had always felt more comfortable dealing with issues of ‘low politics’ than with those of ‘high politics’ or with security issues, such as the Gulf crisis. Moreover, there is no question that Asian stability and prosperity is important to Japan. The region straddles Japan’s supply routes and a prolonged economic crisis had the potential of destabilising the region. This has always been an important consideration in the determination of Japan’s foreign policy, and explains why the East Asian countries are the major recipients of Japanese Official Development Assistance. The Japanese government provided financial assistance to the individual crisis countries and proposed funding an Asian Monetary Fund to deal with the present and future crises. The proposal to establish the Fund was made in September 1997 at a meeting of the IMF and the World Bank in Hong Kong. The Japanese government offered US$100 billion to establish a fund to provide assistance to countries in crisis. The proposal was made in the early stages of the crisis and reflected the government’s serious desire for a quick resolution. The regional reaction was generally positive, and Malaysian Deputy Prime Minister Anwar Ibrahim declared that the proposal merited serious consideration. The Far Eastern Economic Review observed that the crisis had allowed both Japan and China to score points at the expense of the US and the IMF, Japan because of its proposal for the Asian Monetary Fund and China because of its promise not to engage in competitive devaluation even at the cost of a loss of international competitiveness and reduction of export revenue.17 The proposal for an AMF was not simply an extension of Japan’s chequebook diplomacy but an important initiative to establish an institutional framework for managing this and future crises. At least, in hindsight, it is clear that the proposal was an appropriate response to the Asian crisis. The Asian crisis was essentially a crisis of confidence made worse by flight of capital from the region. The AMF might have restored confidence by injecting fresh capital into the regional economies and by sending positive signals to foreign investors who, in the absence of contrary indicators, acted from an irrational herd mentality.18 The Asian Monetary Fund proposal also would have overcome any financial limitations of the IMF and other international agencies in responding to the crisis. The IMF is limited by its quota subscriptions as to how much financial assistance it can provide, and Japan could not

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increase its quota subscriptions without upsetting the balance of voting rights within the IMF, which would probably not have been acceptable to the US. Apart from these important considerations, the initiative for an AMF can also be understood as part of an attempt by the Japanese government to improve its regional standing relative to that of China. In the region both Japan and China have leadership aspirations, and while they maintain a close bilateral relationship they also compete for the hearts and minds of the other countries, in a struggle in which Japan is disadvantaged by a number of factors. The most important of these factors are the wartime memories and the feeling that the Japanese government has not fully demonstrated its remorse and thus brought that particular chapter of Japanese history to an acceptable close. Moreover, the presence of large Chinese minorities in several of the key East Asian countries meant that governments had to be cautious in not risking links with China. In particular, as long as Japan and China were seen as engaged in competitive leadership struggle, the regional countries could be expected to try and maintain a safe distance and not line up with Japan too closely. Thus, on 14 January 1998, when Japanese Prime Minister Hashimoto, concluding a regional tour, elaborated upon a desire to elevate relations with regional countries to a summit level forum to discuss security and economic issues, the suggestion received only a cool reception. This was because ASEAN countries were concerned that such a move would antagonize China.19 They may also have been reticent about accepting a proposal that threatened to undermine the ASEAN Regional Forum (ARF), an ASEAN-based structure for the discussion of security and political issues. China had emerged relatively unscathed from the crisis despite the loss of international competitiveness. Its currency was spared the crisis of devaluation because the yuan was not convertible on the capital account and escaped the attack that other currencies were subjected to by speculators. In the aftermath of the Asian crisis, the Chinese government won immediate praise for its commitment not to devalue the yuan, even if it meant a loss of China’s international trade competitiveness. During a visit to Southeast Asia in August 1997, Chinese Premier Li Peng highlighted China’s positive and constructive leadership in not reacting to the currency devaluation in the crisis countries with a devaluation of the yuan. The premier also criticized the US, which he accused of merely lecturing and bullying the regional countries into accepting American standards.20 This was a welcome expression of support for the Southeast Asian leaders, Lee Kuan Yew of Singapore and Mahathir Mohammad of Malaysia, who have championed ‘Asian values’ while rejecting western liberalism. The

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US, as mentioned earlier, had by contrast attributed the crisis to Asian values, which had allegedly given rise to corruption and political cronyism to the detriment of economic rationality and prudence. In contrast to the ups and downs of US–China relations, relations between Japan and China have been relatively close, based on considerable Japanese financial aid and investment in China though still not without some friction. The Chinese government, for example, has been a staunch critic of the Japanese Ministry of Education for censoring school textbooks and for refusing to permit a full and open depiction of atrocities committed in China by the Japanese military. The issues of a formal Japanese apology and of compensation for victims and their descendants have also not been satisfactorily settled.21 In the early 1990s, Japanese Prime Minister Murayama Tomiichi expressed remorse for the past injustices but the issue cropped up again in 1998 when Chinese President Jiang Zemin visited Japan. This visit in late November was the first ever by a Chinese president since the end of the war, but the two governments decided not to sign a joint declaration on their bilateral relations after the Japanese government refused to include a written apology as demanded by the Chinese government. The Japanese government offered only an oral apology, which the Chinese rejected as inadequate. In the unsigned declaration, the two governments agreed, however, to work toward a twenty-first-century ‘partnership’ of better relations between the economic and military giants of East Asia. The seriousness of the regional leadership rivalry between Japan and China is enhanced by the lack of institutionalization in the Asia-Pacific region. Unlike in Europe, where developments since the Second World War had centred on the progressive deepening of institutional and structural linkages, interactions in the Asian region had developed much more slowly in the context of an institutional vacuum. Apart from ASEAN, the other important regional institution is the Asia Pacific Economic Cooperation but it, too, had been deliberately left without much institutional support. With the proposal of an Asian Monetary Fund the Japanese government tried to facilitate the formation of formal regional institutions that would also inevitably be dominated by Japan and reflect its interests. This would also serve to foreclose the EAEC option and ensure open rather than closed regional institutionalism. The EAEC proposal had created a dilemma for Japan, which since the end of the Second World War has maintained very close ties with the US. Thus, while Mahathir expected Japan to play a lead role in bringing the idea of Asian regionalism to fruition, the Japanese government, mindful of its trans-Pacific links, withheld support but did not openly reject it

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either. The lukewarm Japanese reaction stemmed from a view that this would endanger and undermine the important strategic and economic relationship with the United States, which remains the cornerstone of Japan’s international diplomacy. Given the centrality of US–Japan relations and the likely deepening of Japan’s relations with Asian countries, various scholars have presented frameworks for the future of Japanese foreign policy. T.J. Pempel, for example, has conceptualized the emerging pattern of Japanese foreign policy as a torii such as stands at the entrance to Japanese temples.22 A torii consists of a horizontal beam resting on two columns, forming an entry to temple grounds. According to Pempel, Japanese foreign policy is analogous to a torii straddling the Pacific. Through much of the postwar period, Japanese foreign policy had been exclusively focused on maintaining and strengthening relations with the United States. However, in recent years, it is clear that the Japanese government has tried to strengthen relations with other Asian countries while maintaining its alliance relationship with the US. This is not an easy task considering the strained relations between the US and several Asian countries, notably Malaysia. For Japan to act as a bridge between the East and the West, or to position itself as a ‘trans-Pacific torii’, it is necessary that regional institutions are not paralysed by existing or emergent philosophic divides between Asian countries and the US. Despite the fact that the proposal for the AMF was well received by the crisis countries and that it would be funded largely by Japan, it failed to win crucial American support. As the junior partner in the US–Japan alliance, Japan did not feel confident about pursuing it further on its own, or at least until the groundwork for it had been more carefully established. The US rejection of the AMF stopped it dead in its tracks. Nonetheless, the proposal was an important act of leadership by the Japanese government, and one that could have contributed to an efficacious resolution of the crisis. Yet, even as the US rejected the AMF, it demanded that Japan act decisively to demonstrate leadership. As far as the US was concerned, leadership meant reflating the Japanese economy and increasing imports from the affected economies. Certainly, as mentioned above, the crisis countries welcomed the proposal as useful, but their response was not so enthusiastic as to overcome and override the negative US reaction.

American rejection of the Asian Monetary Fund As soon as the Japanese government proposed financial assistance to the crisis countries through an Asian Monetary Fund, the American govern-

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ment rejected it as unnecessary and harmful. It would have been appropriate for the US to offer its support, since American and Japanese interests were coincident at least in facilitating the emergence of more moderate forms of Asian identity and regionalism. Without American support, the Japanese government did not feel confident enough to unilaterally pursue its establishment and abandoned the project. The fate of the AMF and Japanese compliance to American sensitivities revealed the overriding importance, as far as Japan was concerned, of emphasizing relations with the United States. By abandoning its initiative, Japan left the Asian countries with little choice but to accede to IMF conditionality. More importantly, according to Walden Bello, the Japanese government had passed on a ‘golden opportunity’ to move decisively into a leadership position in the region.23 The American rejection was premised on a belief that existing multilateral institutions were adequate to deal with the Asian crisis. The US was concerned also that an AMF, along the lines proposed by Japan, would undermine existing institutions like the IMF because it would free crisis countries from the required economic discipline that only the IMF and the World Bank were in a position to impose and monitor. IMF lending to countries is always contingent on successful implementation of an IMFdictated programme of economic reforms. Structural reforms are not painless, as the debtor countries discovered during the debt crisis of the 1980s, and the concern this time was that the Japanese proposal would allow crisis countries to escape conditionality and avoid necessary reforms and structural adjustment, either intentionally or through mismanagement by Japan.24 Indeed, the Japanese government was reportedly not an enthusiastic supporter of IMF interventionism and saw the proposed fund more as a ‘friendly neighborhood bank’.25 If, however, the US was concerned that lack of discipline and conditionality would only exacerbate the situation, there were of course many critics of the IMF who accused it of misguided and formulaic policy prescriptions that were uninformed by the situation on the ground. Critics claimed that the formulaic approach was often more harmful than useful to a country in crisis, and at best irrelevant, such as when the IMF demanded economic liberalization to deal with a financial crisis. According to the detractors, IMF policy towards a crisis was simply to ‘round up the usual suspects’, without first obtaining an assessment of the situation on the ground. Thus, typically, IMF conditionality required imposing a regimen of austerity, which often was unnecessary and worsened the situation by exacerbating the plight of the poorest segment of the population, which depended on a range of welfare programmes.

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These criticisms had been levelled at the IMF ever since the Latin American debt crisis, and the IMF response to the Asian crisis seemed to be a replication of its formulaic approach to crisis management. However, the US government was a staunch defender of the IMF and the American defence of the IMF was articulated by Dan Tarullo, assistant to the president on international economic policy, during a White House press briefing on 20 November 1997. He stated that ‘The IMF has the resources, they have the expertise, they have the experience of how to assist countries in stabilizing. We have a good institution, we ought to support it, we ought to use it.’ The American defence of the IMF is understandable because the United States effectively controls it, whereas an Asian Monetary Fund would be largely under Japanese control and in competition with the IMF. In many ways, IMF programmes have helped to advance American commercial interests. IMF lending, as mentioned, is subject to strict conditionality, and in the design of rescue packages for Asian countries the United States played a leading role even though Japan provided most of the funds for the packages. For instance, in the South Korean rescue package the US Chamber of Commerce, according to a knowledgeable Korean source, wrote a significant part of the final agreement.26 The packages contained requirements to substantially liberalize the Korean economy and move against the Korean conglomerates, even though it is debatable how these would have helped to resolve the crisis at hand. They certainly helped American commercial interests by weakening Korean international competitiveness. The influence of the United States extended to disbursement of IMF funds. In the Asian crisis, IMF was criticized for tardiness in releasing funds committed to Korea, perhaps because it wanted to extract additional concessions from South Korea. This may have served American interests but did not facilitate an early resolution of the crisis. This was a crisis borne out of liquidity shortage and in such situations, according to G.K. Helleiner, it was important to ‘insert liquidity, i.e. finance that is available at very short notice, in large amounts, and virtually unconditionally’.27 Arguably, since the Asian Monetary Fund would not impose the same conditions as the IMF, disbursement of funds were likely to be faster than through the IMF. The US government perceived the crisis as a reflection of structural defects in East Asian countries, and its successful resolution as requiring structural reforms. As such the crisis was seen as an opportunity to dismantle structures of ‘Asian capitalism’, including state intervention in national economies, and supplant them with liberal institutions and

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structures modelled on those in the West. The US rejection of AMF was premised on a belief that a regime of ‘easy money’ would make reforms harder to achieve and produce no lasting benefit. This was not simply a concern for the welfare of regional countries but was also influenced by a desire to see American-style liberal capitalism replace state-centric Asian capitalism. Asian capitalism had attracted the ire of US government and trade officials as undermining US industries, and the crisis was an opportunity, as they saw it, to level the playing field. According to Sakakibara Eisuke, a senior Japanese Finance Ministry official, a primary American objective during the Asian crisis was to restructure Asian economies, an objective that was inconsistent with the provision of ‘easy money’.28 The AMF was also criticized on the grounds that a regional response to a crisis emanating from economic and financial globalization was inherently flawed and misguided.29 According to this view, a more fruitful avenue, instead, would be to study ways for reforming the global financial architecture much as is being advocated by US government officials. However, while it is true that the Mexican and the East Asian crises resulted from financial globalization, in the Mexican crisis the United States assumed primary responsibility for assisting Mexico and in the East Asian crisis international attention and expectation was focused on Japan to lead the rescue effort. Indeed, the Japanese government provided a large bulk of the financing for IMF programmes to the East Asian countries, and in proposing the AMF indicated also its readiness to commit substantially more in financial assistance. Thus it does not necessarily follow that only a global institution like the IMF can effectively respond to a crisis of economic and financial globalization. The proposal for an Asian Monetary Fund also reflected Japanese interest in a larger regional role. Such a fund would of course be dominated by Japan but could also at the same time have been expected to shield regional diplomacy from the more xenophobic elements, given Japan’s close economic and security linkages with the United States. Yet, the American rejection of the AMF was understandable, as the US has long held suspicions of new institutions that could weaken US domination over global affairs or impinge upon American sovereignty. Such sentiments have been especially significant in the Congress and were behind the torpedoing of early postwar attempts to establish an International Trade Organization and, again, though this time unsuccessfully, the attempted vetoing of the World Trade Organization when it was established in the mid-1990s. The AMF, a regional institution, could not conceivably impinge upon American sovereignty, but would clearly lay the groundwork for greater Japanese influence, perhaps at the expense of the United States.

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The US is the sole remaining global superpower, with a greater capacity to pursue its interests than during the cold war. If the US regarded some institutions with suspicion during the cold war, it does so even more under the New World Order. For the United States, international and regional institutions are potential encumbrances that could limit its freedom of manoeuvre. It is not surprising that the US has not supported institution-building efforts in the Asia Pacific, which was why it was initially ambivalent about the APEC proposal and accepted it only later as part of a wider strategy to force the European governments to offer concessions in the Uruguay Round of trade negotiations of the General Agreement on Tariffs and Trade. Indeed, given the known American suspicion of new institutions, a cynical view of the Japanese proposal could be that the initiative was for purposes of demonstration only and not meant to be taken seriously, that it demonstrated Japan’s desire to be generous in assisting Asian countries safe in the knowledge that the generosity was unlikely to be called upon. However, the cynical interpretation is just that. Even after reservations expressed by the United States and the IMF, Japan and the ASEAN countries continued to work on details during meetings in November, in order to clarify and explain the proposal to the US. In the end, the proposal failed to elicit US support. The IMF in December 1997 established instead the Asian Standby Facility to assist countries already receiving IMF assistance but which needed additional help. Several countries, such as Japan, Singapore, Australia and Malaysia, committed funds to the standby facility that countries may access after they have drawn down other loans from the International Monetary Fund, the World Bank and the Asian Development Bank.

The AMF revisited At one level, American rejection of the AMF could have been anticipated as necessary to protect, for example, the IMF as the leading international financial institution. At another level, however, the American response was odd, considering that it had consistently argued for a more active international role for Japan. This may have encouraged the Japanese government to float the idea of a regional financial institution. But once American rejection was obvious, the Japanese government quickly abandoned the institutional approach to crisis resolution. This was not odd in the context of Japanese diplomatic history, which, according to Michael Blaker, displays clear patterns of cautiously following others and of ‘coping’ with the prevailing international situation rather than seeking to

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modify the external environment to its own advantage.30 From a study of Japan’s participation in the Third United Nations Law of the Sea Conference (UNCLOS III) in the 1970s and the Gulf War crisis in the early 1990s, Blaker concluded that Japanese foreign policy strategy is to initially test the water, avoid commitments, and then wait for another to take the lead. In the Law of the Sea Conference, Japan, as a leading maritime nation, initially defended the existing maritime regime, with narrowly confined territorial and exclusive economic zones. It quickly found itself to be completely isolated and ultimately accepted an outcome that reflected complete capitulation and without any attempt to influence final agreement. It reflected a policy strategy of flowing with the tide rather than struggling to secure its national interest. In the Gulf War crisis too, Japan’s initial response led to humiliating isolation and it quickly modified its behaviour to suit to the prevailing winds. Japan was in the end the largest financial contributor to the war effort, but did not escape criticism for a tardy response limited to only monetary contributions. That Japan should seemingly abandon the AMF at the first sign of resistance was not odd. Yet, despite American rejection of the AMF, the Japanese government, surprisingly, did not completely abandon the idea of an Asian contingency fund. This was a departure from established practice. At the 1998 APEC summit, Finance Minister Miyazawa Kiichi outlined an initiative to provide additional assistance to the Asian countries. This was in response to Asian frustrations with western aid programmes and with IMF conditionality. The Miyazawa Initiative (or Miyazawa Plan) provided funding of US$30 billion for the crisis countries, Indonesia, South Korea, Thailand, Malaysia and the Philippines. Included in this special assistance package was a programme to assist in a restructuring of the Thai banking industry and another programme to assist export industries in Malaysia. As part of the Initiative, the government of Japan had committed about US$1.9 billion in assistance to Malaysia by late April 1999. In proposing the initiative, Miyazawa expressed hope that ‘the initiative bearing his name will eventually grow into a regional contingency fund open to Asian and non-Asian participation alike’.31 In announcing the plan, the Japanese government did not hide its displeasure with the IMF and its handling of the crisis, and pointedly emphasized that the IMF would have no say in the disbursement of funds. One official in the Japanese Ministry of Finance stated that ‘You will notice that the IMF has not been asked to join. That is deliberate. And Malaysia is included in the Plan. That too, sends a message.’32 The Miyazawa Plan to counteract continuing credit contraction was welcomed by the Southeast Asian countries, by the IMF and by the World Bank. In a speech at the Foreign Correspondents Club of Japan in

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December 1998, Miyazawa explained that since currency crises were becoming more commonplace,33 it was worth looking into the possibility of establishing regional financing mechanisms for all regions, such as Europe, Asia and Latin America, to be funded by countries in the region. Such regional funds could provide new liquidity to countries in crises which, Miyazawa observed, was essential to the Asian countries, these having suffered a net capital outflow of US$44.3 billion in 1997 compared with a net inflow of US$28.8 billion in 1996. In February 1999 the Japanese government formally revived the idea of the AMF when it set up a study team composed of twenty members to make detailed recommendations about establishing an AMF.34 The interest shown by the Japanese government in institutionalizing collaborative arrangements within the region can perhaps be explained by the failure of ASEAN to develop meaningful responses to the financial crisis. Not only was ASEAN ineffectual in formulating a collective response to the crisis, it was also weakened by internal squabbling, disagreements, and unilateralism in dealing with the crisis-induced challenge to economic prosperity. Sensing that ASEAN was in disarray, the Japanese government probably expected to fill the institutional vacuum with a structure that would enhance its own regional profile. It was obvious also that institutionalisim will inevitably give Japan a greater role and say in regional affairs since it is likely to be the primary source of financial contributions to establish and maintain regional institutions. The Japanese government has already increased its influence in the Asian Development Bank by channelling generous and less onerous loans to developing countries through the ADB. In turn, the ADB lent its support to the proposal for an AMF. An AMF alongside the ADB would replicate at a regional level the two existing multilateral institutions, namely the IMF and the World Bank. In the region, support for an AMF-type scheme was strongly voiced by the Malaysian government. Malaysia had refused to accede to IMF conditionality and opted for an unconventional approach to managing the crisis, which included currency controls. Expressing his distaste for IMF structural adjustment programmes, Prime Minister Mahathir, in late 1999, asserted that if an institution like the AMF had existed then ‘the East Asian currency crisis of 1997–98 would not have occurred, would not have endured and would not have gone to such ridiculous depths’.35 In late November 1999, deputy finance ministers from Japanese and ASEAN countries reached preliminary agreement on establishing a standby fund to prevent a recurrence of financial crises. Despite assertions to the contrary, the standby fund had essentially resuscitated the AMF by

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stealth, since it would be a permanent structure to provide soft finance to regional countries confronting a potential crisis situation.36 Sakakibara Eisuke had been a strong proponent of the AMF, and following his retirement the idea was carefully nurtured by his successor Kuroda Haruo. According to Sakakibara, the AMF proposal had ‘many supporters in Japan’,37 and once ASEAN countries proposed to institutionalize funding provided under the Miyazawa initiative, Japan was able to move on that request quickly. The AMF, by stealth, moved a step forward when a recently established ‘ASEAN Plus Three’ forum, comprising the ten ASEAN countries and Japan, China and South Korea, met in Chiang Mai, Thailand, in May 2000 and the relevant finance ministers agreed to strengthen regional monetary cooperation. They also agreed to a regime of currency swaps, to provide foreign currency loans to countries in crisis. The Japanese newspaper Nihon Keizai Shinbun remarked that ‘The AMF concept, which was abandoned in the face of US opposition, will be realized in a different form.’38 The Chiang Mai initiative set up a two-tiered support mechanism, the first being an agreement to extend an existing currency swap arrangement among the ASEAN countries. Under this, the capital base of the ASEAN currency swap would be increased from US$200 million to US$1 billion. The second tier of support was a series of bilateral currency swap arrangements among the ten ASEAN countries and the three Northeast Asian states, China, Japan and South Korea. The remarkable aspect of the Chiang Mai initiative was that unlike in 1997, when the US was vehemently opposed to the AMF, it was decided not to speak out against the currency swap arrangement, which will inevitably diminish the influence of agencies like the IMF. By mid-2001, Japan had completed bilateral swap agreements with Thailand, South Korea and Malaysia and was negotiating for similar agreements with Indonesia, Singapore, China and the Philippines. The bilateral swap agreements may eventually become a basis for a regional monetary fund, but that is still in the distant future – although Murakami Seichiro, the Japanese vice-minister of finance, commented at a news conference in Honolulu in May 2000 that he was keen to see the bilateral agreements develop into a monetary fund. He added that an AMF might be ‘created when everybody thinks it is time to do so after making substantial progress’.39 Japan may only be putting in practice within a regional setting the institutional bases of hegemonic control and influence that the United States has maintained on a global scale since the end of the Second World War. It may also be a way of managing China’s growing influence in the

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region and ensuring that Chinese behaviour is constrained by institutional norms and does not become a source of competition and conflict. American reaction to the AMF, however, is a major stumbling block for Japan. US officials have already expressed concern that the idea is also being supported by the ADB, perturbed as they are that proliferation of regional institutions that deviate from strict IMF lending policies will undermine US ability to influence global economic events. In early May 1999, at the annual ADB meeting, Edwin Truman, a senior US Treasury official, called for the ADB to follow IMF guidelines in lending to the developing countries. This was to ensure that IMF objectives are not undermined by regional institutions that offer concessional loans, and also to preserve US influence by requiring regional bodies to accept common universal standards that have been devised by the United States to shape international economic transactions to comply with its preferred vision.40 For its part, the US government took the initiative in calling for reforms in the global financial architecture, with the objective of preventing future crises. Crisis prevention, however, is part of what the IMF has been trying to do since the Latin American debt crisis. Again, following the Mexican debt crisis, the IMF emphasized plans to exercise better surveillance to warn of potential dangers and provide accurate information to financial markets to permit informed decision-making. If the importance of these had been recognized after the Latin American debt crisis then the Mexican crisis of 1995 dramatically exposed the IMF’s failure to become a force in crisis prevention. The East Asian crisis was yet another example of the difficulty of implementing a fail-proof system of crisis prevention. The American call for better crisis management and prevention has focused attention on ways of strengthening existing international financial structures. To that effect, the US government proposed that the IMF might establish a precautionary line of credit for countries that had sound economic practices to help them ward off future currency crises. This would transform the IMF into a global central bank and give to it the function of a lender of last resort. Just as national central banks assist domestic banks to overcome liquidity crises, the IMF, under this proposal, would commit itself to providing liquidity to countries in a crisis situation. However, the analogy of an illiquid but solvent bank cannot be extended to a sovereign country. Countries do have liquidity problems, but the concept of solvency or insolvency does not apply to them. In effect, a line of credit would boost a country’s foreign reserve and enhance its capacity to fend off a speculative attack on its currency. If this

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works as anticipated, it should help to deter such speculative attacks. The board of the International Monetary Fund was expected to deliberate on this proposal in early March 1999, but in the early stages senior IMF officials had already voiced their dissent. In the past Michael Musa, IMF’s economic counsellor, had opposed this idea and, according to Onno De Beaufort Wijnholds, executive director of the IMF, the proposal is flawed because it would give countries carte blanche to, for example, defend an exchange rate when it was no longer economically feasible. Before the currency depreciation that instigated the Asian crisis, said Wijnholds, central banks came close to exhausting their reserves in questionable attempts to defend an exchange rate, and with an open line of credit they might only compound their folly. He also argued that such a line of credit would only exacerbate the ‘moral hazard’ dilemma since it would commit the IMF to bail out countries that had observed sound economic practices in the past. Instead, he maintained that the IMF should remain only an ‘indispensable lender’ rather than a lender of last resort, providing financial assistance but only in concert with structural adjustment programmes.41 Nonetheless, in May 1999 the IMF established contingent credit lines (CCLs) as a precautionary line of defence. The purpose was to make funds available to member countries to avert a potential crisis, and it rounded off the establishment of a supplemental reserve facility, in December 1997, for countries already in the throes of a crisis. As a line of credit, the CCLs were envisaged as providing between 300 and 500 per cent of their respective quota subscriptions to countries that feared a contagion effect for a period of twelve to eighteen months. However, rather than automatic approval, the IMF decided to make funds available only to countries that already had in place strong economic policies and a sound financial system. Moreover, a country with a line of credit could access about 5 per cent of the total amount immediately, and draw the remainder subject to reviews by the executive board of the IMF, a limited form of conditionality. Under conditions imposed on countries wishing to access the CCLs, it is clear that East Asian nations would not have been able to borrow funds prior to the 1997 crisis. Indeed, even as late as mid-2001, no country had applied for funds under this programme, even after the IMF in November 2000 decided to make the scheme more attractive by lowering associated the charges and fees, and relaxing the rules. The main reason countries shied away from CCLs was that they did not want to signal to capital markets that they were in near-crisis, which might only exacerbate rather than alleviate their current difficulties. No country dared to be the first to join the ‘CCL club’ and risk being punished by capital markets. The IMF

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acknowledged only that while some countries had expressed an interest they had, for the time being, decided against the CCLs.

Conclusion Japanese advocacy of the Asian Monetary Fund was premised on the assumption that the Asian crisis was essentially a financial crisis and its resolution did not require structural reforms, as had been tried in Latin America in the 1980s. By contrast, the US assumed that the crisis had deeper roots in East Asian economic and political structures, and insisted that only IMF conditionality could return these countries to a sustainable growth trajectory. It argued that provision of easy money would simply defer crisis resolution. According to Japan’s Vice-Minister of Finance for International Affairs Sakakibara Eisuke, the US government eventually recognized that the position of the Japanese government was fundamentally correct and modified its stance to permit the establishment of new facilities to provide liquidity to East Asian countries. The Japanese response to the crisis included a suggestion for the establishment of an Asian Monetary Fund to provide financial assistance to countries under sustained pressure on their currencies. The proposal had considerable merit and potential for managing the crisis but was rejected by the United States as an unnecessary addition to existing institutional arrangements. The Japanese government dropped advocacy of the AMF as such, but still managed to side-step American obstructionism and become party to a currency swap agreement at a meeting of the APT (ASEAN Plus Three) in 2000. This effectively revived the AMF but in a different guise. This time, the United States did not voice its objections. The APT also effectively revived an earlier Malaysian proposal to establish an East Asian Economic Caucus, a body consisting only of the regional countries. The US and Australian governments objected to the EAEC because of its closed membership principle, and this was a critical factor in determining Japan’s reluctance to support it. Without active Japanese support, the Malaysian proposal failed to make any significant headway. Japanese foreign policy posture is, of course, influenced by US preferences, but since the 1980s the Japanese government had also developed a practice of acting in concert with a Labor government in Australia on regional issues, such as the APEC. The basis of this concert diplomacy was common interests and common outlook, since both countries had for historical reasons an uneasy and uncomfortable position in the AsiaPacific region. But the election of a conservative and xenophobic government in Australia in the mid-1990s shattered the concert diplomacy,

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a development that ultimately created new options for Japan’s regional diplomacy. The influence of the US is of course far greater than that of Australia, but the US did not raise objections to the APT agreement, perhaps because analysts, in the intervening three years, had found much to recommend about the original AMF proposal. Effectively, therefore, the crisis has led to a partial fruition of both the EAEC and the AMF but under different guises. In scuttling the original AMF proposal, the United States had only delayed its eventual realization.

7 Conclusion

In the long march of Japan’s postwar economic development there had been periodic dips in economic performance, but the overall picture was one of increasing wealth and prosperity. This came to a halt in the early 1990s, and since then the Japanese economy has been relatively stagnant. Large fiscal measures and public works projects failed to lift it out of stagnation, and added only to the debt burden of the public sector. Amid this economic drift, the Asian financial crisis of 1997 had a sharp, painful impact on economic conditions in Japan. Spreading economic gloom and the collapse of large banking and securities companies prompted the government to rethink its policy strategies and take more active measures in resolving the festering banking crisis in order to restore economic growth. Reform of the financial sector was only one of the many necessary tasks that confronted the government, but in his short time in office Prime Minister Obuchi failed to implement any comprehensive solution to the economic crisis. Importantly though, in the process of reforming the financial sector Obuchi elevated the position of elected politicians over the bureaucracy. According to Sasaki Takeshi: With the infusion of public funds into the nation’s financial institutions, the political sector entered territory into which the bureaucracy could not venture, and in so doing assumed a huge responsibility. Our political leaders will no longer be able to win the people’s approval by pinning responsibility on the bureaucracy. This means that the quality of political leadership has become a bigger issue than ever before.1 If quality of leadership had become more important, Obuchi and his successor fell short of the mark. The momentum for reform could not be 144

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sustained even by Obuchi and was abandoned completely by his successor, Mori, who excelled only in his ineptitude and bungling. The reformist impetus did not resume centre stage until after Koizumi had replaced Mori as prime minister in early 2001. Despite Koizumi’s assertive stand on structural reforms and commitment to ‘reforms without sanctuaries’, however, there remain many uncertainties about his capacity to implement reforms that are necessary or have been foreshadowed. This is because many of the LDP’s party elders are suspicious of the changes being proposed, which even if they are necessary from the perspective of revitalizing a stagnant economy will be politically disastrous and undermine their electoral support base. Regionally, the Asian financial crisis was an opportunity to mend fences, and indeed the proposal to establish an Asian Monetary Fund was a clever and opportune plan to assist regional countries recover from their crisis. Japan offered to provide the initial capital to establish the AMF, which would provide regional countries in crisis with financial assistance at concessional terms. It was to be less demanding than the International Monetary Fund, which imposes strict structural adjustment requirements on countries that apply for financial assistance. The AMF was however rejected by the US as an unnecessary duplication of existing institutional arrangements. In light of an unfavourable American response, the Japanese government abandoned its initiative but in succeeding years quietly led the establishment of alternate mechanisms to deal with any future currency crisis. The entire process of early initiative and patient and painstaking effort to establish regional mechanisms cast some doubt on perceptions of Japanese foreign policy as reactive and unimaginative. Japan also provided considerable financial assistance to regional countries in crisis, although the continuing economic stagnation in Japan meant that Japan was unable to assist in an export-led regional recovery. Nonetheless, as noted, the Japanese government did demonstrate a willingness to assist regional countries financially and with proposals for new institutional responses. While these were positive initiatives, at another level the Japanese government continued, as before, to send mixed and confusing signals to regional countries. Prime Minister Koizumi’s visit to the Yasukuni Shrine, in August 2001, was seen as a sign of Japanese arrogance and insensitivity, made all the more unpalatable because the Japanese government has consistently refused to offer a formal apology to regional countries and to victims for the wartime atrocities including the so-called ‘comfort women’. It is remarkable that more than fifty years after the end of the Second World War no Japanese government appeared willing and able to achieve

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a final resolution of that dark chapter in Japanese history. More remarkable still is that fact that Prime Minister Koizumi, who has been both bold and different in many ways from his predecessors, ultimately repeated the ‘sins’ of his predecessors and managed to antagonize neighbouring countries. To make amends for his diplomatic blunder, the prime minister, two days after his visit to the shrine, commemorated the end of the Second World War by giving a speech in which he emphasized relations with Asia and expressed remorse for Japan’s wartime inhumanity, but again was unable to offer a formal apology. In domestic economic management, after the failure of successive pumppriming measures to lead the economy out of stagnation, the Obuchi administration began the difficult task of rehabilitating the financial sector, as a precondition for sustainable economic recovery. Later, the Koizumi administration in 2001 embarked on a more radical path of structural and administrative reforms to end the economic malaise. Reforms in the context of a stagnant economy will impose further hardships on the people but support for reform was such that Prime Minister Koizumi Junichiro became the most popular Japanese prime minister in the postwar period. Where his predecessor had popularity ratings in single digits, Koizumi became almost a cult figure, with ratings of more than 80 per cent. Popular support for reform, however, was no guarantee that Koizumi would be able to force party leaders to support the reform programme, while if he were to retreat from reforms his popularity among the electorate would no doubt suffer. If reforms are implemented, it is of course equally possible that the anticipated economic downturn will lead to a quick dissipation of popular support. In Koizumi’s first month in office the rhetoric of reform outpaced any real achievements, thanks simply to the political difficulties faced by the government in persuading the more traditional leaders within the Liberal Democratic Party to support the reform agenda. His cautious start can be attributed to vested interests within the LDP and to a looming Upper House elections which consumed the attention span of the government. However, Koizumi could not also continue to ignore swelling public sentiment in favor of change, having himself encouraged and prepared the people to expect regulatory and liberal reforms. Yet, even after leading his Party to an improbable electoral victory, the Prime Minister was unable to convince his parliamentary colleagues to support his mandate for change. Instead of sweeping reforms, he was unable to deliver more than cosmetic changes. In early 2002, the reform agenda looked even less credible after a series of ministerial misadventures led to a dramatic collapse in the approval

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rating of the Prime Minister. In the end, it looks likely that Koizumi will go down in history as a ‘tragic’ political leader who, failed to act on his large popular mandate for change, hoping instead to legitimize structural reform within the LDP, and subsequently fell victim to his Party’s policy rigidity. The main focus of the pro-reform group in Japanese politics has been on revitalizing the banking sector and deregulating the economy. The actions here will also have an impact on corporate reforms and restructuring. Although banking reforms, corporate restructuring and deregulatory initiatives are all critical to sustainable economic growth, Japan has also been affected by weak consumer spending. Weak consumer spending had forced the government to step in to pick up the slack, but the economy remained in stagnation while the government accumulated huge public sector debt. This strategy was obviously unsustainable and the Koizumi administration was forced to declare that its reform agenda would be implemented in tandem with deficit reduction strategies. That this would be socially painful was obvious and the interesting detail is that the prime minister enjoyed very high popular support despite advocating policies that promised pain and increased hardship for the average consumer. Low consumer spending has been a constant feature of postwar Japanese economic growth and performance, and despite policy shifts that have followed sustained external pressure, consumer spending remains low. It used to be accepted knowledge that low consumer spending was largely a feature of a particular taxation mix that provided tax breaks on savings. In the 1980s, tax incentives to save were phased out but rather than open the floodgates of pent-up demand, consumption levels remain low and have exacerbated poor economic performance in the 1990s. Declining consumer spending cannot be attributed to a saturation of consumption demand, because consumer demand is sensitive to new products and technologies and to improved and upgraded functions of existing products. In its economic survey the Japanese government noted that there was ‘plenty of room for providers of consumer goods and services to stimulate consumer demand by supplying totally new goods and services . . . and [by developing] new needs’.2 Instead, low domestic demand can be attributed to a climate of uncertainty, fuelled by concerns that high private savings are essential in view of demographic shifts and assumed inability of the state to meet future pension and welfare obligations. Consumers are concerned about not only future economic prospects and job security but also ensuring adequate post-retirement incomes and on-going price deflation.

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Japan has an ageing population, and there is considerable concern lest the government prove unable to fund old-age welfare programmes. It is estimated that by 2015 slightly more than a quarter of all Japanese will be aged 65 and above. The birth rate has fallen below that needed to maintain a stable population and while many local governments have introduced ‘procreation award systems’ these have not offered sufficient incentives to reverse existing trends. The awards are also inferior to practices in other countries. For example, in Japan the first child attracts a monthly payment of Y5000 for the first three years, whereas in Germany a benefit of Y13 126 continues until the child is eighteen years old.3 More Japanese women, in all reproductive age groups, are choosing not to marry, and the strong social taboo against birth outside marriage hardly offers any easy solution to worsening Japanese population demographics. Given an ageing population and high public sector debt, the personal savings rate has remained high to ensure that sufficient funds are available for retirement and old age. That is to say, precautionary savings of households are intended to help cover the anticipated shortfall between future consumption and welfare provisions. Low consumption is also a result of price deflation, which has logically depressed present consumption in favour of future consumption, when goods are expected to be cheaper still. For instance, the January 2001 consumer price index in the Tokyo area was approximately 0.5 per cent lower than it was twelve months before.4 Not surprisingly, rational consumers had opted to put off consumption plans, although one consequence of this was to add to current economic difficulties. With the failure of the state to gain control over the economy and promise a secure future, Japanese consumers, according to Leonard Schoppa, have decided to pursue private solutions. Schoppa writes, for example, that individuals and firms now have the wealth and freedom necessary to pursue private solutions to their economic problems – solutions that make perfect sense from an individual or corporate perspective but that actually aggravate economic problems at the national level.5 Thus, individuals have built their own retirement funds at the expense of current consumption and the corporate sector is poised for an exodus to pursue profits in other markets. The slowdown of consumption demand is an important key to Japan’s contemporary economic plight, and however painful it may be in real terms, the same determination to pursue ‘private solutions’ appears to have fatally weakened the argument

Conclusion 149

that the Japanese have a unique, group-oriented behavioural pattern, where community benefits take precedence over private ones. Clearly, that thesis can no longer be sustained, and prolonged economic stagnation has provided good examples of rational behaviour based largely on calculations of self-interest. If commitment to collective good was the main determinant of Japanese behaviour then the economic crisis could have an easy solution. Instead, individually national belt-tightening behaviour of Japanese consumers has aggrevated the national crisis. Japan’s deflationary spiral not only influenced consumer behaviour but also had a detrimental impact on corporate debt. It is well understood that inflation has the practical consequence of reducing total real debt and that deflation has the opposite effect. Many of the largest Japanese corporations, such as Daiei, a retail giant, and Kumagai Gumi, a construction company, have large debts and the long period of deflation only made it harder to manage their debt burden. Their economic activity, as well as that of the economy, has suffered as a result of debt overhang and deflation. As mentioned earlier, Krugman has identified Japan’s economic problem as one of liquidity trap, from which an exit strategy requires the government to instigate a period of inflation. Krugman argues that Japan required an inflation target of 4 per cent a year for a period of 15 years to transit through the debt overhang. Others have explored the potential of inflation in managing corporate debt, and according to Itoh and Shimoi an inflation rate of 2 per cent a year over a ten-year period would effectively reduce Kumagai Gumi’s total debt of Y1057 billion by Y233 billion, more than 8.6 times its average annual profit for the past five years. They also estimated that an inflation rate of 4 per cent for the same length of time would halve Kumagai Gumi’s total debt.6 To the extent that total debt was undermining the position of both the corporate and the banking sectors, as creditors and lenders, it is easy to see the attractiveness of an inflationary target as a way of resolving debt overhang in Japan, as well as stimulating consumer demand. Even if inflation is attractive, the Japanese government remains unconvinced that it is a viable solution, partly because of the likely difficulties in controlling it within target levels. To deal with weak domestic demand, the government announced a radical new policy of providing consumers with free shopping vouchers, as well as tax reforms. In November 1998 it instigated additional fiscal measures to stimulate domestic demand. The $195 billion (Y24 trillion) package was the largest ever and included additional spending programmes as well as cuts in personal income tax. Income tax cuts had long been advocated to restore consumer confidence in the economy and to

150 Japan in Crisis

encourage consumer spending and shift the balance between savings and consumption. The LDP proposed to cut the top individual tax rate from 65 per cent to 50 per cent as well as to offer tax breaks on purchase of real estate and housing. Tax concessions on properties were intended to spur a recovery in the real estate sector that could also help banks and financial institutions recover some of their bad debts. The dilemma for the LDP was that it lacked a majority in the Upper House of the Diet, and the opposition parties were not too keen on the proposed tax cuts, which were unlikely either to benefit a majority of Japanese households or to boost current consumption. There were concerns, as well, that tax cuts directed at high income earners would only add to the pool of savings rather than stimulate current consumption and therefore become self-defeating in their stated objectives. In late March 1999, however, the Japanese Diet approved the tax reduction bill giving individuals and the corporate sector permanent tax cuts of Y9.4 trillion (US$79.29 billion). The tax cuts, effective from April, were expected to provide a significant boost to corporate sector profits. However, while the government cut income taxes, it refused to roll back the consumption tax, at present set at 5 per cent,7 despite suggestions that the increase in consumption tax was an important factor behind weak consumer confidence. As mentioned above, another somewhat unusual measure to encourage economic growth was a decision by the government to distribute free shopping vouchers to consumers. The expectation was that the additional demand generated by consumers using shopping vouchers would kickstart a recovery process. The logic of this measure was similar to that of the one used by Prime Minister Nakasone in the mid-1980s. At that time Nakasone, under pressure from the United States to reduce a widening bilateral trade imbalance, went shopping for imported products to encourage consumers to increase their purchase of imports by US$100 per person in order to eliminate the trade imbalance and defuse trade conflict with the US. The strategy had little obvious effect on consumer behaviour, and in the end the two governments agreed to exchange rate changes to balance trade. The difference in 1999 was that rather than rely on verbal exhortations the Japanese government decided to give consumers additional purchasing power with which to increase consumption demand. The distribution of shopping vouchers worth US$6 billion (Y700 billion) began in early 1999. The main requirement was that the shopping vouchers were to be used before August of that year. It was a bold new experiment to release the latent power of Japanese consumers, but economists predicted that consumers would simply spend the coupons and

Conclusion 151

save the equivalent in cash, thereby defeating the objectives of the programme.8 At best, they argued that benefits were likely to be only shortterm. Sustained recovery of consumption demand could not be achieved through contrived and gimmicky measures, but was possible only after a significant turnaround of consumer confidence. The problem of low consumption demand could be attributed not to lack of purchasing power, which could perhaps be remedied by the innovative decision to issue shopping vouchers, but rather to continuing apprehension about job security, future economic prospects and price deflation. As the government had done throughout the current economic recession, in November 1999 it announced an additional fiscal stimulus programme of Y18 trillion to facilitate recovery. This was the ninth stimulus package since 1992 and earmarked spending for public works programmes and support for small businesses. The supplementary stimulus package was necessitated by a concern that economic recovery might be derailed by a resurgent yen and before increased domestic demand had created the bases for sustained economic recovery. The EPA estimated that economic growth in the fiscal year to March 2000 would be about 0.6 per cent. In the first quarter of 1999, the economy achieved a growth of about 2 per cent and in the second quarter 0.1 per cent. In the third quarter, however, it contracted by 1 per cent, rekindling fears that the it remained vulnerable. Despite the third-quarter reversal, the Japanese economy was still expected to achieve the official growth target of 0.5 per cent for the year but not the strong recovery that had been anticipated after first-quarter growth rates was released. In 2000 recovery looked more likely after two consecutive quarters of growth. In the January–March quarter, the economy expanded 2.5 per cent and this was followed by a 1 per cent growth in the following quarter. It amounted to an annual growth rate of 4.2 per cent, well above the official government forecast of a 1 per cent growth in the fiscal year 2000 (April 2000–March 2001).9 A positive feature of the latest growth figures was that consumer spending had increased 1.1 per cent in the second quarter of calendar year 2000. A sustained programme of public works expenditure could perhaps slowly begin to restore consumer confidence, but it is also unclear how long the government can continue deficit spending, given that fiscal deficits are already very high by international standards. None of the implemented measures had any discernible impact on consumption demand. Given that deflationary tendencies were a factor behind depressed consumption demand, one option for the government was to devise strategies for controlled inflation that might encourage

152 Japan in Crisis

consumers to bring forward their consumption plans in order to avoid paying higher prices in future. At the least, it was important that the government look for new ways to boost business and consumer confidence, or alternatively shock reticent consumers into unleashing their spending power by threatening price inflation. After a decade of economic stagnation and gloomy forecasts of an impending crisis in the national welfare system, it was not easy to encourage an ageing population to loosen purse strings, but that is precisely what was necessary to revive growth and bring the economy out of recession. Figures for July 1999 showed a small recovery of 0.7 per cent in household spending compared with June, suggesting that the Japanese economy might have turned a corner.10 Instead, the economy failed to maintain a momentum and continued to swing erratically. In the seesawing path of Japan’s troubled economy, 2001 brought a slide back into gloom and pessimism. On 20 August 2001 the Nikkei share market index closed at 11 257.94, the lowest point since December 1984, a reflection of poor economic forecasts. And instead of promising any quick fixes, Prime Minister Koizumi warned of a few years of continuing economic hurt to come as he committed his government to a rigorous course of ‘reforms without sanctuaries’. The high approval rating of the Prime Minister was a clear indication that ordinary citizens were prepared to accept short-term pain in return for structural reforms but Koizumi instead has delivered continuing pain and the status quo. In early 2002, the economic outlook remained gloomy, amid falling share prices and deflationary threats. In February, the Nikkei share price fell below 9,500 for the first time in 18 years. A Y30 trillion cap on issuance of new deficit bonds added to the gloom by limiting the capacity of the government to take remedial fiscal policy measures in order to boost flagging demand within the economy. In order to rein in the ever-increasing government deficit, the prime minister committed the government to a cut in public works expenditures in fiscal year 2002. Throughout the post-bubble economic stagnation, governments had injected vast sums into public works and construction programmes, which did little to correct the economic downturn except perhaps in the construction industry. In the stagnant economic conditions, most industrial sectors were affected except the construction industry, and, reflecting the buoyant conditions in the that sector, daily wages within it continued to climb in the 1990s. In 1989 at the peak of the bubble economy the average monthly wage in the construction industry was Y373 000, but by 1997 this had increased to Y468 000,11 whereas in manufacturing it increased from Y352 000 in 1990 to Y413 000 in 1997.12 In the predicted economic downturn following the

Conclusion 153

introduction of structural adjustment and budgetary restraint, the construction industry is expected to be particularly hard hit, and this will inevitably have a severe ripple effect within the LDP. The construction zoku, the lobby group for the construction industry, is particularly strong within the LDP and their attitude will be an important determinant of whether Prime Minister Koizumi is ultimately successful in his reform objectives. Economic downturn and opposition within the LDP among senior party leaders do not bode well for the government’s reform agenda. The opposition Democratic Party of Japan has better reform credentials, with a clear majority of its representatives elected from urban districts, but its prospects of winning government are not very promising, leaving the LDP as the dominant party in the immediate future. The question then is whether Koizumi will be able to push and cajole his party to accept the reformist position. I argue that this scenario cannot be taken for granted and that institutional inertia is more likely to prevail over his reformist zeal. An escape to the comfort zone provided by institutional inertia could perhaps become all the more attractive when economic conditions begin to deteriorate further as a result of reforms. Koizumi has been keen to remind the nation that there can be no gain without shortterm pain, but it is still uncertain whether he will himself be able to hold the fort when employment and economic conditions deteriorate. Indeed, in August 2001, as unemployment reached 5 per cent, the government already began to plan for a supplementary budget to provide relief to the unemployed and for job creation activities. Were such an emergency budget to be implemented, Stephen Lunn has observed, it would be ‘a significant policy backflip for Mr Koizumi who had consistently promised no additional government pump-priming for the economy as part of his “no pain, no gain” structural reform package’.13 While the outlook for reform is uncertain under present conditions, we cannot always assume that established patterns must constantly assert themselves. There are numerous examples of successful reforms within an obdurate and inflexible institutional structure. Certainly, there were strong institutional constraints in the Soviet Union against Mikhail Gorbachev launching his movement for perestroika (reform) and glasnost (openness), but he was still able to defy pressures to conform. The change of direction was necessitated by an under-performing economy and new international challenges, but the reforms, in the end, destroyed both the Communist Party of the Soviet Union (CPSU) and the Soviet Union itself. The Japanese situation is considerably different from that of the Soviet Union in the mid-1980s, but the danger to the Liberal Democratic Party of continuing on a reformist track may not be too unlike that which

154 Japan in Crisis

destroyed the CPSU. It is quite possible that if Gorbachev had not embarked on his reform agenda he would still be in power as secretary general of the CPSU. In Japan, the Liberal Democratic Party is divided along lines of reforms and stability, and an aggressive push for reforms may serve only to widen the fissures and lead ultimately to a break-up.

Notes 1 Introduction 1 The oil crisis was sparked by a decision of the Organisation of Petroleum Exporting Countries (OPEC) to quadruple crude oil prices in late 1973. The sudden jump in oil prices had an immediate adverse impact on industrial economies and ushered in a long period of economic recession and price inflation. This was considered such an unlikely combination that economists had to coin a new term, stagflation, to describe this unique set of circumstances. 2 Japan Statistical Yearbook 2001, Government of Japan, Tokyo; see table 11–5, p. 391. 3 Amyx, J., ‘Political Impediments to Far-reaching Banking Reforms in Japan: Implications for Asia’, in Noble, G. W. and John Ravenhill (eds), The Asian Financial Crisis and the Architecture of Global Finance, Cambridge University Press, 2000, p. 143. 4 ‘OECD chief says Japan needs political leadership to reform’, Japan Policy & Politics, 15 May 2000. (http://www.findarticles.com/cf_1 /m0XPQ/2000_May _15/62122746/p1/article.jhtml/?term=Regulatory+Reform+in+Japan) 5 Lincoln, E., ‘Deregulation in Japan and the United States: A Study in Contrasts’, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom: Deregulation and the Japanese Economy, Brookings Institution Press, Washington DC, 1998, p. 61. 6 It is precisely because of this separation between formal and real authority that the principle of ‘mandate of heaven’ has been so enduring and, unlike in China, allowed for uninterrupted imperial descent. The monarchy could continue its cloistered existence in splendid isolation from power struggles that continued elsewhere, whereas in China, emperors guilty of misrule were often overthrown. 7 The role of crises in reshaping existing order is, of course, not limited to Japan. 8 Lonny E. Carlile and Mark C. Tilton (eds), Is Japan Really Changing its Ways? Regulatory Reform and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998. 9 Feldstein, M., ‘A Self-Help Guide to Emerging Markets’, Foreign Affairs, March/April 1999, p. 93. 10 Cited in Tachi, R., The Contemporary Japanese Economy: An Overview (translated by Richard Walker), University of Tokyo Press, Tokyo, 1993, p. 194. 11 Kindleberger, Charles P., Manias, Panics, and Crashes: A History of Financial Crises, revised edn, Basic Books, New York, 1989, pp. 34–5. 12 Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, pp. 16 ff. 13 Kristoff, N. D., ‘Long Mandibles, Sleek Carapace. A Steal at $300’, New York Times, 10 April 1999, p. A4. 14 Kindleberger, Charles P., Manias, Panics, and Crashes: A History of Financial Crises, revised edn, Basic Books, New York, 1989, p. 132. 15 Carlile, L. E., ‘The Politics of Administrative Reform’, in Lonny E. Carlile and Mark C. Tilton (eds), Is Japan Really Changing its Ways? Regulatory Reform 155

156 Notes and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998. 16 Carlile, L. C. and Mark C. Tilton, ‘Is Japan Really Changing?’, in Lonny E. Carlile and Mark C. Tilton (eds), Is Japan Really Changing its Ways?, Brookings Institution Press, Washington, 1998, p. 197. 17 Dennis Yasutomo cited in Doner, R. F., ‘Japan in East Asia: Institutions and Regional Leadership’, in Katzenstein, P. J. and Takashi Shiraishi (eds), Network Power: Japan and Asia, Cornell University Press, Ithaca and London, 1997, p. 211.

2 Economic Stagnation in Japan 1 See Miyajima, H., ‘The Impact of Deregulation on Corporate Governance and Finance’, in Carlile, Lonny E. and Mark C. Tilton (eds), Is Japan Really Changing its Ways? Regulatory Reform and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998. See also Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, pp. 66 ff. 2 New York Times, 4 August 1990, p. 122. 3 See, for example, Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, p. 71. 4 Itoh, M., Nihon Keizai o Kangae Naosu, Iwanami Shoten, Tokyo, 1998, pp. 142–3. 5 Noguchi, Y., ‘The “Bubble” and Economic Policies in the 1980s’, in Journal of Japanese Studies, vol. 20, no. 2, summer 1994, p. 292. 6 Itoh, M., Nihon Keizai o Kangae Naosu, Iwanami Shoten, Tokyo, 1998, p. 153. 7 Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, p. 73. 8 This was a term used by Chairman of the US Federal Reserve Bank, Alan Greenspan, to explain the surge in the Dow Jones Index in the 1990s. 9 Kindleberger, Charles P., Manias, Panics, and Crashes: A History of Financial Crises, revised edn, Basic Books, New York, 1989, p. 6. 10 Mera, K., ‘The Making of Japan’s Failed Land Policy’, in Gibney, F., Unlocking the Bureaucrat’s Kingdom: Deregulation and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998, pp. 180 ff. 11 Wood, C., ‘Japan’s Financial System’, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom: Deregulation and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998, p. 229. 12 Cargill, Thomas F., Michael M. Hutchison and Takatoshi Ito, The Political Economy of Japanese Monetary Policy, MIT Press, Cambridge, MA, 1997, p. 110. 13 Wolferen, K., in New York Times, 8 February 1993, p. D1. See also Hollerman, L., ‘Whether Deregulation? An Epilogue & Japan’s Industrial Policy?, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom. Deregulation and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998. 14 Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, p. 165. 15 See Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, p. 167. 16 New York Times, 17 November 1998, p. A5. 17 New York Times, 2 October 1991, p. D2. 18 Miller, M., ‘Asian Financial Crisis’, Japan and the World Economy, vol. 10, no. 3, July 1998, p. 357. 19 Henderson, C., Asia Falling: Making Sense of the Asian Crisis and its Aftermath, Business Week Books, McGraw-Hill, New York, 1998, p. 172.

Notes 157 20 Japan Economic Almanac 1998, published by Nikkei Weekly, Tokyo, 1998, p. 57. 21 Marshall, D., ‘Understanding the Asian Crisis: Systemic Risk as Coordination Failure’, Economic Perspective (Federal Reserve Bank of Chicago), vol. 22, no. 3, third quarter 1998, p. 14. 22 Wood, C., ‘Japan’s Financial System’, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom, Brookings Institution Press, Washington, DC, 1998, p. 227. 23 New York Times, 10 December 1997, p. D1. 24 See Economic Research (Keizai Kikakucho Keizai Kenkyujo), no. 2, June 1998, p. 54. 25 See Economic Research (Keizai Kikakucho Keizai Kenkyujo), no. 2, June 1998, p. 55. 26 See Foreign Policy Bulletin, vol. 9, no. 3, May/June 1998. 27 See Paul Krugman at http://web.mit.edu/krugman/www/japtrap.html 28 ‘Improvement Projected for First Half of’ 99’, Nikkei Weekly, 11 January 1999, p. 3. 29 Ichimura, S., Political Economy of Japanese and Asian Development, Springer Verlag, Tokyo, 1998, p. 81. 30 Miller, M., ‘Asian Financial Crisis’, Japan and the World Economy, vol. 10, no. 3, July 1998, p. 358. 31 Brown, B., ‘Currency Plan Offers Remedy for Deflation’, Nikkei Weekly, 11 January 1999, p. 14. 32 ‘MITI Chief Takes Proactive Approach’, Nikkei Weekly, 11 January 1999, p. 1. 33 Hollerman, L., ‘Whither Deregulation? An Epilogue to Japan’s Industrial Policy’, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom: Deregulation and the Japanese Economy, Brookings Institution Press, Washington DC, 1998, pp. 251–2. 34 ‘LDP, Liberals Agree to 25 Per Cent Cut in Bureaucrats’, Japan Times, 22 January 1999, p. 1. 35 ‘Overtures Directed at New Komeito’, Japan Times, 19 January 1999, p. 3. See also ‘Do kawaru Seikan: Ugoki Dasu Seisaku Kettei Kaikaku’, Nihon Keizai Shinbun, 23 January 1999, p. 5. 36 ‘Keizai o miru me’, Toyo Keizai, 30 January 1999, p. 3. 37 Shimada, S., ‘Nihon Keizai Saisei no Senryaku: Keizai Kaikaku to Keiei Kakushin’, Chogin Soken, Chogin Sogo Kenkyujo, vol. 179, December 1998, p. 42. 38 New York Times, 15 September 1998, p. C5. 39 Sanger, David E., ‘Tokyo Leader Blames Many for Banks’ Crisis’, New York Times, 22 September 1998, p. A13. 40 Lunn, S., ‘Stricken Japan Targets Debt’, The Australian, 10–11 March 2001, p. 11. 41 ‘Desperate Japanese Kick-Start’, The Australian, 15 August 2001, p. 1.

3 Financial Reforms in Japan 1 Non-performing loans are difficult to define with any precision and it is difficult also to estimate the level of NPLs in the Japanese financial sector, since banks have been reluctant to disclose figures and there is a widespread tendency to underestimate NPLs. According to Horiuchi, some banks only began to

158 Notes

2 3 4

5

6

7

8

9 10 11 12

13 14 15

declare NPLs in March 1996, namely (a) loans to bankrupt borrowers, (b) interest payments overdue by more than 3 months and (c) loans with reduced interest to borrowers in trouble. See Horiuchi, A., ‘Financial Fragility and Recent Developments in the Japanese Safety Net’, Social Science Japan Journal, vol. 2, no. 1, April 1999, pp. 24–5. Horiuchi, A., ‘Financial Fragility and Recent Developments in the Japanese Safety Net’, Social Science Japan Journal, vol. 2, no. 1, April 1999, p. 25. ‘Risk Disclosure by Financial Institutions’, Quarterly Bulletin (Bank of Japan, Tokyo), February 1997. Sakaiya, T., ‘Ima, Naze, Gyosei Kaikaku ka’, in Min to Kan: 2001 nen Yakusho to Yakunin wa ko naru, edited by Gyokaku 700 nin Iinkai, Kodansha, Tokyo, 1999, p. 12 ff. See Miyauchi, Y., ‘Kisei Kanwa wa Keizai Saisei no Kiri Satsu da’, in Min to Kan: 2001 nen Yakusho to Yakunin wa ko naru, edited by Gyokaku 700 nin Iinkai, Kodansha, Tokyo, p. 169. The population projections are taken from Japan Statistical Yearbook, 1999, Government of Japan, Tokyo, p. 33. A declining fertility rate prompted some local authorities to encourage Japanese women to have more children by offering prizes of US$5000 per child. These had little effect and were, instead, criticized as inadequate compensation. At one time, Prime Minister Hashimoto Ryutaro also suggested that Japanese women forego higher education to concentrate on raising families, but understandably his remarks were not well received. See, Rostow, W. W., ‘Modern Japan’s Fourth Challenge: The Political Economy of a Stagnant Population’, Japanese Economic Review, vol. 51, no. 3, September 2000. In past economic downturns, the Japanese government relied on export-led recovery but that option was no longer available in the 1990s. The Japanese government was afraid of reigniting trade disputes with trading partners, who had long accused Japan of taking advantage of open markets overseas while denying imports equal access to the Japanese market. Despite the LDP’s loss in Upper House elections, it remained the party in power by virtue of its standing in the Lower House of the Japanese Parliament. The Lower House is the more powerful of the bicameral Japanese Parliament and the Prime Minister is also chosen by the Lower House. Kristoff, N. D., ‘Warming to ‘Cold Pizza’ ‘, International Herald Tribune, 2 April 1999, p. 1. New York Times, 15 September 1998, p. A14. Komine, T. ‘Ajia no Tsuka Kinyu Kiki to Senzaiteki Seichoryoku’, Economic Research (Keizai Kikakucho Keizai Kenkyujo), no. 2, June 1998, p. 15. The Financial Supervisory Agency was established on 22 June 1998 to perform fair and transparent supervision of financial institutions. Soon after its establishment it asked for reports from banking institutions, following up with intensive audits of the 19 major banks, in collaboration with the Bank of Japan. ‘Ginko no Mondai Saiken 73 cho Yen’, Nihon Keizai Shinbun, 23 January 1999, p. 4. Cargill, Thomas F., Michael M. Hutchison and Takatoshi Ito, The Political Economy of Japanese Monetary Policy, MIT Press, Cambridge, MA, 1997, p. 133. See ‘Japan’s Mr Reform’, Asiaweek, 7 May 1999, p. 33.

Notes 159 16 Managing the Crisis: The FDIC and RTC Experience 1980–1994, Federal Deposit Insurance Corporation, Washington DC, 1998. 17 ‘ “LTCB King”, protégé blamed for bank’s failure’, Japan Times International, 16–30 June 1999, p. 5. 18 Nihon Keizai Shinbun, 13 February 1999. 19 By late 1999, the government had already invested US$13.8 billion in restructuring LTCB. See Japan Times International, 16–30 September 1999, p. 10. 20 Boston Globe, 16 October 1998, p. D2. 21 ‘Banking System or Welfare State’, Euromoney, September 1998, p. 101. 22 ‘Konnichi teki Fukyo o do Kaiketsu suru ka’, Toyo Keizai, no. 5539, 30 January 1999, p. 49. 23 ‘Japan’s Regulators Act Tough as Bank Deadline Nears’, The Wall Street Journal, 8 February 1999, p. A17. 24 ‘Japan Banks Say They See End of Losses’, International Herald Tribune, 9 March 1999, p. 15. 25 Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998, p. 190. 26 Sagawara, S., ‘Taking On Japan’s Banks’, International Herald Tribune, 17 March 1999, p. 11. 27 Chong, F., ‘Japanese Banks See Light Through Merger’, The Australian, 2 September 1999, p. 27. 28 Sakamoto, S., ‘IBJ, Fuji, and DKB to Join Forces – Foreign Acquisitions by Japanese Banks Will Now Be Permitted’, Journal of Japanese Trade and Industry, vol. 18, no. 6, November/December 1999, p. 32. 29 Horiuchi, A., ‘Financial Fragility in Japan’, in de Brouwer, G. and Wiswarn Pupphavesa (eds), Asian Pacific Financial Deregulation, Routledge, London, 1999, pp. 239 ff. 30 Horiuchi, A., ‘Financial Fragility in Japan’, in de Brouwer, G. and Wiswarn Pupphavesa (eds), Asia Pacific Financial Deregulation, Routledge, London, 1999, p. 246. 31 Harner, S. M., Japan’s Financial Revolution: And How American Firms are Profiting, M. E. Sharpe, Armonk and London, 2000, p. 27. 32 Cargill, T. F., ‘What Caused Japan’s Banking Crisis?’, in Hoshi, T. and Hugh Patrick (eds), Crisis and Change in the Japanese Financial System, Kluwer Academic, Boston, Dordrecht, London, 2000, p. 43. 33 Rafferty, K., ‘Playing a Whole New Ball Game’, Euromoney, no. 376, August 2000. (http://global.umi.com/pqdweb?ReqType=301&UserId=IPAuto&Passwod +IPAuto &COPT=REJTPM&Enabled+1&TS=983324241) 34 The net result was not dissimilar to Bolivia’s experience with debt buyback in 1988. Bolivian debt totaled US$670 million and had a secondary market value of US$40.2 million at the discount rate of 0.06 cents to the dollar. The Bolivian government bought back $308 million of its debt with US$34 million at the discount rate, leaving its total debt at $362 million. The debt buyback resulted in markets upgrading the discount rate to 0.11 cents to the dollar, giving the remaining debt a market value of $39.2 million. In real terms, Bolivia had used $34 million to secure a debt relief of only $400 000. Like Bolivia, the Japanese government tried a partial solution but this failed to resolve the fundamental problem. See Rogoff, K., ‘Dealing with Developing Country Debt in the 1990s’, World Economy, vol. 15, no. 4, 1992, p. 480.

160 Notes 35 Okumura, H., Corporate Capitalism in Japan, Macmillan Press, Basingstoke, 2000, pp. 37 and 43. 36 Odagiri, N., ‘Kabu Mochiai Kaisho’, Ekonomisto, 9 January 2001, p. 20. 37 Kiuchi, T., ‘Japanese Economy: Facing a Real Test for Restructuring’, speech delivered at Beijing on 21 March 2001, unpublished. 38 Lunn, S., ‘Japan Ventures Nothing in Band-Aid Zero Rate’, The Australian, 21 March 2001, p. 29. 39 Bremner, B., ‘Roadblock at the Bank of Japan’, Business Week, 12 February 2001, p. 57. 40 ‘Japan Punts on Power of Zero Rate’, The Australian, 20 March 2000, p. 25. 41 See Richard Katz’s review of Freedman, C., Why Did Japan Stumble?, in Journal of Japanese Studies, vol. 27, no. 1, 2001. 42 Japan Times, 31 March 2001. 43 Negishi, M., ‘Doubts Linger Over Loan Disposal’, Japan Times Online, April 7 2001. 44 Shirakawa, H., ‘Keiki to kozo kaikaku wa ryoritsu suru no ka’, Ekonomisto, 29 May 2001, p. 45. 45 Kurata, Y., ‘Nihon kigyo o kaishimeru: Ripplewood no Shotai’, Shukan Daiyamondo, 14 July 2001, pp. 123 ff.

4 Corporate Reforms 1 The keiretsu replace the prewar zaibatsu or financial cliques that brought together a number of corporations under a single, family-owned holding company. The zaibatsu were dissolved by American occupation authorities at the end of the Second World War because of their uncompetitive practices and economic domination. Japan did not emulate western capitalism, however, and in time, after the occupation of Japan was over, the zaibatsu were replaced by informal keiretsu groupings but without the formal control of a holding company. The keiretsu can be either vertically or horizontally integrated and are held together by legally permissible cross-ownership of shares and linkages to a main bank. 2 Holzhausen, A., ‘Japanese Employment Practices in Transition: Promotion Policy and Compensation Systems in the 1990s’, Social Science Japan Journal, vol. 3, no. 2, October 2000, p. 224. 3 Miyajima, H., ‘Regulatory Framework, Government Intervention and Investment in Postwar Japan: The Structural Dynamics of J-Type Firm–Government Relationships’, in Miyajima, H., Takeo Kikkawa and Takashi Hikino (eds), Policies for Competitiveness: Comparing Business Government Relationships in the ‘Golden Age of Capitalism’, Oxford University Press, 1999, p. 59. 4 See Hoshi, T., ‘The Economic Role of Corporate Grouping and the Main Bank System’, in Aoki, M. and R. Dore (eds), The Japanese Firm: The Sources of Competitive Strengths, Oxford University Press, 1994, p. 294. 5 For a discussion of the alternate explanations for concentrated share ownership in Japan, see Yafeh, Y., ‘Corporate Governance in Japan: Past Performance and Future Prospects’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000. 6 Yafeh, Y., ‘Corporate Governance in Japan: Past Performance and Future Prospects’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000, p. 76.

Notes 161 7 Lazonick, W., ‘The Japanese Economy and Corporate Reform: What Path to Sustainable Prosperity?’, Industrial and Corporate Change, vol. 8, no. 1, March 1999, p. 623. 8 See Yafeh, Y., ‘Corporate Governance in Japan: Past Performance and Future Prospects’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000, p. 79. 9 Hoshi, T., ‘The Economic Role of Corporate Grouping and the Main Bank System’, in Aoki, M. and R. Dore (eds), The Japanese Firm: The Sources of Competitive Strengths, Oxford University Press, 1994. 10 Lazonick, W., ‘The Japanese Economy and Corporate Reform: What Path to Sustainable Prosperity?’, Industrial and Corporate Change, vol. 8, no. 1, March 1999, p. 609. 11 Nakamori, T., ‘Daiichi no “Yama” wa 6 Gatsu Matsu ni mo Yatte Kuru’, Shukan Ekonomisto, 26 June 2001, pp. 22–3. 12 ‘Japan’s Regulators Act Tough as Bank Deadline Nears’, Wall Street Journal, 8 February 1999, p. 417. 13 Harrison, B. and Barry Bluestone, The Great U-Turn: Corporate Restructuring and the Polarizing of America, Basic Books, New York, 1988, p. 7. 14 Japan Statistical Yearbook 2001, Government of Japan, Tokyo, 2000. 15 Japan Statistical Yearbook 2001, table 7–35, p. 316. 16 See Japan Statistical Yearbook 2000, Tokyo, 1999, table 5–14, p. 204. 17 Seniority-based wages meant automatic and uniform across the board wage increases every year, regardless of employee performance. The seniority-based wages were in effect linked to ‘expected needs’ of employees, as they raised children and sought better housing, but it also had the powerful effect of ensuring employee loyalty to the firm, since an employee who changed companies lost seniority in the new company. 18 Okuda, H., ‘Slashing Payrolls Shows Executive Incompetence’, Japan Echo, vol. 26, no. 6, December 1999. 19 Dore, R., ‘Japan’s Reform Debate: Patriotic Concern or Class Interest? Or Both?’, Journal of Japanese Studies, vol. 25, no. 1, winter 1999. 20 Pempel, T. J., Regime Shift: Comparative Dynamics of the Japanese Political Economy, Cornell University Press, Ithaca, NY, 1999, pp. 180–95. 21 Imai, M., Kaizen: The Key to Japan’s Competitive Success, Random House Business Division, New York, 1986. 22 Sato, K., ‘Japan at a Crossroads’, Japanese Economic Studies, vol. 24, no. 4, July/August 1996, p. 88. 23 Porter, M. E., Hirotaka Takeuchi and Mariko Sakakibara, Can Japan Compete?, Perseus, Cambridge, MA, 2000, p. 81. 24 Porter, M. E., Hirotaka Takeuchi and Mariko Sakakibara, Can Japan Compete?, Perseus, Cambridge, MA, 2000, p. 170. 25 In 1999, Japanese overcapacity in steel was estimated at 39 per cent, automobiles at 26 per cent and shipbuilding at 22 per cent. See Porter, M. E., Hirotaka Takeuchi and Mariko Sakakibara, Can Japan Compete?, Perseus, Cambridge, MA, 2000, p. 82. 26 Pempel, T. J., ‘Structural Gaiatsu: International Finance and Political Change in Japan’, Comparative Political Studies, vol. 32, no. 8, December 1999, p. 917. 27 Yahata, S., ‘Structural Change and Employment Adjustment in the PostBubble Recession’, Japan Forum, vol. 9, no. 2, 1997, p. 143.

162 Notes 28 Katz, R., Japan, the System That Soured: the Rise and Fall of the Japanese Economic Miracle, M. E. Sharpe, New York, 1998, p.276. 29 On the nature and effect of regulation in Japan, see Min to Kan: 2001 nen Yakusho to Yakunin wa ko naru, Gyokaku 700 nin Iinkai, Kodansha, Tokyo, 1999, pp. 156 ff. 30 Sheridan, G., ‘Brave New Japan’, The Australian, 14 July 1999, p. 34. 31 Strom, S., ‘Mitsubishi Electric to Slash Jobs’, International Herald Tribune, 1 April 1999, p. 13. 32 Ajia 1999: Konrango no Ajia o Minaosu, Daiyamondo Sha, Tokyo, 1998, p. 151. 33 ‘Japan Restructures, Grudgingly’, The Economist, 6 February 1999, p. 63. 34 Pokarier, C., ‘Continuity and Change in Japanese Human Capital Formation’, in Maswood, J., Jeffrey Graham and Hideaki Miyajima (eds), Japan: Continuity and Change, Curzon Press, London, 2002 (forthcoming). 35 Cohen, Stephen S. and Gavin Boyd, Corporate Governance and Globalization: Long Range Planning Issues, Edward Elgar, Cheltenham, 2000, p. 236. 36 Krugman, P., ‘Why I am Even More Depressed About Japan’, Financial Times, 4 May 1999, p. 12. 37 ‘Koyo ya Shunyugen 82 per cent ga fuan’, Asahi Shinbun, 25 April 1999, pp. 1 and 11. 38 See Far Eastern Economic Review, 1 April 1999, p. 10. 39 Miyajima, H., ‘Regulatory Framework, Government Intervention and Investment in Postwar Japan: The Structural Dynamics of J-Type Firm– Government Relationships’, in Miyajima, H., Takeo Kikkawa, and Takashi Hikino (eds), Policies for Competitiveness: Comparing Business–Government Relationships in the ‘Golden Age of Capitalism’, Oxford University Press, 1999, p. 66. 40 See Japan Statistical Yearbook 2001, table 12–13, p. 423. 41 ‘The Growing Mobility of Labor’, Focus Japan, vol. 27, no. 8, JETRO, Tokyo, October 2000, p. 4. 42 Lazonick, W., ‘The Japanese Economy and Corporate Reform: What Path to Sustainable Prosperity?’, Industrial and Corporate Change, vol. 8, no. 1, March 1999, pp. 627–8. 43 Mandate of heaven refers to a principle for legitimizing imperial rule in China and Japan. 44 Holzhausen, A., ‘Japanese Employment Practices in Transition: Promotion Policy and Compensation Systems in the 1990s’, Social Science Japan Journal, vol. 3, no. 2, October 2000. 45 Yafeh, Y., ‘Corporate Governance in Japan: Past Performance and Future Prospects’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000.

5 Regulatory Reforms 1 Vogel, S., ‘Can Japan Disengage? Winners and Losers in Japan’s Political Economy, and the Ties that Bind Them’, Social Science Japan Journal, vol. 2, no. 1, April 1999, p. 4. 2 Rogowsky, R. A., ‘The Benefit of Regulatory Reform’, in OECD Proceedings: Regulatory Reform and International Market Openness, Paris, 1996, p. 43. 3 Ishiguro, K., ‘The WTO New Round and Japan’s Role’, in Japan Review of International Affairs, vol. 13, no. 4, winter 1999, p. 234.

Notes 163 4 MacAvoy, P. W., ‘Twenty Years of deregulation’, in Paul W. MacAvoy (ed.), Deregulation and Privatization in the United States, Hume Papers on Public Policy, vol. 3, no. 3, Edinburgh University Press, autumn 1995, pp. 8–9. 5 Porter, M. E., Hirotaka Takeuchi and Mariko Sakakibara, Can Japan Compete?, Perseus, Cambridge, MA, 2000, chapter 1. 6 Francis, J., The Politics of Regulation: A Comparative Perspective, Blackwell, Cambridge, MA, 1993, p. 205. 7 Keizai Kikakucho, Nihon Keizai no Genkyo: Naiju Chushin no Antei Seicho o Mezashite, Tokyo, 1985, pp. 140–1. Cited in Maswood, S. J., Japan and Protection, Routledge, London, 1990, pp. 109–10. In presenting cross-country statistical data, the EPA added the caution that the figures were not precisely comparable because of national differences. It cautioned that the comparative figures were for indicative purposes only to show the variance between countries. Indeed, the variability of estimates is highlighted also a different set of numbers which suggest that the percentage of GDP in the regulated sector of the US economy decreased from 28.9 per cent to 23.3 per cent between 1980 and 1992. See MacAvoy, P. W., ‘Twenty Years of Deregulation’, in Paul W. MacAvoy (ed.), Deregulation and Privatization in the United States, Hume Papers on Public Policy, vol. 3, no. 3, Edinburgh University Press, autumn 1995, p. 5. 8 Speech by Miyauchi Yoshihiko, chairman of the Regulatory Reform Committee, at Foreign Correspondents Club of Japan, 26 May 2000. (http://www.somucho.go.jp/gyoukan/kanri/speech.htm) 9 Carlile, L. E., ‘The Politics of Administrative Reform’, in Lonny E. Carlile and Mark C. Tilton (eds), Is Japan Really Changing its Ways? Regulatory Reform and the Japanese Economy, Brookings Institution Press, Washington DC, 1998, p. 89. 10 Speech by Miyauchi Yoshihiko, chairman of the Regulatory Reform Committee, at the Foreign Correspondents Club of Japan, 26 May 2000. 11 McAlinn, G. P., The Business Guide to Japan, Butterworth-Heinemann Asia, Singapore, 1996, p. 23. 12 The Impact of Regulatory Reform in Japan – Assessing Consumer Benefit, Economic Policy Analysis Report no. 1, Research Bureau, Economic Planning Agency, Tokyo, January 2000. 13 Yamamura, K., ‘The Japanese political Economy after the “Bubble”: Plus Ça Change’, Journal of Japanese Studies, vol. 23, no. 2, 1997, p. 322. 14 Speech by Miyauchi Yoshihiko, chairman of the Regulatory Reform Committee, at the Foreign Correspondents Club of Japan, 26 May 2000. 15 Nader, R. and Lori Wallach, ‘GATT, NAFTA, and the Subversion of the Democratic Process’, in Jerry Mander and Edward Goldsmith (eds), The Case Against the Global Economy: And for a Turn Toward the Local, Sierra Club Books, San Francisco, 1996. 16 See Nihon no Hakusho: Waga Kuni no Genjyo to Kadai, Nihon Joho Kyoiku Kenkyu Kai, Seibunsha, Tokyo, 2000, p. 104. 17 Sakakibara, E., ‘Reform, Japanese Style’, in Gibney, F. (ed.), Unlocking the Bureaucrat’s Kingdom: Deregulation and the Japanese Economy, Brookings Institution Press, Washington, DC, 1998. 18 The separation between nominal and real power centres was a necessity based on the principle of ‘mandate of heaven’. In the Japanese understanding of this principle, since the imperial lineage was absolute, the ruling emperor had to be

164 Notes

19 20 21 22

23

24 25 26 27 28

29 30 31 32

insulated from worldly policy failures, such that failures could be blamed on others, whether the Tokugawa shogunate before the Meiji Restoration or the ruling genro (elder statesmen from the four southern provinces who inspired the Meiji Restoration) during the Meiji period. By contrast, in the Chinese understanding of this same principle, imperial authority was not an absolute and so the ruler could reign supreme. Instead, emperors could be held accountable for policy failures, and a ruling monarch could thereby forfeit the mandate of heaven and be replaced by another dynasty. Thus Chinese history provides evidence of many dynastic transitions whereas the Japanese are proud of an unbroken line of emperors. There are some very rare exceptions in Japan, as when the ruling emperor in the eighth century accepted blame for a series of natural disasters and attributed them to heavenly displeasure at his lack of virtue. Imperial infallibility, however, is the rule that has been adhered to in Japan. See Sansom, G., A History of Japan to 1334, Cresset Press, London, 1958, p. 75. Grunberg, G., ‘France’, in Crewe, I. and David Denver (eds), Electoral Change in Western Democracies, Croom Helm, London and Sydney, 1985. See Chuo Koron, April 1999. Asahi Shimbun, 9 September 2000, p. 4. See Vogel, Steven K., ‘Can Japan Disengage? Winners and Losers in Japan’s Political Economy, and the Ties that Bind Them’, Social Science Japan Journal, vol. 2, no. 1, April 1999, pp. 11–12. In an earlier work, Pempel had acknowledged the reality of a regime shift but was unsure of the future equilibrium point but in a later work he is at least confident that the earlier strategy will be replaced by a return to its pro-farm policies. See Pempel, T. J., ‘Structural Gaiatsu: International Finance and Political Change in Japan’, Comparative Political Studies, vol. 32, no. 8, December 1999. Masuda, E., ‘ “Koizumi Kakumei” no Taagetto’, Shukan Ekonomisto, 22 May 2001, p. 18. ‘Koizumi Stumps on Intention to Redirect Road-only Revenue’, Japan Times, 18 June 2001, p. 1. ‘Round of Verbal Sparring Opens Election Campaign’, Japan Times, 13 July 2001, p. 1. Asaumi, N., ‘Popularity a Two-Edged Sword’, Daily Yomiuri, 17 June 2001, p. 6. The Upper House has 247 seats and of these 121 seats (73 constituency seats and 48 proportional representation seats) were contested in the July elections. Upper House members are elected for a six-year term, with half the members contesting elections every three years. In the July 2001 elections, nearly 500 individuals, including TV celebrities and professional wrestlers, registered themselves as official candidates. The postal savings system is technically Japan’s and the world’s largest bank, with deposits of approximately Y260 trillion in March 2000. Ishiyama, K., ‘Zoku-giin Threaten Koizumi’s Reforms’, Daily Yomiuri, 22 June 2001, p. 7. Hironaka, Y., ‘Koizumi Ready to Run in Reform Race’, Daily Yomiuri, 24 June 2001, p. 1. In early August 2001, relations between the prime minister and the foreign minister had cooled considerably over disagreement with several bureaucratic appointments, and there were suggestions that the prime minister had come close to dismissing her but was constrained by her immense public popularity.

Notes 165 33 Tanaka, A., ‘Tanaka Makiko Gaisho wa Hayaku Jinin Subeki Da’, Chuo Koron, July 2001, p. 32 ff. 34 ‘Ozawa to Pick at Koizumi’s LDP Taint, “Self- Contradictions” ‘, Japan Times, 13 July 2001, p. 3. 35 Saito, J., ‘Cries of Ouch over Reform Pain’, Asahi.com, 27 July 2001. (http:www.asahi.com/english/politics/K2001072600534.html) 36 Saito, J., ‘Cries of Ouch over Reform Pain’, Asahi.com, 27 July 2001. (http://www.asahi.com/english/politics/K2001072600534.html) 37 Francis, J., The Politics of Regulation: A Comparative Perspective, Blackwell, Cambridge, MA, 1993, p. 34. 38 ‘Takenaka Speaks on Reforms’, Daily Yomiuri, 23 June 2001, p. 18. 39 Yamamura, K., ‘The Japanese Political Economy after the “Bubble”: Plus Ça Change’, Journal of Japanese Studies, vol. 23, no. 2, 1997.

6 Japan’s Regional Economy and the Asian Monetary Fund 1 ‘Present Situation and Future Prospects: Japanese Corporations’ Business Development in Asia’, Japanese Finance and Industry Quarterly Survey, IBJ, no. 109, first quarter 1997, p. 1. 2 Katzenstein, P., ‘Introduction: Asian Regionalism in Comparative Perspective’, in Katzenstein, P. and Shiraishi, T. (eds), Network Power: Japan and Asia, Cornell University Press, Ithaca and London, 1997, p. 3. 3 Rix, A., ‘Japan and the Region: Leading from Behind’, in Okuizumi, K., Kent Calder and Geritt Gong (eds), The US–Japan Economic Relationship in East and Southeast Asia: A Policy Framework for Asia-Pacific Economic Cooperation, Westview Press, Boulder, CO, 1993. 4 Doner, R. F., ‘Japan in East Asia: Institutions and Regional Leadership’, in Katzenstein, P. J. and Takashi Shiraishi (eds), Network Power: Japan and Asia, Cornell University Press, Ithaca, NY, and London, 1997. 5 Doner, R. F., ‘Japan in East Asia: Institutions and Regional Leadership’, in Katzenstein, P. J. and Takashi Shiraishi (eds), Network Power: Japan and Asia, Cornell University Press, Ithaca, NY, and London, 1997, pp. 201–2 6 See for example, van Wolferen, K., ‘The Japan Problem Revisited’, Foreign Affairs, vol. 69, no. 4, fall 1990. 7 Tachi, R., The Contemporary Japanese Economy: An Overview (translated by Richard Walker), University of Tokyo Press, Tokyo, 1993, p. 195. 8 The Economist (London), 11 October 1997, p. 89. 9 Eichengreen, B., ‘Bailing in the Private Sector: Burden Sharing in International Financial Crisis Management’, Fletcher Forum of World Affairs, vol. 23, no. 1, winter/spring 1999, p. 67. 10 Levinson, Jerome I., ‘The International Financial System: A Flawed Architecture’, Fletcher Forum of World Affairs, vol. 23, no. 1, winter/spring 1999, p. 14. 11 ‘Japan Official Denounces IMF’, International Herald Tribune, 27–28 March 1999, p. 17. 12 Levinson, Jerome I., ‘The International Financial System: A Flawed Architecture’, Fletcher Forum of World Affairs, vol. 23, no. 1, winter/spring 1999, pp. 22–3.

166 Notes 13 Far Eastern Economic Review (Hong Kong), October 1997, p. 15. 14 Boston Globe, 18 November 1998, p. A2. 15 Petri, Peter A., ‘Asia Summit Offers a Chance to Tackle Crisis’, Boston Globe, 17 November 1998, p. A27. 16 See ‘Mahathir Sees Asia’s Woes as Western Plot’, The Australian, 13 October 1999, p. 13. 17 Far Eastern Economic Review (Hong Kong), October 1997, p. 15. 18 The herd mentality of foreign investors is manifest in the way that actions of one foreign investor are quickly replicated by others to unleash a tide of capital flows in and out of a country. 19 The Economist (London), 8 January 1998. 20 Far Eastern Economic Review, 11 September 1997, p. 14. 21 Japan’s tardiness in dealing with these issues is in sharp contrast to the approach of the European countries which have continued to provide financial compensation to victims of persecution in the Second World War. For example, in May 1999, the Norwegian government announced compensation, a standard payment of NOK 200 000, to heirs and surviving victims of anti-Jewish measures during the Second World War. See New York Times, 3 May 1999, p. A24. 22 Pempel, T. J., “Transpacific Torii: Japan and the Emerging Asian Regionalism”, in Katzenstein, P. J. and Takashi Shiraishi (eds.), Network Power: Japan and Asia, Cornell University Press, Ithaca and London, 1997. 23 Bello, W., ‘East Asia: On the Eve of the Great Transformation’, Ampo: Japan Asia Quarterly Review, vol. 28, no. 3, 1998, p. 13. 24 Takii, M. and Fukushima, M., Ajia Tsuka Kiki: Higashi Ajia no Doko to Tenbo, Nihon Boeki Shinkokai, Tokyo, 1998, p. 36. 25 ‘A Regional Test for Japan’, Japan Times, 19 January 1999, p. 16. 26 Bullard, N., Walden Bello and Kamal Malhotra, ‘Taming the Tigers: The IMF and the Asian Crisis’, in Jomo, K. S. (ed.), Tigers in Trouble: Financial Governance, Liberalisation and Crises in East Asia, Zed Books, London and New York, 1998, p. 103. 27 Helleiner, G. K., ‘The East Asian and Other Financial Crises: Causes, Responses and Prevention’, in Jomo, K. S. (ed.), Tigers in Trouble: Financial Governance, Liberalisation and Crises in East Asia, Zed Books, London and New York, 1998, p. 235. 28 Sakakibara, E., ‘Watashi ga Tatakatta Beikoku Shijo Saikyo Conbi’, Bungei Shunju, September 1999, p. 134. 29 See Khanna, V., ‘Think Twice About an AMF’, BT Online (Singapore), 22 February 1999. (http://business-times.asia1.com.sg/1/focus/focus14.html) 30 Blaker, M., ‘Evaluating Japanese Diplomatic Performance’, in Curtis, G. L. (ed.), Japan’s Foreign Policy After the Cold War: Coping with Change, M. E. Sharpe, Armonk, NY, 1993. 31 ‘A Regional test for Japan’, Japan Times, 19 January 1999, p. 16. 32 ‘The Real Message in Miyazawa’s Plan’, Asiamoney, vol. 10, no. 1, February 1999, p. 14. 33 The Asian crisis of 1997 was followed by similar crises in Russia and Brazil in 1998. 34 Khanna, V., ‘Think Twice About an AMF’, BT Online, 22 February 1999. 35 See ‘Mahathir Raspberries West, Media’, The Australian, 19 October 1999, p. 27.

Notes 167 36 Richardson, M., ‘Japan Backs Standby Fund for Southeast Asia’, International Herald Tribune, 27 November 1999. 37 Richardson, M., ‘Asian Monetary Fund Stirs Again Despite US Veto’, The Australian, 30 November 1999, p. 25. 38 See http://www.nttls.co.jp/fpc/e/shiryo/jb/0018.html. 39 ‘Next Currency Swap Targets Revealed’, Japan Times Online, 12 May 2000. 40 See Financial Times (London), 3 May 1999. 41 Wijnholds, Onno De Beaufort, ‘Maintaining an Indispensable Role’, Financial Times, 1 March 1999, p. 16.

7 Conclusion 1 Sasaki, T., ‘Assessing the Obuchi Administration’, Japan Echo, vol. 27, no. 4, August 2000. Italics in original. 2 Economic Survey of Japan 1997–1998: Preparing for Creative Development, Economic Planning Agency, Government of Japan, Tokyo, 1999, p. 21. Italics added. 3 Ujimoto, K. Victor, ‘The Aging of Japanese Society: Human Resource Management in Transition’, in Bowles, P. and Lawrence T. Woods (eds), Japan After the Economic Miracle: In Search of New Directions, Kluwer Academic, Dordrecht, 2000, p. 174. 4 Kiuchi, T., ‘Japanese Economy: Facing a Real Test for Restructuring’, speech delivered at Beijing on 21 March 2001, unpublished. 5 Schoppa, Leonard J., ‘Japan: The Reluctant Reformer’, Foreign Affairs, vol. 80, no. 5, September 2001. 6 Itoh, M. and Naoki Shimoi, ‘On the Role of Monetary Policy in a Deflationary Economy: The Case of Japan’, Journal of Japanese Trade and International Economies, vol. 14, no. 4, December 2000, p. 250. 7 The consumption tax had been increased earlier in the year at the insistence of the Ministry of Finance in order to reduce public sector debt. Earlier, in 1994, the Ministry of Finance had tried unsuccessfully to increase the consumption tax from 3 per cent to 7 per cent. 8 Wu Dunn, S., ‘Japan Gives Consumers Free Money’, International Herald Tribune, 15 March 1999, p. 13. 9 See New York Times, 12 September 2000. 10 ‘Japan’s Shoppers Herald Recovery’, The Australian, 3 September 1999, p. 23. 11 Masuda, E., ‘Kokyo Jigyo ni yoru Chiho Ikkyoku Shuchu wa Hokai e’, Shukan Ekonomisto, 22 May 2001, p. 21. 12 Japan Statistical Yearbook 2001, Government of Japan, Tokyo, 2000, table 3–26. 13 Lunn, S., ‘Japan Hits Panic Button Over Jobless’, The Australian, 29 August 2001, p. 21.

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Bibliography 169 Holzhausen, A. (ed.), Can Japan Globalize? Studies on Japan’s Changing Political Economy and the Process of Globalization in Honour of Sung-Jo Park, Physica-Verlag, Heidelberg, 2001. Hoshi, T. and Hugh Patrick (eds), Crisis and Change in the Japanese Financial System, Kluwer Academic, Boston, 2000. Ichimura, S., Political Economy of Japanese and Asian Development, Springer Verlag, Tokyo, 1998. Imai, K., Kaizen: The Key to Japan’s Competitive Success, Random House Business Division, New York, 1986. Itoh, M., Nihon Keizai o Kangae Naosu, Iwanami Shoten, Tokyo, 1998. Jomo, K. S. (ed.), Tigers in Trouble: Financial Governance, Liberalization and Crises in East Asia, Zed Books, London and New York, 1998. Katz, R., Japan, The System that Soured: The Rise and Fall of the Japanese Economic Miracle, M. E. Sharpe, Armonk, NY, 1998. Katzenstein, P. J. and Takashi Shiraishi (eds), Network Power: Japan and Asia, Cornell University Press, Ithaca, NY, and London, 1997. Kindleberger, C. P., Manias, Panics, and Crashes: A History of Financial Crises, revised edn, Basic Books, New York, 1989. McAlinn, G. P., The Business Guide to Japan, Butterworth-Heinemann Asia, Singapore, 1996. MacAvoy, Paul W. (ed.), Deregulation and Privatization in the United States, Hume Papers on Public Policy, vol. 3, no. 3, Edinburgh University Press, autumn 1995. Managing the Crisis: The FDIC and RTC Experience 1980–1994, Federal Deposit Insurance Corporation, Washington, DC 1998. Mander, J. and Edward Goldsmith (eds), The Case Against the Global Economy: And a Turn Toward the Local, Sierra Club Books, San Francisco, 1996. Maswood, S. J., Japan and Protection, Routledge, London, 1990. Maswood, S. J. (ed.), Japan and East Asian Regionalism, Nissan Institute/Routledge Japan Studies Series, London, 2001. Maswood, S. J., Jeff Graham and Hideaki Miyajima (eds), Japan: Change and Continuity, Routledge Curzon Press, London, 2002. Min to Kan: 2001 nen Yakusho to Yakunin wa ko naru, Gyokaku 700 nin Iinkai, Kodansha, Tokyo, 1999. Miyajima, H., Takeo Kikkawa and Takashi Hikino (eds), Policies for Competitiveness: Comparing Business – Government Relationships in the ‘Golden Age of Capitalism’, Oxford University Press, 1999. Morinaga, T., Baburu to Defure, Kodansha, Tokyo, 1998. Nihon Keizai no Genkyo: Naiju Chushin no Antei Seicho o Mezashite, Keizai Kikakucho (Economic Planning Agency), Tokyo, 1985. Nihon no hakusho: Waga kuni no genjyo to kadai, Nihon Joho Kyoiku Kenkyu Kai, Seibun sha, Tokyo, 2000. Noble, G. W. and John Ravenhill (eds), The Asian Financial Crisis and the Architecture of Global Finance, Cambridge University Press, 2000. Okuizumi, K., Kent Calder and Geritt Gong (eds), The US–Japan Economic Relationship in East and Southwest Asia: A Policy Framework for Asia-Pacific Economic Cooperation, Westview Press, Boulder, CO, 1993. Okumura, H., Corporate Capitalism in Japan, Macmillan Press, Basingstoke, 2000. Pempel, T. J., Regime Shift: Comparative Dynamics of the Japanese Political Economy, Cornell University Press, Ithaca, NY, and London, 1998.

170 Bibliography Porter, M. E., Hirotaka Takeuchi and Mariko Sakakibara, Can Japan Compete?, Perseus, Cambridge, MA, 2000. Reeve, A. and Alan Ware, Electoral Systems: A Comparative and Theoretical Introduction, Routledge, London, 1992. Sansom, G., A History of Japan to 1334, Cresset Press, London, 1958. Tachi, R., The Contemporary Japanese Economy: An Overview (translated by Richard Walker), University of Tokyo Press, Tokyo, 1993. Takii, M. and Fukushima, M., Ajia Tsuka Kiki: Higashi Ajia no Doko to Tenbo, Nihon Boeki Shinkokai (JETRO), Tokyo, 1998. The Impact of Regulatory Reform in Japan – Assessing Consumer Benefit, Economic Policy Analysis Report no. 1, Research Bureau, Economic Planning Agency, Tokyo, 2000.

Articles Bello, W., ‘East Asia: On the Eve of the Great Transformation’, Ampo: Japan Asia Quarterly Review, vol. 28, no. 3, 1998. Bremner, B., ‘Roadblock at the Bank of Japan’, Business Week, 12 February 2001. Dore, R., ‘Japan’s Reform Debate: Patriotic Concern or Class Interest? Or Both?’, Journal of Japanese Studies, vol. 25, no. 1, winter 1999. Eichengreen, B., ‘Bailing in the Private Sector: Burden Sharing in International Financial Crisis Management’, Fletcher Forum of World Affairs, vol. 23, no. 1, winter/spring 1999. Feldstein, M., ‘A Self-Help Guide to Emerging Markets’, Foreign Affairs, March/April 1999. Haley, John O., ‘Governance by Negotiation: A Reappraisal of Bureaucratic Power in Japan’, Journal of Japanese Studies, vol. 13, no. 2, summer 1987. Hanazaki, M. and Akiyoshi Horiuchi, ‘Is Japan’s Financial System Efficient?’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000. Horiuchi, A., ‘Financial Fragility and Recent Developments in the Japanese Safety Net’, Social Science Japan Journal, vol. 2, no. 1, April 1999. Holzhausen, A., ‘Japanese Employment Practices in Transition: Promotion Policy and Compensation Systems in the 1990s’, Social Science Japan Journal, vol. 3, no. 2, October 2000. Ishiguro, K., ‘The WTO New Round and Japan’s Role’, Japan Review of International Affairs, vol. 13, no. 4, winter 1999. Iwao, N., ‘A Design for Transforming the Japanese Economy’, Journal of Japanese Studies, vol. 23, no. 2, summer 1997. Kitaoka, S., ‘LDP – Liberal Coalition Prospects’, Japan Quarterly, vol. 46, no. 2, April–June 1999. Komine, T., ‘Ajia no Tsuka Kinyu Kiki to Senzaiteki Seichoryoku’, Economic Research (Keizai Kikakucho Keizai Kenkyujo), no. 2, June 1998. Kurata, Y., ‘Nihon Kigyo o Kaishimeru: Ripplewood no Shotai’, Shukan Daiyamondo, 14 July 2001. Lazonick, W., ‘The Japanese Economy and Corporate Reform: What Path Sustainable Prosperity?’, Industrial and Corporate Change, vol. 8, no. 1, March 1999. Levinson, Jerome I., ‘The International Financial System: A Flawed Architecture’, The Fletcher Forum of World Affairs, vol. 23, no. 1, winter/spring 1999.

Bibliography 171 Marshall, D., ‘Understanding the Asian Crisis: Systemic Risk as Coordination Failure’, Economic Perspective (Federal Reserve Bank of Chicago), vol. 22, no. 3, third quarter 1998. Masuda, E., ‘ “Koizumi Kakumei” no Taagetto’, Shukan Ekonomisto, 22 May 2001. Miller, M., ‘Asian Financial Crisis’, Japan and the World Economy, vol. 10, no. 3, July 1998. Nakamori, T., ‘Daiichi no “Yama” wa 6 Gatsu Matsu no mo Yatte Kuru’, Shukan Ekonomisto, 26 June 2001. Nakamura, K., ‘Seiryu Kansoku’, Shukan Ekonomisto, 26 June 2001. Noguchi, Y., ‘The “Bubble” and Economic Policies in the 1980s’, Journal of Japanese Studies, vol. 20, no. 2, summer 1994. Odagiri, N., ‘Kabu Mochiai Kaisho’, Ekonomisto, 9 January 2001. Okuda, H., ‘Slashing Payrolls Shows Executive Incompetence’, Japan Echo, vol. 26, no. 6, December 1999. Pempel, T. J., ‘Structural Gaiatsu: International Finance and Political Change in Japan’, Comparative Political Studies, vol. 32, no. 8, December 1999. Rafferty, K., ‘Playing a Whole New Ball Game’, Euromoney, Issue 376, August 2000. Rogowsky, R. A., ‘The Benefit of Regulatory Reform’, OECD Proceedings: Regulatory Reform and International Market Openness, Paris 1996. Rostow, W. W., ‘Modern Japan’s Fourth Challenge: The Political Economy of a Stagnant Population’, The Japanese Economic Review, vol. 51, no. 3, September 2000. Sakakibara, E., ‘Watashi ga Tatakatta Beikoku Shijo Saikyo Konbi’, Bungei Shunju, September 1999. Sakamoto, S., ‘IBJ, Fuji, and DKB to Join Forces – Foreign Acquisitions by Japanese Banks Will Now Be Permitted’, Journal of Japanese Trade and Industry, vol. 18, no. 6, November/December 1999. Sasaki, T., ‘Assessing the Obuchi Administration’, Japan Echo, vol. 27, no. 4, August 2000. Sato, K., ‘Japan at a Crossroads’, Japanese Economic Studies, vol. 24, no. 4, July/August 1996. Schoppa, Leonard J., ‘Japan: The Reluctant Reformer’, Foreign Affairs, vol. 80, Issue 5, September 2001. Shirakawa, H., ‘Keiki to Kozo Kaikaku wa Ryoritsu Suru no Ka’, Ekonomisto, 29 May 2001. ‘Sori to iu no wa fujiyu na mon da: Mori Yoshiro sori tandoku interview’, Bungeishunju, October 2000. Tanaka, A., ‘Tanaka Makiko Gaisho wa Hayaku Jinin Subeki Da’, Chuo Koron, July 2001. Vogel, S., ‘Can Japan Disengage? Winners and Losers in Japan’s Political Economy, and the Ties that Bind Them’, Social Science Japan Journal, vol. 2, no. 1, April 1999. Van Wolferen, K., ‘The Japan Problem revisited’, Foreign Affairs, vol. 69, no. 4, fall 1990. Yafeh, Y., ‘Corporate Governance in Japan: Past Performance and Future Prospects’, Oxford Review of Economic Policy, vol. 16, no. 2, summer 2000. Yahata, S., ‘Structural Change and Employment Adjustment in the Post-Bubble Recession’, Japan Forum, vol. 9, no. 2, 1997. Yamamura, K., ‘The Japanese Political Economy After the “Bubble”: Plus Ça Change’, Journal of Japanese Studies, vol. 23, no. 2, 1997.

Index accountability 18 adaptive change 74–5 administrative reform 12–14 see also bureaucracy; regulatory reforms Administrative Reform Commission (ARC) 93–4 Afghanistan 3 ageing population 43, 148 amakudari 65, 96–7 Argentina 123 Asaumi, N. 108 ASEAN Plus Three (APT) 16, 139, 142, 143 ASEAN Regional Forum (ARF) 130 Asia Pacific Economic Cooperation (APEC) 117, 121, 125–6, 131, 136 Asian bubble 24–8 Asian capitalism 134–5 Asian crisis 8–9, 9–12, 115, 116, 145 catalyst for change in Japan 12–16 foreign policy opportunity 119–25 Japanese aid to crisis countries 119–20, 125–8, 129, 137 and Japanese economy 3–4, 5, 28–30 and Japanese financial sector 5, 14, 40, 41, 45–6 US perception of 125–6, 128, 131, 134–5 Asian Development Bank (ADB) 14, 123, 138, 140 Asian Monetary Fund (AMF) 15–16, 16, 118, 142, 145 American rejection 15, 128, 132–6, 142, 145 initiatives following American rejection 136–42 Japanese proposal 126, 127–8, 128–32 Asian standby facility 136, 138–9 asset price inflation 20–1

Association of South East Asian Nations (ASEAN) 126–7, 138 atrocities, wartime 14, 115–16, 131, 145–6 austerity measures 29, 133 Australia 6, 9, 121, 136, 142–3 automobile industry 69, 80 aviation industry 88 Aziz, R. 126 bad loans see non-performing loans bailouts 36–7, 47–8 Bank of Japan 38, 41–2, 58–9 interest rate cuts 17, 24, 27, 47, 58 interest rate increases 20, 21 and managed inflation 30 bank closures (East Asia) 123, 124 bank lending 19–20, 21 non-performing loans see nonperforming loans overseas 24–8, 41 bank oversight 18, 65, 66 Bank of Tokyo-Mitsubishi 52 banking and financial sector 16, 39–61, 91 Asian crisis and 5, 14, 40, 41, 45–6 bailouts 36–7, 47–8 crisis in 40–6 main bank system 18, 62, 64–5, 66–8 reform and persisting economic weakness 56–61 reforms 3–4, 5, 13, 46–54, 144, 146 regulatory controls and surveillance 41, 54–6 bankruptcies 41, 69–70 Bello, W. 133 big-bang reforms 55 bilateral swap agreements 139 birth rate 148 Blaker, M. 118, 136–7 blood transfusions 32 boards of directors 65

172

Index 173 Brady Plan 123 Bretton Woods agreement 122 Brown, B. 31 bubble economies 11 Asia 24–8 Japan 2, 13, 17–24, 97 bubbles, speculative 11 bureaucracy 7–8 decline in powers 31–3 opposition to deregulation and reform 94, 96–7 bureaucratic capitalism 89 Bush, G. 113 Bush, G.W. 107–8 business confidence 57 cabinet town meetings 108, 112 capital injections 51–2 capital reserves 27, 39, 51–2 capitalism Asian 134–5 bureaucratic 89 Japanese 73 captive imports 77 Cargill, T.F. 21, 48, 55–6 Carlile, L. 12–13, 93 Carter, J. 92 chequebook diplomacy 120 Chiang Mai initiative 139 China 116, 119, 129, 130–1 Chrysler Corporation 37, 81 Chuo Trust Bank 50, 53 Citicorp 69 Clinton, W. 46, 125, 128 Communist Party of the Soviet Union (CPSU) 153–4 competition banks and global financial market 52–4 regulation and 91 comprehensive economic measures (CEM) package 29 conditionality 133, 134 constitution, pacifist 121 construction industry 152–3 consumers 94, 95–6 confidence 82–3 consumption demand 4, 22–3, 147–52

consumption tax 24, 36, 43, 150 contingent credit lines (CCLs) 141–2 contraction, economic 46–7 convergence corporate reforms and 68–74 regulatory 94–5 convoy strategy 66 core business 75 corporate sector 4, 16, 62–86 adaptation to shocks 6–7 corporate reform in Japan 74–83 corporate reforms and convergence 68–74 debt 149; NPLs see non-performing loans foreign takeovers 60–1, 84, 85 main features of the J-firm 63–8 corruption scandals 31–2, 34, 97 Council on Economic and Fiscal Policy (CEFP) 109, 110 crises 10, 87 cross-ownership of shares 4, 57, 65–6, 67 currency reform 31 currency swap regime 139 Daiei 149 Daiichi Kangyo Bank 53 Daiwa Bank 51 debt forgiveness and waiver 59–60 government debt 93 NPLs see non-performing loans overhang 149 public sector debt 2, 13, 23, 147 deficit bonds 152 demand, domestic 4, 22–3, 147–52 Democratic Party of Japan (DPJ) (Minshuto) 45, 100, 111, 113, 114, 153 electoral support and policy strategies 102, 103, 104, 105–6 Democratic Socialist Party (DSP) 99, 104 demography 43, 148 Deposit Insurance Agency (DIA) 35 deregulation see regulatory reforms developmental state 88–9 domestic demand 4, 22–3, 147–52

174 Index Doner, R. 117, 118 Dore, R. 73 East Asian countries 45–6 see also Asian crisis; and under individual names East Asian Economic Caucus (EAEC) 117, 126, 127, 131–2, 142 Economic Planning Agency (EPA) 28–9, 35, 92, 94 economy 1–2, 9, 17–38, 146 Asian crisis and 3–4, 5, 28–30 bubble economy 2, 13, 17–24, 97 contraction 46–7 domestic demand 4, 22–3, 147–52 explaining failure of economic recovery packages 30–6 growth 1, 72, 151 stagnation 2, 3–5, 9, 21–4, 144 EIE Group 50 elections 1993 34 1998 34, 43–4, 103 2001 3, 108–9, 111 electoral reforms 100 employment system 53, 71, 86 long-term employment 64, 78, 81, 84 ethnic violence 127 exchange rate 6–7, 21–2, 71 Export-Import Bank of Japan 125 export-oriented industrialization (EOI) 10 exports 6–7, 22, 116 Far Eastern Economic Review 129 Federal Deposit Insurance Corporation (FDIC) 49 Feldstein, M. 10 fertility rate 43 financial assistance IMF role 122–3 Japan’s provision 119–20, 125–8, 129, 137 Financial Rehabilitation Law 48 Financial Restructuring Commission (FRC) 48–9, 50, 52

financial sector see banking and financial sector Financial Services Agency 56 Financial Supervisory Agency 47, 51–2, 55–6 Financial System Planning Bureau 56 fiscal stimulus packages 3, 4, 23–4, 29, 37, 151 foreign acquisitions 60–1, 84, 85 foreign direct investment (FDI) 25, 116–17 foreign managers/executives 85 Francis, J. 113 free rider 120 free shopping vouchers 149, 150–1 Fuji Bank 53 G–8 Summit 1997 128 General Agreement on Tariffs and Trade (GATT) 136 globalization 73–4 Gorbachev, M. 153–4 Gore, A. 126 government debt 93 Great Depression 87 gross domestic product (GDP) 72 growth, economic 1, 72, 151 Gulf War 21, 118, 120–1, 137 Harner, S. 55 Hashimoto Ryutaro 4, 29, 36, 98, 109, 130 financial reforms 42–3 resignation 30, 44 Hata Tsutomu 99 Hayami Masaru 30, 38 Helleiner, G.K. 134 Henderson, C. 25 Hitachi Metals Ltd 79–80 Hokkaido Takushoku Bank 41, 48, 51 Hollerman, L. 21, 32 Holzhausen, A. 64, 86 Honda 89 Hong Kong 25, 26 Horiuchi, A. 54–5 Hoshi Takeo 67 Hosokawa Morihiro 100 housing loan corporations (jusen) 21, 47–8

Index 175 Ibrahim, A. 129 Ichimura, S. 30 Imai, K. 74 import substitution industrialization (ISI) 10 imports 150 captive 77 incentive pay system 72–3 income distribution 1 income tax cuts 149–50 individualism 148–9 Indonesia 10, 124, 125, 127 Japanese aid 125, 137 Japanese investment in 25 Industrial Bank of Japan 53 industry see corporate sector inflation asset price inflation 20–1 and corporate debt 149 Koizumi reforms 37–8 managed 30 injection of public funds 51–2 innovation 89 interest rates 24, 37–8 cuts 17, 24, 27, 47, 58 increases 20, 21 threatened increase 28 International Monetary Fund (IMF) 15, 128, 137, 138, 145 AMF proposal and 129–30 Asian crisis 122, 133–5 Asian standby facility 136, 138–9 criticisms of 133–4 Latin American debt crisis 122–3 precautionary line of credit 140–2; International Trade Organization 135 intra-keiretsu contracting 82 intra-regional trade 12, 116–17 investment 18–19 FDI 25, 116–17 Ishibashi Tanzan 10, 106 Itoh, M. 149 J-firm 62, 63–8, 68 Japan Communist Party 45 Japan Leasing Company 50 Japan National Railway ( JNR)

91

Japan Socialist Party ( JSP) 99, 104, 105 Jiang Zemin 131 job losses 79–80, 83 Johnson, C. 120 Johnston, D. 7 jusen (housing loan companies) 21, 47–8 Kajiyama Seiryoku 44 Kan Naoto 32, 105–6 Kato Koichi 48, 98, 101–2, 106 Katz, R. 59, 77 Katzenstein, P. 117 Kawamoto, A. 97 Keidanren (Federation of Economic Organization) 13, 92–3 keiretsu 64–5 Kindleberger, C. 11–12, 20 Kiuchi Takashi 57, 58 Koizumi Junichiro 2–3, 9, 44, 102, 114, 115, 145–7 NPLs 40 and reform agenda 106–13 reforms and pain 37, 152, 153 visit to Yasukuni Shrine 116, 145–6 Korea, South 10, 116 IMF rescue programme 124–5, 134 Japanese aid 125, 137 Japanese investment in 25 Krugman, P. 30, 82, 90, 149 Kumagai Gumi 59, 149 Kuroda Haruo 139 labour costs 78–9 Latin America 10, 36 debt crisis 20, 28, 41, 122–3, 140 Lazonick, W. 66, 67 Lee Kuan Yew 130 letters of intent 123 Levinson, J. 123 Li Peng 130 Liberal Democratic Party (LDP) 33–4, 45, 145, 146, 153–4 and bureaucracy 32–3 elections: 1998 43–4, 103; 2001 3, 109, 111 Koizumi and reform agenda 106–13

176 Index Liberal Democratic Party (contd) party politics 97–106 passim proposed tax cuts 150 Liberal Party 32, 33, 100, 106 lifetime employment 64, 78, 81, 84 Lincoln, E. 7 line of credit 140–2 liquidity trap 30, 149 Long-Term Credit Bank (LTCB) 37, 50 long-term employment 64, 78, 81, 84 Lunn, S. 153 MacAvoy, P.W. 88 Mahathir Mohammad 127, 130, 131, 138 Mahoney, C. 49 main bank system 18, 62, 64–5, 66–8 Malaysia 10, 117, 127, 136, 137 American criticism of 125–6 AMF 138 managed inflation 30 mandate of heaven 86 market share 76 Marshall, D. 26 Matsumoto Shinsaku 84 McAlinn, G.P. 94 Meiji period 98 Mera, K. 20 mergers banks 53–4 corporate 81, 84 Mexican debt crisis 115, 135, 140 Millard, F. 142 Miller, M. 25 Ministry of Education 131 Ministry of Finance 20–1, 25, 27, 31, 36, 37 criticism of 55–6 inaction in post-bubble recession 32 Ministry of Foreign Affairs 3, 29, 32 Ministry of Health and Welfare 31–2 Mitsubishi 69, 79 Mitsubishi Electric 79, 80 Mitsubishi Research Institute 13 Mitsubishi Tokyo Financial Group 54, 57 Mitsui Trust & Banking Co. 50, 51, 53 Miyajima Hideaki 65, 84

Miyauchi Yoshihiko 92, 93, 95 Miyazawa Initiative 16, 137–8 Miyazawa Kiichi 2, 23, 34, 47, 138 Mizuho Group 54 moral hazard 36 Mori, Prime Minister 4, 98, 101, 107, 115, 145 Morinaga Takuro 53 Murakami Seichiro 139 Murayama Tomiichi 131 Musa, M. 141 mutual shareholding 4, 57, 65–6, 67 Nader, R. 95 Nakamura Shozaburo 121 Nakasone, Prime Minister 150 nationalization of banks 49, 50 Neiss, H. 124 Neuffer, J. 44–5 New Komeito 106 New Liberal Club (NLC) 99 Nikkei share market index 19, 21, 57, 152 Nippon Credit Bank 50 Nissan 69, 80, 81 non-performing loans 5, 20, 35, 39, 59–61 accumulation of new NPLs 56, 59 Obuchi reforms 13, 47–52 overseas lending and 24–5, 27, 40–1 two-year strategy for reducing 60–1, 67–8, 109 NTT 91 Obuchi Keizo 4, 36, 37, 44–5, 107, 115, 144–5 financial reforms 3–4, 5, 13, 46–54, 144, 146 oil crisis 1, 71 Okuda Hiroshi 72–3, 75 Organization of Petroleum Exporting Countries (OPEC) 1 overseas lending 24–8, 41 Ozawa Ichiro 32, 99, 100, 101–2, 111 pacifist constitution 121 party politics 97–106 see also under individual parties

Index 177 Peace Keeping Operations (PKO) law 121 Pempel, T.J. 74, 104, 132 pet stag beetles 11 Petri, P. 126 Philippines 137 Plaza Accord 17 Pokarier, C. 82 Policy Research Council 110 political leadership 144–5 economic mismanagement 33–6 political power 7–8 Porter, M.E. 75–6, 89 postal savings system 109 precautionary line of credit 140–2 price deflation 148 price stability 37–8, 58 prime ministers, tenure of 113 procreation award systems 148 production capacity 18–19, 45–6, 81 profitability 76–7 public sector debt 2, 13, 23, 147 public works programmes 17, 23, 151, 152 punctuated equilibrium 6 quality control circles

64

rationalization see corporate reforms Reagan, R. 92 real estate 27 bank lending 19, 20–1 speculation 11 recapitalization plan 51–2 Reed, J. 69 reform agenda 106–13 regional diplomacy 14–16, 16, 115–43, 145–6 Asian crisis: as foreign policy opportunity 119–25; Japanese aid to crisis countries 125–8 Asian Monetary Fund 128–32; American rejection 132–6; initiatives following American rejection 136–42 regulation of financial sector 41, 54–6 Regulatory Reform Committee (RRC) 94

regulatory reforms 12–14, 16, 78, 87–114 bureaucratic opposition 96–7 Koizumi and reform agenda 106–13 politics in Japan and US 88–93 reforms in Japan 93–6 structural reforms and Japanese party politics 97–106 resistance to reform 13–14, 96–7, 109–10 Resolution and Collection Corporation 109 Resolution Trust Corporation (RTC) ( Japan) 50 Resolution Trust Corporation (RTC) (US) 49 Ripplewood Holdings 50, 60–1 Rix, A. 117 Rogowsky, R. 88 rural–urban divide 102–3 Sakakibara Eisuke 52, 97, 135, 139, 142 Sakura Bank 54 Sanyo Securities 48 Sasaki Takeshi 144 Sat-Cho-Do-Hi clique 98 Sato, K. 75 savings 22, 148 Schoppa, L. 148 Second World War 8, 10 wartime atrocities 14, 115–16, 131, 145–6 seniority-based wages 64, 81–2 shares, cross-holdings of 4, 57, 65–6, 67 Shimada, S. 35 Shimoi, M. 149 Shinsei Bank 50, 57 Shinseito (Renewal Party) 99–100 Shinshinto (New Frontier Party) 100, 102–3 Shinto Sakigake (New Harbinger Party) 99 shopping vouchers, free 149, 150–1 Singapore 25, 26, 127, 136 ‘six plus one’ reforms 42

178 Index Social Democratic Party of Japan (SDPJ) 34, 105 social welfare system 89 Sogo department store 67 Sohyo 105 Sony Corporation 66, 79, 89 Soviet Union 153–4 specialization 63 splinter parties 99–100 stag beetles, pet 11 stagflation 1 stagnation 2, 3–5, 9, 20, 21–4, 144 stock market collapse 57–8 strategy 75–6 structural adjustment IMF structural adjustment programmes 123–5, 133 Japan 5–9 subsidiaries 80, 82 subsidies 81 Suharto government 124 Sumitomo Bank 52, 54 Sumitomo Corporation 80 Sumitomo–Mitsui Banking Corporation 54 surveillance 54–6 Tachi Ryuichiro 120 Takao, K. 28–9 Takemura Masayoshi 99 Takenaka Heizo 114 Takeo Hiranuma 60 Tanaka Makiko 3, 110–11, 112 Tarullo, D. 134 taxation consumption tax 24, 36, 43, 150 reforms 149–50 temporary tax cuts 29–30 technology 73 Thailand 10, 24, 125 Japanese aid 125, 137 Japanese investment in 25 Tobacco and Salt Monopoly Corporation 91 Tokugawa period 98 torii 132 town meetings 108, 112 Toyama Atsuko 110 Toyota Motor Corporation 66, 69, 75

trade 90–1 exports 6–7, 22, 116 friction with US 17, 22, 150 imports 150; captive 77 intra-regional 12, 116–17 liberalization 6, 77 Truman, E. 140 Tsubame 6–7 tulips 11 unemployment 2, 9, 60, 72, 81, 153 labour costs and 78–9 ‘unequal treaties’ 8 United Financial of Japan 54 United Kingdom (UK) 6, 87, 91–2 United Nations Law of the Sea Conference (UNCLOS III) 137 United States (US) 6, 72, 143 APEC 121 Asian crisis 125–6, 128, 131, 134–5 bailout of Chrysler Corporation 37, 81 corporate reforms 69 endorsement of Koizumi 107–8 IMF line of credit 140 Mexican debt crisis 115, 135 regulatory reforms 87, 88, 91–2, 113 rejection of AMF proposal 15, 128, 132–6, 142, 145 savings and loans crisis 26, 49 trade friction with Japan 17, 22, 150 US–Japan relations 110, 132 urban–rural divide 102–3 Uruguay Round 136 Van Wolferen, K. 21, 120 vested interests 94, 95 Vogel, S. 103 wages structure 64, 71, 81–2 wartime atrocities 14, 115–16, 131, 145–6 Weber, M. 96 Wijnholds, O. De B. 141 Wood, C. 26 workforce reductions 79–80, 83 World Bank 123, 128, 129, 133

Index 179 World Economic Forum 73 World Trade Organization (WTO) 73, 95, 135 Yafeh, Y. 65–6, 86 Yamaichi Securities 29, 41, 46, 48 Yamamura, K. 94–5, 114 Yanagisawa Hakuo 48, 56, 69, 98

22,

Yasukuni Shrine 116, 145–6 yen appreciation in 1995 21–2 shock in 1980s 6–7, 71 Yosana Kaoru 31 Zoku giin 109–10