Japanese Economy: Obstacles and Opportunities

Speech by Toshimitsu Motegi,
Minister of State for Financial Services and Administrative Reform

Foreign Correspondents' Club of Japan
August 25, 2008

Introduction

Distinguished Guests, Ladies and Gentlemen

It is my great honor to have this opportunity to make an address at this privileged Club. This is my first English speech since I was appointed to the current job earlier this month. As I will be visiting the United States this Wednesday, I have a great interest in how my address today will be reported in the foreign media… or whether it will be totally ignored.

Today, I would like to speak with a broader perspective than that of the minister in charge of the financial sector and administrative reform. In this address, I would like to share with you what I have been thinking about recently as a member of the House of Representatives.

The title of my address today is "Japanese Economy: Obstacles and Opportunities." Though it is true that the economic and social environment surrounding Japan poses difficult tasks ahead, I believe that an obsession with negative aspects will not produce any solutions. Rather, my view is that Japan's revival will require a "paradigm shift" in which negative factors will be transformed into positive factors. This will be the key message in my speech today.

The Three Challenges for Japan

Among a variety of challenges facing Japan, I identify three challenges. The first is the demographic change arising from Japan's rapidly ageing population with a low birth rate. The second is soaring energy and raw material prices. This could severely harm Japan's natural-resource-scarce economy. The final challenge is slipping global competitiveness and diminishing attractiveness.

First let me start with the issue of the demographic change. In Japan, the speed of increase in the ageing rate, which measures the proportion of the over-65-year-olds within the population, is three times as rapid as that of the United States or European countries. Please look at slide 1. You will find that, in the other developed countries, it took 60-80 years for the ageing rate to rise to 20 percent from 10 percent, whereas it took only 21 years in Japan.

In order to facilitate your understanding of the magnitude of this issue, I would like to share with you the following figure. In Japan, there were only 158 people aged over 100 years old in 1955, when I was born. According to the latest figure, however, more than 32,000 in Japan are over 100 years old. If this figure is broken down into men and women respectively, it is 4,600 men and more than 27,000 women. In addition, Japanese women are ranked as the top in the world in terms of their average life expectancy.

Chouju-Syakai, or a society with long life expectancy itself is not bad. As Japan's society is accompanied by a low birth rate, however, it entails two difficulties. One is a large increase of social security expenditures. If you look at slide 2, you will find the expanding trend of these expenditures in Japan. For instance, the total budget expenditures for public pensions, medical care, and other welfare-related expenses were 3.5 trillion yen in 1970, whereas they amount to 93 trillion yen in the latest year. This is an increase of 30 times. The expenditure for public pensions has risen more than 50-fold as it reached 50 trillion yen as compared to 900 billion yen in 1970. This expansionary pressure on the social security expenditures is the biggest bottleneck of fiscal structure reform in Japan.

Another difficulty to be brought about by the demographic change is a shortage in the labor force. Slide 3 shows that, if the pace of the demographic change continues at the current rate, there would be a shortage of 4.4 million in the labor force in 10 years. In addition, the labor shortage will widen further and is expected to reach the level of 10 million in 2030. This is a serious concern as it could lead to a dramatic shrink of Japan's economic output.

Now I would like to move on to the issue of soaring energy and raw material prices. As you already know, the corporate goods price index recorded a 7.1 percent year-on-year increase in July, the biggest jump since January 1981, which was due to the second oil shock. The important point is that this is not a cyclical trend but rather a structural one.

The world population is now over 6.5 billion and will rise to 9 billion in 30 years. Moreover, the growth of BRICs and other emerging economies will further increase the demand for energy and raw materials. This poses a huge challenge for Japan where energy and raw material resources are scarce.

Next I am looking into the third issue of the Japanese economy: slipping global competitiveness and diminishing attractiveness. Please turn to slide 4. The survey by the International Institute for Management Development shows that Japan's global competitiveness ranked 16th in 2006 but fell down to 24th in 2007. The top ranked is the United States in the two consecutive years. China is up to 15th from 18th, and Germany is up to 16th from 25th. The survey by the World Economic Forum shows a similar picture. The United States is ranked as number one both in global competitiveness and business competitiveness. Germany ranks 5th and 2nd respectively, whereas Japan is 8th and 10th in the respective indices.

I studied at Harvard in the early 80s. It was the time right after Dr. Ezra Vogel wrote the book, "Japan as Number One." At that time, the US economy was experiencing serious distress while Japan was in the spotlight as the rising economic power. If I may share an episode of my time there with you - I was selected from other students as a research assistant for Professor Robert Reich, who later served as Labor Secretary in the first Clinton administration. At first, I thought that it is honor and he had a good eye to select the right person. But the truth was that he just needed an assistant who had a good command of Japanese and thus could conduct a literature survey in Japanese for his research on Japan's industrial policy. I was the only student in the class who passed that criterion. Not only that, I was often asked about Japan's industrial policy and MITI's behavior during my days at Harvard. During those days, the people in the United States learned about Japan's economic and management system with great eagerness. Such a drastic change of perception is well represented in the buzzwords for Japan from time to time, starting from "Japan as No.1" to "Japan Bashing," "Japan Passing", and most recently "JAPAIN."

As compared to those good old days, Japan is undoubtedly facing a series of serious challenges right now as its global competitiveness fell down. Despite these difficulties, however, I believe that the revival of Japan is possible, like the revival of the US economy triggered by the IT revolution after the late 80s. Japan's revival could be achieved by a "paradigm shift" by which obstacles will be transformed into opportunities.

Tackling the Demographic Change

~Fixing Labor Shortage and Controlling Medical Benefit Expenditure~

Now I would like to talk about how to tackle the first obstacle, the demographic change in Japan, in more detail.

As stated earlier, Japan is ranked as number one in terms of life expectancy. When it comes to Japanese women, the average life expectancy is an astonishing 86 years. More importantly, Japan also ranks at the top in terms of healthy life expectancy, which is a measure of how long a person can live in a healthy condition. Please look at slide 5. You will find that the healthy life expectancy of Japanese men is 72 years and that of Japanese women is nearly 78 years, both being ranked as the world's number one.

Given that the retirement age is currently around 60-65 years old in Japan, it implies that there is a large number of the population who can work 5-10 years more after their retirement. In light of this prospect, I suppose that utilizing these "silver" labor forces and enabling active participation of lifetime in the society will have a huge potential, because there will be a shortage of 4.4 million in the workforce in 10 years, as you saw in slide 3.

In fact, making use of this "silver" labor force has another benefit. As I mentioned earlier a difficulty posed by the demographic change is the expansion of social security expenditures. There is a reverse correlation between working in health and spending in medical expenses. Please look at slide 6. It shows 47 prefectures in Japan in terms of medical expenses for the elderly per capita in the horizontal axis and labor utilization of the elderly in the vertical axis. It reveals that Fukuoka spends the most and Nagano spends the least on medical expenses, whereas the labor utilization rate of the elderly is the highest in Nagano and the lowest in Fukuoka. It vividly shows that exercising physically through working for a purpose would lead to maintaining the health of the elderly. Thus, the policy outcome of the utilization of "silver" labor forces would not only increase labor supply but also save social security expenditures.

Japan's Attractiveness and Underutilized Money: Two Examples

~Utilizing Household Financial Assets and Overseas Retained Profits~

Indeed, Japan's fiscal situation is severe in view of the ever-rising expansionary pressure of social security expenditures. The outstanding total debt of the national and local governments amounted to 773 trillion yen at the end of fiscal year 2007. Despite such a grim fiscal picture, however, I believe that there is still underutilized money in the Japanese economy.

In this regard, I would like to make two cases. The first one is related to the attractiveness of the Japanese financial market. In slide 7, you will find that the Japanese market is rated very high, in terms of the abundance of household financial assets, relative to New York and London or Hong Kong and Singapore. On the other hand, the Japanese market is rated poorly in terms of strict regulations, high firewalls, and insufficiency of high-end human resources. In fact, these are the issues targeted by the "Better Market Initiative" announced last December. The pillars of this initiative include 1) Establishment of the vibrant and creditable market, 2) Creation of the business environment that vitalizes the financial services industry, 3) Improving the regulatory environment through better regulation, and 4) Enhancing the broader environment surrounding the financial markets. Thus, the shortcomings of the Japanese market are being addressed.

Although a huge stock of household financial assets corresponding to 1500 trillion yen exists in Japan, it has two features that could undermine the potentials of the Japanese economy. One feature is distribution of the financial asset holdings across generations. Please look at slide 8. It clearly shows the generation that holds most of the financial assets is the over-60s. In 1970, the generation of the 30s and 40s used to hold more than half of the financial assets as compared to 18 percent held by the over-60s. Now the ratio is completely reversed. More than 60 percent is held by the over-60s, whereas only 20 percent by the 30s and 40s.

Another feature is the composition of the product type of financial asset holdings. Slide 9 shows uneven holdings between savings and investments. In Japan, more than half of the financial assets is held in cash and deposits whereas less than 10 percent as investments in equities or investment trusts. In contrast, in the United States or in Germany, the proportion of cash and deposits is much lower than that in Japan and more than 20 percent is held in the form of equity investments.

Therefore, changing these features will be a major policy challenge in the period ahead. I think that the former one, which is related to distribution among generations, needs to be addressed by reforming taxation on donation among family members before inheritance. As regards the composition of financial products which calls for "from savings to investment" policies, a review of taxation on securities investment will be a crucial point of discussion for the fiscal year 2009 tax reform, which will take place toward the end of this year.

Please look at slide 10. It summarizes the taxation scheme on securities investment envisaged in the fiscal year 2008 tax reform. According to this scheme, the reduced rate of 10 percent over the capital gains and dividends on listed stocks will be terminated and replaced by the standard rate of 20 percent at the end of 2008, except that a reduced rate of 10 percent will be applied to capital gains up to 5 million yen and dividends up to 1 million yen until the end of 2010.

I believe, however, that a review and further enhancement of this scheme is essential for accelerating the momentum for the trend "from savings to investment." In this respect, two measures are important. One is to increase the number of small investors through special tax treatment for securities investments up to a certain amount. Another is to ensure a stable life after retirement through special tax treatment for dividends and capital gains enjoyed by the elderly. I will finalize our agency's tax reform requests by the end of this month and will take active part in developing the 2009 tax reform package.

The next topic relates to the second example of the underutilized money in Japanese economy. Slide 11 shows that around 30 percent of business activities by Japanese companies are performed outside Japan. As overseas activities increase, profits from such operations increased 4 times between 2001 and 2006 and over 30 percent of profits come from overseas activities.

Slide 12 makes clear that profits from those operations remain overseas and are not sent back to Japan, partly because of the Japanese tax system. As approximately 2-3 trillion yen of retained earnings have been accumulated in recent years, total surplus retained in Japanese overseas companies exceeds 17 trillion yen.

Please look at slide13. Among many factors affecting this trend, one of the main drivers behind such a huge retained surplus is Japan's international taxation system. As you know, there are broadly two types of international tax systems. One is called a "foreign source income exemption system," adopted by 21 OECD countries including France, Germany and Canada, in which corporate taxation is restricted to income sourced from the domestic territory. On the other hand, Japan, the United States, the United Kingdom and the other 6 OECD countries adopt a worldwide income tax system in which corporate taxation is imposed upon any income arising anywhere in the world at the rate set by its own tax law. Thus, a Japanese company may need to pay for tax rate differences between Japan and overseas. My judgment is that such a tax system has prevented sending profits back to parent companies in Japan and thus requires a review, including adoption of a foreign source income exemption system. It is necessary to create a virtuous cycle through which overseas profits will be sent back and utilized for the purpose of research and developments and other productive use in Japan. This will also be a hot topic for the fiscal year 2009 tax reform.

Positive or Negative? Impact of Soaring Energy and Raw Material Prices and New Perspective for Enhancing Global Competitiveness

~Realizing Japan's Potential in Efficiency-Related Technology~

Now I would like to turn to the next item and will touch upon the issue of soaring energy and raw material prices and the decline of Japan's global competitiveness altogether. As I stated at the beginning, the price hike of energy and raw materials could hit natural-resource-scarce Japan more severely than other countries. On the other hand, Japan also has strengths in relation to such soaring prices.

In fact, through overcoming the hardship caused by the two oil shocks, the Japanese economy has achieved the world's top level of energy efficiency as well as resource-utilization efficiency. Please look at slide 14. It is the comparison of energy efficiency among selected countries. It is measured by energy input per unit of GDP output. It reveals that Japan's economic system is twice as energy efficient as the United States and European countries, more than 8 times in comparison with China, and even 17 times as compared to Russia.

In terms of resource-utilization efficiency, slide 15 also points to a similar tendency. It is measured by natural resource input per unit of GDP output. Japan is 2-3 times as efficient as the United States and European countries. Moreover, it also reveals that Japan improved its efficiency at the highest rate during 1997-2000.

Japan's economic growth has been maintained in such a manner that the top industries of the times lead economic expansion nationwide. Right after World War II ended, it was the textile industry. The ship-building and steel industries took over later in the 60s. In the 80s, the electronics and automobile industries emerged and have continued to play a leading role until now, without being overtaken by any other new industry. Japan's automobile industry still retains global competitiveness. On the other hand, Japan's electronics and ICT industries with vertical integration, experienced hardships as a result of a challenge from the US and Europe's modular-type companies with horizontal specialization.

In this regard, I believe that important lessons for Japanese companies can be drawn from the revival of US enterprises through the IT revolution in the 90s. What I mean by this is that the next strategy for enhancing Japan's global competitiveness will not be to chase another leading industry. Rather, it will be the industry-wide application of Japan's energy-and-resource efficient technologies that can improve competitiveness of Japan's industry across the board.

Although the US economy experienced difficulties in the 80s, the commission chaired by Mr. John Young, CEO of Hewlett-Packard at that time, produced the so-called "Young Report" for improving industrial competitiveness. The main message of the report was an emphasis on "core competence" or "selection and focus" in the business model, together with a measure to foster the venture business, including the IT business. Effectively, it was, as far as I understand, to revive the US economy through focus on strengths and the IT revolution. The implication was not confined to strengthening the IT industry, but rather had broader impacts extending to the retail and financial industries in terms of IT utilization. If I may add, the managerial capabilities of the US enterprises also improved remarkably as a consequence of IT application. Although, Japan's management system was admired in the United States until then, information technology has made it possible to connect top management and field operations very closely and flattened the organizational structure, thereby improving the managerial capabilities in the US corporations.

I suppose that the same logic holds for Japan's efficiency-related technologies in the 21st century. Technological innovations ranging from energy-saving semi-conductors, batteries, electric vehicles, to solar power generation systems could be applied to Japanese industries across the board, so that the global competitiveness of Japan will be raised fundamentally to this end. This is one of the Fukuda cabinet's initiatives to realize a low-carbon society in Japan. Such a scenario is not only possible but also necessary way for Japan's future prosperity.

Lastly, I would like to draw your attention to slide 16. It ranks top 20 countries in terms of GDP per capita. The latest figure shows that Japan has fallen down to 20th in the ranking. I believe, however, that there is no need to be over-reactive to this data since it is largely caused by the exchange rates. This is why the European countries, including Luxembourg, Switzerland, and Iceland advance in the ranking, as the euro has appreciated. In addition, the recent rise in oil prices has pushed up the rankings of the oil-producing countries, such as Norway and Qatar.

What requires close attention are the characteristics of the countries in the high rankings. If you look at the top 10, you will find that they are the countries with populations less than 10 million, except the United States. These small countries have their own particular strengths, in finance in the case of Switzerland and Luxembourg, in natural resources in the case of Norway and Qatar, and in IT in the case of Ireland and Finland, thereby achieving the highest level of global competitiveness and GDP per capita.

Based upon my experience as Minister of State for Information Technologies, I warn that Japan's ICT industries might follow the fate of the Galapagos where the too-unique eco-system evolved in the completely isolated environment. Since Japan has a reasonably large scale domestic market with a population of more than 100 million, Japanese companies tend to be less ambitious regarding developing their business operations into global markets. On the other hand, as in the case of Finland whose population is only 5 million and insufficient to secure the survival of the domestic enterprises, they look beyond the national borders and eventually evolve into a global company such as Nokia.

In this light, it occurs to me that a desirable direction would be developing industrial policies for each region of Japan, such as Hokkaido, Tohoku, and Kyushu respectively, with populations of around 10 million, rather than doing so in nationwide of 120 million. I also suppose that this argument could lead to the discussion on the fundamental restructuring of local government in Japan, that is, the introduction of the "Do-Shu" system. By this change, existing 47 prefectures will be merged to form around 10 provinces called "Do-Shu" which will act like states in the United States.

In connection to this, the national government also needs to reform itself. As the minister also in charge of administrative and civil service reform, I will implement a 5-year reform program under the framework of the Civil Service Reform Act enacted this June. The urgent agenda is to establish the "Cabinet Personnel Office," next fiscal year, which supervises personnel affairs of all executive officers in the government. These measures will be crucial to eliminate inefficient sectionalism among national government agencies. Also, the Reform Act will ensure the provision of opportunities for "revolving doors." Through these opportunities, rotations between the public sector and the private sector would be facilitated in order to increase productivity and efficiency of the public sector. I will promote such flexibility through the "Center for Public and Private Personnel Exchanges" which will be established toward the end of this year to eliminate harmful elements in re-employment of national government officials, notorious "Ama-Kudari."

By these measures, it is envisaged that Japan's civil servants will perform their duties truly on behalf of the people's interest without being constrained by ministerial concerns and precedents, and eventually the Japan's administration will become more responsive to social and economic changes. In addition to the reform of the central government itself, I will carry out a comprehensive review on government corporations and special accounts of the national budget, namely "Doppou" and "Tokkai."

After these national level reforms, I believe, further change in Japan's governmental structure should be pursued under the concept of the "Do-Shu" system which I mentioned earlier. Under the system, the "Do-Shu" will be mandated for the welfare system, infrastructure building and industrial policies, whereas cities or towns will be responsible for the day-to-day operations of welfare services.

Closing Remarks

Today, I focused only on selected topics because of the time constraints. I admit that the demographic change and soaring energy and raw material prices pose disadvantages to Japan. As I explained so far, however, the revival of Japan rests upon a "paradigm shift" to transform such obstacles into opportunities. This is the key message in my speech today.

As I mentioned earlier, the United States, which lagged behind Japan in the 80s, succeeded in reviving its economy and its corporate system through the IT revolution. A "paradigm shift" of a similar sort is of critical importance to Japan's economy of today. Although the media tends to pay intense attention to the gloomy part of Japan except achievements in the Beijing-Olympics, my view is that it is vital to look at the bright side and to actively seek new potentials. As Winston Churchill once said, "A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty." The priority of the Fukuda cabinet is to solve the pension problem and to eliminate administrative inefficiency so as to recover a sense of security and confidence among the Japanese people. In that process, I, as the Minister of State for Financial Services and Administrative Reform, am determined to put forward a clear vision of my own for the hopeful future of Japan.

Thank you.