The Construction of a New Japan-U.S. Economic Relationship and
New Stirrings in the Japanese Economy

Osamu Nariai
Professor, Reitaku University
April 1999

A decade of change

The time has come to think about rebuilding the role of the Japan-U.S. relationship to match the major changes that have taken place in the world economy. We also need to examine whether structural reform in keeping with these changes is in fact progressing in Japan.
　Of the changes that have occurred in the world economy during the 1990s following the end of the cold war, it is possible to cite three that are especially major. First is the rapid progress of globalization, whereby factors of production other than goods, such as capital, move on a large scale unconfined by national boundaries. In the area of international trade as well, capital movements and service transactions have increased dramatically alongside conventional merchandise trade. Second, the launching of the euro at the beginning of 1999 marks a shift from the state to the region as the central concept, or in other words, a shift from nationalism to regionalism in thinking about economic affairs. Third, the information revolution has proceeded apace, providing the necessary technology for the actual functioning of a global economy. Statistical evidence of these changes is to be seen, for example, in the growth rate of trade, which is running at a faster pace than the world's economic growth rate, and also in the volume of cross-border financial transactions, such as buying and selling of foreign equities, the daily total of which is now a tremendous $1.5 trillion--an amount equivalent to one-third of Japan's annual gross domestic product.
　The performances of the Japanese and U.S. economies against the backdrop of these changes over the past decade are a study in contrasts. The United States has been enjoying steady growth with low unemployment and low inflation ever since 1992. The principal power behind this has been information-related investment. But in Japan some have even been pronouncing the 1990s a "lost decade" for the economy. Factors like the delay in dealing with the non-performing loans left over from the collapsed bubble economy of the late 1980s, failure to keep up with the information revolution, loss of corporate and consumer confidence, and inept government policy have resulted in an average annual growth rate of only 1.7 % from 1991 through 1997, compared to the United States' 2.3 %.
　Why has Japan become stuck in this prolonged recession? In the 1970s, the economy as a whole and individual corporations as well were quick to cope with the posed challenges, for example, by the rise of the yen following the switch from fixed to floating exchange rates and by the oil shocks that seemed to threaten the nation's economic viability. What has caused the adjustment process to drag on so long this time? The difference is probably a reflection of the provenance of the difficulties. When challenged by external shocks, the Japanese economic system was able to respond speedily and skillfully. But neither the government nor other economic actors have had a ready response for the challenges of the entirely new type of downturn, a recession led by a credit crunch, that has resulted from the collapse of the internally generated bubble economy. Japan's inability to stage a comeback has had a negative impact on the rest of the world, especially on the Asian economies in the wake of the currency and financial crises that have hit them starting in 1997. And within Japan it has pushed the unemployment rate up to 4.6 % (as of February 1999), higher than the U.S. figure. The cost of the recession has been high, both domestically and internationally, but if this provides the impetus for the needed structural reform of the Japanese economy, it can serve as the basis for sustained economic development in Japan and the rest of the world over the medium to long term.

Prospects for recovery and progress on the reform front

The spread of the awareness that the long recession is financial in nature, that it arises from the huge volume of bad loans being carried by banks and other financial institutions, has accelerated the Japanese government's policy response. The Bank of Japan pushed down the interest rate on the call market, which is the short-term market for interbank lending; in March the rate effectively to zero. In addition, the government injected a massive 7.45 trillion yen of public funds into banks to improve their capital adequacy. The banks receiving these injections of capital were given strict conditions: They were expected to finish getting rid of their leftover bad loans by the end of March, and they were told to submit sweeping restructuring plans aimed at improving their operational strength. Though it was slow to act, the government has finally undertaken major surgery on the banking system, including temporary nationalization of institutions incapable of staging an autonomous recovery. Banks have received what is probably their last chance to free themselves from the spell of the convoy system of regulation and transform themselves into efficient institutions operating on competitive principles.
　Reflecting these moves by the government, the money multiplier (the measure of the extent to which an increase in the monetary base causes an even greater increase in the volume of credit), which had fallen sharply since 1992, has started rising again since October 1998. This is evidence that people's confidence in financial institutions has recovered somewhat. In the period to come, we are likely to see an acceleration of moves to consolidate or close weaker institutions. Though we are not out of the woods yet, the reform process offers the hope that Japan's financial system will get back on its feet and start to operate more efficiently, allowing it to contribute to the global economy.
　The moves toward reform in the Japanese economy are not limited to the financial sector, where it has become possible for institutions to cross the traditional dividing lines between industries; significant progress has also been made in fields like communications, civil aviation, commerce, and temporary staffing. Existing companies have been pushed to lower their prices and improve their services. As estimated by the Economic Planning Agency, the relaxation of controls on business, particularly as relating to the provision of telecommunications services and the opening of large-scale retail outlets, and other aspects of business has produced economic benefits in excess of 8 trillion yen over a seven-year period. In order for further such benefits to be achieved, it will be necessary to smooth the way for new entrants by liberalizing use of existing physical infrastructure and improving conditions for fund raising.

A new Japan-U.S. economic relationship

Given the major changes that have taken place in the economies of Japan and other countries, it is time now to review and update the economic relationship between Japan and the United States and the respective roles of the two countries. It is anachronistic to attempt to measure economic affairs, whether globally or bilaterally, by looking primarily at merchandise trade and other forms of movement of goods. In terms of the bilateral merchandise trade balance between the two countries, the United States's deficit with Japan is continuing to rise because of the expanding demand being generated by its own booming economy. The merchandise trade deficit for 1998 was a record $ 231.1 billion, but the share of the deficit attributable to trade with Japan was 27.7 % for the year and 23.7 % for January 1999, less than half the share of 65.1 % recorded in 1991. Meanwhile, the share attributable to China has been rising slowly by steadily; the figure reached 24.8 % in January this year, making that country the largest single contributor to the deficit.
　In the field of direct investment, as of 1997 investment in the United States accounted for 38 % of Japan's total direct investment overseas, the largest share by target country. Going in the other direction, U.S. direct investment in Japan represents 51 % of the total of inbound direct investment, making the United States by far the country's biggest foreign investor. As Japan moves forward with its Big Bang program of financial deregulation, American financial institutions have been aggressively moving into the Japanese market. When Yamaichi Securities, formerly one of Japan's top four brokerages, went out of business at the end of 1997, Merrill Lynch hired approximately 2,000 of its former employees. This is one indication of how human resources are being employed productively through movement between U.S. and Japanese corporations. Meanwhile, the lowering of corporate tax rates and decline in the price of land are making Japan a more attractive target for American investors. American purchases of Japanese stocks are also sharply on the rise. Going in the other direction, Japanese investors own 7.9% of the United States' Treasury notes, which is a sizeable share and about the same as that held by British investors.
　The relationship between Japan and the United States is thus growing ever closer in areas other than merchandise trade. And this increased closeness not only is essential for the two countries' macroeconomic stability but will also contribute to an Asian economic recovery. Even though Japan is running a huge deficit in its national budget--on the order of 7.8 % of GDP in fiscal 1999--it has announced plans for some $ 80 billion in assistance to other Asian countries, including $ 30 billion under the New Miyazawa Initiative, which is steadily being implemented.
　The end of the long financial recession is finally in sight. In order to ensure a solid recovery, it will be necessary to banish the specter of moral hazard hanging over the financial sector. And moves are being made in that direction. We must keep up the drive to build a Japan that can hold its own in global competition.