Japan's Grand Reforms
From an Economic Social and Political Perspective

Yuichi Shionoya, Ph.D.
(Transcript of a speech delivered on May 12, 1997, at Asia Foundation and Public Policy Institute of California in San Francisco, CA.)

It is my great pleasure to be here to talk about reforms in Japan. My government has asked me to speak to you specifically about reform of the welfare state in present day Japan. Indeed, restructuring the welfare state is a common challenge to the developed countries today. I will not burden you with a detailed analysis of social policies for pensions, health care, long-term care for the elderly, and related issues. Instead, I will try, in the short time we have, to present the "big picture" of what is happening to Japanese society. These are my private observations and not the official views of the Japanese government.

Before I begin, I am reminded of an old formula that Sumner Slichter, professor of economics at Harvard, propounded on how to make an audience listen. He died a few years before I studied at Harvard 35 years ago. I heard this story later from a friend of mine.

Slichter proposed a 4-point formula:
First, tell them something they know; it gives you credibility.
Second, tell them something they don't know; it piques their interest.
Third, tell them something they like; it sets them up.
And fourth, tell them something they don't like; it gives them pause for thought.

This formula sound strange. Whether or not the audience understands a speech, the speaker may win either credibility or interest. Whether or not the audience likes the topic, the speaker may stimulate either pleasure or thought. In other words, "anything goes." As I interpret it, Slichter's optimistic formula implicitly presupposes an important assumption: that audiences are so refined and appreciative that they react to a speech only with the feelings of acceptance, interest, pleasure, and thought, not with the feelings that the speaker is boring, tedious, and tiresome. In your case, I am confident that this assumption is valid.

If I am asked what characterizes Japanese society as a whole today, I can definitely say that it is the six grand reforms that are proposed in the political agenda and supported overwhelmingly by public opinion. People are watching to see what will be accomplished. The six reforms are budget reform, economic reform, financial reform, welfare reform, educational reform, and administrative reform. Prime Minister Hashimoto has publicly stated that achieving these reforms is his highest priority.

These reforms all relate to various aspects of government activity. They aim to review the relationship between government and the marketplace and to overhaul the structure of government. These reforms are also intended to reduce the work of government through deregulation, decentralization, privatization, and cuts in government spending as well as to reorganize the surviving government functions into a smaller number of ministries. Administrative reform, one of the six reforms, is pivotal in that it pulls together structurally and facilitates the outcomes of other reforms. The Council on the Administrative Reform has been in charge of this work since last November. It includes 13 representatives from the private sector, with the Prime Minister himself as chair. I am also a member of this council. In addition, I chair the Council on Health Insurance and am working to reform our welfare program.

Why are these large-scale reforms required in Japan today? The reasons are different for different reasons. But, generally speaking, restructuring the social system, including the government, is needed to help revitalize society in response to fast-changing circumstances. To revitalize the society and regain its dynamism, it is necessary to reduce redundant government intervention and to place greater emphasis on a freer play of market forces. In the face of changes in the basic conditions, Japan's institutions and conventions that have been designed principally for industrial development and catching up to the Western countries should be made more flexible.

In Japan, five factors are generally perceived as major changes in the underlying circumstances:
First, economic maturity or decline in economic growth.
Second, growing budget deficits.
Third, an aging population and declining fertility.
Fourth, economic globalization, including the catching-up of Asian countries.
Fifth, revolution in information and communication technology.
These factors represent major challenges to Japan. It is argued that under these circumstances, the reform of government institutions is badly needed, and that without reform Japan will face a serious crisis. The argument for reforms runs as follows:
First, the regulations and subsidies for sheltered industries have fueled the high-cost structure of the economy as a whole. This, in turn, weakens the nation's competitiveness internationally and hinders the improvement of its living standards.
Second, rigidity and inefficiency in government spending swell the budget.
Third, intervention of the government prevents free market activities.
Fourth, frequent scandals within the bureaucracy have diminished the government's credibility with the Japanese people. The growing public distrust of elite bureaucrats is a driving force toward reform on the citizen's level.

Thus the government, under the leadership of Prime Minister Hashimoto, has begun a serious effort to streamline the swollen fiscal and administrative branches of government and to liberalize the over regulated economy. The Prime Minister has directed that plan for reform be designed by the end of November, and that reforms be in place and start on January 1, 2001. A preliminary report was released two weeks ago. The coming six months will be an extremely tense period in Japan's political arena.

I have briefly described the specific reforms mandated, the underlying conditions, and the reasons why the reforms are needed. These could apply generally to a number of developed countries. However, the practical problems involved in the reform of government institutions and policies are rooted in the unique environment of a specific country. Thus, the practical implications of Japan's reforms can be comprehended only against Japan's particular economic, social, and political environment. These perspectives will suggest how the reforms can succeed.

In discussing the economic, social, and political perspectives, I will identify within each perspective some givens, choices, and ways out (as summarized in the handout).

How do most Americans view Japan? Typically, they have an economic image--that in the 1970s and 1980s Japanese auto exports invaded the United States and threatened to destroy Detroit. In Japan, we saw TV footage of fired American workers knocking Japanese cars to pieces with hammers. "Japan-bashing" became popular in the United States during this period.

For 20 years after World War II, through the oil crises in the 1970's, the Japanese Gross Domestic Products in real terms increased at 10% annually, and this was called a global miracle. During the oil crises, the Japanese economy succeeded in restructuring business in order to save energy, and the growth rate of the economy was maintained at 5%. Japanese products such as automobiles and electronics became competitive internationally.

The success story of the Japanese economy is a story with which Americans are familiar, but they are not fond of it. Judged by points one and four of Professor Slichter's formula, I must now be credible and have won your attention.

Owing to their success over two decades, the Japanese became convinced of the superiority of Japanese management, which is different from that of Western countries in no small way. A book entitled Japan as Number One by Professor Ezra Vogel was enormously influential in formulating such a conviction among the Japanese. For a long time before then, they had considered Japanese systems like lifetime employment, and wages based on seniority as prefetches and something to be overcome. At first, they were puzzled by the admiration from abroad for their systems. Economists of developed as well as developing countries positively received industrial planning, intervention, and protection by the Japanese government in terms of a new concept, "industrial policy." As a result, it cannot be denied that the Japanese became arrogant for a time, based on their performance as an economic superpower.

However, the criticism grew stronger abroad that the Japanese economic system--sometimes called Japan, Inc.--was quite unfair in light of the rules of a free market. In the midst of globalization, the Japanese barriers to entry, business affiliation, indigenous custom, and so on hampered competition from abroad. A major issue in diplomatic negotiations between Japan and other developed countries has long been the demand that Japan open its market and adopt the standard rules. And the negotiations still continue.

In the latter half of the 1980s, Japan failed in the management of its macroeconomic policy. The nation was assaulted with heavy inflation, in which people were absorbed in stock and land speculation. According to the mechanism of business cycles, the higher the peak, the deeper the trough. From 1992 to 1995 the growth rate of the economy remained nil. As a result, the average citizen lost confidence in the economy and became pessimistic about the future.

In contrast, the American economy seems to have regained its competitiveness in the 1990s. Information and communication industry is now a leading industry in the United States. In the present decade, the United States flourishes while Japan flounders.

The Prime Minister is trying to curtail next year's budget and, for fiscal balance, has set a target that the budget deficit as a percentage of GDP should be less that 3% by the year 2003. Public work, official development assistance, agricultural subsidies, social security, education, and defense are all subject to budget reduction. Based on a blueprint for reduced spending in the 13 core areas of the budget, the government is expected to draft the Fiscal Reform Law, which is to be enacted this fall.

Of course, this is not an easy job. The Prime Minister must shepherd reforms through the political and bureaucratic process, which so often in the past has blocked serious reform. For example, as it happened in the compilation of this year's budget, hard-nosed conservative lawmakers vigorously pushed special interests for constructing new lines of high-speed trains in remote rural areas and for paying subsidies and funding public works projects. Ministries--in collaboration with Diet members--are also prepared to firmly resist fiscal reform in order to keep what you call their "pork barrel" projects.

Nevertheless, the so-called iron triangle of politicians, bureaucrats, and business leaders seems to be changing slightly. Due to their frustration at being beaten in international competition, business leaders have demanded reform and deregulation. They have a strong interest in large-scale reform and support the program of Prime Minister Hashimoto. Indeed, reforms will be undertaken at the initiative of business, a partner in the triangle. The most prominent leaders of the business community are members of the Administrative Reform Council.

Not all sectors of the Japanese economy are in difficulty, however. We see the emergence of a dual economy. Top multinationals are developing in international markets and benefit from a weak yen. By business-led reforms, I mean that the leading international industries are urging the domestic industries (finance, construction, transportation, retailing, agriculture) to transform themselves so that the economic fetters can be lifted from the nation.

The Japanese multinationals are no longer members of the iron triangle. They are no longer a part of Japan, Inc. These multinationals are shifting production overseas faster than ever before. Japanese companies manufacture more overseas than they export from home. Those industries remaining in the triangle are sheltered domestic industries with low productivity and high costs. This situation has resulted from the forces of globalization far more powerful than Japan, Inc., which is now a castoff skin of giant corporations.

I believe that the present pessimism about the future of the Japanese economy is excessive. The recent depression is a cyclical phenomenon, not a symptom of long-term stagnation. In fact, in 1995 the growth rate of the real GDP was 2.4% and the economy is now in the process of recovery. The 1990s represent an upward phase of the long-swing that is characterized by the revolution in information and communication technology. In my view, a series of reforms will be required to sustain and accelerate growth.

The most prominent factor in the social context is a demographic one: the aging population. This is a common trend in all industrial countries, but the situation is extreme in Japan. In February, my institute published population projections up to the year 2050. We have found that:
*The life expectancy in Japan is the longest in the world. In 1995, average life expectancy at birth was 76 years for males and 82 years for females.
*The proportion of the population 65 years and over is currently 14% but will increase to 27.4% in 2025, the highest percentage in the world. Moreover, the speed of aging is also the highest.
*The total fertility rate has been consistently declining. With a current rate of 1.42, Japan--together with Germany and Italy--has the lowest fertility rate in the world.
*The total Japanese population will begin to decrease from the year 2007. The working population (aged 15 to 64) had already begun to shrink from 1995.
*And finally, the ratio of the working population to the elderly was 10.8 in 1965, which means that 30 years ago, 11 employed persons supported one elderly person. By contrast, the ratio in 1995 was 4.8 Thirty years from now, in the year 2025, the ratio will be 2.2. In other words, the rate of dependency is increasing rapidly.
Acceleration of the aging population is caused by longevity and declining fertility. The major reasons for declining fertility relate to changes in the behavior of women:
*the extent of their schooling,
*their increasing participation in the work force,
*their rising age of marriage,
*and the increasing proportion of unmarried women.
The gender revolution will continue for some time.

The direct impact of aging on economic growth is uncertain, but the aging population no doubt imposes a heavy fiscal burden on the welfare state. Japan's welfare state provides universal coverage by social insurance for pensions and health care. Although long-term care for elderly people who are frail is provided under the present Japanese health care system, a new, separate social insurance scheme for long-term care--similar to the one in Germany--will be introduced.

Because the Japanese welfare system was extensively expanded during the postwar period of rapid economic growth, it has provided a very generous level of welfare services in an economically inefficient way. Nevertheless, the relative amount of public welfare spending in Japan is not high by an international standard. A comparison of welfare spending by developed countries as a percentage of national income shows that, in order of magnitude, the percentages are 52% for Sweden, 35% for France, 31% for Germany, 26% for the United Kingdom, 19% for the United States, and 16% for Japan. But, in view of the increasing aging population, an increased burden of welfare spending in the near future is inevitable; this percentage is projected to be 30-35% in the year 2025. This poses a choice between raising tax and reducing benefits.

In Japan, the government uses the "rate of national burden" to indicate the relative size of government activity; that is, the sum of taxes, social insurance contributions, and budget deficit as a proportion of the national income. The rate is currently 45%, and the government has set an upper limit of 50% to this ratio in 2025. The target of 50% implies that, although the burden of welfare spending must increase as aging proceeds, Japan will avoid approaching the model of the welfare state in Sweden, where the ratio already exceeds 70%.

Let me discuss briefly the specific welfare reforms we envision. In health care, we seek three changes:
First, drug pricing should include the use of market prices, reference prices, and generic prices.
Second, instead of the current fee-for-service system, a global budget system will be introduced.
Third, the co-payment of aged patients should be raised from a fixed amount to fixed percentage.
For pensions, the followings are generally proposed:
First, increase the payroll tax.
Second, cut benefits.
Third, increase pension age.
Fourth, provide the basic pension by the public system, and entrust earnings-related pensions to private insurance.
In my view, social welfare reform should embody these principles:
*Social security is "supplementary" to the individual's performance in markets.
*Use of public benefits as a safety net is "restrictive."
*And assignment of beneficiaries is "selective," because benefits go only to those in risk. Although social security so far has favored the aged, it is now clear that the elderly are not the only group that needs protection. More resource--care and education--should be allocated to children.

As a strategy for the aged, our social policy must be concerned with how to establish a social system for productive aging, one that involves a paradigm shift in the conceptions of work, life, retirement, voluntarism, pensions, education, training, and so on. Based on the goal of productive aging, our overall restructuring of welfare programs should emphasize improved design rather than cost containment.

Finally, let me deal with the political perspective of the reforms. This aspect of Japanese society is little known in the United States. Although Japan in an economic superpower, its political leaders are nameless around the world. According to the Slichter formula, because you are not familiar with this subject, it should interest you.

Since 1993, politics in Japan has been unstable and fluid. For 40 years after the war, the political map invariably reflected the confrontation between the Liberal Democratic Party--the LDP, which enjoyed an overwhelming majority in the Diet--and the other political parties. The largest opposition party was always the Socialist Party--the SP--on the left.

In 1993, the LDP split into factions, and a reformist group joined with all opposition parties except the Communist Party to form an anti-LDP alliance that succeeded in seizing power. This ended the long-standing monopoly of power by the LDP. Expectations were high for the new Prime Minister Hosokawa as a reformer at home and abroad, but he resigned from office after eight months due to his inexperience and inadequate management of the government.

A newly nominated Prime Minister was from the reformist group of the former LDP. Within the anti-LDP alliance, the Socialists quite naturally did not agree on policy with other parties. When the other parties tried to work in closer cooperation with each other to strengthen their base of power to the exclusion of the Socialist Party, the SP quit the alliance in protest. Consequently, the former anti-LDP was divided into the Socialist Party and the non-Socialist Party. The non-SP group still in power lost a majority in the Diet and collapsed after a majority vote of non-confidence in the government after only two months.

Then the Liberal Democratic Party, as an opposition party, performed a remarkable feat--it allied with the Socialist Party and returned to power. In terms of representation in the Diet, the LDP was the largest party and the Socialist Party was the next largest, but the LDP gave the post of Prime Minister to the Socialist Party. Thus a curious bipartisan coalition government started under a socialist Prime Minister. A big change occurred within the Socialist party when it was forced to renounce various ideological positions, such as its objection to the U.S.-Japan Security Treaty and the Self-Defense Forces.

This government lasted a year and a half, and it merited praise for facilitating compromise among the various political parties. During this period the parties regrouped; the anti-LDP alliance without the Socialist Party was united as the New Frontier Party--or the NFP. The Socialist Party split into the Democratic Party and the Social Democratic Party--the SDP. The SDP, which has kept the legacy of the old leftist ideology, lost many seats in the Diet in the election last November.

At its start the ruling Hashimoto government was based on the LDP alone, but it has been supported by the Social Democratic Party and one very minor party. However, as indicated by the objection of the SDP to recent legislation enabling U.S. forces to continue using land in Okinawa after their leases expire, the SDP has sometimes remained at a distance from the Liberal Democratic Party. Therefore, the LDP has to seek support elsewhere.

New Frontier Party--with 141 members in the Diet--is located at the most conservative side of the political spectrum, and the Democratic Party--the next largest opposition with 52 members--is on the liberal side. The LDP with 244 members--is located between the two. The left wing consists of he Communist Party--with 26 members--and the Social Democratic Party--with 15 members. After obtaining support on the Okinawa leases from both sides, the LDP is expected to approach the New Frontier and Democratic Parties on other issues. But within the LDP there is disagreement about which party it should join hands with--the NFP or the Democratic Party. Within the New Frontier Party there is also a conflict about forming an alliance with the LDP. Cooperation will depend on policy issues.

Realignment of the political parties is still to be accomplished. Therefore, the political map remains in flux. You thought U.S. politics were complicated. However, it is possible to envision a nonpartisan approach to policy issues among the New Frontier Party, the LDP, and the Democratic Party. In this context, it is noteworthy that all parties agree on the need for reform. But on the substance of the reforms there is no unanimous consent, and there is already resistance on such detail from vested interests in all quarters.

If the grand reforms are to be realized, a general consensus among the political parties is essential and will be worked out. It remains to be seen where the LDP government will place more weight--on the conservative or the liberal side--to achieve the reforms. In any case, it is possible that the alliance focusing on reform may reorganize the political process itself. Since reforms will mean the realignment of vested interests, an alliance of the political powers that are expected to control those vested interests is much more important for the realization of reforms than the leadership of the Prime Minister.

I have spoken about what you know, about what you don't know, and about what you don't like, but I am afraid I don't know what you actually like. So while I am uncertain that I have given you pleasure, I thank you for your kind attention.

(The above article is offered for reference purposes and does not necessarily represent the policy or views of the Japanese Government)

Yuichi Shionoya

Born: Toyohashi, Aichi-Prefecture, Japan: 2 January, 1932
Position: President, The National Institute of Population and Social Security Research Professor of Economics Emeritus, Hitotsubashi University
Education: Nagoya University
  B.A.(Economics), 1953
Hitotsubashi University
  Ph.D.(Economics), 1985

Major academic appointments:
Hitotsubashi University
  Assistant, 1958-59
  Lecturer, 1959-64
  Associate professor, 1964-72
  Professor, 1972-95
  Dean, Faculty of Economics, 1985-87
  President, 1989-92
The Social Development Research Institute
  President, 1995-96
The National Institute of Population and Social Security Research
  President, since 1996

Fellowships and short-term academic appointments:
Oxford University, British Council Fellow, 1961-62
Harvard University, Rockefeller Foundation Fellow, 1962-63
Delhi School of Economics, Visiting Professor, 1968-69
Bocconi University, Visiting Professor, 1979-80
Oxford University, Visiting Professor, 1983
National Humanities Center (USA), Fellow, 1993-94

Professional association posts:
Studies in the History of Economics, Macmillan, Editorial Board, since 1990
Review of Political Economy, Edward Arnold, Editorial Advisory Board, 1991-95
Journal of Evolutionary Economics, Editorial Board, Springer-Verlag, since 1991
Studies in Economic Ethics and Philosophy, Springer-Verlag, Editorial Board, since 1991
History of Economic Ideas, Physica Verlag, Advisory Board, since 1993

Memberships in academic associations:
International Joseph A. Schumpeter Society, President, 1990-92
History of Economics Society
History of Economic Thought Society (Japan)
Economics and Econometrics Society (Japan)
Society for Economic Policy (Japan)

Memberships in government councils:
University Council (Ministry of Education), 1989-92
Economic Council (Prime Minister's Office), 1994-96
Council on Health Insurance (Ministry of Health and Welfare), Chair, since 1995
Council on National Welfare (Prime Minister's Office), since 1996
Council on Administrative Reform (Prime Minister's Office), since 1996

Back to Index