Coping with a slump

The Japanese economy is in big trouble. Will the Hashimoto Government's latest package of measures save the day for Japan Inc?

THOSE who had believed that things could not get any worse for Asia were taken by surprise. While South-East Asia was still coming to terms with the debilitating after-effects of the currency crises that affected the region, Sony chairman Norio Ohga recently declared that Japan is the next Asian major on the brink of collapse. The immediate provocation for his assessment was a sharp slowdown in growth in the country. Gross domestic product (GDP) growth was a negative 0.2 per cent over the year ending with the fourth quarter of 1997. It was expected to decline this year as well and improve to a still meagre 1.25 per cent in 1999 even according to optimistic projections.

The manufacturing sector has been particularly badly hit. Industrial production fell by 3.1 per cent over the year ending February 1998. Two factors have played a role here. The first factor is a decline in exports to crisis-ridden East Asia, which is a far more significant market for Japan than for other developed industrial nations. The second factor is a slump in domestic demand, with department store sales estimated to have fallen by 20.8 per cent year-on-year in March. Associated with the slump have been a number of other indications of decline. Unemployment has touched an unheard-of 3.9 per cent in April. The stock markets are down and threaten to head further south. And the yen depreciates against the dollar despite signs of a rising current account balance, because capital flows out of Japan into the United States and elsewhere.

In response to the slump, the Japanese Government announced on April 24 a 16,000-billion-yen ($124 billion) package to pump-prime the economy by spurring domestic consumption and investment demand. According to the Government, there is an equivalent of 12,000 billion yen in extra spending in that package which should raise growth by 2 percentage points over the next 12 months. The package includes temporary tax cuts totalling 2,000 billion yen this year and a further 2,000 billion yen next year; public works spending to the tune of 7,700 billion yen; 2,000 billion yen of financial support to small businesses; and special measures of financial support aimed at boosting the slack property and equity markets. The message is clear.

Despite its earlier commitment to halve its fiscal deficit to 3 per cent of GDP by 2004, the Government finds no alternative in the current situation to tax cuts and new expenditures aimed at boosting demand and growth.

ALL concerned have welcomed the new package, and there are few who are convinced that it would not deliver what is needed to stave off a crisis. This pessimism is explained by three long-term developments. First, the current recession virtually aborts what appeared to be a recovery from a prolonged period of slack growth. Since 1992, Japan's GDP growth has averaged just 1.3 per cent a year. However, in 1996, output expanded at 3.5 per cent. While this trend of acceleration was maintained during the first quarter of 1997, a sharp deceleration set in during the second quarter of that year and has worsened since. Thus, this recession is seen by many people as the culmination of a deeper 'structural' crisis in the Japanese system.

Second, the years of slow growth showed up a fundamental weakness in the functioning of the Japanese industrial system. In the course of the boom, banks (which ostensibly rule industry in Japan's bank-based monitoring system) bought equity and provided huge loans to over-extended industrial conglomerates, which earned low returns but survived and grew because of low interest rates and low returns on equity. When growth slowed, these over-geared and over-extended corporations were not in a position to keep themselves afloat without the infusion of extra funds from the lead banks. To avoid writing off huge volumes of bad debts, these banks chose to lend even more, increasing the volume of non-performing assets carried by the financial system, which is currently estimated at 77,000 billion yen ($592 billion).

This huge burden of bad loans threatens to create a financial crisis as Japan liberalises its hitherto closely controlled financial system. That threat can turn real when corporate profits fall further in the coming months.

Faced with this situation, banks are reticent about lending any further, especially to less-creditworthy small businesses, making a credit crunch another contributor to slow industrial growth.

Finally, the problem of slow growth has persisted since the early 1990s, despite the Government's repeated efforts to pump-prime the economy with tax cuts and additional spending. Since the first signs of a slowdown in the summer of 1997, the Japanese Government has announced five packages aimed at reviving the economy. In fact, such packages have been announced periodically right through the years of slow growth. According to an estimate by the Organisation for Economic Cooperation and Development (OECD), between 1992 and 1995 at least 64,000 billion yen had been spent on such packages, which included income tax cuts that reduced government revenues by 17,000 billion yen, new public investment totalling about 38,000 billion yen, and government land purchases and public loans to the tune of 20,000 billion yen. All that spending contributed to a 4 per cent growth over the period as a whole. This suggests that even in the brief recovery of 1996, stronger export growth fuelled by the depreciation of the yen rather than domestic spending played a major role.

THE last of these has been quoted by many as indicative of the futility of trying to use one more package, even if it is of mammoth proportions, to stem the current economic decline in Japan. Yet, if Tokyo has chosen to push ahead with tax cuts and spending plans it is because of three reasons. First, even if exports are the best way to spur a recovery and if such an increase in exports is likely in the wake of yen depreciation, the recovery could be aborted by a protectionist response from the West to a recession-induced rise in Japan's exports. If such a response is to be pre-empted at all, Japan should make it amply clear that it is doing a lot at home to revive the economy.

Secondly, among the things the West sees as being an appropriate response to Japan's difficulties, Keynesian style pump-priming may be the better option for the Japanese Government. The other alternative is what the rest of the industrialised world is pushing for, namely, a deregulation of Japan's financial and industrial sectors in the name of increasing "efficiency". The liberalisation option could trigger a wave of financial and industrial bankruptcies that would force Japanese companies to sell out to the myriad multinationals on the prowl in crisis-ridden Asia in search of assets at bargain prices. Forewarned about such a possibility by the collapse of two financial firms, Sanyo Securities and Yamaichi Securities, and of the 10th largest commercial bank in Japan, Hokkaido Takushoku, the Japanese Government would like to go slow on liberalisation and deregulation. So it has sought to appease its OECD partners by offering to play the role of the locomotive of world growth by pump-priming the Japanese economy at a time when none of the others is willing to opt for Keynesian style measures for fear of financial instability.

Not surprisingly, U.S. Treasury Secretary Robert Rubin only half-heartedly welcomed the package. "These are positive steps," he reportedly declared, but added: "We hope the Government will put these measures into place quickly and effectively and move forward with further actions, including measures to strengthen Japan's financial system and open and deregulate its economy to help establish a basis for long-lasting, demand-led growth."

PRIME MINISTER Ryutaro Hashi-moto and his team have in essence bought themselves time by opting for this package. They intend to use that time to restructure Japan's financial system in the least painful way possible. One such plan leaked to the press involves injecting 30,000 billion yen (around $250 billion) of taxpayers' money into a plan to restructure the ailing banking system. About 17,000 billion yen will be used to pay off depositors in banks that need to be closed down and another 13,000 billion yen would be used to shore up bank capital through purchases of equity and debt in individual banks. Restructuring of this kind is expected to strengthen financially the banking system and help it resume normal lending of a kind required in an economy on the way to recovery. That recovery, it is hoped, would be triggered partly by the new spending package and partly by a rise in exports in the wake of yen depreciation.

This plan, if successful, could prove Ohga of Sony an alarmist. But its success would mean that international capital and the governments of the industrialised West do not get what they expected from Japan's recent troubles: a more liberal economy and financial sector and, therefore, a share in the assets of Japan's beleaguered banks, finance companies and industrial firms. A backlash may ensue, prophesied perhaps by a statement from the credit-rating agency Moody's in early April that it is unsure of the top rating its gives Japan. This requires talking up Japanese markets and cajoling both the rating agencies and Western governments to give Japan one more chance.

Eisuke Sakakibara, Japan's Vice-Minister of Finance for Inter-national Affairs, has the role of travelling the world to convince all who matter that Japan can indeed stay on course and even recover without affecting the rest of the world too adversely. To an extent, the survival of Japan Inc. depends as much on the success of his mission as it does on the package of Hashimoto.