Introduction

The Japanese economy by the end of Koizumi's tenure stabilized and reached a point of sustainable growth. Although Japan experienced several recovery periods since 1990 only to be followed by decline and instability, the recovery that started in 2003 has been more substantial. In the late 1990s and first year or two of the new century, there was considerable discussion about the potential for another decade of economic distress. As of September 2006, this type of discussion has all but disappeared. This does not imply an absence of economic and political challenges facing Japan in the near future. It does mean, however, that for the first time in a decade and half, the Japanese economy and political systems at the end of 2006 could realistically have a more positive attitude about the future. This view needs to be qualified to some degree because Japan's economic recovery has been based narrowly on the export sector, the political impasse and uncertainty that emerged with the LDP-CGP (Clean Government Party) government's loss of the majority in the July 2007 upper house election and the opposition parties' controlling the upper house, and continuing indications that the potential for deflation has not been completely rung out of the Japanese economy.

On the positive side, real GDP increased 2 percent in 2006, unemployment declined, although it still remained high by historical standards, equity prices increased, and, for the first time since 1991, real estate prices and rents in Tokyo begun to move upward.

Introduction

Prime Minister Koizumi came into office April 2001, when the economy was in serious, protracted stagnation and deflation, despite nine years of repeated government stimulus packages and the unprecedented ZIRP of the BOJ starting February 1999. In 2001, the economy was in renewed decline, and real GDP growth was only 0.21 percent in 2001, after a brief modest recovery in 2000 (2.4 percent real growth). The unemployment rate of 5.0 percent in 2001 was the highest in postwar history and was still climbing. Deflation continued with a 0.77 percent decline in the CPI in 2001 (OECD, various years). Observers in and outside Japan were wondering whether a “second lost decade” was in the making. The Japanese public and businesses felt helpless in the face of the seemingly insurmountable economic stagnation and ineffective government policy. They were desperate for any change or any political leader who could offer any alternative solution to the economic and financial distress that had passed the decade mark.

The Japanese placed their hope in Koizumi – very unconventional, energetic, and atypical of LDP leaders – when he emerged in 2001 with the promise of changing Japan and engineering economic growth and, if necessary, destroying his own LDP in the process. Koizumi attempted reform in many areas of the economy and government intervention, some successfully and some not so successfully.

Introduction

The period from 1980 to 1985 represents the high-water mark of the Japanese economy in terms of financial and central bank policy outcomes. In terms of most economic and financial indicators, Japan's performance outpaced many other industrial countries, especially Japan's ability to achieve stable noninflationary growth in the face of a second set of oil price shocks in 1979 while at the same time adopting a policy of domestic and international financial liberalization. Japan appeared to have successfully adapted to the new economic, political, and technological environment and achieved an impressive record of economic and financial performance. It drew world attention both in terms of Japan's absolute performance and Japan's relative performance to much of the industrialized world.

Japan's state-directed approach to managing the economy combined with a powerful bureaucracy seemed to function in the more liberal and open financial environment as well as it did during the first part of the postwar period. The second half of the 1980s appeared to be a continuation of these trends. But in fact, a slow accumulation of stresses occurred as equity and land prices began to increase in 1985 and 1986 and then began to increase at very rapid rates, which by 1988 reflected a full-blown asset bubble. The asset inflation bubble combined with strong real GDP growth and price stability rationalized the phrase “bubble economy.

Introduction

The financial and economic distress that characterized Japan's economy for fifteen years has been largely resolved; however, Japan has not yet returned to stable, broad-based growth and price stability as of late 2007. Although the majority of observers both inside and outside of Japan regard Japan to be growing at a “moderate” rate, there continue to remain problems with the reliance on the export sector, weak balance sheets of the large number of small financial institutions, weak consumption spending by the household sector, and the low levels of measured inflation. Hence, to conclude that Japan has achieved sustainable economic stability and growth is premature as of late 2007. But, at the same time, it appears that Japan's economy will continue to grow moderately, and a return to the economic and financial distress of the 1990s is unlikely.

Many changes have taken place in Japan in the past two decades. But Japan is not finished with change. Change and reform are still ongoing, and Japan will continue to change until it reaches a new equilibrium where its political-economic regime stabilizes. It is not a straightforward task to project how Japan will change and how it will affect its politics and economy in the coming future. Nonetheless, some projections can be offered with a reasonable degree of confidence. This last chapter reviews the direction in which Japan's politics, liberalization policies, and economy are likely to go in the next several years and beyond.

Introduction

Society is in a constant state of change even though change may be too subtle or gradual to notice. Japanese politics under the LDP's one-party dominance was changing in a similar manner – change was present but subtle. The political regime during the postwar period looked stable, for the most part: The same party ruled the government for almost four decades. The interest-based competitive and cooperative relationships among politicians, bureaucrats, and socioeconomic interests dominated the policy-making process on issues vital to their interests. Politicians engaged in the same old distributive politics. Despite repeated calls for the reduction of corruption and money politics, ruling LDP politicians went about their usual business, and little changed in the way of money politics and pork barrel politics. Most of the time, the interests of citizens and consumers were given secondary attention by policy makers, unless they threatened the LDP's electoral prospects. And many politicians implicated in corruption scandals kept getting reelected to the Diet, and the LDP continued to be the party in power.

Yet, under this apparent tranquility, there were also changes. The LDP's electoral strength lay more in rural than urban areas. But the party's electoral support experienced long-term decline, partly as a result of the movement of Japanese people from rural to urban areas during the high growth period and because of the decline of the agricultural population that had supported the LDP. The LDP's other electoral bases – such as the distribution, construction, and transportation sectors – also became relatively stagnant industries and the sources of economic inefficiencies.

Introduction

In the 1970s and 1980s, Japan's economic institutions came into conflict with a new set of economic and technological changes that first emerged in the late 1960s and accelerated by the late 1970s. Japan, however, was not special in this regard. The new environment clashed with the majority of economic institutions throughout the world. Collectivist approaches to managing the economy from the mild welfare state of the United States to the command economies of China, Russia, and Eastern Europe became increasingly incompatible with a new economic and technological environment more consistent with open, transparent, and individualistic solutions to economic and political problems.

The conflict between the new environment and existing institutions throughout much of the world generated a wide variety of market and government innovations from the 1980s on to resolve the conflict. The process differed from country to country but, collectively, it involved the liberalization and internationalization of economic institutions and, in some notable cases, involved dramatic shifts in the political institutions, such as the Soviet Union and East European countries from authoritarian to more representative political regimes in the late 1980s and early 1990s. Liberalization became a widespread phenomenon in the 1980s and continues to the present. Friedman (2000) refers to this process as the “democratization” of technology, finance, and information, and argues that it has made the world “flatter” because there is now a more level playing field among countries (Friedman, 2005).

Introduction

Japan emerged from World War II in 1945 as a devastated nation with much of its infrastructure destroyed, hyperinflation fueled by government deficits and rapid monetary growth, political institutions in disarray, and a deep pessimism about the ability of Japan's economic and political institutions to provide economic growth and political stability in the future. The prewar economic and political institutions had embodied Japan's view of how the world functioned and had served Japan up to World War II but were found wanting in the postwar environment. This was an especially difficult attitudinal change on Japan's part, considering the overall impressive performance of the Japanese economy since the start of modernization in the 1870s.

The modernization effort itself was the outcome of the political decision manifested by the Meiji Restoration of 1868 to develop a set of economic and political institutions to first achieve industrial and military parity with the West and then surpass the West. These institutions over time incorporated a social contract between the government and its citizens, in which the government was given authority to manage the economy in exchange for economic security. The institutions that evolved after the Meiji Restoration built on a series of favorable conditions established during the Tokugawa period (1603–1867), such as a road system, centralized government, strong work ethic, and relatively high level of education. The policy outcomes of the Meiji Restoration were impressive by any standard.

Introduction

The immediate effect of the collapse of asset prices in 1990 and 1991 was recession, disinflation, and weakened balance sheets for financial institutions and corporations; however, this economic and financial distress intensified over the decade. The decade has frequently been characterized as Japan's “lost decade” in terms of lost financial and economic development, but because the economic and financial distress continued until 2005, one could just as easily refer to the entire period as a decade and half of lost financial and economic development. The 1990s also witnessed political instability and uncertainty with the end of the “1955-System” of LDP rule and party realignment.

This chapter focuses on the economic and financial distress of the 1990s and ends with a summary of the most important policies of the Koizumi government starting in 2001. Although economic and financial distress continued for several more years, the economy would experience a significant turning point after Koizumi became prime minister.

The Cabinet Office's official business cycle turning points (see Table 5.1) indicate that Japan experienced a series of business cycles during the past decade and half. The three “expansions” after the collapse of asset prices with the most recent starting January 2002 and continuing through late 2007 mask a stagnant economy. Real GDP growth averaged 1.2 percent from 1991 to 2003, the year in which most observers conclude that the economy began a sustainable recovery.

The beginning of the new century witnessed a major turning point in Japan's economic and political performance and institutional design. Starting from a flawed financial liberalization process in the 1980s and the collapse of equity and land prices in the early 1990s, followed by a decade of economic and political distress in the 1990s, Japan started a transition toward more aggressive market reforms after Prime Minister Junichiro Koizumi came to power in 2001. By 2005, there were signs that the Japanese economy and financial system had finally commenced a sustainable recovery. Japan's economic and political institutions have also undergone significant redesign.

The book is part of a new series of books by Cambridge University Press and focuses on Japan's economic, political, and social development since 1980; hence, the title of this book – Japan Since 1980. Clearly the date of 1980 is somewhat arbitrary, especially when applied to more than one country. Nonetheless, important institutional changes took place in many developed and developing countries in the past three decades, with 1980 as a loose pivotal year. This is certainly the case for Japan.

It was not an easy task to provide an overview of Japan's economic and political performance and institutional development over the past three decades. At a minimum, it required the collaboration of an economist and political scientist to tell the story properly. Our collaboration on this book essentially started when Cargill and Sakamoto met and participated in a conference at Southern Methodist University in 2004.

Introduction

Japan's fiscal program has undergone significant change in the late 1990s and the first years of the new century. The fiscal program consists of the general budget for the central and local governments based on the familiar revenue-spending framework and the FILP based on a flow-of-funds framework. The general budget stipulates government revenues from various taxes, fees, and bonds and how the revenues are allocated to various components of government spending. The FILP is referred to as Japan's “second” budget, because of its size and importance. Both the general budget and the FILP budget are drafted by the government and approved by the Diet. The FILP funds came primarily from postal savings deposits, postal life insurance, and national pension contributions. The FILP budget allocated funds to a system of government banks, enterprises, corporations, and local governments, which were referred to collectively as FILP agencies. Starting in 2001, FILP funding sources changed and a major redesign of FILP and the PSS occurred.

There were many catalysts for the change in Japan's fiscal program, but one of the more important was the growing recognition that Japan's conventional fiscal program was the source of economic inefficiencies and prevented Japan from adjusting to the new reality of the globalized international economy, which put competitive and efficiency pressures on most industrial nations. The general budget often was used as an instrument of stabilization policy in the context of Keynesian demand management.

Introduction

The evolution and transition of Japan's economic and political institutions during the entire post–World War II period is remarkable for two reasons. First, Japan completed reindustrialization and reestablished prewar economic growth trends in record time. By the 1970s, Japan emerged as the second largest economy in the world. Japan remains a major component of the world economy with one of the world's higher standards of living for its population. Second, following the completion of reindustrialization, Japan's economic and political development exhibited wide fluctuations in performance. After a short but turbulent period of economic distress in the early 1970s, Japan achieved impressive economic, financial, and political stability from 1975 to 1989. The perception of Japan's economic invincibility became widespread during this period. Starting in 1990, however, Japan experienced intense economic, financial, and political distress. The economy and financial system continued to decline or stagnate until 2005. Despite economic recovery by the mid-2000s, Japan continues to face lingering economic and political problems.

The record of Japan's economic performance since the early 1970s and how Japan has adapted to internal and external forces of change have offered a number of important insights into the development process in general. Japan has become a major case study and has influenced economic and political institutions in many countries as they either tried to emulate Japan's economic success or learn from Japan's failures.

The general outline of Japan's postwar development can best be understood by dividing the postwar period into four distinct periods.

Introduction

The economic problems of the 1990s and 2000s had an impact not only on the Japanese government's economic policy, politics, and political outcomes but also on broader aspects of Japanese society and life. Although many factors were attributed to Japan's economic problems, policy makers, politicians, and observers argued that the structural features of the Japanese economy were an important cause of the problems. Japan's corporate governance, financial system, labor market practices, and the clientelistic relationships between government and industry were considered sources of economic inefficiency, impairing the performance of the Japanese economy.

Japanese corporations themselves also felt the need to restructure their business and management and regain competitiveness and efficiency to improve their performance, as many of them suffered poor performance, debt, excessive investment and capacity, low rates of returns, redundancy, and high production costs. Private corporations, particularly those in the export sector, were the first ones to acknowledge the need for change and to initiate reform, because they were exposed to international competition and had no other choice but to change if they wanted to survive in the market economy. They were thus much more forthcoming in executing their own changes than politicians, bureaucrats, and their constituent industries and sectors that had been accustomed to favorable government policy and protection provided by politicians and bureaucrats. These traditional constituents' first inclination was to hang on to their entitlements and ride out the economic recessions with help from the government.