Unblocking Japanese reform

Trade Directorate

Japan’s economic reforms could lose their edge if they get caught up in the country’s institutional machinery. Determined action is therefore needed to prevent that from happening. The views expressed in this article are those of the author and do not necessarily represent the official views of the OECD.

The troubles of the Japanese economy have been well documented by now. GDP fell by about 2.6% in real terms in 1998 and a weak performance is expected in 1999. Unemployment is expected to remain dispiritingly high by Japanese standards and, although the yen looks to have strengthened, the saga of suffering financial institutions seems to be never-ending. The impact of Japan’s problems on other Asian markets and the knock-on effect around the world have been striking, making the need to tackle deep-rooted structural problems clearer than ever. That at least has been recognised by the Japanese public and their political leaders and some progress in tabling reform has been made. In fact, the Japanese government has asked the OECD to conduct a broad-based review of regulatory reform in Japan; at the time of writing that review was under way, with the final report expected later in the spring.

The challenge for Japan is a formid-able one. Many of the economy’s structural problems have an institutional dimension. There is nothing unusual about that – other OECD countries have over the years been under pressure to undo age-old practices which block growth. But Japan’s institutional set-up is particularly rigid and it will take a dogged effort to change it.

Not that the Japanese government is in any danger of underestimating the tasks that lie ahead. It has already devoted significant resources to formulating and ensuring the implementation of the Deregulation Action Plan it introduced in 1995. Early initiatives were courageous enough. Indeed, they would have been unthinkable only a few years before. For example, the government allowed two major financial institutions to fail, rather than intervening to bail them out. Its deregulation package has led to a substantial fall in petrol prices, as well as to the first new entrant, Skymark, to the domestic airline business in 35 years. Meanwhile, the government’s independent Economic Strategy Council has recently come out with daring re-commendations to change the civil service and even to abolish Japan’s unwieldy public trust fund.

These changes have clearly streng-thened the government’s reputation. However, despite recent breakthroughs in addressing Japan’s troubled financial sector, questions remain about the government’s capacity to carry out more difficult reforms which lie ahead.

So far it is pressure from global trading partners which has largely been responsible for bringing about the recent policy initiatives in Japan. This is partly because trading partners tend to see Japan’s internal regulatory environment as having a direct bearing on their trading interests too. But there are limits to what their pressure can achieve. Japan has to act for itself, to define its goals and to decide how they can best be achieved. The impediments to change have to be clearly identified and vigorously tackled. And as part of the exercise, the effectiveness of the approach to reform has to be re-assessed and the entire programme given some fresh impetus. Otherwise the objective of a durable recovery could become elusive.

A legacy of detail

The first problem to look at is the Deregulation Action Plan itself. It got off to a good start in 1995 and has played a key role in facilitating some worthwhile changes. In fact, the decision to allow the new airline entrant was made possible thanks to it. But even from a regulatory expert’s point of view the sheer size and detail of the Deregulation Action Plan is overwhelming. The 1998–2000 plan now consists of about 600 reform items, although as before, that number may well grow. Each individual detail might make sense in its own right, but it is extremely hard to get a feel for where the sum of the measures will take the economy. A small example is reform in the energy sector, where electricity generation has been opened for tender. In spite of the high take-up, it is still uncertain that the outcome will, or is intended to be, lower prices. There is a similar lack of clarity running throughout the action plan. In the end, whether or not a more competitive, market-oriented Japan will emerge from the reforms is an open question.

It could be argued that the plan lacks a firm political hand to drive it forward and give it overall shape and coherence. Questions have to be asked about its content, its meaning and purpose. What will the plan’s overall impact be on competition or on labour markets, for instance? In some respects, the Deregulation Action Plan, which has been extended to run for another three years, resembles a car plant where the individual component experts working alongside each other have not considered whether the car they are building will actually start.

Japanese reform would be strengthened if broad goals, such as competition and transparency, were made clearer and more up front. Numerous deregulatory measures, such as those removing restrictions on foreign exchange, have been introduced to the financial ser-vices sector. But the lack of transparency in the procedures for approving new financial products and in building the rules governing the sector remains a major problem which has not been properly dealt with. This is a worry, since the discretionary powers of ministerial departments and the need for their prior approval are one of the causes discouraging innovation in the first place. As a result, the financial markets are still not convinced that the ministries are committed to a true competition agenda. After all, talk about igniting the entrepreneurial culture is very well, but enterprise needs competition to spark it.

The abolition of the ‘demand and supply adjustment’ clauses, which were essentially discretionary clauses intended to restrict new entry into various markets, such as transportation and telecommunications, has been widely welcomed. But here again, there are outstanding issues to be resolved before market competition can be realised. Some of these might not be unique to Japan, but that does not make them easier to resolve. For example, Japan’s main telecommunications company, NTT, still controls the internal network and new entrants in the market are discouraged by high entry costs. Unless the ministerial departments responsible for reform show a clear and thorough commitment to competition, the impact of even the most positive reforms will be weakened, inhibiting new entrants as well as possibly discouraging long-term investment.

Decision-making has to be sped up

Slow and incremental decision--making is a particular problem in Japan. Such is the nature of its institutional struct-ure. Of course, any government undertaking reform has to avoid social disruption and to cater for a range of interests. Reform often has to be steered through political minefields. But in Japan there is simply too much room for delaying tactics to be used by the regulatory agencies and ministries whose interests may run counter to the spirit of competition reform. Again, evidence of this can be seen in the financial sector. Akiyoshi Horiuchi, a professor at the economics faculty of Tokyo University, recently commented on the unusual slowness with which bad loans were being handled, which he surmised as being part of the attempt by the finance officials to protect the weaker institutions from -going under.

The decision process in matters concerning deregulation is arduous. Typically, new rules and reforms are proposed to the Deregulation Committee. After a long discussion, the authorities agree to modest revisions, taking care not to commit themselves to anything long-term or fundamental. They also have a veto to stop the reforms if they feel they need to. There are plenty of illustrations of the effects of this lengthy procedure. For example, it took more than ten years from the original US request for Japan last year to scrap its Large Retail Store Law restricting the expansion of large super-market outlets. Another example is the abolition of the domestic shipping cartel, which was finally agreed in 1998 after long discussion in the Administrative Reform Council. The catch is that a transition arrangement has been worked out too, which will keep the cartel effectively alive for another 15 years.

Behind this slowness is the foot-dragging of powerful groups determined to resist fundamental change in go-vernment practice. These are the so-called ‘iron triangles’, made up of back-bench and local politicians, businesses and the administrative departments. Such bonds may not be peculiarly Japanese. In fact, the phrase comes from US political science. But in -Japan iron triangles are extremely powerful and, in most cases, they are led by government bureaucracies. The institutions which make up the iron triangle tend to offer prestigious and stable career prospects to highly qualified and committed staff.

Iron triangles cover both the public and private sectors and are pervasive even at local level. They are in many cases bolstered by the legal framework, or basic foundation law, which gives ministries influence in the business sectors they are concerned with. Moreover, bureaucracies can cite the greater public good to control regulated industries and can draw on specific legal provisions to back them. Because Japan lacks a competition authority or other administrative/-judicial tribunals with teeth to resolve any differences of opinion with regulatory agencies, these discretionary powers make Japan’s government departments particularly influential.

[Ratio of amakudari board members (selected Japanese industries)] -- Table available in print edition.

The descent from heaven

Such is the power of the administration that business has a strong incentive to stay on its side. One favourite way of doing this is for companies to appoint recently retired administration officials to board positions. As -nothing is quite as high as government, this practice has been dubbed the amakudari, or descent from heaven. The table shows that regulated industries have a higher proportion of amakudari board members than unregulated ones, for example in the auto-motive sector. The practice of making appointments from the minis-tries simply strengthens the iron triangles.

Career paths between the public and private sectors can be found in other countries, but the practice of amakudari is unusual -because of the Japan-ese attachment to life-long employment. This puts ministries under pressure to find posts for their retiring officials every year and fuels the amakudari practice. Recent scandals have thrown the habit into question, but if the fundamental incentives to hire former offi-cials are not changed, amakudari is unlikely to disappear.

Reaching out

Policy-makers tackling Japan’s economic problems always have to take this underlying institutional structure into account when embarking on reform. Changing long-standing prac---tices in the interaction between government and the private sector is not easy to achieve in any country. Yet, without change other reform policies might simply run aground.

Fortunately, Japan’s problems are not insurmountable by any means, though some new ideas may be needed. For inspiration, the government could look at changes taking place locally. The US federal government has found this approach to be useful, for ex-ample, in airline deregulation when it was inspired by reforms that were successfully implemented in the state of California.

But while relying on internal initiatives is clearly important, looking for international solutions might also prove fruitful. Economic policy-making in several European countries was in a state of inertia too in the period after the Second World War. The projects to build the European Community and latterly the -single market and mone-tary union have helped to lift individual nations out of their domestic mires, freeing up trade and capital flows and stimulating growth. The problems Japanese policy-makers face may in many ways be different from those of their European counterparts. But it is precisely because Japan’s problems affect markets beyond its borders that reaching out in search of durable solutions would be a positive step. After all, Japan and the world economy would only benefit.

For more on regulatory reform, please visit our site.

©OECD Observer No 216, March 1999 




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