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Monday, Jan. 19, 2004

JAPANESE PERSPECTIVES

Japan must preserve upswing by allaying public fear with reform


Expectations are growing that Japan will finally achieve a full-scale economic recovery this year.

The current one is Japan's third recovery since the collapse of the bubble economy in the early 1990s. But this one differs from the previous two in that it is being led by the private sectors, including the corporate sector.

Japan has posted an average growth of 1.5 percent since the ongoing upturn began in the January to March period, with domestic private-sector demand expanding 0.9 percent and overseas demand 0.7 percent. Meanwhile, domestic public-sector demand fell 0.2 percent.

This situation contrasts sharply with the two previous recovery phases, which relied heavily on large stimulus packages from the government that were mainly focused on public works projects. During the two previous upturns, public-sector demand expanded 0.5 percent on average.

Reliant on public-sector demand, the past two recovery phases lacked vigor. In particular, the most recent one -- January 1999 to October 2000 -- was the shortest in Japan's postwar history.

However, the current recovery is unfolding amid a government-led effort to structurally reform the economy, and the private sectors are definitely playing the leading role.

Corporations have improved their profitability as a result of painful restructuring, and due to positive developments in overseas markets, they expect to report sharp gains in the business year ending in March.

Capital investment is also picking up, and the Bank of Japan's "tankan" survey suggests fiscal 2003 will see the first rise in such spending in seven years.

If that proves true, the first task will be to solidify the private-sector-led recovery and put the economy on a longer-term growth path. And the key to doing that will be to stimulate household demand, including consumer spending (which accounts for nearly 60 percent of GDP) and housing investment, which has a far-reaching impact on the overall economy.

Given the tight fiscal condition of the Japanese government, taking radical steps like the major income tax cuts introduced in the United States may be impossible. But the government should at least make sure that concerns about tax and social security systems don't put a damper on household demand. Late last year, the government and the ruling coalition debated terminating tax cuts related to housing loans, even though housing investment hadn't picked up yet. Although they eventually decided to retain the tax cuts following strong requests from Keidanren, such a proposal runs counter to the nation's economic interests.

It has also been pointed out in recent years that uncertainty over the future of social security is discouraging consumers from spending today. In their discussions on pension system reform for fiscal 2004, the government and the ruling coalition failed to come up with a grand design and merely decided to cap pension premiums at 18.35 percent of income. They have not addressed people's concerns about how much they'll have to pay and how much they can receive in the future.

A large portion of the public is already aware that the social security system will not be sustainable unless pension benefits are reduced and consumption tax revenues are used to cover its costs. Unless the government comes up with some clear answers to these problems, public uncertainty will only intensify.

To minimize the public's burden in the future, the government must quickly lay down a concrete design for reform and carry it out today.

Yoshio Nakamura is a senior managing director of Nippon Keidanren.


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