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Monday, April 24, 2006

JAPANESE PERSPECTIVES

Fiscal policymakers seek Japan's true potential


An intense debate is raging among three of the nation's top fiscal panels on how to reform state revenues and expenditures in an integrated manner. The bodies are the Council on Economic and Fiscal Policy, the Liberal Democratic Party's fiscal reform panel, and the fiscal system council of the Finance Ministry.

One of the major issues in the debate is how to assess Japan's economic growth rate in the future. The government has already set a goal of achieving a primary balance -- where expenditures (excluding interest payments and debt redemption) are covered by revenues excluding bonds -- by the early 2010s.

But even if that goal is achieved, the government's huge debt will continue to expand as long as the rate of economic growth stays below the rate of interest on government bonds.

Many experts forecast roughly 3 percent nominal annual growth for the coming years. Some argue that the nation should aim for 4 percent.

Critics say these targets are not backed by reliable estimates, but given Japan's growth potential such levels do not appear so difficult to attain.

Growth potential can be assessed in different ways. People who take a pessimistic view of Japan's growth prospects cite the decline in the workforce projected to accompany the dropping birthrate and rapid graying of the population. However, an estimate by Keidanren suggests this factor does not necessarily pose a major threat to growth.

Sure, the baby boomers -- the generation born right after World War II -- will soon reach retirement age and the youth population will continue to steadily shrink, but these factors are only projected to reduce growth by a mere 0.2 to 0.3 percent.

The negative impact from this trend can be alleviated by encouraging the nation's roughly 23 million unemployed citizens (not including the elderly) to join the work force.

Another figure, Japan's total factor productivity -- a measure that greatly affects the growth potential of an economy -- is rising faster than is widely believed.

If Japan's economic growth in recent years is divided into three factors -- labor, capital and TFP -- via the growth account method, it will show that the contribution of total factor productivity has reached the mid-1 percent range. TFP's contribution will rise further if the nation promotes innovations in manufacturing and other fields, including research and development in basic science.

But such efforts should not be confined to just economic fields. They should be extended to social systems as well, where obsolete norms still exist.

Capital accumulation -- another major component of growth potential -- is expected to provide a substantial positive impact.

The Japanese economy has largely rid itself of the excess capacity that has plagued the nation since the 1990s, paving the way for companies to make aggressive capital investments. This has been made possible by the change in the mind-sets of corporate executives, coupled with abundant cash flow resulting from brisk earnings.

Government statistics on the funds cycle show that the corporate sector experienced its first funds shortage in eight years in 2005 -- meaning Japanese companies have finally returned to the practice of borrowing money to invest.

An earlier Keidanren survey estimated that capital contribution to growth would be slightly less than 1 percent, a figure that is still valid today.

These kinds of labor, capital and TFP conditions suggest that Japan has the potential to achieve at least 2 percent real annual growth.

If a certain level of inflation is achieved through sustained growth and appropriate monetary policy, nominal annual growth of over 3 percent should be well within Japan's reach in the coming years.

Yoshio Nakamura is an acting director general of the Japan Business Federation (Nippon Keidanren).


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