Mr. Koizumi's Policy Stance-Problems and Options

Introduction to the Shishido essay

As suggested by the Kitaoka and Kobayashi essays on the "Opinions" page, everyone seems to be supporting "structural reform" as an abstract concept, which has led to the tremendous popularity of the Koizumi administration. However, different people may well have different programs and timing in mind when it comes to the actual implementation of structural reform, depending on one's political and policy stance and also on one's evaluation of the reality of the economic conditions in Japan.

The Shishido essay below tries to spell out those differences in terms of policy simulation, so that one may clearly differentiate Mr. Koizumi's policy stance from various other scenarios for turning the economy around in a decade or so. The author points out the political risks involved in Mr. Koizumi's "radical but classical" approach, and instead proposes a "Big Push" scenario to accelerate economic growth first and achieve fiscal balance later.

Japan's Economy and New Policy Stance of the Koizumi Cabinet: Problems and Options

1. Economic Stagnation and Diverse Opinions

The remarkable success achieved by the Koizumi Cabinet in public opinion surveys has revealed that the people have long been sickened by the traditional LDP leaders and were strongly impressed by Koizumi's personal character and iron will devoted to political reform. The economy, however, seems to be heading for a kind of deflationary spiral symbolized by falling prices, a bearish stock market and a widening GDP gap. Although there is widespread consensus on structural reform, views are quite diversified with regard to the strategies and the timing of the execution of various reform programs, such as financial, fiscal, and government administrative initiatives.

Let me roughly summarize Japan's present situation in terms of political preference in the table below.

Note: Pessimism is based on a wide-gap estimation, while optimism is based on a narrow-gap estimation.

Koizumi's political stance can be classified as category C in the above table. Neo-liberalism of the Thatcher-Reagan brand in the 1980s seems to be at the core of his political initiative, although it has been aimed at, to a certain degree, by his predecessors in the LDP, especially by Hashimoto's cabinet. The Democratic Party, the strongest opposition party in Japan, now seems to be supporting Koizumi's political stance, but they are not strongly united.

Regarding the other categories, the Liberal Party and half of the LDP can be classified as category A, while the Communist Party seems to be included in category E. Some economists and mass media are supporting the policy stance of category B with a high expectation for the role of monetary policy, as in the cases of the major industrial economies.

Now let us look at the reality of the present economic condition. Unlike the traditional and optimistic interpretation by the government with respect to the GDP gap, growing numbers of economists and policy makers have begun to realize the danger of a deflationary spiral restraining economic recovery. Four important points are being emphasized: (a) a rising tendency of real interest rates that tend to depress business and residential investment, (b) a deterioration of unemployment, (c) a declining tendency of tax revenues and worsening of the government deficit and (d) a danger of further appreciation of the yen.

The most important issue is whether positive effects of structural reforms should overcome their negative effects, such as a rise in the unemployment rate and a decline in private consumption. In this context, it should be noted that Koizumi's structural reform is scheduled to be carried out in the midst of deflation, contrasting sharply with Western industrial nations where various structural reforms were successfully carried out despite some social frictions under an inflationary environment. The Koizumi Cabinet's reform will be the first in the world if it is successfully achieved. As can be seen in Japanese history, reforms under austerity are not necessarily new, as was pointed out in Koizumi's administrative policy speech in the Diet. The case of a mayor of Nagaoka is a typical example. However, nobody can deny the political risks involved if it were to be carried out in the present. In the next section I shall propose an economic growth approach more realistic than Koizumi's radical but classical approach, which places emphasis on structural reforms.

2. A Big Push Toward Rapid Recovery: Getting Rid of the Deflationary Spiral

As pointed out above, a deflationary spiral is a self-accelerating process once it has started. To eliminate this process and narrow the gap between actual and potential GDPs we need a "big push" to the present stagnant economy, as suggested below. This policy package resembles policy category A, but it differs from the conventional type in that more emphasis is placed on the private sectors, especially housing investment and IT related business investment. In response to these big impacts, a new infrastructure needs to be expanded. A revolutionary reform of the real estate tax system, like in the United States, needs to be introduced with an aim to boost residential investment by about 30% in 2005 and about 50% in 2010. Active increases are also assumed for public and semi-public investments. Our strategy is to accelerate GDP growth by giving a big push to the economy until 2006, and later to start raising consumption tax and personal income tax rates between 2006 and 2010 to restore fiscal balance of the general government on the basis of accelerated growth and employment opportunity.

Two policy scenarios are shown in the Summary Table. Our base line scenario assumes that the continuation of the present deflationary trend, a modest increase of 2% in real public investment (which might be a little too ambitious by Koizumi's standard) is expected. Because of low investment growth, the current account surplus continues to rise, reaching $340 billion in 2010. Fiscal deficit also deteriorates in terms of the ratio of long-term government debt to GDP. In addition, a high unemployment rate will continue until 2010.

In a Big Push scenario, a quite different picture of growth is presented. As we assume a big impact on both housing and business investment as well as government infrastructure, real GDP grows at about 5% until 2006 and at about 4 to 3% between 2007 and 2010. A GDP gap or deflationary gap falls significantly, while the unemployment and current account surplus also improves. Getting out of the deflationary trap, modest price increases are observed for both consumer prices and GDP deflators.

Finally, most important is a remarkable improvement in government fiscal balance, as indicated by government bond issuance and the government debt/GDP ratio. This clearly implies that government fiscal reform would not be successful before the economy fully recovers.

Reference: Shishido, S. (2000), Renaissance of the Japanese Economy: Is it Feasible? No.2, Input-Output Analysis -Innovation & I-O Technique Vol. 9, No.4 (Dec.2000)