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Ditchley Foundation Annual Lecture XXIII

Japan’s Role from the Global Perspective

11 July 1986
Delivered by:
Mr Yoshio Okawara, Executive Adviser to the Keidanren and former Ambassador of Japan to the United States of America.
It is a great pleasure and honour for me to be here today to present the 1986 Ditchley Lecture. For my lecture today, which I have entitled “Japan’s Role from the Global Perspective”, I am pleased to address a subject which the Ditchley Foundation has so admirably pursued since its inception — that is our interdependence in an increasingly complex world. In my remarks I will give particular attention to what Japan can do to help promote peace and prosperity around the world.

INTERACTION OF THE POLITICAL WORLD
Only a few days after the simultaneous elections of the two Houses, the House of Representatives and the House of Councillors, on July 6, it is rather risky to predict the possible development of the political situation in Japan. However, I can say without hesitation that the leadership of the Liberal Democratic Party, the conservative governmental party, will continue, with the fresh mandate from the voters, to push ahead with economic policies seeking economic development of the nation harmoniously with the international community and will make every possible effort to play a role commensurate with Japan’s international responsibility.

During the past three decades, the economic interrelationship has increased steadily and substantially. The ratio of trade to GNP in each country has risen, overseas direct investments have grown and international movements of capital have been accelerated. The introduction of new technologies and new types of services has made the world much smaller, making interchanges and communications easier and closer. These developments have contributed to economic prosperity. As the economic interrelationship develops, the borders between external and domestic economies are gradually lowered and markets have become more integrated. In the field of economics, the age has been shifting from nationalism to globalism. The same is true with the political world. Domestic politics cannot remain isolated from international politics. International situations cannot but impact on domestic political developments and in return domestic considerations influence the international policies of a nation. In last week’s elections in Japan, one of the issues hotly debated in the election campaign was the impact of volatile exchange rates on the nation’s economy and voters’ living standards. The opposition parties, including socialist parties and others, tried to capitalize on the serious adverse effects on industrial activities caused by a very rapid and sharp appreciation of the yen since last September, criticising the Government for its handling of monetary issues.

This and other issues are none other than the reflection of major changes which have taken place in the political and economic situations both at home and abroad in recent time. Japan has now attained the status of economic power second to the US, and is asked by the international community to make a contribution proportional to the expanded influence it now exercises. Prime Minister Nakasone stated in his address delivered before the Canadian Parliament in January this year that “for Japan, which has long enjoyed the benefits of world peace and prosperity and of freedom and democracy, it has now become a national mission to respond positively to the call of the international community and to exert its energies toward the happiness of mankind”.

In this address, he also emphasized the need to strengthen solidarity among the free nations of the world and stated that “Japan has established as fundamental policy the maintenance of our peaceful and stable society on the basis of political and economic cooperation among the countries of North America and Western Europe and Japan, which share the same values”.

You will recall that Japan participated actively in the political declaration of the Williamsburg Summit in 1983. This act by the Japanese Government was particularly significant for Japan in that it participated directly in the discussion of Western security in the firm belief that solidarity among the Western nations is important in the context of the East-West relationship, particularly following the Russian military action in Afghanistan.

In this connection, we in Japan are very happy to note that the Tokyo Declaration of this year’s Summit stated the belief of the summit leaders in a significant contribution by “close partnership of Japan, North America and Europe” toward “the search for a safer and healthier, more civilized and prosperous, free and peaceful world”.

DEVELOPMENTS IN THE WORLD ECONOMY
The second half of the 20th century has been a period of remarkable growth and development in the world economy. Much of this growth and the resultant prosperity have been made possible by the free world’s adoption of a trade system under the GATT-IMF régime. This régime facilitated flows of trade, investment and technology among all the countries of the world. It produced unparalleled and unprecedented prosperity of the world.

Without doubt, the US dominance of the world economy, the Pax Americana, contributed to the post-war restoration in the world economy and created a relatively stable environment for a free trading system from which all countries in the world benefited. However, as overriding US economic influence on the world economy has declined relatively and a degree of polarization has taken place, it has become increasingly difficult to maintain an international economic order solely dependent on US economic strength, and there has not been any country to take the place of the United States in the world. No individual economy can unilaterally dictate developments in the world economy any more. Instead, the world economy has developed through cooperation between and coordination of national economies. Therefore, we have entered a new era, an era of real economic interdependence. In this era, economic performance in one country affects economic developments in other countries. The economic centre of the world is no longer located exclusively in the US. It is now spread among the US, Europe and Japan, even though the US still maintains the predominant position.

The focus of economic dynamics has decisively shifted from the national economy to the world economy. The increase of capital movements accompanying trade flows has been remarkable. Particularly notable are the movements initiated by enterprising companies, which formulate their corporate strategy taking into account various factors such as the world economic situation, the economic policies of those countries where they export or have industrial operations, and exchange rate fluctuations. All of us have become keenly aware that the economic policy of any country has a direct and often readily observable impact on other economies.

This economic interdependence has brought challenges as well as benefits. Among the challenges affecting the world today are external imbalances among industrialized nations, and large and ever-widening gaps between the South and the North, along with the serious and persistent indebtedness of the developing countries. These problems adversely affect the global economic environment; they have tended to be politicized, intensifying protectionist pressure, and have generated instability in international markets.
As for the trade imbalances, we know that the US Administration under President Reagan adopted a supply side economic policy which stimulated domestic demand and in turn produced large trade deficits with many countries. Japan was one of the major supplying nations which responded to the strong demand in the US, incurring huge trade imbalances. It is also noted that export oriented economic growth coupled with excess saving over investment have brought about an unusually large current account surplus for Japan. There is a clear recognition in Japan that it cannot continue to accumulate such a huge current account surplus. Incidentally, you will appreciate that the recent decline of primary commodity prices, particularly the sharp fall of oil prices, has led to Japan paying smaller import bills. I wish to add here that one survey shows the following fact; one third of US imports from Japan cannot be replaced by US products, because it comprises original equipment manufacturing (OEM), imports from US corporations in Japan, and imports of parts and goods which are not produced in the US (like video recorders).

Since there are different systems and different phases of economic growth within the global economy, there exists a basic imbalance among countries, even though movements of goods, services and money have increased more than ever before. On one side, there are countries which tend to spend more than they can afford in terms of supply from their own resources. And on the other side are countries which tend to spend less than they can afford in terms of supply from their own resources. As the Economic Declaration at the Tokyo Summit this May said, “If large imbalances and other distortions are allowed to persist for too long, they will present an increasing threat to world economic growth and to the open multilateral trading systems”. “In formulating our policies, we need to look to the medium and longer term, and to have regard to the interrelated and structural character of current problems”. Unquestionably structural adjustment is called for as the urgent task facing the world today.

Japan, the US and European Community (EC) all have important roles to play in order to make these adjustments and revitalize the world economy in ways that ensure sustainable economic growth. Japan, as the second largest economic power in the world, can no longer play a passive role merely being buffeted by world economic dynamics. Japan is keenly aware that its economic decisions have broad-reaching consequences. That being so, Japan is now playing a positive role, seeking harmonized economic development of the world.

STRUCTURAL ADJUSTMENTS IN THE TRILATERAL COUNTRIES
I would now like to turn to the question of how the industrialized countries should promote structural adjustment. The OECD Ministerial Meeting last year stressed the importance for the OECD countries of structural adjustment. It described roles for its member nations; the US must reduce its fiscal deficits, Japan must reduce its trade surplus, and the other OECD countries must reduce rigidities in their labour markets. I recall that US Secretary of State Shultz most eloquently addressed these matters in April last year at Princeton University.

In his speech, Secretary Schultz also appealed for joint efforts of the United States, Japan, and Europe in tackling deep-rooted economic imbalances: the United States in respect of the budget deficit and high interest rates; Japan for the current account surplus and investment-saving imbalances; Europe for economic structural rigidities.

When Prime Minister Nakasone stated in New York last October, “We shall make efforts to change the Japanese social and economic fabric or structure so that it will be harmonious with the world”, I believe he had in mind something very similar to Mr Shultz’s speech. A reduction in the US fiscal deficits will definitely improve the existing imbalance between savings and investment in the US economy. This imbalance affects the position of the US dollar and ultimately impacts on its external trade situation, producing a very detrimental effect on the world economy. While there has been a significant development in the prognosis for future US fiscal deficits as a result of the enactment of the Gramm-Rudman-Hollings Act last December, there still is much to be done. We now have the verdict of the US courts declaring the Gramm-Rudman-Hollings Act to be unconstitutional. However, we are glad to see that the US is tackling the question of deficits.

At the Madrid meeting of the Trilateral Commission this May, Viscount Etienne Davignon stressed that Europe must move further and faster in reforming its economic structure. It is clear that additional labour flexibility in the EC market should be given the top priority; fostering new approaches to collective bargaining that increase job opportunities through enhanced flexibility and appropriate wage formation, and promoting occupational and geographical mobility. Conditions favouring this should be urgently provided for.

This past May, I had occasion to visit a Japanese-Spanish joint venture in Spain and found that the workers were predominantly older people. When I remarked on this observation, the company’s executive said that this was an example of rigidities in the labour market. He complained how difficult it was to hire young workers.

TASKS FOR JAPAN
Now that I have briefly touched on the roles that each of the trilateral players has in promoting the required structural adjustment, I would like to speak in a somewhat greater detail about the tasks that lie ahead for Japan.

In Japan, we recognize that it is neither desirable nor healthy to maintain a huge current account surplus. This creates economic friction with other countries. This friction destabilizes the global economy and forestalls further growth and prosperity for Japan. Japan must reorient its economy in a fundamental way.

Last October, Prime Minister Nakasone set up a private Advisory Group on Economic Structural Adjustment for International Harmony, otherwise known as the Maekawa Committee. This group submitted the result of its five-month deliberations to the Prime Minister this past April. Since I myself was one of the seventeen members of the Maekawa Committee, it is my great privilege to share with you the underlying thoughts of the Committee Report. Let me explain the salient points of consideration in this Report.

The Report was written with the basic recognition that Japan cannot and should not continue to accumulate such a huge surplus, of the order of 3.6% of GNP, as we witnessed in 1985. Japan now stands at a “historical turning point” for re-orienting both its economic policy and pattern of life. Slashing the surplus, therefore, should be a national goal. This is the Committee’s fundamental message to the Japanese people. The Maekawa Committee seeks to motivate and enlighten not only the public and the private sector leaders but also the people of the nation in meeting the formidable challenge of economic restructuring.

How are we going to do that?

1 — Expanding Domestic Demand.
Until September of last year, most observers thought that Japan’s external surplus was caused mainly by the high US dollar and the undervaluation of the yen. Since the G-5 meeting in New York, the US dollar has been depreciated by more than 40% vis-à-vis the yen while its fiscal deficits have levelled off. During the first term of the Reagan Administration, the United States maintained the position of upholding “a strong US with strong US dollars”. Now the Reagan Administration has switched to “weak dollars to maintain a strong US”. We observe the US economic policy has made a 180° turn.

It is obvious that currency realignment alone will not solve the trade imbalances. In order to tackle the fundamental question of unduly large current account surpluses, the Japanese economy must now switch from excessively export dependent growth to economic expansion powered by domestic demand.

Japan maintains excess saving over investment. This creates current account surpluses. Serious consideration has been given to various ways of reducing this imbalance between savings and investment. These measures should not aim at reducing savings, but rather should be designed to increase investment.

To this end, expansion of housing investment is most important. There is a strong need for improvement of housing conditions. Housing investment, with all the outlay required for new houses, has very high multiplying effects. Recognizing that housing investment is currently restrained by limited disposable income and expensive land prices in urban areas, the recommendations put forward are: tax incentives, deregulation of construction and land use restrictions, and fiscal “pump priming”.

A second approach is the promotion of private capital spending. For this to happen, as BIAC indicates, the rate of return on equity after tax must be higher than the cost of capital borrowing. This calls for a reduction of corporate taxes. The real tax burden on corporate profits in Japan, including national and local taxes, is 51.60%, the highest in the world; compared with 32.35% in the US, 49.84% in the Federal Republic of Germany, 18.06% in the UK, and 42.20% in France. Such tax reform proposals are now under active discussion in Japan.

Another thrust in this direction is stimulation of personal consumption. Income tax reduction, shorter working hours and a full 5-day working week are recommended in this respect. The Maekawa Report also urges tax reform from the viewpoint of achieving impartiality, fairness, simplicity, vitality, and international compatibility. It is expected that the overall review of the tax system will be finalized by the end of the year and will recommend specific reform measures. The recent US tax reform plan has attracted most keen interest and attention in Japan.

There have been those in Japan who have argued that the benefits derived from lower oil prices, which are estimated to be over $12 billion, should be transformed into macroeconomic gains, that is to say more investment and consumption, through lower prices, under flexible market mechanisms.

In sum, the Maekawa Committee’s first proposition means tapping the surplus pool of savings for investment and consumption at home, rather than abroad, thus correcting the investment-savings (I-S) imbalance.

2 — Towards an Internationally Harmonious Industrial Structure.
Second, consequent and parallel to the switch to economic expansion powered by domestic demand, a transformation of Japan’s industrial structure is required.
Japan is a society in which free competition has been operating quite intensively. Over the last four decades, Japan’s policy for industrial development has been radically transformed both in its objectives and in the methods employed to attain those objectives. The governmental role lies in eliminating obstacles to the full operation of market mechanisms. What count most are market mechanisms and the self-reliance of each enterprise.

The industrial structure of Japan is not created through an “industrial policy of the government”. It is formulated through market mechanisms. These market mechanisms work according to supply and demand factors. These factors, including rapid development of information processing technology, various consumer needs, and continual, intense competition, influence the industrial structure in Japan. It is inevitable that with changes in the business environment, some industries will lose their competitive edge, while some sectors of industry will gain competitive advantages.

Active adjustment policies to shift out of non-competitive industries and direct investment overseas are the two major forms of action which need to be taken in these circumstances. We need to import from abroad more products which at present are produced domestically and to produce overseas products which we export today. The policy objective is to expedite the process of economic restructuring and promote an international division of labour.

With regard to shifting out of non-competitive industries, the Maekawa Report says, “Japan should drastically reduce domestic production of coal and replace it with imports”.

For instance, to give you some figures, the Japanese coal industry employs 17,000 people and produces 16 million tons of coal towards a total domestic consumption of about 100 million tons per year. Although it is a declining industry, some rural districts almost totally depend on coal production for survival. The recommendation is, therefore, an extremely bold one, exemplifying the long-term policy orientation entertained by the Maekawa Committee.

Furthermore, the Committee recommended accelerated completion of industrial structural adjustment programmes under the “Depressed Industries Law” which is due to expire in 1988.

The other field for action in industrial restructuring is direct investment overseas both inward and outward.

Investing overseas will help resolve external current account imbalances and it will contribute to economic development in host countries. As can be seen already, in automobiles, colour television sets and other consumer electronic products, such investment will lead to less exports and more local employment.

Direct investment overseas has been expanding rapidly in recent years and should be further encouraged. In this regard, the Keidanren (the Japanese Federation of Economic Organizations) has taken an active role. This Organization has already sent three investment expansion missions to 16 states in the US this spring. It also sent economic missions to Europe, visiting the UK, the Netherlands, Belgium, Italy and France in January this year and visiting Portugal and Spain in May.

In relation to direct investment overseas, there is talk of “deindustrialization”, which is reportedly happening in the US. Business Week Magazine of March 3, 1986 quoted Mr Morita, Chief Executive of Sony Corporation, as saying, “American companies have either shifted output to low-wage countries or come to buy parts and assembled products from countries like Japan that can make quality products at lower prices. The result is a hollowing of American industry. The US is abandoning its status as an industrial power”. This phenomenon brings about continuous and structural trade deficits in the US.

By analogy, some observers expressed concern that Japan may lose its industrial base by expanding direct investment overseas. That is, Japan’s economy could become deindustrialized through the further expansion of direct investment overseas. However, I do not believe that the problem of the so-called deindustrialization’ happens to pose a serious threat to Japan. I would like to point out what is happening to Japanese industry right now. As you all know, some Japanese sectors such as steel, shipbuilding, textiles and petrochemical industries have been facing fierce competition, particularly from the newly industrialized countries (NICS). However, these Japanese industries have been working hard to reform their structure so that they can shift their products to more value-added ones. For example, these industries place much more emphasis on high-technology and engineering, and put greater resources into the research and development of new materials. These efforts have been made possible by the relatively long-term perspective of Japanese management. They are also due to a receptive response by labour unions and a flexibility in Japan’s labour market. When more Japanese industries shift their production sites overseas through expanding direct investment overseas, Japan will cope with the resultant situations domestically by creatively introducing more sophisticated products.

As for investment in developing countries, the transfer of technology and management will enhance industrial development and promote export industries of the host country. This will also contribute to alleviating the debt problem. In this vein, governmental economic assistance, private sector technology transfers and cooperation in marketing efforts geared to increasing manufactured imports from developing countries are also recommended.

On the other side of the coin, foreign companies should also be encouraged to invest in Japan. This will contribute to internationalizing Japan’s economic structure, reducing the distance between foreign suppliers and Japanese consumers and facilitating the effective introduction of foreign companies into the Japanese distribution system.

3 — Further Improving Market Access.
Now, I wish to turn to the question of trade imbalances. There are many cases of countries with high trade barriers that have high trade deficits and countries with low trade barriers that have trade surpluses. Although we appreciate the US Administration’s efforts to maintain free track under very difficult circumstances, the Unite States has, as a matter of fact, restricted track through numerous non-tariff measures, including “voluntary restraint arrangements” (VRAs) on automobiles, steel, machine tools and so on. Despite these steps Japan’s trade surplus has increased, while the US trade deficit has not declined.

The question of market access involves a matter of perception. On many points of criticisms by trading partners against Japanese market conditions, oftentimes the Japanese do not share the views they express. There certainly exist differences of perception on a given point.

The Japanese counter this kind of criticism by mentioning the lack of marketing efforts and ignorance of market conditions existing in Japan on the part of trading partners.

Indeed, there are lots of success stories of foreign corporations which have made successful efforts to penetrate the Japanese market. However, as long as Japan remains subjected to this kind of criticism, we have to look into the matter without any prejudice and make efforts to improve the situation.

Having regard to the increase of our huge current account surplus, we have redoubled our efforts in tackling the question of market access in order to dispel doubts about the openness of our market or the fairness of our trade practices. The MOSS (Market-Oriented, Sector-Selective) talks and the Action Programme have been the two major vehicles for our recent efforts in this regard.

The Joint Report by Foreign Minister Abe and Secretary Shultz of January 10 on the MOSS concluded, that important progress has been achieved as a result of the MOSS discussions for the four sectors.... telecommunications, medical equipment and pharmaceuticals, electronics, and forest products”. Secretary of State Schultz cited “very substantial purchases” by Japan as evidence of the success. The MOSS process will be continued to cover a new sector. While the MOSS process is a bilateral discussion between the US and Japan, it goes without saying that the fruits of the MOSS benefit other trading countries.

With regard to the Action Programme introduced last July, it was formulated from the viewpoint of “freedom in principle, restrictions only as exceptions,” and it took account of criticism sometimes voiced by foreigners that Japan’s opening-up initiatives are no more than nice-sounding words. The Programme was designed to achieve radical improvements in market access, including large-scale tariff reductions and the elimination oF 1,849 tariff items, and drastic changes in the standards and certification systems and import procedures.

A variety of measures dealing with capital markets, services and import promotion have been executed in order to enhance access for foreign products. While it is difficult to describe quantitatively the degree of implementation of the programme, roughly speaking, I should say more than 70% of the three year programme has already been implemented.

4 — Stability in Exchange Rates.
At the Tokyo Summit, the leaders of the seven
major industrialised countries and the representatives of the European Communit3 stated that the objectives of improved coordination should include the fostering ol greater stability in exchange rates. To this end, they requested the seven Finance Ministers to review their individual economic objectives and forecasts collectively at least once a year, conducting multilateral surveillance using objective indicators. Since the currency question has been of the utmost concern to all the world economic communities and yet has remained unsettled for some time, calling for urgent attention by all, this new initiative should be followed up by positive and constructive efforts on the part of the governments concerned.

As regards the conduct of the ‘review’ using indicators, I think some specific points should be taken into consideration. For example, in terms of statistics, the ratios of Japan’s fiscal deficits to GNP are recorded to be smaller compared with those of other Summit countries, because Japan’s expenditures for social welfare are less than in other OECD countries, due to the less aged population and to the comparatively shorter history of the country’s social welfare scheme. Also, statistically, Japan’s unemployment rate is presented as lower than in other countries, because of a different definition of unemployment and different employment practices.

Though there are some concerns about multilateral surveillance by the use of the indicators, stability of exchange rate carries an overriding importance, because Japanese industries are complaining about the pains as well as uncertainties caused by the sharp and exceptionally rapid rise of the yen. These pains and uncertainties for the future have already brought a negative impact on investment behaviour by corporations.

Stability of exchange rates reflecting the economic fundamentals of each country is emphasized. The recent yen appreciation is considered as a vehicle for economic structural adjustment, and stability of exchange rates is essential for smooth and continued adjustment.

The need for major countries to pursue economic policies compatible with one another cannot be stressed too much if exchange rates are to be stabilised.
While ensuring international compatibility of basic economic policy, it is important that efforts should be made to build upon the accumulated experiences of international cooperation in developing a framework for future stability. In this connection, I think it is most important that there should be opportunities for experts to exchange views frankly on monetary issues, in order to find ways to reduce volatility in exchange rates, as they did last autumn in Washington, DC, and at the International Parliamentary Working Round on Exchange Rate and Co-ordination held in Zurich last month.
5 — Promotion of International Cooperation.
Finally, the Maekawa Committee’s Report proposes that Japan should play a more active role for the well-being of the entire international economy.
Just after World War lithe US recycled its trade surplus through financing international public goods, by strengthening the financial bases of multilateral development and financial institutions such as the World Bank and IMF, and providing the Marshall Plan for Europe. These US efforts provided the basis for recovery from the devastation of war and the subsequent economic development on a tremendous scale that took place in the post-war era. Recently, international indebtedness and the rapid decline in prices of primary products have forced us to pay renewed attention to the question of international assistance. Although the recent oil price decline is considered to have beneficial effects in general, the full impact on oil producing countries, especially debtor countries, is yet to be assessed, calling for overall review of the problems involved.

I consider it is high time for Japan to come forward with ways to utilize, for international purposes, the benefits produced by the oil price decline. This is especially true since Japan has now accumulated as sizeable a current account surplus as the US did after World War II.

At the same time, Japan should make increased efforts to make an international contribution in the fields of science, technology and culture. We should also help to promote Japanese language education and Japanese studies overseas.

In the field of trade, the Tokyo Economic Declaration states that the Summit countries, “are fully committed to the preparatory process in the GATT with a view to the early launching of the New Round of multilateral trade negotiations”. GATT will hold a final preparatory meeting in July to produce a draft declaration and will hold a ministerial meeting in September in Uruguay for the purpose of promoting a New Round. We welcome such progress leading to early launching of a New Round. In this New Round, we should respond positively to matters of interest to developing countries and strive for the establishment of international rules in such new fields as trade in services and intellectual property rights.

The promotion of this new round is essential to stem growing protectionist tendencies and to rebuild and reinforce the General Agreement on Tariffs and Trade. As leaders in the move to preserve the free trade system, Japan, the United States, and Europe must demonstrate their firm opposition to protectionism and take the initiative in moving the New Round forward.

The tasks ahead are not easy for any of us. There is no panacea, and the current account imbalance will not disappear overnight.

Structural adjustment requires time, and, empirically, it often encounters political resistance. Tenacious efforts and extraordinary vigour are called for to meet the challenge, and policies must be consistent in the medium and long-term perspectives. A comprehensive approach and cooperative actions are needed in the light of the interrelated nature of the current problems facing the world economy. Because of the close interconnection of the international economic imbalance, the Japanese efforts will bear fruit effectively only if coupled with similar efforts on the part of the US, the EC and the rest of the world.

Sharing common objectives, the United States, Japan and other OECD countries will without doubt meet positively this formidable challenge of restructuring. What we need now is the courage to tailor our policies and turn visions into reality.

We face a strong challenge brought about by technological innovation and the integration of markets. But this challenge can open a new horizon of opportunities.

We stand at a crossroad. The actions taken today will critically affect the world economy in the coming decades.