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Japan's financial role in the 1990s.

Japan is experiencing the best economic performance among the major industrial countries. The effects of the Gulf Crisis on Japan may be less severe than in the 1970s. After considering near-term concerns, the author discusses longer-term challenges of declining savings, an aging population and a falling savings ratio. From an international point of view, future problems include financial market fragility, regional integration and the transition to market economies of Eastern Europe and the Soviet Union. International policy coordination will be necessary, with particular emphasis on fiscal discipline.

BEFORE DISCUSSING Japan's financial role in the 1990s, I would like to make a brief comment on recent developments and provide some perspective on the Japanese economy.


As you have seen on the World Economic Outlook issued by the IMF, the Japanese economy has been showing the best performance among major countries - maintaining the highest growth rate (+ 5. 1 percent for 1990), the lowest inflation (+ 1.5 percent for 1990) and lowest unemployment, while the balance of payments surplus is steadily declining (+ $47.5 billion for 1990; in the GNP terms, 1.7 percent from 2 percent in 1989).

In spite of some concerns that corporate investment and private consumption might slow, because of the so-called "triple decline" in some financial assets' prices (stock prices, bond prices and the yen's exchange rate) in the earlier part of this year, the performance of the real economy had not been affected.

It is almost impossible to predict at this stage the impact of the Gulf Crisis on the Japanese economy in the precise terms. However, a general perception exists in Japan that the impact is expected to be smaller or less severe than earlier ones in the 1970s. Higher oil prices will weaken economic growth somewhat and cause inflationary pressures to increase, but it is generally expected that, provided the price of oil remains within the range of $27-$30 for the rest of 1990 and the duration of the crisis is rather short (say six months), the growth rate of the Japanese economy would be pushed down by 1/2 percentage point (from 5 to 4.5 percent) and the inflation rate might be pushed up by 3/4 to 1 percentage point (from 1.5 percent to more than 2 percent). At any rate, the impact will be less severe than in the previous two oil shocks.

The Japanese economy has undergone significant structural changes in response to previous oil shocks. Conservation of oil consumption has progressed and stockpile of oil is high (at least 158 days). In addition, inflationary expectations of both corporations and household have been so far contained, and there has been no conspicuous speculative move in both corporate and household sectors.


Having said that, I did not mean that things will continue to go well. There are several sources of concern for the future:

1. Labor shortages and rising unit labor costs

2. Continuing high rate of growth of the money supply

(in terms of M2 + CDs, money supply is still more

than 11 percent higher than the previous year's

level, although it has started to decelerate very


3. Possible resurgence of an increase in commodities

prices (in particular, oil prices).

Under these circumstances, the Bank of Japan decided to raise its official discount rate by 0.75 percent to 6 percent on August 30. Since then, the stock and bond markets have shown a certain instability. Particularly, the decline in stock prices bas been rather pronounced. But such a decline is still widely considered as a correction of past financial bubbles. The causes of the recent fall in stock prices are considered to be the following: 1. Market concerns about a further outflow of funds

from the stock market, reflecting prevailing expectations

of higher interest rates. 2. Market concerns about the negative impact of the

Gulf Crisis on Japanese economic fundamentals,

particularly, fears of outbreak of war and resultant

stoppage of the supply of oil from the Gulf. 3. Significant increase in program trading of equity

stocks and various arbitrage operations, which did

not trigger the decline but must have accelerated

the process of decline. Fortunately, however, these developments in the stock market have not affected the performance of the real economy, Corporate fixed investment and private consumption are firmly sustaining a robust growth of the economy, and the yen's exchange rate has been strengthening. But if the recent weakness of the stock market continues, corporate (investment) behavior may change somewhat in the future, because raising low-cost funds through new issues of equities would remain almost closed for a while; some financial institutions are already beginning to feel a certain negative impact of these development on their business performance and their plans to strengthen the capital base. We can't be too optimistic.

Coinciding with these developments in the financial markets and steady decline in the current account surplus, there are interesting discussions going on in Japan whether "The sun also sets" or "The sun is still high." No doubt the sun will set in the end, but, insofar as the above-mentioned discussions are concerned, the truth is somewhere in between, as is often the case.


The following are underlying conditions of medium-term concern: narrowing of net savings in terms of I-S balance; an aging population; and a declining savings ratio.

Recent decline in net savings during the period of 1988-89 reflects a sharp increase in corporate investment, which was the result of corporate efforts for survival under the pressures of the strong yen. Corporate investment is expected to maintain the current strong momentum, and it will result in our increase in productivity and competitiveness in the future. Thus it will contribute to an increase in savings in the medium term.

The household sector is unlikely to reduce its savings in a dramatic way. The savings ratio of the household sector declined gradually from 23 percent in the mid-1970s to 15-16 percent in 1989, but it has fluctuated year by year. It is true that the consumption behavior of the general public has changed, but it is yet uncertain whether such change will lead to a decline in the savings rate. What is crucial in this context is the fiscal policy stance of the government. Our government made a commitment to increase the public works expenditures at the SII negotiations with the U.S. Even if the implementation of such a commitment were well managed, it is inevitable that the public sector deficit would increase again.

It is also true that the Japan's population has been aging, but the issue of aging population is unlikely to become a serious problem before the early twenty-first century (in 2030, the share of age group above 64 will be 24 percent).

All in all, a moderate decline in Japan's net savings is expected, but its net savings (external surplus) will not disappear and Japan would maintain its status of capital generating country.
 Savings as a Percent of Nominal GNP
 Mid-1970s Mid-1980s 1989
Household +10 +9.5 +9.3
Corporate -5 -1 -6.9
Public -6 +4.5 +0.6
External - -4 +2.0


Reflecting Japan's economic development throughout the past two decades, Japan's financial markets and financial system have experienced significant changes. Large domestic net savings have been accumulated, and as a result Japan has become the largest capital generating country in the world. Also, financial and real assets have been accumulated under prolonged easy money conditions. Reflecting these developments, the outstanding financial assets of the domestic nonfinancial sector as a whole have grown at a considerably higher rate than the growth rate of the real economy. Outstanding assets were 3.6 times nominal GNP at the end of 1988, compared with only 1.9 times at the end of 1975.

Against such a background, firms and households have become more sensitive to interest rate fluctuations, and their fundraising and investment activities have diversified. The leverage ratio of the nonfinancial corporate sector fell rather sharply during the past ten years (45 to 35 percent). This is in a sharp contrast to the clearly rising trend of the leverage ratio in the U.S.

In response to these changes, Japanese financial institutions have also promoted globalization to meet various needs of Japanese corporations abroad as well as in domestic markets. At the same time, Tokyo has emerged as an international financial center and has begun to provide a source of yen funds and a market for international capital flows.


Reviewing the economic and financial developments in the 1980s worldwide, we recognize that the major economies resolved some short-term crises rather successfully, such as energy crises and the stock market crash in 1987. They dealt with other major macroeconomic issues with mixed success, such as sustaining noninflationaly growth, managing floating exchange rates, keeping markets open and protectionism in check, and responding to the LDC debt problem.

All these issues remain on the agenda for the 1990s. In addition, there are the following complex and systemic issues:

1. Financial market fragility

2. Regional integration of economic areas: Europe in

1992, North American Free Trade Area and, although

more loosely defined, increasing economic

interdependence in the Pacific Region.

3. Transitions to market economies in Eastern Europe

and the Soviet Union.

Financial Fragility

In the area of financial market fragility, Japan is expected to play a crucial role. Japan has to correct financial bubbles on one hand, but has to avoid serious turbulence in the current financial markets. Correction of Japan's high stock prices has substantially progressed. Although there remains certain uncertainty in the markets, current market conditions appear to be somewhat exaggerated by the fear of war in the Gulf.

In order to minimize systemic risk in the financial markets, what is most important is that an individual financial institution has to strengthen its self-discipline in risk management. In the wake of the recent developments in the financial technology, various risks are emerging. At the same time, it is important for the official sector to improve the safety net mechanism. In this regard, the role of a central bank in important and international coordination is all the more required in order to cope with moral hazard problems.

Regional integration

Under a global framework of the so-called "Tripolar" relationships among North America, Europe and the Western Pacific (Asia Pacific), a crucial question is whether this new relationship will produce conflict over economic issues or a healthy combination of competition and cooperation. Looking back on the past ten years' history of economic and financial integration of major economies, the only way towards the prosperity and stability of the world economy is to keep such Tripolar relationships benign. At the same time, since the risk of economic conflicts continues to intensify, the U.S., Europe and Japan should bear collective responsibility under U.S. leadership for the stability of the framework. In the international currency and trade fields, these three should play a role of collective anchor for the stability of regimes. In economic fields, all major countries should coordinate their macroeconomic as well as microeconomic structural adjustment policies.

For Japan, it is imperative to maintain noninflationaly sustainable growth. Japan, at the same time, has to continue to provide the rest of the world with some net savings to finance various demands. At the same time, in order for the yen to become more easily usable globally, it is indispensable to promote further liberalization of the Japanese economy. In this context, the SII is useful and acceptable, but we should bear in mind that structural reforms are basically support measures for demand management and can't be a substitute, and reforms take time.

In the wake of recent dramatic change in the world political-military structure, the economic issues among major countries have become more complex. We are no longer able to look at issues simply from the economic viewpoint. In particular, as for Japan, we recognize that there is still an ominous picture of Japan and the Japanese in some American journals. They say that Japan is unique and peculiar, an enigma difficult to solve through ordinary reasoning, a player who follows completely different rules, and therefore, the spread of Japanese power must be contained. These discussions seem to be providing a kind of theoretical ground for advocates of protectionism to attack Japan. The world is, however, becoming increasingly interdependent, and there is a strong support for cultural pluralism. The world is seeking ways for each nation and people to get along with others without giving up their special features. This is not the time to discuss whether Japan fits into the world or not. Clearly Japan is within the world.

Having said that, I do not intend to justify slow action or sometimes inaction on Japan's side. The Japanese must modify their behavior in many respects. They themselves share the blame for their current treatment as strangers, since for many years the Japanese have repeatedly emphasized how unique they are. Yet many Japanese are seriously concerned about the role Japan should fulfill at this time and they are well aware that some existing customs and institutions must be changed.

East Europe

I am pleased to learn that the currency and economic unification of Germany has shown a good start, while there remains a lot of problems to be solved.

In order for East Europe and the Soviet Union to transform their economies to one based on a market mechanism, some dramatic changes in the economic and social framework are required, and major countries should extend assistance to them in facilitating these changes. Problems to be solved and tasks to be tackled are really formidable, e.g.:

1. How to absorb unfulfilled purchasing power without

causing inflation,

2. How to enhance the supply condition of the


3. How to develop institutional and legal infrastructures

to induce and encourage foreign investment,

4. How to accumulate managerial and technological


5. How to improve the quality of the labor force, and

6. Finally, how to coordinate the economic, financial

and political relations between East European

countries and the Soviet Union.

In addition to these problem and tasks, there is another, but most crucial problem: How to finance the cost to absorb these East European and Soviet economies into one international market economy and how large the cost will be.

No plausible estimates about this cost have yet been made. What we could only presume at the moment is that the size of the financial needs and cost will be formidable, but net savings available for this purpose around the world is rather limited even in the medium term, taking into account the overhanging needs to finance LDC debt and the U.S. budget deficits. But, the task to absorb East European and Soviet economies into the international market economy is the most important historical challenge with which the world economy has been faced since the end of World War Il. We have to accomplish this task, and, thus, financially speaking, all the major countries have to try to save more and/or spend less in the medium or long term in order to cope with this task.


In concluding, I would like to reiterate that, in order to implement the historical task with which we are now faced, the U.S., Europe and Japan should bear collective responsibility under U.S. leadership, further enhancing international policy coordination.

In this context, what should be done first of all is to incorporate fiscal policy discipline in the framework of macroeconomic policy coordination among nations and, in particular, for the U.S. to reduce its budget deficits. More globally speaking, in order to enhance policy coordination among nations, we have to improve our multilateral surveillance process. And for that process:

1. We, the major countries, should be prepared to

pursue firmly the common policy objective of "noninflation"

through prudent fiscal and monetary policies,

2. We should act forcefully as well as flexibly in a way

to convince markets fully, and

3. We should be prepared to subordinate our national

interests to international objectives when really


As you are well aware, now the U. S. and Japanese financial markets are almost completely integrated. But the U. S. and Japanese manufacturing industries are also multinationalized and intertwined in their operations. Money and capital move around across the border throughout twenty-four hours. Under the globalized and interdepended world, no matter which country a corporation comes from, what really matters is whether new capital, technological knowhow and managerial expertise are contributing to the innovations, improvement of productivity and the prevention of undue conflicts among nations.

As we see in such a close and interdependent relationship between the U.S. and Japan, as with marriage, the close international economic cooperation can be enjoyed only at the expense of something. Further enhancement of a good relationship between the U.S. and Japan is all the more crucial in the 1990s to all countries in the world.

* Takeshi Ohta is a Special Adviser to Daiwa Bank, Tokyo, Japan. He was former Deputy Governor for International Relations, The Bank of Japan. This article was presented at the 32sd Annual Meeting of the National Association of Business Economists, September 23-27, 1990, Washington DC.
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Title Annotation:International Perspective; presented by the author at the 32nd Annual Meeting of the National Association of Business Economists, September 23-27, 1990
Author:Ohta, Takeshi
Publication:Business Economics
Date:Jan 1, 1991
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