Economic Reforms and U.S.-Japan Relations
Ambassador Howard H. Baker, Jr. at the Symposium on Building the Finanical System of the 21st Century
Gotemba, October 4, 2003
As Prepared for Delivery
I am delighted to be here in Gotemba for a conference renowned for bringing together key public and private financial sector leaders from our two countries.
I must confess that my main experience is in the area of political analysis - and practice - rather than economics. I therefore won't attempt to replicate the in-depth analysis of the Japanese economy and financial system provided by such luminaries as John Taylor, Glenn Hubbard, and Shinjiro Takagi - especially in front of this audience of financial practitioners. However, I thought it would be useful to give a brief review of the state of U.S.-Japan relations and the importance of that relationship. I'd also like to note some of the reasons why I remain optimistic about Japan's future before offering some observations on economic issues both here in Japan and abroad.
I believe that U.S.-Japan relations today are the best they have ever been. Our security partnership with Japan is the cornerstone of stability in East Asia and the Pacific. Just as important, Japanese cooperation is instrumental across the spectrum of issues the United States faces around the world, from the reconstruction of Afghanistan and Iraq, to the war on terrorism, to attempts to preserve stability on the Korean peninsula.
The current strength of U.S.-Japan relations reflects the fact that we are not only allies with mutual security interests - we are also friends. That friendship is based on shared values such as the importance of democratic institutions, as well as our common interest in international peace and prosperity and in open competitive markets both at home and abroad.
Another factor that has helped strengthen the ties between our countries is the close personal relationship between President Bush and Prime Minister Koizumi - which I have witnessed first-hand. The two men genuinely like and respect one another, and that kind of relationship at the top can't help but improve ties all the way down the line.
Japan is important not only to U.S. security interests, but also to our prosperity. Japan is our largest trading partner and our largest export market outside of NAFTA. I often say that when Japan prospers, America prospers, and when America prospers, Japan prospers. Both Japan and the United States benefit from our ability to buy and sell goods and services freely between our two countries. Just as important are the benefits we derive from investing in each other's countries. Those international investment flows enable firms and individuals in each country to finance, and to reap the benefits of, economic growth in the other country.
Both Japan's ability to continue to play a leadership role on the international stage and its capacity to contribute to global prosperity are critically dependent on the health of its domestic economy. A Japan with a growing and dynamic economy is better able to contribute to peace and stability in the region and around the world than a country with an economy stuck in neutral. And a vibrant, dynamic Japanese economy could of course better contribute to healthy balanced global growth, complementing the recent signs of improvement in the U.S. economy.
The importance to the United States of a healthy Japanese economy explains our focus on Japanese economic issues, including the banking system and regulatory policy. It is also why we have been so supportive of Prime Minister Koizumi's economic reform efforts.
There is no shortage of analysis on the problems confronting the Japanese economy. All economists cite the need to fix the bank bad loans, persistent deflation, excessive regulation, and large government deficits in order for Japan to return to a healthy growth path. I won't deny that those concerns are real. But I think it's also useful to remind ourselves of the resources Japan has at its disposal to meet those challenges and secure a bright economic future.
The most important resource Japan can bring to bear is abundant human capital in the form of an industrious and well-educated work force. The growing number of Japanese Nobel laureates and the increasing prominence abroad of Japanese popular culture provide ample evidence of intellectual and cultural dynamism. Another key resource Japan has in abundance is industrial capital comprised of a large number of world-class firms across the spectrum of consumer and industrial products and services. A third key resource is financial capital as the world's largest creditor nation, with over $12 trillion in household financial assets.
But the most important reason for my optimism about Japan's long-term outlook is the fact that Japan is a well-governed democracy, whose institutions are under the rule of law and ultimately subject to the will of the people. I believe that key strength will allow Japan to marshal the human, industrial, and financial resources needed to address its economic challenges.
In that regard, I am especially encouraged by the renewed commitment to economic reform expressed by Prime Minister Koizumi after his recent re-election as LDP President and his selection of the new cabinet. The Prime Minister's continued high level of popular support despite policies opposed by key constituencies is evidence of enduring political impetus for economic reforms.
The composition of the new cabinet suggests there will be no slackening of the momentum for economic reform, including in the key area of banking sector policy. Some observers had criticized the government's Financial Revival Program as insufficient when those measures were announced a year ago. However, Resona Bank's recognition that it was under-capitalized and needed public funds showed that Japan is making real progress toward improved evaluation of banking system assets and capital. And the speed and skill with which the Japanese authorities acted contained the risk of contagion and financial instability.
Even more important than the crisis management skills demonstrated in the Resona recapitalization was the government's insistence on replacing bank management and a substantial dilution of existing shareholders as a condition for providing public funds. The recapitalized bank's recent announcement that it will increase loan loss charges to \1 trillion is a hopeful sign that the new management will do what is necessary to return Resona to financial health.
The government's determination to impose tough conditionality on banks receiving public funds is heartening. It shows that Japan has learned from the mistakes of the past, when the government provided funds without requiring the management and operational changes needed to prevent the problems from reappearing.
The Resona recapitalization may not be perfect. Some observers have criticized the government for merely diluting the bank's shareholders rather than wiping them out. They argue that more severe penalties for shareholders would enhance incentives for investors to monitor management more carefully. Those are compelling arguments for including even tougher management and shareholder responsibility principles in the new framework for public funds injections than those used in the Resona recapitalization. But when all is said and done, I think most observers would agree that the conditions imposed in the Resona case were a step in the right direction.
I am also encouraged by continued progress in the area of corporate restructuring. The jury is still out on whether the Industrial Revitalization Corporation of Japan will be able to take on enough business to make a major contribution to addressing the "bad borrower" side of Japan's bank bad loan problem. But there can be no question about the talents and dedication of many of the IRCJ's leadership, including Professor Takagi as well as some current and former employees of firms represented at this conference. If the FSA forces the banks to write down their loans to their market prices, the IRCJ and private sector investors can be a real force for change in Japan's corporate sector. But even beyond the IRCJ, Japan now has in place much of the infrastructure needed to restructure its corporate sector, including improved bankruptcy laws.
Just as important as new public institutions and an improved legal framework, there are encouraging signs of increased use of measures to improve corporate governance. A growing number of firms have outside directors on their corporate boards and audit committees. There are also increasing signs of auditors asserting their independence from management and their need to represent the interests of shareholders.
Japan also has a growing body of domestic turnaround firms and distressed asset investors. These domestic players can complement the foreign-owned distressed asset firms. Perhaps even more important, the increased role of Japanese firms can help defuse the political stigma that has in the past been associated with investment in distressed borrowers. Too often in the past, bank reform opponents have played on concerns about foreign investors buying up Japanese firms on the cheap. I hope that the growing presence of Japanese distressed asset investors will help limit the use of nationalist rhetoric by opponents of faster NPL disposal.
I would also like to reject once and for all the misperception that the U.S. support for bank reform was intended to promote the interests of U.S. distressed asset investors. A whole range of otherwise respectable Japanese commentators and public figures have repeatedly mischaracterized U.S. objectives in this way. U.S. firms and investors may well benefit from more rapid disposal of the banks' bad loans. But my contention has always been that Japan would be the main beneficiary of growth in the distressed asset market - through improved resource allocation leading to stronger economic growth.
Over the past five years, Japan has attracted less than $9 billion per year in net foreign direct investment inflows. That's less than two-tenths of 1% of GDP, by far the lowest such figure among industrial countries. Prime Minister Koizumi recognized the potential benefits to Japan of increased foreign investment when he promised to double the stock of FDI in Japan over the next five years. The Japan Investment Council has published a report listing dozens of measures to improve the investment climate. The ACCJ and the U.S.-Japan Business Council are both working on reports this year with similar recommendations. Local governments around Japan are taking the initiative to attract foreign investment, establishing investment promotion offices in the United States, organizing seminars to highlight their special characteristics, and even sending missions led by progressive governors. The U.S. Embassy is working closely with METI and JETRO in our Investment Initiative to increase the flow of foreign investment to Japan.
We hope Japan will now implement the many excellent recommendations from economic and business experts. One good step involves changes in Japan's legal and regulatory system. For example, cross-border mergers receive different treatment than domestic mergers in Japan, and this greatly discourages foreign investment flows into Japan. I know that several Ministries are working on rectifying this problem, and I can only encourage them to do so.
Indeed, it seems to me that if we all work together on investment, we can easily surpass the Prime Minister's goal. Over the past five years, the U.S. has attracted nearly a trillion dollars of new FDI, a figure equal to almost 10 percent of our annual GDP. Imagine if Japan had pulled in this amount over the same time period - we would hardly be talking about "economic doldrums." The point is that major economies have the potential to attract major investments, and I am confident the Japan will no longer be an exception over the years ahead.
We also welcome the Koizumi Government's continued commitment to regulatory reform. Our own experience - as well as the experience of Japan and a wide range of other countries - shows that removing regulatory and other barriers leads to stronger economic and productivity growth, higher living standards and increased competition. Regulatory and structural reform is also essential to remove the barriers to the establishment of new businesses. The Special Zones for Structural Reform are one way to accelerate regulatory and structural reform in Japan. Japan's localities have a wealth of creativity and knowledge and can work with the private sector through these zones to improve business conditions. We hope to see more successful zone proposals approved by the ministries and for the Koizumi government to spread the reforms to the rest of the country. I firmly believe that the Prime Minister will accelerate the pace of his regulatory and structural reforms and that Japan's economy benefit.
Nothing has been more fundamental to the prosperity enjoyed by both Japan and the United States than removing barriers to foreign trade. In that regard, The WTO Ministerial in Cancun was a missed opportunity. The United States came to negotiate and play a constructive role, despite our many domestic sensitivities. It was unfortunate that others were unwilling to do the same. We continue to support ambitious global trade liberalization, and remained convinced that this would benefit all countries, developed and developing alike. For with trade liberalization, poverty is reduced, economies grow, incomes rise, jobs are created, costs are lowered, and consumers get more choices.
Achieving success in the Doha negotiations is in Japan's economic interest, and would bolster economic growth and reform in Japan. As global leaders and economic superpowers, our two countries have an obligation to lay the groundwork for stronger global growth and to help reduce poverty in the developing world. In the coming months, Japan has important decisions to make. We look to Japan to join us in demonstrating leadership and vision in seeking to bring the negotiations to a successful conclusion.
President Bush will soon be on his way to Bangkok for the annual meeting of the leaders of the twenty-one economies in the Asia-Pacific Economic Cooperation forum, together representing half of global trade and more than half of global GDP. When the United States invited APEC leaders to meet for the first time ten years ago at Blake Island, Washington, they envisioned an "Asia-Pacific community" that promotes prosperity through cooperation. At their eleventh meeting in Bangkok, APEC leaders will face some of the same economic challenges. Then it was bringing the Uruguay Round of trade negotiations to a successful close; this time they must consider how to proceed with the Doha Development Agenda following the Cancun WTO Ministerial. But in many ways APEC leaders are confronting new and different circumstances, including terrorism, and the reconstruction of Iraq and Afghanistan. At the same time, here in Japan the Koizumi Administration is reinvigorated by the Prime Minister's victory in LDP party elections and subsequent changes to his cabinet. The United States, Japan, and the other APEC leaders, along with the rest of the world community, have both an opportunity and a responsibility to address these new circumstances, because the economic and security spheres cannot be managed in isolation but will affect each other.
I'd like to conclude my remarks by noting my deep and abiding respect and affection for the Japanese people - sentiments I believe are shared throughout the United States. Our two peoples have learned much from each other as we have benefited from the past 150 years of cultural, intellectual and commercial exchanges. I believe this conference can contribute to further deepening our mutual understanding of the economic and financial ties that bind us together.