Reflections on the U.S. - Japan Economic Relationship and Its Future
Michael Michalak
Minister-Counselor for Economic Affairs, U.S Embassy in Tokyo
Speech at Fukui Prefectural University
December 5, 2003
I. Greeting
This is the Second time I have been to Fukui since returning to Japan in July of 2000. I came about two or three years ago to take part in a discussion of Japan's economy. At that time it was getting close to winter, much the same as today. I remember hearing about the company that makes glass-frames. The company had moved out of Japan to go to China. Many people in Japan, including out in the provinces, are now seeing China as more of an opportunity than a challenge. I would be interested, after my talk, to hear what your current views are about China.
Things seem to be changing in Japan. The economy and politics of Japan are changing into something new. I hope we are all ready for it. The change is coming and we can either manage the change and become a part of it, or be left behind by it.
II. Reference to the past (and future)
Our two countries have been important economic partners ever since Commodore Perry came to Japan about 150 years ago, but the modern U.S.-Japan economic relationship began after World War II. Then Japan was working hard to rebuild after the war, and the U.S. is proud to have played a part in that reconstruction. Japan's post-war economic miracle was truly a victory for the Japanese. It was a tremendous accomplishment and a tribute to the ability and resilience of the Japanese. Although much remains to be done, there are signs in the market place of a newly revitalized Japanese economy. Such developments are important to us all, because the world reaps the benefits of an economically vibrant Japan and America hopes that Japan will be its partner going forward into the 21st century.
III. Symbiotic Relationship: Why Japan is so important to the U.S.?
The alliance between the U.S. and Japan has never been stronger. We are thinking and working in parallel on many fronts - from the war in Iraq to the battle to pull the global economy back on a path of growth.
Our two leaders have formed a close personal relationship. Ever since they first met at Camp David two and a half years ago their relationship has been characterized by their ability to discuss the wide range of US-Japan relations - security as well as economics - in a frank and open manner. Ambassador Baker has often said that the US-Japan relationship, which has so many reasons to be a close one because of the breadth and depth of our relationship, is unique because we are also friends. And for the two largest economies in the world, to be not only allies, but also friends is an important positive development for the rest of the world.
Even aside from the close ties between our two nations, exemplified by the close personal relationship between Prime Minister Koizumi and President Bush, there are many reasons why Japan, and the economic success of Japan, is important to the United States.
Japan is the world's second largest economy. Producing 14 percent of the world's GDP, Japan's output is roughly twice that of Germany. Again to quote Ambassador Baker, "When Japan prospers America prospers and when America prospers Japan prospers."
Japan is also America's largest trade partner outside of NAFTA. In 2002, the U.S. exported $67 billion in goods to Japan and Japan sold $138 billion in goods to the U.S.
Looking at such statistics, it is easy to see why working closely with Japan on many fronts is so important to the U.S.
IV. Comparison of U.S. and Japanese Economic Trends
As the world's two leading economies, the United States and Japan have a leading role in sustaining economic growth and spreading the benefits of economic opportunity around the world. If we drop the ball there is really no one to pick it up. Economic growth along with Official Development Assistance, or ODA, is the only real long-term defense against terrorism. Economic poverty breeds discontent, frustration and forms the foundation for terrorists all over the world. Besides economic development, the US and Japan have an obligation, as two of the primary beneficiaries of the world trading system, to work together to maintain that system by promoting the success of the Doha Development Round in the WTO. So we have to play the game together and have the same goals in mind.
Recently, the United States has been doing its part to promote global growth and stability. In the past few years, the United States has demonstrated its resilience, through a recession and the bursting of an investment bubble, terrorist attacks, corporate scandals and war.
U.S. economic data in the past several months has been positive. The U.S. GDP has grown steadily and speedily in 2003, at the extraordinary rate of 7.2 percent between July and September - the fastest rate since 1984.
Japanese growth rates have also exceeded expectations and have paralleled the surprisingly speedy growth of the U.S. over the same period. According to private estimates, Japan experienced its seventh successive quarter of growth between July and September, with GDP rising 1.4 percent at an annualized rate after rising 2.3 percent between April and June. Equity markets on both sides of the pacific have also picked up. Japan's Nikkei 225 index is up about one third since April. The U.S. Nasdaq is up nearly 45 percent from last year and hit a 21 month high this month. The Dow Jones Industrial Average and S&P 500 are up 17 and 19 percent respectively compared with last year and each hit 17 month highs this month.
And I understand that some macroeconomic experts are pointing to signs that Japan's real estate market may be bottoming out.
The reasons for the recovery on both sides of the Pacific seem to be recovery of key components of domestic demand, mainly private investment. In the US Consumption continues to play a positive role, although believe it or not, American savings rates are starting to increase. In Japan, consumption has been relatively flat, but it has not been a drag on the economy and sometimes has played a positive role in recent quarters. In fact, some economists are starting to see the Japanese savings rate, which used to be the highest in the world, begin to come down to actually be around ten percent. Japan's economy, however, still seems to be rather heavily dependent on the US economy. As long as the US continue to pull in exports form Japan (and elsewhere in the world) Japan can continue to grow, but should the US slow down, the effect on Japan could be very severe. The good news is, however, that the US economy shows no signs of slow down for the next year or so. That is good news for both of our private sectors and for government policy makers. The growth gives us both a chance to move ahead with much needed reform policies in both countries.
I say this because we cannot ignore the fact that both countries have significant structural issues, for example, fiscal deficits. The U.S. fiscal deficit is most significant in the fact that we have moved from a surplus of 2.4 percent of GDP to a deficit of 3.5 percent of GDP in only three years. Japan's deficit has been more longstanding and now stands at about 6 percent of GDP. I remember when Japanese government officials would lecture us about our "twin deficits" and it looks like we are going to have to get back to fighting that problem again in America.
Deflation continues to be a problem in Japan. Prices are still falling in Japan, but we thought the situation was getting better until the second quarter of this year when Japanese deflation was 2.5 percent This was among the highest quarters of deflation since Japan went into a deflationary spiral in late 1994. As a result of deflation, Japan's economy is still shrinking in nominal terms - because although output is rising, the yen value of the output is falling. In the US, economists, especially at the Federal Reserve, have been watching carefully for signs of deflation but so far it seems that monetary policy has led us down the proper path for avoiding that problem.
The banking system is perhaps the one sector of the economy that can benefit most from the recent economic upturn. Japan's financial system continues to battle with non-performing loans, although there has been some improvement in this area as well over the past year. The U.S. faced similar issues in the early 1990s with our Savings and Loan crisis. We took longer than we should have in setting up the Resolution Trust Corporation (RTC) to take over and dispose of our bad loans. Japan has not moved very quickly either, and as a result the problem has ballooned. Measured as a percentage of GDP Japan's bad loan problem could be four to six times as large as the American S&L problem. The over 50 trillion yen in nonperforming loans held by Japanese banks (by conservative estimate) is equivalent to more than 10 percent of Japan's GDP. This is not a problem that can be fixed over night. But Japanese banks have begun to make a dent in the numbers. Japan has two government entities to facilitate NPL disposal, the Resolution Collection Corporation (RCC) and the Industrial Revitalization Corporation of Japan (IRCJ) - which was just established last April. So the infrastructure is in place and Prime Minister Koizumi and the FSA are sending a message that it is time to pick up the pace. The current economic climate is not so severe which should help the banks to make better efforts to get rid of these bad loans. No one should think that they could relax because the economy looks a little better!
Private sector investors and corporate turnaround firms, both foreign and domestic, are increasingly playing an important role in NPL disposal and in helping to revitalize the Japanese economy. In the 1980s, when Japanese investors purchased such U.S. landmarks as Rockefeller Plaza and the Pebble Beach golf course, Americans raised the alarm that Japan was "buying America." Twenty years later, Japanese weekly magazines have labeled U.S. investors in Japan "vulture capitalists." And the refrain sounds very familiar. We must all recognize that such investors - in the U.S, in Japan and everywhere in the world - only serve to help the economy grow by bringing market mechanisms and efficiencies back into play.
In this day and age the world's two largest economies simply cannot afford to look only inwardly and cast blame on those outside.
V. Future of the US-Japan Economic Relationship
FDI: In fact, Japan should look to the outside for economic stimulus. One good example of a positive outside influence on Japan's economy is foreign direct investment (FDI). FDI generates employment, boosts productivity, brings much needed financial and management technology to Japan and can provide capital to Japan at a time when savings rates are decreasing and the fiscal deficit is growing. FDI also brings in additional tax revenue by generating more growth in corporate profits and individual incomes. Citing the benefits of FDI for Japan, Prime Minister Koizumi has set a goal to double the cumulative amount of FDI in Japan in five years.
FDI in Japan is far too low at only 1.1 percent of GDP (compared to 27.9 percent for the U.S. and 22.4 percent for Germany). Japan is losing out to other nations in Asia in the competition for FDI. For example, China's FDI inflows in 2002 were $52 billion while Japan's FDI inflows the same year were only $9.3 billion. And FDI flows to Japan fell 42 percent in the first half of 2003. If Japan is to compete for foreign direct investment, it must accelerate economic reform and deregulation and adopt new laws to facilitate M&A. I see such moves as inevitable in the near future - because low levels of FDI are hurting the Japanese economy.
Deregulation is also proceeding in Japan but more is needed As an example, a recent OECD study looked at how long it took and how much paperwork is necessary to set up a business in several countries the results are: In Japan, regulations governing the start up of a business impose a time and monetary cost on the entrepreneur that is matched only by nations such as Uganda, Armenia and Indonesia. The World Bank reports that the regulations and costs on new businesses are less burdensome in places such as Canada, the U.S., Zimbabwe, Sri Lanka, Taiwan, Peru, Thailand and even India. Ranked 21st in global competitiveness, and 11th among OECD nations, Japan is ranked 45 in the regulation of new business. Just to illustrate the burden, in Canada it takes 2 days, 2 procedures and costs USD 280 to start a new business. In Japan, it takes 26 days, 11 procedures and costs USD 3,742 to start a similar new business. With this kind of red tape Japan will not be able to compete with China, Korea and others where the process is becoming faster and more friendly, soon it will be something you can do on the internet!
Other policies that inhibit competition need to be examined. NTT is a huge company, but there needs to be more transparency in examining their books. Telecommunication rates are going up for interconnection to the wired network, so NTT gets higher rates from everybody that uses a dial-up phone, and then gets higher rates from new competitors who have to hook up their subscribers to the wired network to complete a call! Japan's energy rates are among he highest in the world, Landing fees at Narita and Kansai Airport are the highest in the world. Japan's medical system still does not have access to the best medical technology because of outmoded fee structures and bureaucratic stonewalling. We hear about hospitals being non-for-profit. It is common knowledge that the owners of hospitals also own the "tunnel companies" which are tied to the hospitals and which are the sole providers of supplies to those hospitals. Why earn a profit on the hospital when the "tunnel companies" bring in all the profit.
I do not mean to say that Japan has made no progress on deregulation. Some procedures for new telecommunications carriers are simpler and Japan's ADSL connection rates are the lowest in the world thanks to competition. There are other positive examples, but my point is that there are still too many negative examples. Japan and Japanese consumers deserve a better business environment than the one they have. I believe we are getting there, but more needs to be done.
Foreign investment and deregulation are two examples of how the world economy in general, and the U.S. and Japanese economies particular, are becoming increasingly interdependent. In days past, we spoke of U.S. - Japan bilateral trade issues in key sectors such as semiconductors, supercomputers, beef and citrus. Now we are beyond that. We talk about structural reform. We are no longer interested in small sectoral "cut outs" of Japanese economic activity. So the present and future of our bilateral economic relationship is more all-encompassing than it has ever been before. Every aspect of Japan's economy is important to us. And the Japanese look at the U.S. economy in the same way.
SEAMLESS TRADE: When I think of the future of our bilateral economic relationship, I also envision a bilateral trade relationship with significantly lower costs and more secure trade channels. In pursuit of such goals, our two countries are engaged in multi-agency discussions on how to create a Seamless Secure Trade in Asia Initiative (SSTA). The goal of the initiative would be to make it as easy for a company in Nebraska to obtain products from Osaka as from California, both in terms of cost and security. We believe the trade and security relationship between the U.S. and Japan should be of the highest caliber. And with continuing communication and cooperation among many government agencies in both countries, I believe both trade efficiency and trade security goals can be achieved.
We hope to look at ways to make the supply chain more efficient and more secure. That is we are looking at the pieces of the supply chain; ordering over the internet, shipping a product by air, getting through customs on both sides of the Pacific and tracking it anywhere anytime during the shipping process to insure a secure safe result and trying to see if we can make those pieces more secure and more efficient. This is a future project, which has not yet begun, but I have high hopes that we can do this together.
FTAs: Around the world, we are all working together to make the Doha Development Round a success for the WTO. At the same time, there is more and more regional economic cooperation along the lines of the organization for Asia Pacific Economic Cooperation (APEC). Countries are contemplating free trade agreements around the globe. The U.S. is very interested in FTAs with willing partners. In the not too distant future, it may be time to think about what a U.S. Japan FTA would look like. Many people say our economies are too different, that compared to the US, Japan's economy is still too closed and would make the negotiation too much of a one way street. I don't know, I think it could revitalize Japan and force the US to look hard at some of its structural issues.
Tokku: Finally, there is a future oriented project, which we can start right now. We believe the Tokku are an excellent way to begin to deregulate many of Japan's unnecessary regulations. It seems to me that Fukui could examine its industries, decide what regulations make those industries uncompetitive and try to get them removed. I think the Prime Minister is committed to this program, but the bureaucracy needs to be brought along. We are trying to get American companies in interested in combining investment with Tokku ideas and I would be happy to talk with you more about these ideas after this talk.
I think we can all see some signs of revitalization in Japan these days. We must, however, not relax efforts to rebuild the economy, put in place reasonable regulatory schemes and call on outside help when appropriate. I hope I have given you something to think about later on tonight and in the days to come.
Thank you very much