US-Japan Economic Relations: Hopes for Japanese Economic Recovery

James Zumwalt
Mito-city, Ibaraki Prefecture
February 2, 2004

I am quite happy to receive your invitation to come here because it means that I can escape Tokyo for a day. Although I arrive too early to view the plum blossoms, and hundreds of years too late to meet Mito Komon, I still think my visit to your city is quite timely. That is because many of the most exciting efforts to deregulate and restructure Japan's economy these days are occurring not in Japan's capital, but in prefectures and cities outside Tokyo. Ibaraki Prefecture is already host to five special zones for regulatory reform and local governments in Ibaraki have submitted 16 ideas for additional deregulation to the Prime Minister's Headquarters for Deregulation. As I will explain later in my remarks, the United States government is quite interested in these experiments with economic reform and your efforts to take the Prime Minister up on his pledge to "leave to the localities what they can do." After I conclude my remarks, I hope that we can engage in a give and ! take about your hopes and desires for Japan's economic future. I will of course welcome your questions, but also hope to hear your views on what steps Japan is taking to restore economic vitality.

Today I want to talk about U.S.-Japan economic relations, and why the United States is so concerned about slow growth in Japan. When I address this topic, most Japanese assume that I will talk about bilateral trade concerns. While trade issues remain important, American attention has shifted to Japan's pressing domestic economic issues. Today I would like to explain to you why the United States remains so concerned about these domestic challenges.

Japan is America's Most Important Friend and Ally
I want to emphasize that US-Japan relations today are important precisely because the United States and Japan enjoy a strong partnership in economics, politics, and geo-strategic issues. We have maintained this strong partnership over the past fifty years in spite of changes to the world such as the fall of communism, the emergence of China as a major world actor, and the growing threat of terrorism.

We must recognize that the U.S.-Japan relationship also matters to people outside our two countries because of our combined economic size. As the world's largest economies, we can work together as a positive force to influence world events constructively. We do this in places like China where our business communities work together to strengthen China's intellectual property regime and introduce the rule of law, and in Africa where we are working to strengthen the public health system.

Since America benefits from our broad partnership with Japan, we are also affected by Japan's "lost decade" of economic stagnation. Our concern stems from our fear that unless Japan restores its economic vitality, stagnant economic growth will over the long term erode the ability of the United States and Japan to work together for the economic and political betterment of the region. Like many Japanese people, we also want to see a Japanese economy that serves as a global engine of growth and a dynamic and innovative private sector that provides new ideas, new business models, new products and a stimulus for the entire world.

U.S. Japan Relations Have Never Been Stronger
Now back to my first point, which is the strength of US-Japan relations. US-Japan relations have never been better. The warm friendship between President Bush and Prime Minister Koizumi symbolizes this relationship. I think the Prime Minister appreciates that President Bush treats Japan as an equal partner. And I think Prime Minister Koizumi symbolizes, to Americans, a leader who is willing to accept Japan's role as a great power in the world.

Our nations' relationship has grown stronger and endured over the years because of our common interests and concerns. We are working together to resolve the threats emanating from the Korean peninsula. We are winning the war on terrorism and must not let up on these shared efforts. We will continue to work together to bring stability to Iraq and reduce tensions in the Middle East. And we must revitalize the WTO negotiations to benefit both developed and developing countries. These are just some examples of the U.S. and Japan working constructively together.

Our relationship endured in spite of changes in the world. This partnership and friendship remains strong not just because of our shared interests at this moment, it stems from something much deeper. US-Japan relations have remained close for so long because the United States and Japan share common values, and these common values help our friendship withstand changes that might otherwise affect our relationship.

Among our common values include our belief in democracy, our desire to promote human rights, and our conviction that the market economy is the most efficient way of organizing our economies in order to promote growth. And also, we share a belief that it is in our mutual interest to promote sustainable economic growth throughout the world. So these shared values underpin our interests, as the world's two largest economies, to protect and strengthen the world order.

Working Together We Can Promote Peace and Economic Prosperity
I have explained why U.S.- Japan relations have remained strong and durable. But why does this matter for people outside the United States and Japan? The importance of our relationship to the world can be explained by our size and influence. Together, the United States and Japan represent over one-third of the world economy. If we work together, as we are trying to do, we can wield a great deal of influence over the region and the world.

We can see examples of the United States and Japan working together in many parts of the world. The US and Japan have been among the principal players in trying to realize a peaceful settlement to ethnic conflict in Sri Lanka, where we are offering economic assistance to convince the two warring parties to seek a peaceful solution to a twenty year old conflict. In Afghanistan, the United States and Japan are working together to build a road that will link up the many regions in that country and help forge a sense of nationhood. In this way our economic assistance programs can provide a ray of hope to the Afghan people and enhance the prospects for peace and stability. We are working together in the war on terrorism through activities such as stemming the flow of terrorist assets in the international banking system. Because of our combined economic size we have influence, and if we wield that influence in a constructive manner, then we can address many challenges.

Will Economic Stagnation Undermine Our Ability to Work Together?
So, when thinking about the US-Japan relationship, we should remember its strength, its enduring quality, and its global influence. If we turn our attention now to U.S.-Japan economic relations, one issue becomes clear. The most important economic issue between the US and Japan is not even a bilateral issue. From the perspective of the United States our most important economic concern is Japan's persistent economic underperformance.

Our main interest, regarding Japan's economy, is restoration of Japan's economic vitality. The reason for this American concern is obvious. It is because we benefit from our vibrant bilateral relations and we also want to continue to work with Japan in a full range of areas. Unless Japan begins to grow, however, Japan will gradually lose its influence in the world and that would undermine our ability to work together to promote peace, democracy and economic growth.

As I mentioned earlier, one reason for this concern over Japanese growth is Japan's size: your economy represents 14% of the world's GDP. If a major part of the world economy grows below its potential growth rate, that poor performance hurts everyone both inside and outside Japan. Japan's poor economic record hurts Japanese people the most, but it also affects persons living in the United States, and Japan's other trading partners and neighbors.

Yet another area where Japan's economic stagnation hurts the United State is Japan's diminishing ability to work with us in support of common objectives throughout the world. One good example of this lost opportunity is Japan's shrinking foreign assistance budget. Japan will cut its foreign aid by 4.8% this year, marking four consecutive years of ODA budget cuts. Japan has already lost its position as the world's largest donor of economic assistance. Last year at Madrid, Japan announced a very generous aid program to help the Iraqi people reconstruct their devastated economy, but I fear that this money might come at the expense of other worthwhile aid programs, because Japan has stated that it simply cannot afford, given its economic stagnation, to maintain the size of its aid program. This budget constraint is just one example of how Japan's economic stagnation is not only a problem for Japanese people, but it also hurts Japan's overseas friends and partners. Therefor! e, we sincerely hope that Japan will adopt the policies that are necessary to return to sustainable economic growth.

Japan's "Lost Decade" Impact on the Economy
And if I could, just for a second, quantify for you the seriousness of this problem. If Japan had grown at its potential growth rate since 1990, Japan's economy today would be 25% larger. Let me repeat that because it is so important. If Japan had grown at its potential growth rate since 1990, Japan today would be 25% larger today. What that means is problems such as funding the pension liabilities as Japan's society ages would be much smaller and much less dramatic if Japan had adopted the policies needed to restore economic growth ten years ago. This also means that if Japan postpones economic reforms, then these problems will loom even larger in the future.

America's Biggest Concern: Japan's Growth Deficit
When I talk to Americans about U.S.-Japan economic relations, sometimes the first issue that comes to their mind is our bilateral trade deficit. But my response is that the bilateral trade deficit between the United States and Japan, while an important issue, is not the biggest economic problem we face in Japan. Our major challenge is Japan's own growth deficit. What I mean by the growth deficit is the gap between Japan's potential economic and its actual economic growth.

This issue represents a paradox for the United States. Americans are hurt by policies that reduce growth in Japan, even as we acknowledge that the political decisions Japan faces are domestic in nature. Therefore, our role is to point out the choices Japan faces, and perhaps to convey our experience with similar economic problems. We do this in our annual Regulatory Reform talks. Under this initiative either side may point out areas where further deregulation will stimulate economic activity. We are now in the third year of this exercise and I believe we have made much progress in identifying and reducing regulatory impediments to growth.

Japan's economic challenges include financial and macroeconomic challenges. Japan's banking system does not channel capital to the most efficient sectors of society. Instead it continues to funnel capital to zombie companies that have not been allowed to fail. This means that small and medium businesses that employ the largest number of workers in Japan lack the capital needed to grow. Although Japan's banks are making progress in cleaning up their balance sheets, they are still burdened with over 50 trillion yen in non-performing loans, equivalent to 10% of GDP.

Unfortunately deflation has created a lack of confidence among Japanese consumers. With falling prices, consumers tend to defer spending and this in turn depresses the economy further. Again the government and Bank of Japan have made some recent progress here but more work needs to be done.

And finally it is important to mention that excessive regulations place a straightjacket on economic vitality and entrepreneurship in Japan. The more open and transparent an economy, the lower the cost of doing business.

The Road Ahead: Economic Reform to Restore Growth
Now the positive news is that the Japanese government recognizes and understands the challenges it faces. We have been encouraged over the last year, by some of the steps Japan has taken to address these issues. The Financial Services Agency has bailed out Resona and Ashikaga Banks and forced others to pay down the non-performing loans. While these steps cause economic pain for certain borrowers, these steps mean that the Japanese banking system can begin to funnel more capital into the productive sectors of the economy. Over the long term these steps will increase Japanese economic growth.

We are also encouraged by the Prime Minister's initiative to test deregulation in special zones, and if those are successful then to expand those deregulatory zones to the nation as a whole. The Prime Minister said on January 19 that, "regional revitalization is the key to realizing an energetic Japanese economy." As I mentioned at the beginning of my speech, Ibaraki Prefecture governments have taken up this opportunity to experiment with special deregulations zones. I wish you success and hope that some of your best ideas will lead to nationwide deregulation so that the entire nation can benefit from your successful ideas. The 236 special zones throughout Japan, and your five, are a beginning in Japan's efforts to move toward a more competitive and dynamic economy. Ibaraki and other prefectural governments recognize that structural and economic reform can revitalize their economies and improve their societies. Governments such as yours are citing the Cabinet's recent ! economic report that deregulation in the 1992-2002 period resulted in 14.3 trillion yen in benefits to push the central government for greater reforms and more special zones. These decisions are positive and forward-looking. We hope that this deregulation can succeed in restoring Japan's economic growth up to the three plus percent range, where it is certainly capable of growing, and know from first-hand experience that deregulation and reforms can boost growth.

If we look to Japan in the future, I think the decisions Japan takes this year, particularly some of these domestic economic decisions, will determine Japan's global economic position and influence in the next ten years. If Japan chooses to deal resolutely with its economic challenges, those of a banking system once on the verge of bankruptcy, deflation, and regulatory reform, then it will again grow at a healthy rate. Japan is a rich nation with tremendous resources - capital, labor, and intellectual. I am confident that Japan remains capable of robust economic growth that will benefit the Japanese people, but also Japan's economic partners and neighbors.

I am confident that Japan will continue to pursue economic reform and that this nation will continue to be a source of technology, know-how, and innovation. This stimulus would have a very beneficial impact on the United States and on the entire Asia-Pacific region, just as it did in the 1980s in America. Moreover, with these economic steps, then the United States and Japan can look forward to a continuing robust bilateral relationship. In such a relationship we would have the economic strength to work together to resolve many of the world's pressing economic problems.

To briefly review the points I tried to make today: US-Japan relations are very strong, they are enduring, and that strength and endurance stems from our shared values and shared interests. Our combined size of over one-third of the world's GDP means that working together we wield influence, and can tackle difficult problems. However, Japan's economic stagnation threatens to undermine our ability to work together. For that reason, the United States very much hopes that Japan will implement the policies needed to combat its serious economic problems and return to a path of sustainable and long-term economic growth.

Thank you very much.