Japan's Role in Supporting Balanced Global Growth

Remarks by Assistant Secretary of the Treasury Randal K. Quarles
The Foreign Correspondents Club of Japan
As prepared for delivery

March 10, 2005

Thank you. Over the years, the Foreign Correspondents Club of Japan has established itself as a premier venue for ideas, debate - and pointed questions - on the major issues confronting Japan and the world. I'm very pleased to appear before you today to discuss global growth and the challenges facing Japan and the United States.

The defining principle for the Bush Administration in international economic policy is the importance of encouraging strong growth around the world. Raising economic growth to full potential - in individual economies and globally - is the best policy for creating employment, raising incomes, and pulling people out of poverty. With our G7 partners we have fashioned an Agenda for Economic Growth, in which each of us will address structural obstacles to more rapid economic growth.

We've already seen this effort bear fruit. By late 2003 and early 2004 the world economy was growing at the fastest rate in 3 decades. Growth was widespread, and financial crises were notably absent. Economic growth slowed in the G7 countries in mid-2004. And Japan, after two years of healthy growth, saw 3 quarters of modest but consecutive declines in GDP. However, recent data on production and household spending suggest that Japanese growth will resume in this quarter.

Economic forecasting and market analysis are heavily focused on short run outcomes. But the approach of the Bush Administration has been to focus on putting in place fundamental policies that will sustain robust growth over the years. This is important in any economy. But it was particularly so in Japan, which has experienced a decade of stop-go growth since the bursting of the bubble.

Prime Minister Koizumi faced three economic policy challenges when he took office in April 2001. The first challenge was to escape from persistent deflation. Second was the need for urgent action on banks' non-performing loan and related problems in Japan's corporate sector. Finally, comprehensive structural reforms and deregulation were needed to raise Japan's potential growth rate and meet the challenge of an aging population. While this agenda is not yet finished, Japan has made significant progress on all three fronts, especially with regard to ending deflation and strengthening the financial and corporate sectors.

The pace of deflation has slowed - thanks to rapid base money growth under the Bank of Japan's "quantitative easing" policy, and its commitment to maintain that policy until price stability is restored. But the persistence of deflation, coupled with renewed economic weakness last year, underscores the importance of continued aggressive monetary policy.

Macroeconomic policy makers face the additional challenge of the need for deficit reduction in the coming years. This is partly a question of timing - balancing the need to ensure confidence in Japan's public finances against the risk that moving too quickly will resuscitate deflation. Accommodative monetary policy can help here in limiting the risks of deficit reduction.

But as important as timing is the composition of deficit reduction measures - ensuring that they don't weaken long-term growth. Spending cuts and steps to broaden the tax base can help limit the need for higher tax rates, which weaken incentives for work and investment. The Koizumi Government's cuts in low-yielding public works have been important steps in that regard. Continued efforts to rein in government spending and to broaden the coverage of Japan's tax laws will help support stronger growth in coming years.

Japan has made real progress in addressing the banks' bad loan problems since Mr. Koizumi took office. The Financial Services Agency, in its 7 years of existence, has brought fundamental changes in supervision and inspection of financial institutions. The Financial Revitalization Program and its focus on special inspections and tougher loan classification and provisioning has had a significant impact at the major banks. Their non-performing loans fell from more than 8% of total loans three years ago, to less than 5% last September, and are on track to meet the program's 4% target by the end of March. The major banks have disposed of about \30 trillion in bad loan claims through loan sales, private work-outs, and bankruptcy proceedings over the past four years. Those efforts have helped restore liquidity to Japan's property market. They also contributed to progress in corporate restructuring and efficiency.

There is still work to be done. The major banks' need to further reduce their NPLs and improve their profitability. The quality of bank capital should be improved. And the regional banks have made far less progress in bad loan disposal than the large banks. And their main customers, small and mid-sized firms, have made far less progress in reducing debt and raising profitability than large firms.

Bad loan disposal and corporate restructuring is contributing to stronger long-term growth in Japan. However, the Koizumi Administration has recognized that more is needed, and is pursuing an ambitious structural reform program.

We welcome Prime Minister Koizumi's commitment to postal privatization. This is a critical step toward enhancing the market-orientation and competitiveness of the financial system.

But there can be no doubt - this is an enormous challenge. Japan Post's mail services operation is one of the world's largest commercial businesses. The postal savings and postal life insurance systems are two of the largest financial institutions in the world, and they play a central role in Japan's financial system. Clearly, privatization must be handled with care in order for Japan to derive the full potential benefits. In particular, Japan Post privatization should observe the following principles.

  • The government should ensure a level competitive playing field through measures to prevent Japan Post from using its size and scope advantages to dominate the mail delivery, insurance and banking markets.
  • The privatized firms should be subject to the same legal, tax and regulatory requirements as their competitors.
  • And firewall rules to prevent cross-subsidization and risk transfers between the financial and non-financial operations are needed to ensure the safety and soundness of the financial entities.

Prime Minister Koizumi fully recognizes the importance of getting privatization right. His privatization plan embraces the principles I've outlined, as do the private and public comments of government officials working on the legislation. However, the devil will be in the detail. The extent to which those principles are realized will depend on the provisions of the forthcoming law - which will be decided in consultations between the government and the coalition parties.

Postal privatization is just one - very important - item on the government's structural reform agenda. The Council on Economic and Fiscal Policy has announced that it will also undertake reforms of Japan's government-owned lending institutions, to complement the privatization of the postal financial institutions. The sooner the better. The government's regulatory reform efforts have brought continued progress in sectoral deregulation, as have the special deregulation zones.

I am also impressed by the goals set forth in the FSA's "Program for Further Financial Reform." In the new reform program, the FSA sets out to extend recent reform progress in order to both make Japan a nation of investors rather than savers and to make Japan the region's dominant financial center. The program includes commitments to further enhance transparency and to the principal of equal treatment of foreign and domestic firms. Steps to improve corporate financial disclosure, a key component of the FSA's reform program, will also advance these goals.

Perhaps the most important step Japan could take to support the growth of an investor culture would be to ensure that managers remain fully accountable to shareholders. Managers dedicated to maximizing the return on shareholders' capital make better investment decisions so that their companies are less likely to fail.

The benefits of accountable management extend well beyond the gains to shareholders. A profitable company is better able to increase employment and wages than an unprofitable company. And the more firms in a country that are managed in the interests of shareholders, the higher that country's growth potential and the faster living standards can rise.

There are increasing signs of shareholder activism in Japan, perhaps as a result of the decline in cross-shareholding and financial market deregulation. Recent examples of unsolicited acquisition bids by Japanese corporations may increase focus on profitability and return on investment among Japanese corporate managers, to the benefit of shareholders, employees, and the society as a whole. Press reports on takeover battles tend to focus on tactics and personalities. That's always interesting, but we should not lose sight of the principle that management should be held accountable for their performance, and may be replaced if they do not perform.

The ability and the flexibility to shift economic resources - from one set of managers to another or from one sector to another - is the key component of a rapidly growing economy. The Prime Minister's statement from the beginning, that there could be no growth without structural reform, is the essence of this argument. I have emphasized the financial system, but a variety of structural reform and deregulation measures to open up new sectors to competition and create new opportunities for investment and growth is critical to increasing Japan's long term growth rate. And sustained, robust Japanese growth is what's needed to deal with the longer term fiscal and aging problems that the Japanese society faces.

Let me say a few words about the United States. The US economy faced a series of difficulties in 2001 - the bursting of the stock market bubble and the sharp slowing of the economy in 2000, and the events of September 2001. As a result of sound monetary policy and President Bush's well-timed tax cuts, the US economy recovered and strong US growth supported economic growth worldwide.

The United States continues to lead the way. The addition of 3.0 million jobs since May of 2003 and a solid year-over-year growth rate of 4.4 percent show the strength of our nation's economy. Our unemployment rate is down to 5.4 percent - lower than the average rate of the 1970s, 1980s and 1990s. Real after-tax income is up by more than 11 percent since the end of 2000, and household wealth remains high. Inflation and interest rates remain low.

Yet the United States still faces considerable economic challenges, with short-term and long-term implications for our economy and beyond. Now is the time to confront these challenges.

Our budget deficit is unwelcome, although it is understandable, given what our economy and our country have been through in recent history. President Bush is committed to dealing with this deficit - both by controlling spending and by implementing policies that encourage continued economic growth. We remain on track to cut the deficit in half by 2009. And we are also focusing on the longer-term fiscal situation including Social Security and other federal programs.

Confronting the U. S. current account deficit is a shared responsibility. We are doing our part by tackling the fiscal deficit and working to raise saving in the United States. But our actions cannot stand alone. Strong growth in the U.S. economy makes it imperative that our trading partners, too, adopt policies that accelerate growth. Addressing global imbalances also means increasing flexibility in exchange rates.

Both the United States and Japan - the world's two largest economies - are making real progress in our efforts to improve our economic fundamentals and lay a foundation for sustained strong growth. Those efforts, together with similar steps by our trading partners, can help bring higher global living standards in the years to come.

Thank you.