Why Did Japan Stop Growing?

Takeo Hoshi
School of International Relations and Pacific Studies, University of California, San Diego,
NBER, and TCER
andAnil Kashyap
Booth School of Business, University of Chicago, NBER, and Federal Reserve Bank of Chicago
January 21, 2011

* This report is prepared for the National Institute for Research Advancement (NIRA). We
thank NIRA for financial support as well as the comments on an earlier draft by Jiro Ushio,
Reiko Kanda, and Tetsuo Ota. Research assistance was provided by Jess Diamond, Daisuke
Fujii, Eigo Kato, Satoshi Kimura, Norimasa Kudo, Kyohhei Matsuyama, Kazunari Nakajima,
Yuki Nonomura, and Kunitaka Ueno. We benefited from conversations with Takero Doi, Robert
Feldman, Kyoji Fukao, Yuji Genda, Yoshihisa Godo, Masako Ii, Takatoshi Ito, Kazumasa Iwata,
Richard Jerram and Ulrike Schaede.

Table of Contents
1. Introduction ................................................................................................................................. 2
2. End of Rapid Economic Growth ................................................................................................ 6
3. Aging and economic growth ...................................................................................................... 9
4. Japan’s Export-led growth ....................................................................................................... 10
5. Growth Impediment #1: Zombie lending and depressed restructuring ................................... 12
6. Growth Impediment #2: Government Regulatory Restrictions ............................................... 17
7. Growth Impediment #3: Macroeconomic Policy Mistakes ................................................... 22
8. Evaluating Koizumi Reform .................................................................................................... 30
9. Conclusions .............................................................................................................................. 34
References ..................................................................................................................................... 39
Figures........................................................................................................................................... 42
Tables ............................................................................................................................................ 62

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1. Introduction
The Japanese economy has been stagnating for almost two decades. Some recent researchsuggests that at the end of the 1990s the economy fell into a deeper paralysis that differed fromprevious “normal” recessions (Hamada, Kashyap, and Weinstein, 2011). By the middle of the
2000s a recovery seemed to have taken hold, but with the global financial crisis of 2008 Japan
has slipped back into recession and deflation. The governments after the onset of the global
financial crisis (one led by the Liberal Democratic Party and two led by the Democratic Party ofJapan) have proposed various policies to restore economic growth, mainly through fiscal
stimulus, but, overall, they have been ineffective.
Rather than focusing on the immediate growth challenges associated with the fallout fromthe global recession, we take a long-term view. The Japanese stagnation did not start in 2008.
The problem goes back at least to the collapse of stock and land prices in the early 1990s, and wetrace the major causes of stagnation to the failure of Japan to adjust to various challenges thatemerged starting as far back as the 1970s.
Prior to the 1970s, the Japanese economy enjoyed a very rapid pace of economic growth.
But, during the 1970s important factors that supported this rapid growth started to disappear.
First, Japan was catching up with more advanced economies such as the U.S. Thus, Japan could
no longer grow just by imitating or importing new technologies from the advanced economies.
The practices and economic institutions that worked well during the catch-up phase were not sowell-suited for a more mature economy.
Second, financial globalization and the collapse of the fixed exchange rate regime meantthat by the end of the 1970s that Japan could not rely on an undervalued currency to boost its

2

exports. Japan had to rearrange its production system and other economic institutions to copewith globalization.
Third, Japan’s population structure was shifting and becoming increasingly elderly. The
aging meant slower growth of the labor force. The aging and the declining fertility also reduced
the domestic saving that supported economic expansion during the rapid economic growth period.
The end of catch-up phase, globalization, and the rapid aging together created a major
challenge to the Japanese economy. Japan has yet to successfully meet these challenges.
Worse, there were some subsequent policy mistakes, which turned stagnation into
paralysis in the late 1990s. For example, regulatory forbearance on problems in the banking
sector created the situation where zombie banks were supporting zombie firms, which hurt
growth by stifling the process of creative destruction (Caballero, Hoshi, and Kashyap, 2008).
Mistakes in monetary policy created prolonged deflation and entrenched deflationary
expectations. Fiscal policy allocated too much money to ineffective spending programs andcreated a massive debt build up that now will require wrenching adjustment.
Although the Japanese economy started to recover in the mid 2000s under the reformminded Koizumi government, the global financial crisis in 2008 put it back into recession.
Looking back, the “recovery” of Japan was not robust, and Japan needs to change its policy
direction for sustained growth to emerge.
There have been a lot of discussion and research into the causes and remedies for Japan’s
stagnation, often called the “lost decade.” This paper differs from many of those attempts intaking a longer horizon.1 We see the challenge that the Japanese economy faces as comparable
in magnitude to those at past historical turning points, including the opening of the country in the1

Our analysis builds on a few recent studies that also take a longer term perspective such as include Blomström,
Corbett, Hayashi, and Kashyap (2003), Ito, Patrick, and Weinstein (2005) and the ESRI Project led by Koichi
Hamada, Anil Kashyap, and David Weinstein (2010)3

mid-19th century, the turmoil in the 1920s, and the devastation after World War II. How Japan
confronts the challenge is likely to influence its future for several decades.
One important reason why Japan has not successfully responded to the challenges is thatthe status quo has been mostly satisfactory. Thanks to the rapid economic growth in most of the
post-war period, Japan is a rich country now. Therefore, except for a few very severe crises,
there has been little pressure to confront these issues. Without a clear vision on what Japan
could achieve, it is hard to grasp what Japan is losing. One important goal of this paper is tocome up with a clear view of what is possible for Japan in rest of the 21st century.
The paper is organized as follows. In Sections 2 through 4, we start by identifying thechallenges that Japan faced after the rapid economic growth era. Section 2 points out that a
slowdown in economic growth was an inevitable consequence of a successful catch up. As
Japan’s GDP per capita rose, the growth rate fell. The end of the catch up phase, however, is not
the whole story. We show that some advanced countries such as the U.S., Canada, and the U.K.
continued to grow at the rate higher than Japan even after they reached a similarly high level of
GDP per capita. Hence, the right question is what can Japan do to grow like the U.S., Canada
and the U.K?
Section 3 identifies rapid aging as one factor that made Japan’s adjustment to the end of
rapid economic growth more challenging compared to many other advanced economies. Not
only were the effects of aging more pronounced in Japan, but the aging effects started tomanifest at the same time as the catch up phase of economic growth ended. In addition, thesustainability of the export oriented nature of Japan’s growth posed another serious challenge.

4Section 4 reviews this hurdle and shows that Japan needs to change from an exportoriented growth economy that uses imported technologies to try to catch-up to one focusing on
its domestic market and own innovation.
Sections 5 through 7 identify three important impediments that have interfered withJapan’s adaptation to the new environment. Section 5 shows that protection of incumbent firms(and their workers) against macroeconomic shocks in the 1990s stifled the competitive processof creative destruction that is essential for innovation and productivity growth in a matureeconomy. The section is mainly based on the work by Caballero, Hoshi, and Kashyap (2008).
Section 6 examines the role of various government regulations in further reducing the
productivity growth, especially in non-manufacturing industries. Finally, Section 7 discusses
problems and growth reducing consequences of the monetary, fiscal and banking policies thatwere implemented to respond to macroeconomic shocks in the 1990s.
There was a period recently when Japan had a reform minded government andexperienced a brief recovery of economic growth. The government, led by Prime Minister
Junichiro Koizumi, started several economic reforms that appeared to steer the Japanese
economy in the right direction. Section 8 is devoted to an analysis of several major reforms that
the Koizumi government tried. A detailed discussion of major reform programs are in the
Appendix.
Section 9 concludes by summarizing the findings and drawing lessons that Japanesepolicy makers should learn in order to restore economic growth. We close with a brief
evaluation of the New Growth Strategy, which is the current government’s attempt to do that.

52. End of Rapid Economic Growth
For many years the Japanese economy grew very rapidly. From the mid 1950s to mid
1970s, the average growth rate of the real GDP was around 10% per year, but growth then began
slowing. Figure 1, using data based on the 1968 System of National Accounts, shows the real
growth rates from 1955 to 2000. The figure clearly shows a first slowdown in the mid 1970s andthen a second, more pronounced drop during the 1990s. Figure 2, using the current vintage ofnational accounts data, shows real GDP growth rates from 1981 to 2009. Although the growth
seems to have returned briefly in the mid 2000s, Japan stopped growing again after the global
financial crisis of 2008-2009. The purpose of this report is to explain the stagnation that began
in the 1990s and deduce what policies might help reverse it.
Economists have demonstrated that long term growth patterns are generally welldescribed by the so-called “neoclassical” model of growth. This model focuses on the supply
side of the economy and we will use it to organize our discussion of potential causes of theslowdown. To quantify these alternatives, consider the simplest version of the neoclassicalmodel:Y = AF ( K , L )(1)where Y is the level of output, K is the amount of capital input, and L is the amount of labor
input in the economy as a whole and A denotes the level of technology.2 Written this way, themodel presumes technological progress raises output by making both labor and capital moreproductive (rather than favoring capital or labor).

2

We also make the standard technical assumptions that the function F(·) is assumed to be homogeneous of degree
one and the marginal product of each input is positive but declining with respect to the level.
6

If we also assume that capital and labor are each paid their marginal product (as would be
the case if neither had any market power), one can show that the growth rate of output can be
decomposed into three parts.
% ΔY = % ΔA + α % ΔK + (1 − α )% ΔL(2)

where %Δ is the operator to take the percentage change of the variable (for example, %ΔY
denotes the growth rate of output in percentage points) and α is the share of profits (income tocapital) in total national income (and correspondingly 1-α is the share of labor income). This
representation attributes output growth as coming from three sources: increases in capital (thesecond term of the right hand side of the equation), increases in labor (the third term), and/orfrom technological progress (the first term).
One can rearrange (2) to describe output per (quality adjusted) labor input term as arisingfrom either increases in the ratio of capital to labor or from technological progress:⎛Y ⎞⎛K⎞% Δ ⎜ ⎟ = % ΔA + α % Δ ⎜ ⎟
⎝L⎠
⎝L⎠

(3)

Since the marginal product of capital declines as the capital intensity (K/L) increases, the second
term in (3) naturally falls as the economy grows. This observation also implies that countries
that are initially poor can grow very quickly by having high rates of capital growth, but more
importantly it tells us that eventually growth will be governed by technological progress (i.e.
pure productivity improvements). Historically technological progress among rich countries has
been somewhat similar, which means that countries have a tendency to converge to a common
rate of technological progress. Part of what explains Japan’s slowdown is the transition frombeing a poor economy that was catching up with other advanced countries through strong
investment to becoming a rich country whose growth was limited by productivity improvements.

7

To see this clearly Figure 3 shows the trend GDP per capita for G7 countries measured inyear 2000 US dollars (converted using the purchasing power parity) from 1970 to 2005. The
trend estimates were calculated using a standard statistical method developed by Hodrick andPrescott (1997).3 Figure 4 shows the growth rate of the trend compared to the level of the trend.
This presentation allows us to compare the growth rates across countries when each reached agiven standard of living.
The figure shows that most of the countries experienced slowdown of growth as the real
GDP per capita moves from the mid $10,000s to the low $20,000s. Compared with the other G7
countries, Japan continued to have a higher growth rate even when the GDP per capita crossed
the $20,000 level, but then the growth rate declined much more rapidly than elsewhere.
The figure also shows that the countries do not converge to a single rate of growth.
Instead, as per-capita income broached roughly $25,000 we see the countries split into threegroups. First, the U.S., the U.K., and Canada seem to be converging to a steady state growth rateof around 1.7%. Second, France, Germany, and Japan seem to be converging to the growth rateof about 1.0%. Finally, the growth rate has continued to fall and seems to be approaching zerofor Italy. These differences, if sustained, are extremely important. When per-capita incomesgrow at 1.7 percent per year, incomes double in 41 years. In contrast, when the growth rate is 1
percent, then it takes 69 years for income to double.
But Japan’s path is also interesting. Trend growth rate declined very rapidly once GDP
per capita reached a little over $20,000 (around 1990) and for a time looked as if it was on the
Italian trajectory. But in the early 2000s growth recovered slightly so that Japan seems to havesettled in with France and Germany.

3

Specifically we set the smoothing parameter in their algorithm to 400.
8

The figure motivates several questions that we analyze in the rest of the report. Whataccounts for the sharp growth deceleration? What happened in the 2000s to reverse Japan’s
freefall? What can Japan do to match the higher long-term growth rate that the U.S., the U.K.
and Canada seem to enjoy?

3. Aging and economic growth
One factor that may explain the rapid decline of trend growth rate compared to othercountries is aging of the population. Figure 5 shows the proportion of the old (65 years old or
above) to the total population for G7 countries. Japan had relatively low share of elderly people
during the 1960s and the 1970s, but the ratio subsequently increased very rapidly. By 2022, 30
percent of all Japanese citizens will be aged 65 or older, which is nearly twice the percentage inthe U.S.
The neo-classical growth model implies that the long-term growth rates of per capita
GDP declines when the aging proceeds rapidly. Note that the decomposition in equation (3) iswritten in per worker terms and the labor input (hours) is adjusted for distribution of different
worker skill levels. Thus, letting N be the total population, equation (3) can be re-written as:⎛Y L ⎞⎛K⎞⎛L⎞%Δ ⎜⎟ = % ΔA + %αΔ ⎜ ⎟ + %Δ ⎜ ⎟
⎝L N⎠
⎝L⎠
⎝N⎠

(4)

This formulation highlights the fact that as aging leads workers to retire or cut back on hours
worked, per-capita growth necessarily declines because the last term in the equation becomes
negative.
In addition to the effect of reducing labor participation and declining hours, the rate ofquality improvement of labor may also suffer from aging if the skill improvement of old workers
9tends to be lower than that for young workers. Sommer (2009) shows peak earnings occur inJapan as workers reached their late 40s. He also shows that in contrast to the U.S., earnings drop
noticeably shortly after that stage, so that by the time the workers reach their late 50s, they are
earning roughly 30% below the peak level.

4. Japan’s Export­led growth
The neoclassical model assumes that as long as goods are produced efficiently there will
be a buyer, so we can abstract from demand in estimating long term growth. But if demandstagnates, the expanded productive capacity resulting from technological progress will not be
used effectively and will be wasted. The demand side problems have been evident in Japan for
more than 15 years. One clear symbol of this is the persistent deflation that has prevailed since
the mid 1990s. Given its depressed domestic demand, Japan has relied heavily on selling toforeigners.
Table 1 shows the contributions of external demand to the economic growth and theaverage ratios of exports on GDP for G7 countries for the period from 1995 to 2009. Japan’s has
the highest dependence on external demand. This is especially surprising because Japan’s
exports relative to GDP are small. Thus, Japan has had an odd combination of output being
produced to satisfy external demand, while demand in the large domestic market has stagnated.
The reliance on the external demand is a legacy from the rapid economic growth period.
Under the Breton Woods System of exchange rates, Japan benefited from a fixed andundervalued currency that made exports extremely competitive. The combination of a young,skilled workforce with a stable, undervalued exchange rate delivered high growth. The collapseof the Breton Woods regime in the early 1970s put an end to this strategy. The economic success10

of Japan and emergence of competing export-oriented economies in East Asia changed thecompetitive environment for the Japanese exporters.
As Rajan (2010, Chapter 2) argues, an export-oriented growth strategy backed by close
relationships between a country’s government, banks, and industrial firms has been a successful
formula for poor countries to become much richer. Japan and other Asian economies, including
China, used this strategy to grow successfully. When the developing economy is small
compared with the rest of the world, it can continue to depend on external demand. But as the
economy grows larger, depending too much on external demand becomes increasingly difficult.
Another problem of the export-oriented strategy is the absence of market forces in
guiding the allocation of resources. Rajan (2010) points out that protecting domestic firms
against market forces so that they can develop organizational capacities may make sense during
the catch-up phase of growth when a country can grow just by importing new technology andaccumulate capital. As the economy matures, however, a well functioning market to sort out
efficient from inefficient production arrangements becomes essential. The problem with anexport-oriented strategy is that it tends to suppress the market mechanism which usually creates
acute problems in the non-manufacturing sector, particularly the service sector, where there is no
discipline from international competition.
Table 2 compares the experience of Japan with the recent growth experience of China.
For Japan, export led growth was no longer enough to lift the economy (China is likely to face asimilar problem in the near future). Going forward Japan needs to rely on vibrant domestic
markets and we next review some of the problems in domestic markets that have impeded
growth.

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5. Growth Impediment #1: Zombie lending and depressed restructuring
One of the big problems that emerged in the 1990s was the rise of what Caballero, Hoshi,
and Kashyap (2008) call zombie firms. A zombie firm can be defined as an unproductive andunprofitable firm that should exit the market place but stays in business with help from its
creditors or the government. By continuing to operate and hanging onto the workers that should
be reallocated to more productive firms, zombie firms impede the efficiency of the economy.
Healthy firms are able to grow less quickly, and over time if the zombies’ presence becomeslarge enough, productivity growth falls.
Zombies were spawned in the aftermath of the collapse of asset prices in the early 1990s
and subsequent recession. The large loan losses during this period left many banks with very
little capital. The banks, therefore, faced two options: recognize the losses, and try to raise
capital and find new customers, or deny the problems and continue to roll over loans while
hoping for improvement. Most banks, encouraged by the government to support existing firms,
took the latter option.
Caballero et al. (2008) explain how the presence of zombies discourages healthy andproductive firms from entering new markets or expanding their operations. In particular,
because the stronger firms would be forced to compete with the subsidized weak firms to sell
products, hire workers or borrow money, the zombies depress activity. Only the non-zombies
with highest productivity and profitability are able to survive competition with zombies. As aresult, the productivity of the industry (and the whole economy) suffers when there are many
zombie firms.
Identifying zombies is challenging since banks have no incentive to confess that they are
keeping customers on life support with subsidized credit. To come up with a quantitative12

measure Caballero et al. (2008) attempt to estimate what expected credit costs should be andlook for firms that are being charged less than what would be expected. Importantly,
measurement is also hampered because specific lending arrangements between banks andborrowers are not disclosed. Hence, they give all firms the benefit of the doubt and assume thatthey are able to get funding at the most favorable possible rates; effectively they assume thatevery firm is as credit-worthy as the strongest companies in the economy. For example, if thehighest rated firms are able to borrow at a 0.5 percent interest rate in the commercial paper
market, then Caballero et al. (2008) assume that this rate would be available to all commercial
paper borrowers. By making similar assumptions for each type of borrowing they construct thelowest possible amount of interest payments that a firm could reasonably be expected to pay.
Zombies are defined as those firms which somehow manage to pay less than the lower bound.
Figure 6, taken from Caballero et al. (2008), shows two estimates of the prevalence ofzombie firms in the Japanese economy. The top panel shows the proportion of zombies
measured based on simply on the number of firms, while the bottom panel looks at zombie
prevalence by comparing total assets residing in zombies to total assets in all firms. Bothmeasures show that the zombie firms increased rapidly during the 1990s when Japan entered arecession following the collapse of the so-called “bubble economy”. The proportion of zombies
stayed high into the early 2000s.
Figure 7 shows the cross-industry breakdown of the zombies (based on the asset
percentage definition). One striking observation is that the zombies were much more pervasivein the domestic parts of the economy: in manufacturing, which accounts for virtually all exports,
the percentages are low, while in the service sectors the zombie percentages are much higher.
One possible explanation is that the manufacturing sector is continuously subject to global

13

competition so that banks would realize that propping a firm up was potentially very expensive.
In contrast most of the service sector firms face limited foreign competition. Also the averagefirm size is much smaller for non-manufacturing firms and these small and medium sizedenterprises have historically been very active politically in lobbying politicians for favors.
Regardless of whether this conjecture about the explanation for the cross-industry differences iscorrect, if zombies are a problem it looks like they will affect non-manufacturing industries
much more than manufacturing.
The central hypothesis offered by Caballero et al. is that the zombies impede the healthyfirms. To test this proposition one needs a benchmark for what the healthy firms would doabsent the presence of zombies. Caballero et al. use regression analysis to construct thebenchmark and look for distortions in the behavior of the healthy firms that can attributed tocompeting with zombies. They consider three different regression specifications which are
estimated for a panel of publicly listed companies in Japan. The specifications are:Activityijt =δ1′D t +δ 2′D j +β nonzijt +χ Z jt +ϕ nonzijt *Z jt +ε ijt(5)Activityijt =δ3′D jt +β nonzijt +ϕ nonzijt *Z jt +w ijt(6)

Activityijt =δ3′D jt +β nonzijt +ϕ nonzijt *Z jt +θ sijt +vijt(7)

The proxies for economic “activity” that are to be explained are either investment in fixed assets,
employment growth, or the total factor productivity growth.4 These specifications differ
depending on the implied forecast for what would happen in the absence of zombies. The
simplest, baseline specification (5) regresses an activity variable on an indicator variable thatallows for different values for each year and industry (Dt and Dj respectively). This amounts toproposing that knowing the year and the industry is an adequate summary for what investment,
4

The subscripts i, j, and t denote an individual firm, an industry, and a year respectively.
14

employment or productivity would be. In addition, this specification (and all the others) allows
for different estimates of activity for zombies and non-zombies. The non-zombie dummy
variable (nonz) takes the value 1 when the firm is not considered to be a zombie in that year.
Activity is also presumed to depend on the proportion of the assets in the industry held byzombies (Z). The final “interaction” term in the equation (nonz times Z) captures the possibility
that non-zombie firms behave differently when their industry has many zombies than when few
zombies are present.
For investment and employment growth regressions, the zombie hypothesis predicts theinteraction coefficient to be negative. As the number of zombies increases in the industry,healthy firms cut back their investment and employment growth. For TFP growth, the zombie
hypothesis makes the opposite prediction, that the coefficient be positive. To successfullycompete with zombie firms, non-zombies are required to have extra high productivity. Thus, ineach case the regressions can be read as asking the question what happens to activity for nonzombies when it has to confront additional zombies over and above what we already would
expect based on average activity for the whole economy in a given year and for the average
performance in the industry.
Notice that most standard theories of industry dynamics would make opposite predictions
to the zombie hypothesis. For example, if a firm’s competitors are weak, standard theories
would suggest that this would be a good time to hire more workers or to invest in moreequipment to steal market share. Likewise, a firm with poor productivity growth would be
expected to survive more often when its competitors are weak.
Specifications (6) and (7) are estimated to allow for more complicated counter-factual
scenarios. Specification (6) includes a dummy variable for each industry-year combination15

instead of the year-specific dummies and the industry-specific dummies. This allows us toaccount for any factor that influenced all the firms in an industry in a specific year. Although
this makes it impossible for us to estimate the impact of the increase in the zombie index (whichis measured at industry level) on individual firms in general, it is still possible to estimate its
differential impact on the non-zombies.
Specification (7) introduces the firm specific sales growth in addition to the year-industry
combination specific dummies. This is an attempt to control for differences in profitability atfirm level. In other words, besides holding fixed the conditions for all firms in a given industry
in a given year, this equation also accounts for the average activity of a firm with a given level ofsales growth.
Table 3 again from Caballero et al. (2008), reports the regression results. The first threecolumns show the coefficient estimates and their standard errors (in parentheses) for
specification (5). The middle three columns are for specification (6), and the last three columns
are for (7). In all of the specifications, the sign of the interaction coefficient are as predicted by
the zombie hypothesis and in most cases the coefficient is statistically significantly different
from zero. Thus, the regressions suggest that an increase of zombie firms hurt the non-zombies
in the same industry and reduces the investment and the employment growth of those otherwise
healthy firms. More zombie firms also increase the productivity gap between the non-zombies
and the zombies, because the non-zombies have to be extra profitable in order to survive.
We next explore the cross-industry impact of the zombies. The productivity growth of anindustry where there are many zombies is expected to be low not only because there are many
unproductive zombies, but also because the zombies prevent the entry of new productive firms.
Figure 8, again taken from Caballero et al. (2008) plots the total factor productivity growth from16

1990 to 2000 against the change in the (asset weighted) zombie index from the 1980s to the1990s in the industry. As expected the industries that experienced large increases in zombies had
low productivity growth.
Taking this one step further, Figure 9 compares the total factor productivity for the
manufacturing sector to that for the parts of non-manufacturing sector which are considered tohave suffered from the zombie problem. For this calculation non-manufacturing are those
operating in construction, retail & wholesale trade, real estate, agriculture, finance & insurance,and hotels & restaurants. The shaded areas of the graph show recessions according to thebusiness cycle dating by the Cabinet Office of the Japanese government.
The figure shows that both manufacturing and non-manufacturing industries increased
their total factor productivity during the 1980s. During this period manufacturing out-performed
non-manufacturing, but their patterns were relatively similar. In the 1990s, divergence occurs.
The manufacturing industry’s productivity suffered during the recessions but grew during therecoveries. In contrast, the productivity for non-manufacturing has been flat since the early
1990s.

6. Growth Impediment #2: Government Regulatory Restrictions
Another growth impediment is the heavy government regulation in some sectors.
Protection of industries often stifles competition and has a similar effect to permitting zombies.
For example, entry restrictions raise profits of incumbent firms but reduce overall productivity
growth by discouraging the entry of new firms. There are also cases where government
interference can interact with the zombie problem. For example, Tett (2003) recounts
discussions held between the government and the new owners of the Shinsei bank (the successor

17

to Long-Term Credit Bank, LTCB, which had failed and was auctioned by the government) overlending policies. When LTCB was up for sale one of the conditions imposed on bidders was acommitment to continue to support small borrowers. Tett reports that the new bank owners
believed that many of these borrowers were not credit-worthy but nonetheless were pressured by
the government to continue lending.
While systematically documenting any effects of informal pressure such as that describedby Tett is difficult, there are a variety of testable implications of the conjecture that regulation
stifled growth. Most directly, if government regulation is an important impediment, we shouldfind that more heavily regulated industries tend to have lower productivity growth. We should
also expect to find that industries with more restrictions allow inefficient incumbents to operate
longer than otherwise. Moreover deregulation should correct some of these problems, so
deregulated industries should show productivity growth.
The existing literature has some suggestive evidence for these predictions about the
distorting effects of regulation. Nakanishi and Inui (2008) use the data from the JIP (Japan
Industrial Productivity) database to examine the relation between regulation and total factor
productivity at the industry level. The index for regulation in the JIP database is constructedfrom Kyoninka-tō Genkō Hyō (Present State of Administrative Clearance) (published by the
Ministry of Internal Affairs and Communication, Administrative Evaluation Bureau), which
provides 0-1 indicators if a very narrowly defined industry is subject to some administrative
clearance. This assessment is given for 519 sub-industries, and then the data are aggregated to
108 industries by calculating the weighted average (based on the value added) of the underlying
sub-industries. (Fukao et al. 2008, pp.109-110). For the sample period from 1970 to 2002,
Nakanishi and Inui (2008) find more heavily regulated industries have lower total factor

18

productivity growth. Their statistical estimates imply that TFP growth increases by 1.1% peryear when an industry switches from having each sub-industry regulated industry to having none
regulated.
Cabinet Office (2006) uses another index for regulation that is based on not only theexistence of regulation but also how “strong” the regulation is (both in content and in the legal
basis of the restrictions). Their index builds on basic information in Kyoninka-tō Genkō Hyō(Present State of Administrative Clearance), but groups regulations into 4 categories according
to the content of the regulation. Category A regulations require explicit approval or licenses toengage in certain business areas or offer new products. Category B regulations compel the firms
to prove periodically that they satisfy certain standards for products and business. Category C
regulations ask firms to report certain business information to the regulatory agencies. Category
D regulations are other minor regulations (e.g., periodically required training programs). In
addition to these four categories, Cabinet Office (2006) also counts the number of regulatory
reforms that opened up new business areas or new products each year. When such deregulation
occurred, the new business area or product was considered to have been banned before thederegulation although the ban is not listed in Kyoninka-tō Genkō Hyō. Such implicit ban iscoded as a regulation in Category S.
The regulations are also categorized according to the legal bases. If a deregulation isderived from a formal Act, it is classified as Level 4. If it is defined by a government ordinance,
it is Level 3. If it is by a ministerial ordinance, it gets Level 2. If it is just a notice, it is coded as
Level 1.
The weighted sum of the regulations is calculated, using highest weight for Category S
regulation and then Category A regulation, and so on. The index is normalized to 1.0 for 1995 in19each industry, so one cannot compare the extent of regulation across industries. Once again theycorrelate productivity from the JIP database with the regulation proxy. The Cabinet Office findsthat industrial TFP growth from 1995 to 2002 is negatively related with the regulation index in
2002. Thus, the result suggests that deregulated industries (lower value for the regulation index
in 2002) tend to have high productivity growth. The result is statistically significant for nonmanufacturing industries. For manufacturing industries, the result is not statistically significant,but the sign of the coefficient suggests the direction of the effect is the same.
We extend the Cabinet Office analysis by using more recent estimates of the industrial
TFP growth rates contained in JIP Database 2009(http://www.rieti.go.jp/en/database/JIP2009/index.html). This allows us to correlate the TFP
growth from 1995 to 2005 to the regulation index in 2005. We also consider an alternative
regulation index that only considers Category A regulations to be relevant.5
Figure 10 shows the time series of the average regulation index for manufacturing andnon-manufacturing. The coverage of “non-manufacturing” here is the same as that for Figure 9(construction, retail & wholesale trade, real estate, agriculture, finance & insurance, and hotels &restaurants). The regulation index for each industry is weighted by the value added of theindustry and averaged. Note that the index is normalized to be 1 in 1995, so unfortunately wecannot compare the levels of the index across the sectors – although we strongly suspect that
manufacturing was already much more deregulated than non-manufacturing in 1995. We cancompare the speed and the extent of the deregulation from 1995 to 2005.
The regulation index for the manufacturing sector fell to about 0.4 by 2005, while the one
for non-manufacturing stood at around 0.6 in 2005. Thus, over the decade, there was more

5

We thank Tomohiko Inui, Hidehiro Iwaki, and Fumihira Nishizaki at the Cabinet Office for sharing their data on
regulations.
20deregulation (relative to the initial level in 1995) in the manufacturing sector. The more striking
difference is found in the time series pattern of deregulation. While the deregulation for the
manufacturing sector proceeded steadily, the deregulation for the non-manufacturing sector
moved quickly during the 1990s (more quickly than in the manufacturing sector) but then stalled.
In the 2000s, the average regulation index for the non-manufacturing sector actually increased
noticeably. Overall, the graph suggests that the deregulation efforts (to the extent they arecaptured by this index) slowed down in the 2000s for the non-manufacturing sector.
Figure 11 plots the TFP growth rate from 1995 to 2005 against the value of the regulationindex in 2005 for each sector. The TFP growth does not seem to be correlated with theregulation index for either sector. The slopes of the simple regression lines are not significantly
different from zero.
Figure 12 and 13 repeats the same analysis for an alternative regulation index that counts
only the Category A regulations. Figure 12 again shows that the deregulation for nonmanufacturing industries has been much slower than for manufacturing industries. In fact, theregulation index for non-manufacturing trended upward from 1995 to 2005. Compared with theoriginal regulation index in Cabinet Office (2006), the alternative index excludes (1) new
business areas or products opened up during 1995-2005 and (2) deregulation of less important
restrictions in categories B through D. Since allowing new business areas or new products were
often associated with new regulations concerning those areas or the products, it is possible forthe number of Category A regulations to increase even when the firms in the industry gain more
discretion. The gap between manufacturing and non-manufacturing, however, is striking. Even
with the potential upward bias, the index shows steady deregulation in the manufacturing sector.

21

In the non-manufacturing sector as aggregate, this index does not show any evidence of
deregulation.
The Figure 13a for manufacturing is very similar to Figure 11a. We do not find acorrelation between deregulation and productivity growth. For non-manufacturing, however,relatively more deregulated industries experienced higher productivity growth – although thiscorrelation is not statistically significant.
Overall the results here are broadly consistent with the results of Cabinet Office (2006).
But, the updated figures imply that deregulation in non-manufacturing seems to have stalled
during the 2000s. When we focus on Category A regulations, we do not see any trend of
deregulation for non-manufacturing. The lack of deregulation in the non-manufacturing seems
like another potential cause of stagnation.

7. Growth Impediment #3: Macroeconomic Policy Mistakes
There are three broad areas of economy-wide economic policy where Japan made major
mistakes. The first was with respect to financial supervisions and regulation. The zombie
problem was at its core caused by lax (and/or) misguided oversight of the banking system. The
zombies only continued to exist because impaired banks were allowed to continue extending
credit to them. Normally, healthy banks have no incentive to roll over loans to deadbeat
borrowers. But the Japanese government was not interested in being forthcoming about the sizeof its banking problems. Hoshi and Kashyap (1999) pointed out that the major Japanese banks
were substantially under-capitalized, yet the government neither chose to force the banks to raise
capital nor did they allow stronger foreign banks to buy the bad banks. Instead there were many

22

examples such as the ones documented by Tett (2003) where the government insisted that thebanks keep lending to zombies.
Eventually, as we discuss below, the program designed by Minister of Financial Affairs
Heizo Takenaka succeeded in forcing major banks to get rid of their non-performing loans.
Around that same time, the activities of the Industrial Revitalization Corporation of Japan andother turnaround funds contributed to the restructuring of many firms. There is no good reason
that these steps could not have been taken sooner, which would have promoted an earlier
recovery.
Had the bank support to the zombies been withdrawn sooner, some of the zombies could
have been restructured and regained profitability (provided that there was financial support tofacilitate the reorganization.) For these firms it would have been wise to encourage restructuring
rather than liquidation – but even in these cases, it would have been likely that many workers
would have been released. For other zombies, closure would have been the best outcome.
Given that the fallout from tackling the zombie problem would have involved massive
labor turnover, it would have been advisable to have a strong social safety net in place. This isespecially important for Japan where the lifetime employment was the norm and the market for
mid-career workers has been underdeveloped. But Japan has historically had a weak social
safety net. For example, Figure 14 shows data from the Organization for Economic Cooperation
and Development on public expenditure on active labor market policies in 2001. Japan had thefourth lowest spending of the 23 OECD countries for which data were available. The social
safety net was not significantly improved even after Takenaka’s reform. This lack of a strong
safety net may have contributed to the political backlash against several major economic reforms
that started under the Koizumi government.

23

Fiscal policy more broadly was poorly used during the stagnation period. Between 1992
and 2007 (before the global financial crisis had taken hold), net government debt as a share of
GDP rose from under 20% to about 80%; since 2007 the debt skyrocketed to over 120 percent of
GDP. So over the whole period of slow growth, the country was consistently running substantial
budget deficits. As Figure 15 shows, Japan’s budget position over the last 20 years has moved
from amongst the best of the developed countries to the worst.
Doi, Hoshi and Okimoto (2010) (DHO) examine the time series pattern of deficits andgovernment debt (including both central government and local governments as well as the social
security funds) to assess the long-term implications of Japan’s fiscal trajectory. They start byasking how much tax revenue will be needed to avoid defaulting given the likely path of
expenditures and transfers and the existing level of debt. Broda and Weinstein (2005), looking at
data through 2003, had asked a similar question and reached a relatively benign answer: taxes
would need to be increased but depending on the assumed path of expenditures and transfers,
only to levels that already were observed in the U.S. or Europe.
DHO find that the level of required taxes now appears to be much higher. In the last
several years there have been three important changes. First, there are updated data on
demographics that allow for more accurate projected aging costs. Second, there are revised, andmore realistic, projections about other future spending obligations of the government. Finally,
and most importantly, the initial level of debt used for the calculation is higher reflecting the
sharp increase in recent years. Once these revisions are taken into account, the necessary level oftaxes rises sharply, so that in the baseline scenario government revenue would need to jump byalmost 10 percent of GDP immediately to stabilize the debt to GDP ratio at the (already high)current level by 2100.

24

DHO then examines how the primary budget balance or the tax rate responded to changes
in the debt to GDP ratio in the past 30 years. If the government tends to tighten fiscal policy
when the debt to GDP ratio increases, this kind of policy can limit the debt problem. Put
differently, the government does not have to be in the deficit reducing mode all the time, if theefforts made to reduce debt are sufficiently aggressive at certain times. If the deficit reducing
mode is entered frequently enough, the fiscal policy can be sustainable. DHO conduct several
different tests, but they yield the conclusion that the tax and spending policies observed in thelast 30 years are unsustainable. Japan would need to substantially and rapidly raise revenues toavoid defaulting, but such a policy change is highly unlikely given the observed policies from thelast 30 years. It would take an unprecedented commitment by the government to stabilize thedebt.
Coincident with the increased spending by the government has been a reduction in
investment by the private sector. Figure 16 shows the shares of GDP for the private sector grossfixed capital formation (the broadest measure of private investment in the economy) and public
spending. The investment share has trended down steadily since the early 1990s. Importantly,
this is not just due to the bulge in investment share that accompanied the boom during the socalled “bubble years”. By 1993, the share of the private sector investment was back to the levelfrom the early 1980s, at 20 percent. Since that time the share has dropped further to its current
level of about 16 percent. As our growth accounting calculations indicate this does not bodewell for growth.
In addition, there is a striking negative correlation between the government’s share of
GDP and the share of private investment. During the “lost decade”, 1993 to 2002, thecorrelation is -0.8, and over the whole sample it is -0.7. Obviously, we cannot conclude that the25

government spending increases caused investment declines based on this simple picture alone.
There is no doubt that some of the spending increases were initiated because of weak state ofprivate spending, including investment. But over the period of 20 years the pure reverse
causality explanation for the correlation becomes less plausible.
Probably the clearest way to see the problems with spending is to look closely at its
timing and composition. For example, in 1996, the Hashimoto government believed that theeconomy had recovered from the post bubble recession and it was time for fiscal consolidation tocontain the growth of government debt. The fiscal policy was tightened, and the economy
returned to a recession. Contemporaneous commentary on this decision was generally favorable,with many observers lauding the move. For instance, the International Monetary Fund Executive
Board in July 1997 wrote the “Directors endorsed the fiscal correction measures enacted in the1997 budget as a step in the right direction, given the large budget deficit and to prevent a further
increase in the already high level of public indebtedness. Looking ahead, Directors welcomed thegovernment’s announcement of plans for medium-term fiscal consolidation and proposals forspending restraint in next year’s budget.”6 While in hindsight many criticize this decision, we
think it was defensible.
On the other hand, the resources marshaled to clean up the banking problems were
woefully inadequate. As Hoshi and Kashyap (2009) describe, by the early 1990s Japan’s
specialized housing lenders, the jusen, were widely recognized to be bankrupt. But Ministry of
Finance and many politicians insisted that they could be rationalized without taxpayer support.
When the legislation to clean them up finally passed in 1996, the public was outraged and thegovernment was nearly toppled – even though the total amount of public funds was tiny (¥0.68
trillion). Having witnessed the public reaction to the jusen rescue, neither the elected officials
6

See IMF press information notice 97/19, http://www.imf.org/external/np/sec/pn/1997/pn9719.htm .
26

nor the government bureaucrats were anxious to admit the scope of the banking problems for the
major banks and to allocate the necessary funds to reorganize them. The dithering anddissembling about the true size banking problems were a critical factor in exacerbating thezombie problems.
In addition, the delay meant that government spending overall was high from 1999 to
2002, which likely made it harder to get a handle on the deficits. The Koizumi fiscal
consolidation stands out as the only period of sustained reductions in spending over the lasttwenty years. With the onset of the global recession, budget deficit has reappeared and spendingis on the rise again.
Perhaps more importantly, the deficit spending that did occur was poorly chosen. Most of
the spending went into public works that ceased to be very productive by the 1990s. Doi and
Ihori (2009, Chapter 3) estimate the marginal productivity of public capital in five categories(roads, harbors, and airports; railways; postal services, telephone and telegraph; agriculturerelated pubic capital and fishing ports; and flood control and forest conservation). They find themarginal productivities in all these categories of public investment declined after the end of therapid economic growth period. The marginal productivity had become especially low for thethree out of five groups (roads, harbors, and airports; agriculture-related pubic capital and fishingports; and flood control and forest conservation) by the early 1990s.
Figure 17 shows the percentage of public spending devoted to each category from 1992
to 2003, along with the Doi-Ihori estimate of investment efficiency in 1991. More resources werepoured into the areas where productivity was already low. Total spending on the three categories
of infrastructure totaled 213 trillion yen between 1992 and 2003 and amounted to 89% of the27total public investment during this period. 7 Given the unsustainable fiscal position that Japanfinds itself in now, this kind of nearly useless spending will have to stop.
Monetary policy is the third major leg of government policy that has been mismanaged
for much of the 1990s and 2000s. The path of the interest rate target is shown in Figure 18. The
figure shows that starting in July 1991 the Bank of Japan began cutting its interest rate target,
lowering it by nearly 3 percent between July 1991 and July 1992 (recall that the peak for real
GDP growth came in the 2nd quarter of 1990). By mid 1995 Japan had reduced its target to 50
basis points.
Starting with an influential paper prepared by the Federal Reserve Staff in 2002, Ahearne
et al., it has become fashionable to argue at the Bank of Japan was slow to respond to economic
developments. Indeed, speeches by senior Federal Reserve officials routinely assert that thecritical lesson from Japan’s experience with prolonged deflation is that the BOJ was too slow intrying to stop deflation; see for example Kohn (2006).
As we explain just below, Japanese monetary policymakers committed several errors, but
we believe that the criticism of the early 1990s reflects serious hindsight bias. There are two
ways to see why monetary policy in the early 1990s in Japan does not look irresponsibly tight.
First, as Ahearne et al. (2002) document quite convincingly, neither the Federal Reserve staff
forecasts, the IMF staff forecasts, nor the consensus private sector forecasts anticipated the
deflation that ultimately appeared in Japan. Indeed, we are unaware of any credible analysts thatin real time were criticizing the Bank of Japan for being too slow to cut interest rates.
Second, financial market prices also reflected the belief that deflation was unlikely.
While short-term interest rates were below 0.5 percent by the second half of 1995, longer term
safe interest rates such as the 10 year rate remained above two percent. So given that deflation
7

We thank Takero Doi for providing us with the data.
28

was not forecasted, the implied real interest rates by mid 1995 were already negative. By thelatter part of the decade, it may be the case that real interest rates in Japan were substantiallyhigher than would be desired, but does not appear to be the case through 1995.
Taken over the subsequent 15 years, however, the policy does seem inappropriate. One
indication is that despite the BOJ having an unambiguous mandate of delivering price stability
and having announced a preferred target level of around one percent inflation, the bank has failed
to hit that target. As of 2010 nominal GDP was lower than nominal GDP in 1994. Over a time
period this long, there is no good reason why a central bank should consistently miss its target in
one direction. We agree with the criticisms by Ito and Mishkin (2006) who describe the weakefforts by the BOJ to end deflation and the premature tightening of monetary policy on several
occasions. These mistakes were more important than the interest rate decisions made between
1992 and 1995.
The persistently tight monetary policy has had two modestly bad effects on the economy.
First, by having interest rates near zero for so long, the job of detecting zombies was made moredifficult. If inflation had been consistently positive and interest rates consistently higher thefirms which could not repay their loans would have been easier to spot. But virtually any firm
can make payments of a few basis points.
Second, at least for the last half of the 1990s when deflation was expected, the policy led
to higher real interest rates than circumstances warranted. By 1998 there was plenty of evidence
that the economy was in dire condition and yet the Bank of Japan did not try to drive real interest
rates negative. One of Ben Bernanke’s most memorable speeches was the scolding he delivered
to the Bank of Japan in 2003 listing the many ways in which the Bank of Japan could havepursued a looser policy.

29

We share the conventional view that over long periods monetary policy does not havereal effects. So we are not asserting that a purely monetary fix could have made a big differencein preventing the stagnation of the economy. Rather, it seems that there was no good reason to
pursue the policy that was chosen and perhaps a looser policy would have helped marginally.

8. Evaluating Koizumi Reform
In considering the impacts of government regulation on the (lack of) growth in Japan, wepay particular attention to the experience in the early 2000s. From April 2001 to September
2006, under the leadership of Prime Minister Junichiro Koizumi, Japan embarked on several
economic reforms, which included deregulation attempts in several industries. As we saw inFigure 4, this coincides with the period when the decline in the Japan’s long-term growth rate
seems to have halted.
In this section, we evaluate the role of several economic reforms attempted by the
Koizumi government. As the key components of the Koizumi reform, we consider the following
six high profile reforms:(1). Financial system reform(2). Postal Privatization(3). Labor reform(4). Promotion of FTAs and agricultural reform(5). Deregulation through special zones(6). Local public finance reform (“Trinity” reform)
For each of these six reform areas, we ask several questions. First, how would the reform
restore the growth of Japan? Second, what was the goal of the reform? Was it stated clearly30

with some clear targets? Third, did the reform achieve the stated goal? Fourth, was the reformcompleted? If not, why was the reform aborted? Fifth, did the reform have any unintended
consequences?
Table 4 summarizes our answers to these questions. Here we go through our evaluationof each reform briefly. More detailed discussion of each of the six reforms is found in the
Appendix.
The financial system reform carried out by the Minister Heizo Takenaka started in
September of 2002. The Takenaka plan targeted the reduction of non-performing loans at majorbanks by half in two years. The Takenaka plan consisted of six parts, which forced the banks todisclose the amount of non-performing loans and deal with those. The plan included the optionof using business improvement orders for non-compliance. The plan successfully achieved thetarget. The major banks reduced the amount of non-performing loans by more than a half in two
years. Although the reform did not solve the problem of Japanese banks to find viable businessmodels for the future, it at least restored health of the financial system. By forcing the banks to
get rid of non-performing loans and encouraging restructuring of troubled firms through theIndustrial Revitalization Corporation of Japan (IRCJ), the reform also helped the recovery of thereal economy.
The Koizumi government also initiated the privatization of various special public
corporations and agencies, including postal services. Although these were called privatization,
the reform just restructured the organizations into government-owned joint stock companies andspecified a schedule for divesture of government shares in the future. For example, the postal
privatization planned the divesture of the government shares in the postal savings and the postal
life insurance to start after the listing of the new entities on the stock market in 2010 and to be31complete within five years. This meant that true privatization had not started when Mr. Koizumi
left the office. When the Democratic Party of Japan (DPJ) won the power in late 2009, thedivesture plan was suspended and the privatization process stopped.
The Koizumi government embarked on the reform of the labor market to make it more
flexible. The most often discussed component is the revision of the Dispatched Workers Act in2003. Dispatched workers are those hired by one firm (a work agency) and temporarily placed atanother firm. The reform allowed more variety in the arrangements for worker dispatching thanallowed in the previous version of the law and most notably allowed worker dispatch to
production jobs in manufacturing. This revision is often criticized as the one that substantiallyexpanded the group of workers with unstable and low paid employment. The data reveals that
there was a surge in the use of dispatching after the 2003 reform. But, even for workers
dispatched in manufacturing, there was a practice of using subcontracting to shell companies tohire de facto temporary workers before the 2003 reform. The reform was rather an attempt toformally regulate the employment contracts under this “fake subcontracting” arrangement. Afterthe Koizumi government, there have been attempts to re-regulate worker dispatching.
The Koizumi government tried to change the prevailing agricultural policy as well. The
low productivity of agriculture often hindered government efforts to expand the network of thefree trade areas. The Koizumi government tried to improve the productivity of Japanese
agriculture to cope with globalization of the economy. The traditional support of agriculture
used subsidies to all farmers including small and old farms. This policy was replaced by support
for larger scale farming. It is not clear if the productivity of the agricultural sector improved nor
if the policy enhanced large scale farming at all, but it did certainly weaken the farmers’ political32

support for the LDP. After Mr. Koizumi stepped down, the agricultural policy switched back totrying to protect small farmers.
One method that the Koizumi government used to promote deregulation was creation of
special zones. The government allowed local governments to set up special local economic
zones where some aspects of regulation are relaxed. They are designed to set up example cases
to show the benefits of deregulation. Another objective was to promote local economies throughlocal initiatives. Many special zones were established but only few of them had sizable impact.
Worse, many local promotion zones ended up diverting business from other areas. After the
Koizumi government, creation of special zones slowed down.
Local governments in Japan traditionally relied on the central government for financial
support through the local allocation tax grants and the state subsidies. Typically less than half ofthe expenditures by local governments are financed by the local taxes. To reduce the local
governments’ dependence on the central government, which faced the mounting problem ofgovernment debt, the government implemented the so called “Trinity Reform”. The reform
called for achieving the financial autonomy of local governments through reduction of local
allocation tax grants, reduction of state subsidies, and transfer of tax resources to local
governments. The reform succeeded in reducing the grants and subsidies substantially, andshifted some income tax revenues from the central government to local governments. In net, thereform did not reduce the deficit at the central government very much. For many local
governments, however, the reductions in the grants and subsidies far exceeded the increase in tax
revenues, because the increase in local tax revenues was concentrated in a few rich localities.
Many local governments also saw cuts in the amount of Emergency Fiscal Measure Bonds thatthat they were allowed to issue. These bonds were supposed to be repaid using future local

33

allocation tax grants, so these cuts added fiscal stress at many local governments. After Mr.
Koizumi stepped down, local governments lobbied for transferring more central government
revenues to the local governments, essentially restoring the flow of subsidies and transfers.
Reviewing the reform experience under the Koizumi government, we make several
observations. First, only the financial system reform was fully implemented and successful.
Second, many reform attempts were not specifically targeted to raise growth. Third, somereforms, such as privatization, specified deadlines too far in the future and, hence, weresusceptible to reversal. Fourth, measuring progress was often difficult since there were often no
numeric targets for the reforms. Finally, in many cases, the reforms are still incomplete today
not because the reforms are infeasible but because the policy was reversed by the governmentsthat followed Koizumi.
The review gives us a set of clear lessons for further deregulation to be successful. It is
important to focus on sectors (or distortions) that are important for growth and target those. This
strategy improves the chances that the gains will be meaningful. It also makes it easier toexplain the importance of the reform to the public and measure the progress towards the goal. It
is also important to have clear targets (preferably numerical) that can be achieved in a few years,
not in a few decades.

9. Conclusions
Our report shows that it is now very clear why Japan stopped growing. Some of theslowdown was natural. Japan moved from being a relatively poor economy after World War II
to one of the richest in the world. The easy catch up phase of growth could not go on
indefinitely and invariably brought a reduction in growth.

34

The transition to growing as a mature economy requires all countries to change and Japanencountered two specific challenges in making this transition. First, the structure of its
population was shifting. Instead of having a young, growing work force, it had to confront onolder, declining work force. The aging lowered the growth potential.
Second, Japan’s economy had been organized to produce goods for export, withproduction for the domestic market being an after-thought. Productivity growth in nonmanufacturing lagged that in the manufacturing sector. A more balanced and richer economy
requires a well functioning non-manufacturing sector.
Once asset prices collapsed in the early 1990s, the weaknesses in the non-manufacturingsector became more apparent. Japan compounded the losses from the asset price drop with threesignificant policy errors. First, the government delayed dealing with the losses in the banking
system that accompanied the asset price drop. Weak banks operated for too long by
misallocating credit to obscure their problems. By rolling over loans to zombie firms, the banks
distorted competition, keeping the zombies in business and reducing the rewards to strong firms
from expanding their presence. Over time this reduced productivity growth. These problems
were most pronounced in the non-manufacturing sector where the trouble could be more easily
disguised. Only during the Koizumi administration was real progress made in confronting thebanking problems.
Regulation, or more precisely the lack of deregulation, exacerbated the zombie problems.
In the non-manufacturing sector, the industries that had the most deregulation grew fastest. On
average starting in the late 1990s regulatory barriers to new entrants were actually increased.
Finally, monetary and fiscal policy performed poorly. The Bank of Japan consistently
undershot its inflation objective. The government pursued massive fiscal stimulus during the35

1990s and 2000s, so much so that Japan went from having the best debt position amongst
advanced economies to the worst. Japan’s current mix of spending and taxing cannot besustained without reneging on the future promised transfers (through the national pension systemor the national healthcare system), producing very high inflation (that would reduce the realvalue of debt), or defaulting outright on its debt.
Worse still, much of the spending that took place was misguided. Most of the public
work projects undertaken were directed in areas that had long ago ceased to be productive.
Hence, the payoff from the spending binge will not be high.
Japan now finds itself growing at about the rate found in Germany and France andsubstantially below the trends in Canada, the U.S. and the U.K. If Japan wants to raise its
growth rate, much will have to change. It is encouraging to note that all of these countries
experienced growth slowdowns in the past, from which they have recovered. And likewise, thepast failures in Japan point to what needs to be done to reverse course.
First, and foremost, the priority should be on policies that plausibly raise productivity
growth. Policies that remove regulation to protect inefficient incumbents in many areas of theeconomy are an appropriate place to start. To the extent this will involve more labor reallocation,
it would be wise to set aside money for protecting displaced workers’ incomes and training them
to be redeployed. That kind of spending will be far more productive than continued public
works projects of the type undertaken throughout most of the 1990s and 2000s. Reducing thesize of the government’s claim on the economy will leave more room for private investment andlessen the need to raise taxes; although tax increases are inevitable, and they should be designed
to minimize distortions.

36

Table 5 presents a summary of the “New Growth Strategy” of current government.8
Given the vast number of proposed projects, a full assessment is beyond the scope of this report.
But, using the framework we have developed, it is possible to make four broad points about thecurrent plan.
First, many of the strategies represent old fashioned industrial policies, whereby someindustries or activities are given subsidies. This policy had mixed success during Japan’s catchup period, but there is no evidence that it works well for mature economies (see Beason and
Weinstein (1996) and Pinkovskiy (2009)). These policies are susceptible to lobbying so thatfunds are allocated for political rather than economic reasons and so these findings are notsurprising. Moreover, the goal of an industrial policy is often to provide temporary protection to
an industry so that it will become competitive without government help. If the industry fails to
become competitive, however, it is hard for the government to pull the support and the protection
can turn permanent, further dulling the incentives of the private sector to be competitive.
The New Growth Strategy identifies some seemingly promising areas such as “green”
industries and health care/long-term care industries. Even for these areas, however, one stillneeds to ask why those areas are not developing already without government help. What are theexternalities that the government tries to solve? There may be government regulation and otherstructural reason why the private sector is not eager to invest in these areas. In that case,removing the regulatory barriers will be more effective than giving subsidies or tax breaks.
A second observation is that many of the strategies are export-oriented (e.g., promoting
medical tourism into Japan, exporting infrastructure projects to the rest of Asia, strengthening

8

This is based on two announcements by the Cabinet: “New Growth Strategy – Strong Economy, Robust Public
Finances, & Strong Social Security System” (June 18, 2010)(http://www.npu.go.jp/policy/policy04/pdf/20100618_shinseityou_gaiyou_eigo.pdf) and “On the New Growth
Strategy” (June 18, 2010) (http://www.kantei.go.jp/foreign/kan/topics/sinseichou01_e.pdf).
37intellectual property right (of Japanese firms), etc.). Continuing to rely on external demandrather than developing domestic markets has been a perpetual problem for Japan for at least
twenty years. Given the limits on what Japan can afford to spend on, this seems like acounterproductive way to use public money.
Third, the strategy embraces the idea of special zones similar to the ones started by
Koizumi, but with an emphasis is on tourism where the effectiveness of the zones werequestionable. The upside on these policies is low.
Finally, there are few examples of policies that aim to remove regulations that impede
growth. For example, increasing acceptance of high-skilled foreign workers would increase theamount of quality adjusted labor and help growth. Promoting free trade areas with morecountries will improve competitive pressure on the domestic industries and force them to grow.
Increasing imports will also make consumers better off by giving them more choices. Creating anational ID system would make it possible to improve the efficiency of the tax collection and thesocial security system. Focusing on more reforms like this would be great improvement relative
to past policies.
Japan needs to change direction if it wants to grow. The path that will work is wellunderstood. The main question is whether the political courage to shift to the policies that could
work exists and will be utilized.

38

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Doi, Takero and Toshihiro Ihori (2009) The Public Sector in Japan. Cheltenham, UK: Edward
Elgar Publishing.

39

Fukao, Kyoji, Tsutomu Miyagawa, Hyeog Ug Kwon, Tomohiko Inui, Sumio Hamagata, Keisuke
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Hamada, Anil K Kashyap, and David E. Weinstein (Eds.) Japan’s Bubble, Deflation, andLong-term Stagnation. Cambridge, MA: MIT Press, forthcoming.
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From and How will it End?” in Ben S Bernanke and Julio J Rotemberg (Eds.) NBER
Macroeconomics Annual 1999, pp.129-201.
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Lessons from Japan,” Journal of Financial Economics, Vol. 97, pp. 398-417.
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with Very Low Inflation in the Pacific Rim. Chicago: University of Chicago Press, pp.
131-93.

40

Ito, Takatoshi, Hugh Patrick, and David E. Weinstein (2005) (Eds.) Reviving Japan’s Economy.
Cambridge, MA: MIT Press.
Kohn, Donald L. (2006) “Monetary policy and asset prices” speech delivered at "Monetary
Policy: A Journey from Theory to Practice," a European Central Bank Colloquium heldin honor of Otmar Issing, Frankfurt, Germany.
Nakanishi, Yasuo, and Tomohiko Inui (2008) “Kisei Kanwa to Sangyo no Performance”(Deregulation and Industrial Performance) in Kyoji Fukao and Tsutomu Miyagawa (Eds.)
Seisansei to Nihon no Kizai Seichō (Productivity and Japanese Economic Growth).
Tokyo, Japan: University of Tokyo Press, pp. 203-220.
Pinkovskiy, Maxim (2009) “Growth, Productivity, and Policy Instruments During the Lost
Decade: A Replication of Beason and Weinstein (1996) for the Period 1992-1998”,
Consilience - The Journal of Sustainable Development.
http://journals.cdrs.columbia.edu/consilience/index.php/consilience/article/view/9
Rajan, Raghuram G. (2010) Fault Lines: How Hidden Fractures Still Threaten the World
Economy. Princeton, NJ: Princeton University Press.
Sommer, Martin (2009) “Why are Japanese Wages So Stagnant?” International Monetary
Funding Working Paper 09/97.
Tett, Gillian (2003) Saving the Sun: A Wall Street Gamble to Rescue Japan from its TrillionDollar Meltdown. New York, NY: HarperCollins.

41

Figures
Figure 1: Japan’s GDP Growth Rate: 1956-2000
16
14
12
56-73 Average (9.2%)

10
8
6
4

74-90 Average (3.8%)

2

91-2000 Average (1.3%)

0-2

Source: Japanese Cabinet Office, 1968 System of National Accounts

42

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972

1970

1968

1966

1964

1962

1960

1958

1956

-4

Figure 2: Japan’s Recent GDP Growth (% from a year ago)
10
8
6
4
2
0
-2
-4
-6
-8
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

-10

Year

Source: http://www.esri.cao.go.jp/en/sna

43

Figure 3: GDP per capita in the G7 Countries(per capita PPP expressed in year 2000 USD)

40,00035,00030,00025,00020,00015,00010,000
1970

1975

1980

USA
Germany

1985

1990

UK
France

1995

2000

Japan
Canada

44

2005
Italy

Figure 4: Trend Growth In the G7 Countries: 1971-2009(Measured for per capita PPP GDP expressed in year 2000 USD)

4.5%
4.0%
3.5%

Trend Growth

3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
$10,000$20,000$30,000$40,000

Trend Level
USA
Germany

UK
FranceJapan
CanadaItaly

45

Figure 5: The Proportion of the Elderly in Various Countries (65 years old and above) (%)
40
35
30
25
20
15
10

1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017
2020
2023
2026
2029
2032
2035
2038
2041
2044
2047
2050

5

United States

United Kingdom

Japan

Italy

46

Germany

FranceCanadaFigure 6: Aggregate prevalence of zombies
R a w P e rc e n ta g e
40
35
30
25
(% ) 2 0
15
10
5
0
1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

1997

1999

2001

Asset-weighted Percentage
18
16
14
12
10
(%)
8
6
4
2
0
1981

1983

1985

1987

1989

1991

1993

1995

Note: The sample is listed firms in manufacturing, construction, real estate, retail and wholesale (other than the nine largest general
trading companies), and services

47

60

40
40

0

0
`

20

Real Estate

20
0Manufacturing

`

0

`

48

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

All Firms

20
0

Trade

60
60
60

40
40
40

20
0
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

20
`

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

60

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

20

1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002

Figure 7: Cross-industry incidence of zombies

60
Construction

40`

Services`Figure 8: Zombie Incidence and Productivity Growth

Zombies and TFP Growth
10%

TFP growth 1990-2000

8%
6%
4%
2%
0%
-2%

y = -0.3993x + 0.0336

-4%
-6%
0%

5%

10%

15%

20%

25%

Change in the zombie index: 81-92 average to 93-02 average

Note: Estimates for TFP Growth are from Tsutomu Miyagawa, Yukiko Ito, and Nobuyuki Harada (2004) “The IT Revolution and
Productivity Growth in Japan,” Journal of the Japanese and International Economies, 18(3), 362-389.

49

Figure 9: Total Factor Productivity by Industry, 1980 – 2006
(1995≡100)

110

100

90

80

70

60
80

82

84

86

88

90

92

MANUFACTURING

94

96

98

00

02

04

Nonmanufacturing

50

06

Figure 10: Weighted Average of the Regulation Index from Cabinet Office (2006)

51

Figure 11: Cabinet Office (2006) Regulation Index and TFP growth
A. Manufacturing Sector

52

B. Non-manufacturing

53

Figure 12: Weighted Average of Regulation Index: Alternative Index Using Regulations in Category A only54

Figure 13: Alternative Regulation Index and TFP Growth
A. Manufacturing Sector

55

B. Non-manufacturing sector

56Figure 14: Public Expenditure on Active Labor Market Policies in 2001 (% of GDP)

2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0

57

Figure 15: Net Government Debt of selected OECD Countries (% of GDP)
140
120
100
80
60
40
20
0
19921993199419951996199719981999200020012002200320042005200620072008200920102011
CanadaFranceGermany

Greece

Italy

Japan

United Kingdom

United States

Source: OECD Economic Outlook 87 database. Annex Table 33.

58

Figure 16: Private Sector Gross Fixed Capital Formation and Total Government Spending Relative to GDP
0.30

0.25

0.20

0.15

0.10
80

82

84

86

88

90

92
G_Y

94

96

98

00

I_Y

Source: http://www.esri.cao.go.jp/en/sna/qe103-2/gdemenu_ea.html

59

02

04

06

08

Figure 17: Distribution of Public Spending

Marginal Productivity in 1991 (estimates in
Doi and Ihori 2009)

Public Investment Share and Marginal Productivity
1.2

Postal service, telephone and telegraph
1.0

Railways
0.8

0.6

Agriculture‐related public capital and fishing ports
0.4

Roads, harbors and airports

Erosions of flood control and conservation of forests

0.2

0.0
0%

10%

20%

30%

40%

Share of public investment, 1992‐2003

60

50%

60%

Figure 18: Japanese Policy Interest Rate, 1990 to 201061

Tables

Table 1: Importance of External Demand Across Countries, 1995 to 2009

Country

Contribution of External Demand to
GDP Growth: 1995 to 2009

Average Share of Exports in GDP:
1995 to 2009

USA

-4.4%

10.8%

UK

-4.9%

27.3%

Japan

26.6%

12.5%

Italy

-7.4%

26.1%

Germany

19.9%

35.6%

France

-7.2%

25.9%

Canada

-7.3%

38.7%

62

Table 2: China and Japan

Japan 1955-1971

Growth in
Output per Worker
8.05%

Contribution from
Capital per Worker
3.04%

Contribution from
TFP
5.02%

Japan 1970s

3.74%

1.74%

2.00%

Japan 1980s

3.23%

2.98%

0.26%

Japan 1992-2002

0.59%

0.06%

0.53%

Japan 2003-2007

2.14%

0.73%

1.41%

China 1998-2007

9.79%

5.21%

4.58%

Source: Accounting for China’s Growth by Loren Brandt and Xiaodong Zhu, IZA DP No. 4764, Feburary 2010 and authors'calculations

63

Table 3: Impact of Zombie Firms on the Investment, Employment and Productivity of Non-Zombies

Dependent Variable

I/K

ΔLog E

Log Sales– ⅔ Log E– ⅓ Log K

I/K

ΔLog E

Log Sales– ⅔ Log E– ⅓ Log K

I/K

ΔLog E

Log Sales– ⅔ Log E– ⅓ Log K

Non-Zombie Dummy

0.0256(0.0056)0.00109(0.001751)

0.0139(0.0135)0.0248(0.0057)

0.0002(0.0018)

0.0119(0.0137)

0.0238(0.0056)0.0001(0.0017)0.0150(0.0136)

Industry Zombie %-0.1370(0.0376)-0.0454(0.0116)-0.3418(0.0922)

Non-Zombie *Industry Zombie%-0.0885(0.0330)-0.0232(0.0102)

0.2183(0.0756)-0.0852(0.0333)-0.0188(0.0102)0.2315(0.0767)-0.0716(0.0321)-0.0128(0.0098)

0.1980(0.0770)0.3490(0.0176)0.1404(0.0073)0.3123(0.0256)

Sales growth
Industry dummies
included?

Yes

Yes

No

Yes

Year dummies
included?

Yes

Industry*year
dummies included?

No

No

No

No
Yes

No

Yes

No

No

No
No

Yes

No
No

Yes

No

No
No

Yes

Yes

Yes
Yes

Number of obs.

22,39622,42923,09022,39622,42923,09022,39422,42822,847R2

0.05370.08950.35990.06170.10070.35900.11250.17940.370564

Table 4: Major Koizumi Administration Reforms
Reform area
1. Financial system
reform

2. Postal Privatization

3. Labor reform(Revision of the
Dispatched Workers Act)
4. Promotion of FTAs
and agricultural reform

5. Deregulation throughspecial zones
6. Local public financereform (“Trinity” reform)

Would the reform help
restoring growth?
Yes. By forcing banks
to restructure zombie
firms. Healthy financial
system supports
investment.
Yes. By releasing thepostal savings to be used
more efficiently in theprivate sector.

What was the statedgoal?
Reduce the NPLs atmajor banks to a halfof March 2002 level
by March 2005

Did the reform achieve
the stated goal?
Yes.

Has the reformcompleted?
Almost. Resona Bank,
which received public
capital injection, is still
government owned.

Unintended consequences

Privatize the postal
servicesTechnically yes, buteffectively no.

Deterioration of qualityof services

Maybe. More flexible
labor market reduces thecost of economic
restructuring, thereby
productivity growth.
Yes. By increasing
productivity ofagriculture. FTAs help
maintaining markets forJapanese industrial
products.
Maybe. If growthenhancing deregulation
can spread beyond thezones
Maybe. If increased
financial autonomy oflocal governments leads
to reduction of wastefulspending.

Increase theflexibility of labormarket and thediversity of jobs

Not clear.

No. Divesture ofgovernment owned
shares did not start andnow stopped
indefinitely.
No. Trend of
reregulation after
Koizumi.

Promote large scale
farming that isinternationallycompetitiveNo.

No. Agricultural policy
has been reversed since
Koizumi left.

Trade diversion rather
than trade expansion

Promotion of local
economy;experiment with
deregulation
Reduce the annualtransfers to local
governments by ¥4trillion by FY2006.
Local governments
find their revenues toreplace this.

Varies.

Still continuing. In
some cases, nationwide
implementation of
deregulation.
Reform period (2003 to2006) ended. Gradualroll back after Koizumi
government.

Special zones simply
divert demand away fromthe neighboring regions

Partially. The reduction
was successful, butmany local governments
failed to find newrevenue sources.
Backlash after Koizumi.

65

Credit crunch

Increase of poorly paid
workers with insecure
employment

Severe expenditure cutsin some localities.

Table 5: Japan’s Latest Growth Strategy (June 18, 2010)
Targets
1. Achieve nominal and real growth in excess of 3% and 2% respectively
2. Positive inflation in consumer prices in fiscal 2011
3. Lower the unemployment rate to 3%-4% range as early as possible
There are 7 strategic areas and 21 national strategic projects
1. Green innovation
a. Expand the renewable energy market by introducing “feed-in tariff” system for electricity
b. Designate future cities
c. Promote domestic timber utilization
2. Life innovation
a. Create consortiums to promote new medical careb. Set up medical care visa and accept foreign patience
3. Asiaa. Market infrastructure projects to Asian countries
b. Reduction of corporate tax rates; introduction of tax incentives for foreign investment into Japanc. Globalization of university education; increasing acceptance of high-skilled foreign workers
d. Roadmap for winning the global standard setting race; strengthening intellectual property protectione. Economic partnership through free trade areas
4. Tourism and local revitalization
a. Designate special zones; open skies policyb. Ease tourist visa requirementsc. Expand the existing housing and remodeling markets
d. Open public facilities to private sector promote projects using private sector funds
5. Science, technology and information technology
a. Develop intensive industry-academia-government cooperation in technology
b. Promote utilization of information technologies; introduce a national ID system66

c. Enhance government related R&D investment
6. Employment and human resources
a. Integrate kindergartens and nursery schools
b. Introduce “career grading” system and “personal support” system
c. Implement efforts to build public service supported by the people; reform taxation on donation and NPOs
7. Financial services
a. Create an integrated exchange for securities and commodities

67Appendix for
Why Did Japan Stop Growing?

Takeo Hoshi
School of International Relations and Pacific Studies, University of California, San Diego,
NBER, and TCER
andAnil Kashyap
Booth School of Business, University of Chicago, NBER, and Federal Reserve Bank of Chicago

January 21, 201168

This appendix contains brief case studies of the Koizumi reforms in six key areas.

Contents
1. Financial System Reform.......................................................................................................... 69
2. Postal Privatization ................................................................................................................... 75
3. Labor Market Reform ............................................................................................................... 81
4. Agricultural Reform and FTA Policy ........................................................................................ 89
5. Special Zones ............................................................................................................................ 97
6. Local Public Finance Reform ................................................................................................. 106
References for the Appendix:...................................................................................................... 113
Figures for the Appendix ............................................................................................................ 116
Tables for the Appendix .............................................................................................................. 130

1. Financial System Reform
1.1.

Target and plan
The nonperforming loans problem in the Japanese banking sector were triggered by thecollapse of asset prices in the early 1990s, but continued to exist into the 2000s. As of the endof March 2002, the nonperforming loans (NPLs) held by the major banks in Japan amounted to
8.4% of their total loans. The turning point came in the fall of 2002 when Heizo Takenaka took
over from Hakuo Yanagisawa as the new Minister of Financial Affairs. With the strong backingof the Prime Minister Junichiro Koizumi, Takenaka ordered the major banks to reduce NPLs by69

half. The “Takenaka plan” to reduce NPLs consisted of the six pillars: (1) to have banks makemore rigorous assessment of their assets using the discounted cash flow method of determining
the profitability of a loan; (2) to check cross-bank consistency in the classification of loan quality
for large debtors; (3) to announce the discrepancy between the banks’ self-evaluation and theevaluation by the Financial Services Agency (FSA); (4) to be prepared to inject public funds tounder-capitalized banks if necessary; (5) to impose business improvement orders on banks that
substantially underachieved their revitalization plans; and (6) to prohibit banks from boosting
profitability (and capital) by declaring unrealistically large deferred tax assets.

Let us look at

each pillar more closely.
1.1.1. More rigorous assessment of bank asset quality
To accelerate disposal of nonperforming loans, Takenaka asked banks to more
rigorously evaluate their assets. Many banks tried hard to minimize the stated amount of NPLs
claiming that the loans would become collectible once the economy turned around. In fact, theseloans typically did not prove collectible and instead would eventually be deemed nonperforming,
thus adding to the stock of NPLs. Takenaka tried to stop this cycle by forcing banks to assess
realistically the quality of their loans.. A critical step was to move away from the existing
practice of judging the viability of a loan based on whether the current payments were being
made. In the ultra low interest rate environment that prevailed in 2002, many companies could70make their loan payments and if they could not, the loans could be extended with hardly any
change in the required payments. Takenaka stopped this cover-up by having the examiners use
the Discounted Cash Flow method to estimate the value of loans to the largest debtors, so that thewhole future stream of payments had to be considered in assessing loans. This change forced
the banks to recognize losses much sooner.
1.1.2. Cross-bank consistency of classification of large debtors
The FSA examined how major banks classified large debtors, and tried to requireconsistent evaluations across banks. To do this, the FSA took the most appropriate classificationfor each large borrower and forced that on all the major banks. This emphasis on horizontal
consistency of credit risks across banks was adopted by Federal Reserve in its Supplementary
Capital Assessment Program (the so-called stress tests), and is now viewed as a critical elementof best practice in systemic bank supervision.
1.1.3. Publishing discrepancies between the bank self evaluation and the official examination of
FSA
Starting from March 2003, the FSA began publishing the discrepancies between thebanks’ self evaluation of their loan quality and the official FSA estimates. The banks wereordered to reduce the discrepancy by adjusting their evaluation process. If a bank failed tocorrect the difference in a timely manner, the FSA issued a business improvement order.
71

Thebusiness improvement orders had the force of law and removed the misreporting that had beenpresent.
1.1.4. Injection of public funds
The prevailing government policy had been to consistently understate the capital needs ofthe banking system and to give weak banks satisfactory evaluations. Mr. Takenaka declared hewould inject public funds to under-capitalized banks if necessary, and he did so. Resona Bank’s
capital ratio for March 2003 fell below the regulatory minimum of 4 % after it was not allowed
to count five year worth of deferred tax assets as a part of its capital. The FSA used the Section
102-1 of the Deposit Insurance Act to inject ¥1.96 trillion into Resona Bank.
Ashikaga Bank also saw its capital ratio for March 2003 fall below 4%, when the FSA
refused to allow the bank to count five year worth of deferred tax assets toward its capital.
Ashikaga was actually declared insolvent with negative net worth of ¥1.023 trillion. Ashikaga
Bank was outright nationalized under the Section 102-3 of the Deposit Insurance Act.
The stock market responded favorably to these injections. After falling to thepost-bubble lows below ¥8,000 in March and April of 2003, the Nikkei 225 started to recoverright after the capital injection to Resona and broke ¥10,000 by the summer. Many
contemporaneous accounts of this period credit the commitment of public funds and thedetermination to force banks to find capital on their own or to get it from the public as the72catalyst for turning around the banking problems (Patrick 2004).
The initial government funds put into Resona proved to be inadequate. Indeed, asubsequent audit showed that loan losses in the next few months wiped out all of the capital that
had been put in. But once Mr. Takenaka’s process was in place and it was clear that Resona could
not simply continue to disguise its problems, the stock market began to rally.

As of the end of

August 2010, ¥1.53 trillion of the capital injection of ¥1.96 still remains, and Resona continues
to file biannual progress reports to the FSA.1
1.1.5. Penalty for not reaching the targets in the reconstruction plans
Banks that received public capital in 1999 thereafter were required to file reconstructionplans with the FSA and to update the status of progress on the plan twice a year. Given thewidespread assistance to banks in 1999, this meant many large banks were already filing theseplans when Mr. Takenaka took over. In the plans, the banks were required to state the targets on
their profitability, the size of reduction of branches and employees, and so on. Prior to Mr.
Takenaka’s appointment banks routinely failed to achieve the stated targets, but the FSA did very
little if anything about the misses. Mr. Takenaka introduced the so-called “30% rules.”If abank missed the reconstruction targets by more than 30%, the FSA imposed the penalties throughthe use of business improvement orders. These sanctions sometimes forced the resignation of

1

Progress on the repayment can be found at (http://www.dic.go.jp/english/e_katsudou/e_katsudou3-3.html).
73

senior management and/or reduced salaries and bonuses for management.
1.1.6. Deferred tax assets
At the end of March 2002, Japanese banks collectively had ¥30.2 trillion of core capital,but ¥10.6 trillion of core capital was made up of deferred tax assets. Deferred tax assets were
controversial because of their peculiar nature. They are tax deductions coming from past losses
that the banks would only be able to claim in the future if they became profitable. If the banks
failed to regain their profitability within five years, these credits disappear.
Mr. Takenaka wanted to prevent banks from overstating future profits and thereby
claiming unrealistically large amount of deferred tax assets. Initially this part of his plan met
extremely strong resistance from the banking sector. The FSA examiners and auditors, however,
eventually became more conservative and forced the bank to reduce their reliance on the use ofdeferred tax assets to satisfy their capital requirements. In particular, following the Resona case,the use of deferred tax assets was substantially curtailed (Skinner 2008).
1.2.

Assessment of the reform
The Takenaka plan worked. One noteworthy feature was the precision of his

instructions which reduced the ability of the banks to cover-up non-compliance.

He created atransparent system for monitoring progress by putting numerical targets in place for the reductionin NPLs, and insisting that progress reports come within 30 percent of the actual results.
74

Inaddition, the threat (and use) of business improvement orders was essential in forcing banks toaccede to the wishes of the regulators.
Figure A1-1 shows how the major banks reduced the NPLs following the Takenaka plan.
In March 2002, the amount of NPLs at major banks peaked at ¥ 27.626 trillion. After the
Takanaka plan started later in that year, the NPLs steadily declined. The major banks disposed ofabout ¥7 trillion of NPLs each year from 2002 to 2005. The goal of the plan to reduce NPLs of
the major banks in half by the end of March 2005 was successfully achieved: NPLs at the majorbanks were ¥ 13.567 trillion by March 2005.
Finally, we can speculate what would have happened if Mr. Takenaka had not
implemented the financial revitalization program. Banks probably would have continued toevaluate their assets leniently. As Omura et al. (2002) argue, the non-performing loans would
have stayed on the banks’ balance sheets. The continued lack of harmonization in classifying
loans to largest debtors would have made it easy for banks to carry on without recognizing
troubled loans. Hence, it is not clear when prevailing cycle that was in place before Mr. Takenaka
offered his plan would have ended.

2. Postal Privatization
2.1. Targets and Plans
75

Japanese postal service was operated by the government and provided three types ofservices: mail, postal savings, and postal life insurance. Combining the postal savings and the
postal life insurance, the total financial assets of Japan Post was approximately ¥350 trillion,
which accounted for 25% of banking and life insurance financial asset in Japan. The postal
savings and postal life insurance assets constituted the most important source of funds for the
Fiscal Investment and Loan Program.
During the 1990s, the government started to recognize some problems with the existingmodel of postal services.

The transaction volume and profits of mail services declined

significantly due to the innovation and rapid expansion of the internet and email. For the postal
savings and life insurance, the private sector began criticizing them for using their government
guarantee to compete unfairly with private businesses.
The idea of privatizing postal services goes back at least to 1992, when Junichiro
Koizumi (then Minister of Posts) advocated the privatization. Mr. Koizumi continued to push
for postal privatization and finally implemented it when he was the Prime Minister. The postal
privatization was the cornerstone of Koizumi’s policy to “leave the private sector what it cando.”
The outline of postal privatization was first drafted in October 2003 by Heizo Takenaka,
who later became the Minister of Postal Privatization. In the draft, he specified five core76

principles of postal service privatization. The first is revitalization. Postal privatization must
revitalize the Japanese economy by integrating the functions of the national postal services into
the market economy.

The second is consistency. Postal privatization must be consistent withother structural reforms, such as the financial system reform and fiscal consolidation.
privatization should not harm the financial system.
The third is convenience.

PostalIt should not impose a fiscal burden, either.

Postal privatization should maintain and improve the conveniencecurrently offered to the users. The fourth is full utilization of the existing resources.

Postalprivatization should fully use the human capital, physical capital, know-how and network that
had been accumulated over more than 100 years. Finally, the fifth is job protection.

In postal

privatization, the current jobs should be protected as much as possible.
Mr. Takenaka’s principles eventually developed into the Basic Principles of Postal
Privatization that was approved by the Cabinet on September 10, 2004. The Basic Principles
specified that the postal services would be privatized in 2007 by creating a holding company tocontrol four joint stock companies which represent four function areas of the postal services:mail, postal savings, postal life insurance, and post offices (network). The new companies
would compete with private companies on equal footing. To achieve this, the government
guarantees on postal savings and life insurance contracts would be abolished.
jobs, all the current workers will be employed by one of the new companies.
77

To protect theThe Postal Privatization and five related bills based on the Basic Principles were
submitted to the 162nd ordinary diet session in April 2005.

The postal privatization bill faced

stiff resistance by many diet members from the Liberal Democratic Party (LDP). The bill
managed to pass the House of Representatives by five votes on July 5, 2005, but failed to passthe House of Councilors by seventeen votes on August 8, 2005.

Prime Minister Koizumi

dissolved the House of Representatives and asked the public to vote for the postal privatization.
He also purged the LDP members who opposed to the bill. In the general election of the Houseof Representatives, the LDP won a sweeping victory by adding 47 new seats. The postal
privatization bill passed the House of Representatives on October 11, 2005 and the House ofCouncilors on October 14 during the 163rd special Diet session.
The privatization started in October 2007 with the creation of four new joint stockcompanies that would inherit the assets and business from the old postal service: Japan Post
Service Co., Ltd (JP Service), Japan Post Network Co., Ltd (JP Network), Japan Post Bank Co.,Ltd (JP Bank), and Japan Post Insurance Co., Ltd (JP Insurance).

By clearly separating

business segments, the privatization aimed at stopping the practice of subsidizing losses in mailservices using profits from postal savings and postal insurances. The management of JP Bank,
JP Insurance, and JP Network was given an option to separate each company by regions in the
future if deemed appropriate. The Japan Post Holdings Co., Ltd (JP Holdings) was established as78

a pure holding company that initially would own 100% of the four operating companies. The
privatization was supposed to complete by the end of September 2017. By this date, thegovernment is supposed to divest more than two thirds of the JP Holdings.

The JP Holdings is

supposed to fully divest its shares of JP Bank and the JP Insurance. Soon after the privatizationof 2007, a divesture plan was submitted by the JP Holdings and approved by the Prime Minister.
Under the plan, JP Holdings was supposed to list the JP Bank and the JP Insurance on a stock
exchange in 2010 and fully divest in five years from the date of listing. The JP Holdings’ own
stock was supposed to be listed on an exchange by 2017.
One of the important businesses of the JP Holdings is a management of the Social andRegional Service Fund (SRS Fund). The purpose of this fund is to support and maintain the JP
Group’s universal service. Under the law, JP Service and JP Network must provide universal
service. JP Holdings use the SRS fund to sustain unprofitable post office operations in remoteareas. JP Holdings has to maintain a minimum ¥1 trillion of the SRS fund by accumulating
dividends from JP Bank and JP Insurances shares. When the stocks of the financial companies
are sold to the public in the future, a part of the capital gain on the sale must be contributed to the
SRS fund.
JP Network is responsible for the post office operations all over Japan. The other threecompanies (JP Service, JP Bank, JP Insurance) entrust their service window operations to JP
79

Network. JP Network was also allowed to enter new businesses such as ticket distribution andrenting space for local public service using their post office network.
JP Service provides mail, package, and cargo delivery services. JP Service established acouple of alliances with the private sector companies to improve its profitability.

JP Service’s

package service division merged with Nippon Express’s package delivery business in October
2009. JP Service also established an alliance with All Nippon Airways and launched a newinternational cargo company ANA & JP Express Co., Ltd.
The business of JP Bank and JP Insurance are less restricted than the other JP Group
companies. For example, they are not obligated to provide universal service, although they werestill required to sign long-term contracts (of multiple years) with JP Network to indirectly
support the non-profitable part of the JP group.
2.2. Impact of the Reform
By the phased in nature of the plan, much of the impact would not be felt until theprivatization was further along. But after the Democratic Party of Japan, which originally
opposed the postal privatization bill, took the office in 2009, they have started to roll back postal
privatization. In September 2009, the government intervened in the management of the JP
Insurance and ordered it to cancel of plans to sell inns they own and manage (even though manyof generate losses). In December 2009, the Diet passed a bill to freeze the divestiture in postal
80

companies. In May 2010, the Postal Reform Bill was submitted to the Diet.

The bill seeks tomerge the JP Holdings with the JP Service and the JP Network, to make the JP Bank and the JP
Insurance the subsidiaries of the new merged company, to relax the FSA supervision of JP Bankand JP Insurance, to raise ceilings on insured limits for postal savings and life insurance, to makethe JP Bank and the JP Insurance exempt from consumption tax, and to convert up to 100,000
non-regular employees in the JP group to regular employees.

Thus the bill would roll backessentially all of the Koizumi reforms, restore the cross-subsidization across business lines, andallow parts of the postal system to exploit their government backing for competitive advantage.
The Diet ended before it started to deliberate on the bill, but the current government is still trying
to submit a revised version of the bill to a future Diet.

3. Labor Market Reform

3.1. Target and plan
The rigidity of Japanese labor markets has been the source of large scholarly literature.2
While the Koizumi government implemented several reforms to increase the labor market
flexibility, we focus on the 2003 amendment of the Dispatched Workers Law (Haken Rōdōsha

See Rebick (2005, Chapter 2) for a survey. Ono (2010) finds that continued rigidity introducedby lifetime employment reduced opportunities for new entrants to the labor market during
stagnation.
81
2

Hō).

This amendment was the major labor reform undertaken by the Koizumi administrationand it has become a symbol of the Koizumi’s reforms. Especially when many dispatchedworkers lost their jobs during the global recession of 2008-2009, the public pointed to thischange as having created a large class of workers with insecure employment and low wages.
This amendment was a response to requests by both employers and employees.
Employers wanted to be able to change the labor force quickly to adjust to ever shortening
product cycles. For example, the 1995 report titled “Japanese-style management for new era” by
the Japan Economic Federation argued that “Workers will be stratified in three groups, long-termskilled workers, advanced experts, and temporary workers.” Many workers also favored more
flexible labor contracts so that it was possible to find work at firms that were not prepared to takeon workers with an implicit long-term commitment.
The use of employment agencies to send temporary workers to other companies wasprohibited by law before 1985. To respond to increased demand for more variety of employment
arrangements favored by both management and workers, the Dispatched Workers Act waspromulgated in 1985. This law permitted the use of dispatched workers on a limited basis, andsubsequently was revised to expand its scope.
The first major amendment came in 1999.

Prior to that change, temporary workers

could only be employed for specific jobs (11 originally, 26 later) that were explicitly allowed by82

the government (a “positive list” system). The 1999 amendment reversed this policy so that
dispatching was now permitted for any type of jobs except for those explicitly prohibited by law(a “negative list” system).

Given that the new types of jobs constantly appear withtechnological development, this switch represented a major relaxation of the rules.
The 2003 revision under the Koizumi administration sought to both increase theflexibility of the labor market and increase the overall employment. There were four majorchanges: (1) relaxation of the term limits on certain dispatched jobs, (2) removal of the
manufacturing jobs from the negative list, (3) requirement to offer direct employment at the endof the contracted term, and (4) legalization of “temp to perm” arrangement. Before the revision,
temporary workers in the 26 jobs on the original positive list were allowed to have contracts of
no more than three years. The Koizumi revision eliminated the term limits for those jobs.

Forother jobs, the length of contracts had been limited to be no more than one year, and the revisionextended the limit to three years.
Even after the 1999 revision, dispatching of workers to manufacturing jobs had beenprohibited. The 2003 reform removed manufacturing jobs from the negative list. The length ofcontracts, however, was limited to be no more than one year until February 2007, when the limit
was extended to three years.
The revised law introduced a new requirement that aims to prevent firms from using
83temporary employment just to avoid providing benefits to otherwise regular workers.

A

company is required to offer permanent employment to a dispatched worker if they want to hire
him/her beyond the contract term.

For those temporary workers who had no term limits thefirm is required to offer permanent employment if they have hired him/her for more than three
years. Moreover, when a company hires new regular workers into the same job, the dispatchedworker must be given priority.
Finally, the revised law allowed employers to offer “term to perm” contracts. Under
these contracts, a dispatched worker begins to work with a presumption of becoming directly
employed. If the company and worker agree at the end of contract the worker is then employed
directly. The revised law also allowed a potential dispatched worker who wishes to be on a “termto perm” contract to send in a resume and to have an interview with a company.
3.2. Assessment of the Reform
Figure A3-1 shows data on the number of dispatched workers over time.

The trend

increased modestly in 1999 and much more in 2003. So quantitatively the 2003 amendment
appears important.
Figure A3-2 shows that much of the post 2003 surge was due to an increase in the use of
dispatched workers in manufacturing. But the raw data in the figure overstates the increase.
Even before dispatching to manufacturing jobs were officially allowed in 2003, many84

manufacturing firms had subcontracting arrangements with some other firms whose sole function
is to hire the workers to work at factories of the manufacturing firms.

This was de facto

temporary dispatching, but it took a form of subcontracting to get around the regulation thatprohibited worker dispatching for manufacturing jobs.
After the 2003 revision of the Dispatched Workers Act, the manufacturing firms did nothave to pretend to have the subcontracting arrangements.

They started to use dispatchedworkers and the number of contract-based workers declined. Table A3-1, which shows thechanges in the numbers of dispatched workers and contract-based workers in manufacturing after
2003. The substitution of contract-based workers with dispatched workers was substantial.
From 2005 to 2008, the number of dispatched workers in manufacturing increased by about
488,000. During the comparable period, the number of workers from subcontractors declined
by about 327,000.

Thus, around two thirds of the increase of dispatched workers seems to havebeen just the replacement for de facto dispatched workers from subcontractors.
Several problems had been identified for the use of subcontracting to hire low skilledworkers in the manufacturing. The most important one was the lack of responsibility for the
manufacturing firms in maintaining appropriate working conditions for these workers.
Technically, that was the job of the subcontracting firms, but they did not have any control overthe conditions for what were (supposedly) their own workers.
85

With the revised law, themanufacturing firms had to follow all the rules concerning employment of temporary dispatchedworkers. Thus, the revised law was actually tightened safety standards for these people.
Legalization of “temp to perm” arrangement achieved some positive results. Table A3-2
shows the number of dispatched workers who were hired as regular worker at the end of thecontracts.

The number increased steadily over time, and the proportion of these types ofarrangements relative to the total number of total dispatched workers also increased.
Employers argued the flexibility afforded by the dispatched workers helped them
manage negative demand shocks. Table A3-3 shows that during the global recession of
2008-2009 employment fell by about 610,000, with more than half (320,000) coming from a
reduction in the number of dispatched workers.
The misery of the dispatched workers who lost the jobs was soon highlighted by media as
the dark side of the structural reform and this triggered a political backlash. The media and somepoliticians criticized the corporations that fired dispatched workers and the Koizumi government
for having expanded this unstable form of employment in the first place.
3.3. Unintended consequences
The changes in use of dispatched workers had different effects in different industries.
Prior to 2003, surveys suggest that most dispatched workers were dependent family members.

86

Afterwards, many household heads became dispatched workers, especially in manufacturing.3
As a result, the average wage of dispatched worker increased and the size of lower middle
income class (¥3,000,000-¥4,000,000) grew. (Figure A3-3).

Outside of manufacturing, theimpact on wages was mixed. Earnings for many dispatched workers in Wholesale and Retail andInformation and Communications dropped, while a large percentage of low wage dispatched jobs
in Finance and Insurance disappeared.
There have been many complaints that the increase in the use of dispatched workers has
been an important factor in expanding income inequality and employment instability. Given that
only 8% of the non-standard jobs are held by dispatched workers, it is doubtful that the increased
inequality and instability are direct consequences of the expansion of dispatched workers. But,
as the share of non-standard workers rises, this shift has been associated with a less stable
employment market. A full assessment of how much of the increase in non-standard employment
is causal as opposed to a reflection of other underlying forces is beyond the scope of this study.
3.4. Backlash after Koizumi
In 2010, a new bill to revise the Dispatched Workers Law was submitted to the Diet andas of this writing remains under consideration.
3

The bill proposes four major changes.

First,“Survey of dispatched workers’ lifestyle and job-seeking behavior” (Haken Roudousya No Seikatu To Kyusyoku

Koudou Ni Kansuru Koudou Tyousa), The Research Institute of Economy, Trade and Industry (Keizai Sangyou
Kenkyuzyo) http://www.rieti.go.jp/jp/projects/research_activity/temporary-worker/01.html

87temp agencies are required to have employment contracts with their workers even when they are
not dispatched.

This would eliminate the arrangement where a worker “registers” at aparticular temp agency and sign employment contracts only when (s)he is dispatched to aparticular site.
work.

The employment contract is effective only for the duration of the dispatched

For the 26 jobs that were originally designated to worker dispatching, such “registration”

dispatch would continue to be allowed as an exception. Second, dispatching of production
workers would be prohibited.

This would roll back a 2003 revision of the law.

Third,

dispatching contracts for less than 2 months would be considered day labor dispatch and beprohibited.

Finally, to prevent a company to set up a temp agency just to reduce cost by

replacing the regular employees with dispatched workers, the proposal makes it illegal for a temp
agency to dispatch more than 80% of their workers to its related companies (parent and othergroup companies).
Prohibition of using dispatched workers in manufacturing looks unlikely to increase thenumber of regular workers. For instance, according to the survey of the Japan Production Skill
Labor Association4, if the prohibition is enacted, only 10% of manufacturing companies using
dispatched workers plan to hire dispatch workers as regular employees and only another 10%
4“Questionnaire about Tightening of Regulation of Worker Dispatched Law” in 2009 (Roudousya Hakenhou

Kiseikyouka Ni Kansuru Kinkyu Anke-to), Japan Production Skill Labor Association (Nihon Seisan Ginou Roumu
Kyoukai)

http://www.js-gino.org/jouho/JSLA_enquete2.pdf

88plan to hire new regular employees. Instead, most of companies plan to hire contracted
employees, part-time workers or use outside contractors. Some firms indicated that they mightalso move their factories overseas.

4. Agricultural Reform and FTA Policy
4.1. Target and plan
The Liberal Democratic Party (LDP) traditionally relied on the support of industries suchas construction, agriculture, and postal services. These industries were also among the mostheavily regulated and protected in the economy. Prime Minister Koizumi as outsider owed no
debts to these industries. Thus, by pursuing reforms that opened these industries to competition toadvance his economic goal of “reform without sanctuary”, Mr. Koizumi also weakened the base ofrival politicians in the traditional wing of the LDP.
The agricultural reform was tied to another important initiative of the Koizumi
government: promotion of Free Trade Agreements (FTAs) with various trading partners. The
most serious hurdle for negotiating FTAs was domestic opposition from the agricultural sector that
believed (correctly) that their high production costs would make domestic products uncompetitive
against the cheap foreign products. To prepare the Japanese agriculture for global competition,
Koizumi tried to promote large-scale farming.
894.2. Promotion of large scale farming
Table A4-1 summarizes the major agricultural policies of the Japanese government from2001 to 2010, including both the Koizumi government reforms discussed in this section and thoseof the subsequent governments that are described later.
Historically, Japan’s average farm size was remarkably low (Table A5-2). For instance,
the average Japanese farm is roughly the size of farms found in India, and is 10 times smaller thanthose in Israel, and 150 times smaller than U.S. farms. The LDP protected the small farmers’interests in exchange for their political support. While convenient for the farmers and the LDP,
the result was an inefficient production system that led to higher food prices, especially for rice,which was the most common crop.
The Koizumi government implemented several measures to promote large scale farming.
The government hoped that by removing the historical bias against large scale farming,
productivity could increase and food prices could be reduced. In some cases, such as high quality
rice and luxury fruits, there was hope that Japanese agriculture could become internationallycompetitive.
Mr. Koizumi push to improve the productivity of Japanese farms was not unprecedented.
In 1992, in what is known as the New Policy (“New Policy Direction on Food, Agriculture, andFarm Villages”), the government had announced a goal of creating the agricultural sector where
90the “efficient and stable” production entities are the majority. Based on this idea, the DesignatedFarmers System was introduced in 1993. Under the system, a farmer can get certified as adesignated farmer if (s)he submits a five year farm management improvement plan to the local
government and has the plan approved. Designated farmers gain access to various subsidies andlow interest rate credits. Although there was not an explicit size condition to be a designatedfarmer, the policy’s intention was to encourage large scale and efficient farming.
The Koizumi government seemed to have stepped up its interest in agricultural reform
only in the last half of the administration. In 2004, the Act on Stabilization of Supply, Demandand Prices of Staple Foods was revised to liberalize the rice distribution. Before 1995, thedistribution of rice was strictly controlled by the government under the Food Control Act. This
gave government a monopoly regarding rice distribution. It set the purchase price and theconsumer price of rice every year. Since the prices were typically set much higher than themarket clearing price (even in the absence of international competition), the rice production had to
be rationed. The government did this through gentan (acreage reduction policy) that forced eachfarmer to take monetary compensation to reduce the area for rice production. The policy was
implemented through the Agricultural Coop (nōkyō). In 1995, the Food Control Act was repealed
and replaced by the Act on the Stabilization of Supply, Demand and Prices of Staple Food, whichallowed the private sector to enter the rice distribution business to a limited degree. The 200491

reform of the act completely liberalized the rice distribution. Anyone who buys and sells morethan 20 tons of rice could now get a license to do that. The acreage reduction policy was also
decentralized so that not only the implementation, but also the planning of acreage reduction wasdelegated to local offices of the Agricultural Coop.
The government publishes a Basic Plan for Food, Agriculture, and Farm Village every
five years. The plan published in 2005 reflected some of the reforms that Mr. Koizumi intended.
For example, the plan list five principles for agricultural reform: (1) effective and efficient policy
framework, (2) policy catered to consumers, (3) promotion of innovations by individual farmers
and regions, (4) emphasis on environmental protection, and (5) forward looking agricultural policythat responds to changes in the environment. Although a large portion of the plan is devoted tothe discussion of raising Japan’s self-support rate in food, the plan also mentions the importance ofincreasing the sizes of farms to improve international competitiveness.
At the center of Mr. Koizumi’s policy to encourage large scale farming was theTrans-Products Management Stabilization Policy. The policy subsidizes designated farmers withfarms larger than 4 hectares (ha) (10 ha for Hokkaido) and qualified agricultural corporations withfarms larger than 20 ha. The policy provides two types of subsidies to the farmers. First, when
the cost of production exceeds the sales revenues for a specified set of products that are considered
to be disadvantaged with respect to foreign products, the farmer receives compensation for the full92

difference. Second, when the farm income falls below the past average temporarily, the farmer
can receive 90% of the shortfall.
The main idea was to encourage large scale farming by limiting these subsidies only tolarge scale farmers. The policy, however, included several exceptions. For example, farms inmountainous areas did not have to have the minimum scale to be qualified. If a farm contributes
to the local production adjustment (including acreage reduction policy) disproportionately, the size
criterion was relaxed.5
The Trans-Product Management Stabilization Policy also moved away from thetraditional subsidies based on the production of specific crops. Rather than subsidizing
production of particular products, the government tried to move to an income policy decoupledfrom production.
4.3. Promotion of FTA
Traditionally Japan has opposed bi-lateral trade agreements, including FTAs, arguing thatsuch deals undermine the multilateral efforts for trade liberalization through the WTO.
Observing the success of the FTAs elsewhere (such as NAFTA and EU), the Japanese governmentchanged its stance.

5 Ministry of Agriculture, Forestry and Fishery, “Hinmoku Oudan-teki Keiei Antei Taisaku toha? (What is theTrans-Product Management Stabilization Policy?)”, December 2006.
(http://www.tendo-nogyo.jp/keieianteitaisaku/kamakura-leaf.pdf)
93

The Koizumi government became the first Japanese government to sign an FTA agreement,
entering the Japan-Singapore Economic Partnership in January, 2002. During his term, Mr.
Koizumi successfully concluded FTA negotiations with four additional countries: Mexico,
Malaysia, Philippines, and Thailand. He also started the negotiations with Indonesia, Brunei,
ASEAN as a whole, Chile, Korea, and the Gulf Cooperation Council.

In those negotiations, thetrade barriers on agricultural products have always been a serious obstacle. Article 24 of the
GATT specifies that a free trade agreement must eliminate tariffs and other restrictive regulations
on “substantially all the trade.” The Japanese government used to interpret this to mean morethan 90% of the items. The agricultural lobby asked and often succeeded to make many
agricultural products exempt from tariff reduction. For this reason, the government initially
focused on the countries such as Singapore whose agricultural exports to Japan were tiny. In the
FTA with Mexico, Japan even failed to reduce or eliminate tariffs for more than 90% of items,
because many agricultural products were deemed exempt.
4.4. Impact of the reform
Figure A4-1 shows how the proportion of large scale farms (defined as those greater than
4 ha for all prefectures other than Hokkaido and greater than 10 ha for Hokkaido) changed from1994 to 2009. The proportion increased in both Hokkaido and elsewhere, but the change under
the Koizumi government or (after the 2006 introduction of the Trans-Product Management
94Stabilization Policy) shows no difference from the trend from the mid-1990s. Thus, we do not see
any impact of the large scale farming promotion. More disturbing is the fact that the increased
proportion of large scale farms come mainly from the exit of small farms. The number of large
scale farms actually declined during the 2000s. For the prefectures other than Hokkaido, thenumber of farms that are greater than 2 ha decreased from 324,000 in 2000 to 289,000 in 2009.
The number of farms that are greater than 10 ha in Hokkaido fell from 30,000 in 2000 to 26,000 in
2009. Exits of inefficient entities would increase the average productivity of the sector, but theKoizumi policy explicitly aimed at increasing the number of efficient and stable farms, and here
the result so far suggests that the policy was not effective.
Table A4-3 shows the recent changes in the average size of a farm in Japan. The average
size has been increasing but changes are quantitatively unimportant, merely reflecting the slow
growth in the proportion of large scale farmers documented above. Overall, the impact of theKoizumi’s agricultural reform is not obvious.
On the political side, the reforms unambiguously weakened the LDP members with thestrongest ties to agriculture. This group is known as the “Agricultural Tribe.” Matsuda (2005)
compares the number of votes each LDP politician received in the 2005 House of Representatives
Election (which LDP won in a landslide) to the votes the same politician received in the previous
election in 2003 for both the Agricultural Tribe and others. She finds that the Agricultural Tribe95

increased their votes only by 17.8% on average while the non-agricultural tribe increased theirvotes by 27.9%. In the House of Representatives election of 2005, all three of the top politiciansin the Agricultural Tribe lost their seats.

While this might have pleased Mr. Koizumi, it

weakened the support for LDP in the rural areas, and the DPJ led by Ichiro Ozawa subsequently
took advantage of that.
During the campaign for the House of Councilors election of July, 2007, the DPJ’s
manifesto proposed the Individual Income Compensation Policy for Farmers, claiming to provide¥1 trillion subsidies to all farmers. This was essentially the expansion of the Trans-ProductManagement Stabilization Policy to all the farmers including the ones with tiny scale. The policy
naturally attracted many rural votes, and the DPJ was successful in taking most of the rural seatsthat initially belonged to the LDP candidates.
4.5. Backlash after Koizumi
After the loss at the 2007 House of Councilors election, the LDP government also reversed
course on its agricultural policy. In the fall of 2007, the Fukuda government announced that theywould earmark ¥85 billion for the protection of farmers. The government fund was used to (1)purchase 3.4 million tons of rice to prop up rice prices, (2) subsidize production of rice for flour
and animal feeding, and (3) expand the acreage reduction program.

96

In the priority for agricultural policy, promotion of large scale farming to increase
productivity now clearly has taken a back seat to improvement of Japanese self sufficiency.
Instead of focusing government support on large scale farmers, the governments after the Koizumi
administration spread the subsidies to all the farmers.

It did not matter if the government was led

by the LDP or the DPJ.
The FTA policy also changed after Mr. Koizumi’s departure. Some new FTAs weresigned during the LDP governments, but negotiations of FTAs with large trading partners (such as
Korea and Australia) stalled. Talks with larger trading partners, such as China, the U.S., and theEU, have not even started. Recently the government has decided to postpone until 2011 thedecision to join the negotiation for Trans Pacific Partnership that would include the U.S.

5. Special Zones
5.1 Target and Plan
The Special Zones for Structural Reform Act of 2003 was aimed at two problems. First is
the lack of local autonomy. Under Japan’s unitary system in public finance, local governments
are often subject to identical sets of regulations laid down by the central government. This
creates inconvenience and inefficiency. For example, local governments are unable to respondquickly to economic downturns because they have little authority in making independent
97

decisions. Local governments also rely heavily on the tax funds allocated from the national
government, as we discussed below in the discussion on local public finance reform. Special
zones reform allows some local governments to deviate from the uniform regulations to pursue
unique projects.
The second problem is Japan’s overly regulated service sector. As Yashiro (2005) points
out, the Japanese government imposes heavy regulation on various segments of service
industries, such as healthcare, education, and nursing. Relaxing the regulations often requires
extensive political negotiations. The special zones provide a way for gradual experimentation.
The special zones allow regulations to be relaxed or abolished in some local areas. In principle
the success of a local reform could be used to build a consensus about the wisdom of the change
and line up political supporters to implement the change nationally. We start by describing the
key characteristics of special zones implemented under the Koizumi government. Then, weclassify the special zones into five categories and discuss each category. We select a few cases
from each category and study those carefully. Finally, we evaluate the impact of the special zones
policy and address some critical drawbacks.
5.2. Major Characteristics of the Special Zones
The special zones have three major characteristics. First is the decentralized
decision-making process. Unlike the central government’s top-down approach in its regional98policy, the basic framework of the special zones is a bottom-up process. The program places
great emphasis on local government autonomy and private sector initiatives.
Second is the absence of fiscal support from the central government. Unlike free tradezones in many other countries, Japan’s special zones are characterized only by their special
regulatory status, and receive no financial support from the central government. As Yashiro(2005) noted, the Japanese special zones are not intended to be national projects providing
economic stimulus to underdeveloped areas.
The third characteristic is the potential for the extension to other areas. If a special zone
turns out to be successful, a similar measure can be expanded nationwide. The evaluation process
then becomes critical in determining whether the program is extended. Under the current
framework, each special zone is to be assessed for the quantitative effects of its deregulation
within a year of being established (Cabinet Secretariat 2002).
5.3. Taxonomy of the Special Zones
From its inception in 2003 to the latest application period in July 2010, the special zones
program has gone through 23 application cycles, with a total of 1,114 special zones having been
approved (Cabinet Secretariat 2010). The special zones can be classified into five groups: 1)
welfare/medical care and community life; 2) education; 3) agriculture’ 4) new industry creation;and 5) international exchange and logistics. The distribution of the different types of special
99

zones is shown in Table A5-1.
5.3.1 Welfare/Medical Care and Community Life
Welfare/medical care and community life is the largest category of the special zones,
accounting for nearly 35% of the total (Cabinet Secretariat 2010). These special zones allow
private management of nursing homes, private finance initiative projects in social welfare, anddoctors from abroad. Moreover, they promote paid transportation services for the elderly by
non-profit organizations (NPOs) and joint use of kindergarten and nursery schools, which are
regulated by different ministries (Suzuki 2005).
5.3.2 Education
The educational zones represent roughly 26% of all special zones. The educationalzones introduce more diverse and flexible curricula – such as more emphasis on English
education – than is allowed by the central government.

These zones also permit school

management by entities other than existing school corporations (Suzuki 2005).
5.3.3 Agriculture
Agricultural zones are the third most frequent category with 25% share. Agriculturalzones facilitate farming by for-profit corporations, offer preferential measures for agricultural
start-ups, and allow deregulation on minimum farming areas (Suzuki 2005).
5.3.4 New Industries
100The new industry promotion area accounts for 11% of the special zones. They promote
more flexible utilization of national research institutes and extensive academic-industrial
partnerships (Suzuki 2005). Some special zones waived the prohibition of participating in
subsidiary businesses for faculty of national university (Suzuki 2005).
5.3.5 International Exchanges and Logistics
The international exchange and logistics area occupies 3% of the total number of special
zones. Special zones in this area provide 24-hours customs clearance, leasing of publicly owned
harbor facilities to private entities, and deregulation of visa-application procedures (Suzuki
2005).
There are two major trends regarding special zones. First, the number of approved
special zones varies substantially across prefectures (Iwaki 2006). With 133 cases, Hokkaido
leads the nation in the number of special zones, followed by Nagano, Tokyo and Ibaraki (Cabinet
Secretariat 2010). At the bottom of the list are Saga, Shiga, and Tokushima, where each has only
five special zones. The conventional explanation for these differences is that the prefectures withhigher dependence on central government funding tend to have fewer special zones (Yashiro
2005).
Second, the timing of the approval is unevenly distributed across the categories (FigureA5-2). For instance, the inaugural approval committee in 2003 allowed a significant number of101

special zones in the areas of international exchange and new-industry promotion (Cabinet
Secretariat 2003). The preference of the committee subsequently shifted to favor agriculture andwelfare zones in numbers.
5.4. Case Studies
In Regional Vitality is Japan’s Vitality: Special Zones’ Progress Report, the Cabinet
Office compiled a list of case studies on the special zones. The nine special zones we examine
here are pioneers that provided the framework for the latecomers in the recent cycles.
Basic facts about these cases are given in Table A5-2. Besides summarizing the goalsof each zone, the changes that were enacted to achieve those goals and the progress that wasmade towards the goal, the table also shows the decision about whether the program was
extended nationwide. Keeping in mind that these were relatively well publicized cases, we
caution against interpreting the relatively high success rate of these zones in being extended.
We draw three conclusions from the table. First, the range of deregulation experiments
varies greatly. Some of the changes involve marginal adjustments to existing regulations (e.g.
cutting the number of emergency medical technicians working with an ambulance from three totwo), while other involved fundamental reform (allowing corporations to enter the agriculturalbusiness through leasing land). Second, as discussed below, the link between the objectives ofthe zones and economic growth also varies.

Third, the time between when a zone is approved102and when it is applied nationally also varies greatly, ranging from roughly one year to more than
five years. The heterogeneity in all three dimensions makes it challenging to summarize theeffects of the special zones, and also explains why selective reviews that focus on only somecases might lead to different conclusions.
5.5. Evaluation
The Cabinet Office (2008) compiled a report on the economic effect of the special zones
up to that point. The report summarizes the special zones’ key achievements as: 1) ¥590 billion
increase in business investment; 2) 18,000 jobs created; and 3) 500,000 more tourists. While thereport briefly summarizes the special zones’ aggregate economic effect, it did not provide muchdetail on individual special zones.
As shown in Table A5-2, a proper economic evaluation of special zones is difficult
because the goals and evaluation standard differ greatly from one zone to another. Some types of
special zones, such as those in new-industry promotion, emphasize the number of corporations
solicited or the number of jobs created. On the other hand, agricultural-tourism zones focus on
figures such as the growth of agricultural production or the number of visitors.
Yugami (2007) reports a survey of sponsoring municipalities on their subjective
assessments of special zones for new industry promotion or agriculture. Figure A5-2 shows how
the sponsoring municipalities view the effectiveness of their special zones in six areas: entry of103firms, start-ups/venture capitals, job creation, increase in the number of visitors, increased media
attention, and the overall effects on the local economy. About a quarter of the respondents
answered that their special zones are effective in attracting the start-ups, creating jobs andstimulating the local economy overall. But even more found the zones to be ineffective or barely
effective on these dimensions. Importantly, a high proportion of respondents answered “don’tknow” for many questions. This may reflect the problem of different objectives and evaluation
standards across special zones. Some types of special zones may have a different set of criteria
for the effectiveness.
We read Yugami (2007)’s survey results as delivering an ambiguous judgment on the
success of the special zones. Assuming that the respondents were trying to do a cost benefit
analysis in answering the questions, it seems like the only clear success was with respect toincreasing media attention. Moreover, the questions in the survey do not account for the factthat much of these effects could be zero-sum in that they move activity from one location toanother. So an important factor in judging the overall impact will depend on how much value
one places on the information that is generated by the various experiments and the direct gains to
the regions.
5.6. Do special zones contribute to the economic growth?
As the forgoing discussion suggests the link between special zones and national
104

economic growth is tenuous. At this point, there seem to be three main factors that determine
their impact. First, when local governments attempt to facilitate regional growth by diverting
the demand from the other special zones, such efforts do not lead to nationwide economic growth.
An example is proliferation of “doburoku” zones. The special zone in Iide, Yamagata, is one ofmany that were inspired by Iwate Prefecture’s original doburoku zone. Despite the town’s harsh
winter, the number of tourists visiting Iide has increased by 30%. However, deregulation on thebrewing of doburoku led many villages across the country to follow suit. This led to theproliferation of doburoku zones – ninety-one by 2009 – with limited aggregate gains.
A second issue is the rise of tourism-oriented zones. One of the special zones’ original
goals is to serve as the stepping stone for national deregulatory reform. However, manymunicipalities have exploited the policy and turned it into a means to promote local tourism. By
definition these kinds of zones will not contribute to sustained growth.
The third problem is the inherent tension between the goals of nationwide deregulation
and regional specialization. As Homma (2005) noted, the content of the special zones havebecome increasingly repetitive. This has undermined the policy’s objective of regional
specialization. Furthermore, the policy of nationwide application is reducing the incentive forthe local authorities and private sectors to make original proposals. Once a special zone becomes
successful, other municipalities can copy the model and follow suit. This dynamics discourages
105innovation. Hence, for the policy to raise growth on a continued basis would require thecreation of zones that facilitate growth without diverting demand and are not susceptible toimitation. It is unclear how many regional reforms of this sort are possible.

6. Local Public Finance Reform
6.1. Target and Plan
The primary goal of the local public finance reform was to reduce the budget deficit of
the central government by cutting the massive transfers and subsidies to local governments.
Local governments traditionally relied heavily on the central government to finance theirexpenditures.
The central government supports local governments primarily through two types oftransfers.

The first, the so-called local allocation tax grants, distributes a pre-specified

proportion of major national taxes (such as the income tax, consumption tax, and corporate tax)
to local governments. The allocation is determined through formulas to “adjust imbalances” intax revenue among different local governments, which means poor governments receive moretransfers. Some local governments with ample tax revenues, such as Tokyo, do not get toreceive any local allocation tax grants.

The use of funds is not specified by the central

government and hence the local governments have total discretion over how to use the transfers.
106

The other type of transfers is state subsidies, also called “national treasury
disbursements.” Central government provides subsidies to the local governments for specificprojects. For example, many public works that were included in the fiscal stimulus plan in the
1990s were carried out by local governments supported by the state subsidies. The restriction
on the use of funds separates state subsidies from the local allocation tax transfers.
Since the total amount of local allocation tax distribution is determined by the “needs” of
local governments while the sources of grants are fixed proportions of national taxes, there is no
guarantee that the central government has enough funds to satisfy all the needs of local
governments every year. Indeed, the amount of distribution often exceeded the national tax
revenues earmarked for the grants. The central government financed this shortfall by issuingbonds, but starting in 2001, worrying about increasing debt, local governments were allowed toissue Emergency Fiscal Measure Bonds to cover the deficits. The Emergency Fiscal Measure
Bonds are expected to be paid off using local allocation tax grants in the future. Thus, local
governments viewed the proceeds from the issuance of Emergency Fiscal Measure Bonds as
good as local allocation tax grants. Similar to local allocation tax grants, the use of funds is not
specified by the central government.
Table A6-1 shows the composition of revenues for local governments (both prefectures107and city/town/village municipalities) for each fiscal year from 1970 to 2010.6

The table showsthat the local taxes (local governments’ own revenues) have risen as share of total funds. In the
1970s the funds coming from the central government were larger than the take from local taxes.
By the mid 1980s the two shares were about equal, and by the early 1990s the local taxes werelarger than the contributions from the central government. But, we should also note that theaggregate numbers mask serious heterogeneity among different local governments.

Somegovernments such as Tokyo and Aichi (where headquarter of Toyota is located) enjoy a large
amount of corporate tax revenues and do not need much help from the central government.
Many other local governments, however, have more limited sources of revenues and have to relyon the central government.
By the time Prime Minister Koizumi took office in 2001, the mounting central
government debt was already a central issue for the Japanese economy. Figure A6-1 shows thegross debt to GDP ratios for G7 countries and Greece, which recently experienced a debt crisis.
Japan’s gross government debt stood over 140% of its GDP already in 2001, much higher thanthe peak ratio for Greece.

The net debt to GDP ratio, shown in Figure A6-2, looks better andwas below Italy and Greece in 2001, although it continued to increase during the 2000s and now
exceeds the level of Italy.

6

For the fiscal years 2009 and 2010, the initial budget numbers are shown.
108

By the late 1990s the rating agencies started to downgrade their estimates of the credit
quality of the JGB (Japanese Government Bond). Figure A6-3 shows how S&P (Standard andPoor’s) and Moody’s changed their ratings of the JGB. Moody’s downgraded JGB from Aaa to
Aa1 in November 1998 and to Aa2 by September 2000. The rating was cut eventually to A2 in
May 2002 and stayed there until it started being upgraded finally in late 2007. S&P maintained
AAA rating for JGB till February of 2002, when it was downgraded to AA+. The Moody’s rating
dropped all the way to AA- by April 2002, where it stayed for five years until it started to recover
finally in 2007.
The accumulation of government debt resulted primarily from the decline of tax revenues(that was due to the growth slowdown) and the increase of expenditures at the national level. A
series of fiscal stimulus packages and bank rescues contributed to the increasing expenditures.
The transfers and subsidies to the local governments, however, were also important contributors
to the fiscal deficits. The public works in the stimulus packages often included subsidies to the
local governments.

Moreover, the central government issued bonds to cover the shortfall of

revenues that are used for local allocation tax grants (before 2001).
6.2.

Trinity Reform
One approach that the Koizumi government took to reduce the budget deficit was toreform the system of local public finance.

The government hoped to increase financial
109

autonomy of the local governments so that they would not have to rely on the central government
very much. The policy package to achieve this was called the “Trinity reform” because it
consisted of three parts.
First, the state subsidies were to be reduced over time.

The central government would

also stop specifying the use of some subsidies to give more discretion to the local governments.
Second, local allocation tax transfers were also to be reduced over time.

Third, the central

government was to transfer the tax bases over time so that the local governments can achieve
more financial independence.
The reform targeted reduction of state subsidies and local allocation tax transfers by ¥4trillion between FY2003 and FY2006.

The government aimed at achieving a primary balance

surplus of the central and local governments by FY2011.
6.3.

Consequences of the reform
The reform succeeded in reducing the local allocation tax grants and state subsidies.

The last row in Table A6-1 shows how the amount of the transfers and subsidies changed by thereform. From fiscal 2003 to fiscal 2006, the state subsidies were reduced by ¥2.6 trillion andthe local allocation tax grants by ¥2.0 trillion, exceeding the target for the total of ¥4.0 trillion.
The table shows the local tax revenues increased by ¥4.1 trillion from fiscal 2003 to fiscal
2006, nearly offsetting the reduction of the local allocation tax grants and the state subsidies.
110

The revenue from local bonds, however, fell by ¥4.2 trillion, of which ¥2.7 trillion was the
reduction in Emergency Fiscal Measure Bonds.7
Thus, from the local governments’ point of view, the trinity reform led to revenue
reduction of ¥7.3 trillion (including the reduction of Emergency Fiscal Measure Bonds which areas good as local allocation tax grants), which is much more than the increase in the local tax
revenues. We should also note that the increase in local tax revenues was geographicallyconcentrated, with most of the gains accruing to the relatively well off governments such as
Tokyo and Aichi.

It is understandable many local governments felt that the trinity reform hurtthem financially.
How about the impact for the central government financing?

About ¥3 trillion of tax

revenues has been shifted from the central government to local governments by reducing thenational income tax and increasing the local income tax.

Thus, in net, the trinity reform

reduced the central government budget deficit by around ¥1.6 trillion, which is non-trivial but
not very impressive.

Although the trinity reform cut the future liability of the central

government by ¥2.7 trillion by reducing the issuance of Emergency Fiscal Measure Bonds, it did
not help the budget very much on a flow basis.
After the Koizumi government, the reform seems to have stalled. As Table A6-1 shows,
7 Ministry of Finance, “Chihō Zaisei Kankei Shiryo (Documents on Local Public Finance),” May2009. (http://www.mof.go.jp/singikai/zaiseseido/siryou/zaiseib210511/06.pdf)
111

the local subsidy and local tax allocation started to increase again at the end of the 2000s.
6.4.

Conclusion
The Trinity reform successfully reduced the transfers and subsidies from the central

government to local governments by ¥4.6 trillion from FY2003 to FY2006. At the same time,
however, about ¥3 trillion of income tax revenue was transferred from the central government tolocal governments. Thus, the reform did not help very much in reducing the budget deficit of
the central government.

From the viewpoint of many local governments, however, thereduction of Emergency Fiscal Measure Bonds added to the reduction of subsidies and grants.
With exception of a few relatively well off governments such as Tokyo and Aichi, the trinity
reform left many local governments poorer and financially squeezed.

112

References for the Appendix:
Cabinet Office (2008) “Economic Effect of the Special Zones” Accessed 27 July 2010
http://www.kantei.go.jp/jp/singi/kouzou2/kouhyou/060925/siryou.pdf
Cabinet Secretariat (2002) “Outline of the Law on the Special Zones for Structural Reform,”
http://www.kantei.go.jp/foreign/policy/kouzou2/konkyo_e.html
Cabinet Secretariat (2003) “Nintei sareta Kōzō Kaikaku Tokubetsu Kuiki Keikaku ni tsuite (OnApproved Structural Reform Special Zone Plans),”
http://www.kantei.go.jp/jp/singi/kouzou2/ninteisinsei.html）
Cabinet Secretariat (2010) “Approval Progress on the Special Zones for Structural Reform,”
http://www.kantei.go.jp/jp/singi/kouzou2/kouhyou/100630/keikakunintei.html
Eastwood, Robert, Lipton, Michael and Andrew Newell (2010) “Chapter 65: Farm Size,” in
Pingali, Prabhu and Robert Evenson (Eds.) Handbook of Agricultural Economics Volume
4, Elsevier, pp. 3323-3397.
Godo, Yoshihisa (2010) Sayonara Nippon Nogyo (Good Bye Japanese Agriculture). Tokyo,
Japan: NHK Publishing.
Gunma Kokusai Academy (2007) “GKA: Eiken Group Excellence Award” Accessed 10 August.
2010 http://www.gka-academy.jp/japanese/event/index_070418_group_award.html
113

Homma, Yoshihito (2005) “Chiiki Saisei no Jōken (Conditions for Regional Revitalization),”Chihō Zaimu (Regional Finannce), 608, pp.142.
Iwaki, Shigeyuki (2006) “Chihō Hatsu no ‘Kōzō Kaikaku’ to ‘Chihō Saisei’ – ‘Kōzō Kaikaku
Tokku’ to ‘Chiiki Saisei Keikaku’ o Chūshin ni ("Structural Reform" stemming from
Region and Regional Revitalization: Focus on "Plans for Special Zones for Structural
Reform" and "Plans for Regional Revitalization"),” in Chihō Saisei: Bunken to Jiritsu
niyoru Kosei Yutakana Shakai no Sōzō (Regional Revitalization: Creation ofCommunities with their own Characteristics by Decentralization and Autonomy).
National Diet Library (Japan), pp.109-126.
Matsuda, Kyoko (2005) “Shūin Sen ni okeru Jimintō Tokuhyō Sū no Nobi (Increase in LDP
Votes in the House of Representatives Election)” in Nōgyō Keieisha (Agricultural
Managers), pp.33.
Omura, Keiichi, Iwaki Hidehiro, Mizukami Shinji, Sudou Takahide, and Sugeta Hiroki (2002)“HuryoSaiken no Shori to sono Eikyo nit suite II,” Director General for Economic

Assessment and Policy Analysis, Cabinet Office, Discussion Paper 02-4.
Ono, Hiroshi(2010) “Lifetime Employment in Japan: Concepts and Measurements,” Journal of
the Japanese and International Economies, Vol. 24, pp. 1-27.
Organization for Economic Cooperation and Development (2010) Economic Outlook 87, Paris.
114

Patrick, Hugh T. (2004) “Evolving Corporate Governance in Japan,” Center on Japanese
Economy and Business, Columbia University, Working Paper 220.
Rebick, Marcus (2005) The Japanese Employment System. Oxford, UK: Oxford University
Press.
Shinagawa City (2008) “Joint-Operation of Elementary and Intermediate Education
Curriculum,” Accessed 20 August 2010
http://www.city.shinagawa.tokyo.jp/hp/menu000006200/hpg000006188.htm
Skinner, Douglas J. (2008) “The rise of deferred tax assets in Japan: The role of deferred tax
accounting in the Japanese banking crisis”, Journal of Accounting and Economics, Vol.
46, pp. 218–239.
Suzuki, Wataru (2005) “How to Evaluate Special Zones for Structural Reform: On a Perspectiveof Econometric Approach” Government Auditing Review, Vol. 12, pp. 41-52.
Yashiro, Naohiro (2005) “Japan’s New Special Zones for Regulatory Reform,” International Tax
and Public Finance, Vol. 12(4), pp. 561-574.
Yugami, Kazufumi (2007) “Job Creation through Deregulation – Effects of the Special Zones”
The New Trend on the Regional Job Creation, The Japan Institute for Labour Policy andTraining, pp. 165-196.

115

Figures for the Appendix

Figure A1-1. Non-Performing Loans of Japanese banks: 1996-2010 (100 million

yen)
Source: Japanese Financial Services Agency (http://www.fsa.go.jp)

116

Figure A3-1. Number of Dispatched Workers (1992-2009)

Note: The number of dispatched worker is calculated by adding the number of regular dispatched workers and the number of theother dispatched worker as stated in the number of regular workers.
Source: Report of Worker Dispatching Undertakings (Roudousya Haken Jigyou Houkokusyo) 1992-2009, Ministry of Health, Labourand Welfare. http://www.mhlw.go.jp/stf/houdou/index.html

117Figure A3-2. Number of Dispatched Workers for Manufacturing Job

Source: Report of Worker Dispatching Undertakings (Roudousya Haken Jigyou Houkokusyo) 1992-2009, Ministry of Health, Labourand Welfare. http://www.mhlw.go.jp/stf/houdou/index.html

118

Figure A3-3. Income Distribution by Industry, Worker Type for 2002 and 2007

Source: Basic Survey of Employment Structure (Syugyou Kouzou Kihon Tyousa) in 2002 and 2007, Bureau of Statistics, Ministry ofInternal Affairs and Communications. http://www.stat.go.jp/data/shugyou/2007/index.htm
http://www.stat.go.jp/data/shugyou/2002/index.htm

119Figure A3-3. Income Distribution by Industry, Worker Type for 2002 and 2007, continued

120

Figure A3-3. Income Distribution by Industry, Worker Type for 2002 and 2007, continued

121

Figure A3-3. Income Distribution by Industry, Worker Type for 2002 and 2007, continued

122

Figure A3-3. Income Distribution by Industry, Worker Type for 2002 and 2007, continued

123

Figure A4-1. Proportion of Large Scale Farms
a. All prefectures excluding Hokkaido (farms greater than 2 ha)b. Hokkaido (farms greater than 10 ha)

Source: Japan Statistical Yearbook 2010, Table 7-1.
124

Figure A5-1: Number of Types of Special Zones in Each Cycle 2003-2010 (%)

125

Figure A5-2. Reported Effectiveness of the Special Zones

Note: The number of responces is 259.

126

Figure A6-1. Gross Government Debt of selected OECD Countries (% of GDP)127

Figure A6-2. Net Government Debt of selected OECD Countries (% of GDP)128

Figure A6-3. Downgrading of JGB

Moody’s

S&P

Aaa

AAA
2001.2.22

1998.11.17

AA+

Aa1
2001.11.28

2000.9.8

AA

Aa2
2001.12.4

2002.4.15

2007.4.23
AA‐

Aa3
2008.6.30

2002.5.31

A+

A1
2007.10.11
A2

A

129

Tables for the Appendix

Table A3-1. Dispatched Workers and Contract-Based Workers
Number of Dispatched Number of Contract-Based
Workers(manufacturing industry only)
2004

Workers

865600

2005

69647

2008

558089538128

Note: The survey of contract-based worker is not designed to survey the number of contract-based worker precisely and it would
contain a large error.
Source: Number of dispatched worker: Report of Worker Dispatching Undertakings (Roudousya Haken Jigyou Houkokusyo)
1992-2009, Ministry of Health, Labour and Welfare. http://www.mhlw.go.jp/stf/houdou/index.html
Number of Contract-Based Workers: Field Survey of Dispatched Worker (Haken Roudousya Jitutai Tyousa), Ministry of Health,Labour and Welfare.
http://www.mhlw.go.jp/toukei/itiran/roudou/koyou/haken/04/index.html
http://www.e-stat.go.jp/SG1/estat/GL08020101.do?_toGL08020101_&tstatCode=000001021306

130

Table A3-2. Hiring Dispatched Workers at the End of Contract Terms
Number of hired workers at the The percentage of it to total
end of contracted term
dispatched workers
2004

10655

1.20%

2005

19780

1.60%

2006

27362

1.80%

2007

32497

1.87%

2008

37901

1.91%

Source: Report of Worker Dispatching Undertakings (Roudousya Haken Jigyou Houkokusyo) 1992-2009, Ministry of Health, Labourand Welfare. http://www.mhlw.go.jp/stf/houdou/index.html

131Table A3-3. Dispatched Workers after the Global Financial Crisis
2008

2009

Employee (exclude executive)

5539

5478

Standard Worker

3399

3380

Part-time Worker

821

814

Arbeit331

339

Contract Employee

320

321

Dispatched Worker

140

108

Other

148

139

Note: units are 10,000 people
Source: Labor Force Survey (Roudouryoku Tyousa), Bureau of Statistics, Ministry of Internal Affairs and Communications.
http://www.mhlw.go.jp/stf/houdou/index.html

132

Table A4-1. Japanese Agricultural Policies: 2001-2010
Government

Prime Minister
KoizumiLDP(Apr.2001-Sep.2006)

Primary goal

Target ofsupportRespond toLarge scale

globalization

farmers

Date

Policy (Political event)Apr. 2004

Major reform of rice production adjustment system

Mar. 2005

Basic Plan for food, agriculture, and farm village

Apr. 2005

Abe(Sep.2006-Sep2007)

Basic Strategy of agriculture and forestry marine

Jun. 2006

products export promotion
New subsidies to large scale farmers announced

Apr. 2007

New subsidies to large scale farmers introduced

Jul. 2007(DPJ wins big in the House of Councilors Election)

Increase the
Fukudafood self(Sep.2007-Sep.2008)

sufficiency

All farmers

Fall 2007

Purchase of rice to support rice priceExpanded subsidies for furlough

ratio
Aso

Apr. 2009(Sep.2008-Sep.2009)
DPJ

Hatoyama

Apr. 2010(Sep.2009-Jun.2010)

Subsidies to production of rice for rice flour or
feeding
Direct payment income support system

Note: LDP stands for the Liberal Democratic Party of Japan. DPJ stands for the Democratic Party of Japan.
Source: Authors’ compilation based on the information from Godo (2010).
133

Table A4-2. Farm Sizes in Various Countries
Survey YearCountry

Farm Size (ha)

1997

China

0.67

1995

Japan

1.2

1995-97

India

1.41

1990

Switzerland

11.65

1995

Israel12.35

1999-2000

Belgium

23.12

1999-2000

Germany

40.47

1999-2000

France45.04

1999-2000

U.K.

70.86

2002

U.S.

178.352002

New Zealand222.64

2001

Canada273.4

Source: Eastwood, Lipton and Newell (2010)134

Table A4-3. Average Farm Size for Japan: 2006-2009
Year

Average size (ha)

2006

1.79

2007

1.83

2008

1.87

2009

1.91

Source: 84th Statistical Yearbook of the Ministry of Agriculture, Forestry, and Fisheries Japan Statistics Department. Table II-1-(6).

135Table A5-1. Numbers of Special Zones established by types
2003 2004 2005 2006 2007 2008 2009 2010
Welfare, medical care

58

57

112

95

20

18

15

6

Education

44

68

66

78

30

8

0

2

Agriculture

57

89

43

28

14

22

12

18

New industry creation

56

30

15

11

9

1

0

0

International exchange and logistics 21

2

3

4

1

0

1

0

Total

246

239

216

74

49

28

26

236

136

Table A5-2 Examples of Special Zones
Yokohama Emergency Medical Service Reform Kamikatsu Paid NPOs Transportation Service Zone
Zone
SponsorDate of Approval

Yokohama City

Kamikatsu-Cho, Katsuura-Gun, Tokushima Prefectureth

May 23, 2003 (2nd admission)

March 31, 2008 (16 cycle)

June 14, 2004
(13 months)

Date of Nationwide
Application(Duration)
Goals

To increase the number of medical rescue teams to Provide transportation to the residents, especially the
keep up with the increased demandold, in a rural town of Kamikatsu, where they lacked theservice from private-run bus and taxi companies

Deregulatory
Measures Applied

Legally, an emergency medical service team is required The special measures allowed the NPOs in the zone toto have at least 1 ambulance and 3 emergency medical operate transportation service without drivers withtechnicians (EMTs). The zone allowed an emergency commercial licenses
medical service to be formed with 1 ambulance and 2
EMTs for some lower priority emergency conditions(based on the call-triage assessment)

Progress

Introduction of call-triage system and deregulation on The service improved the means of transportation for
EMTs allowed the city to use more resources for high visiting relatives. The number of NPO drivers registeredpriority cases
increased from 14 to 20. By 2008, the transportation
served a total of 6,096 people
NPO is not required to have drivers with commercial
licenses to run transportation services. NPO is allowed

Nationwide
Application

to provide transportation services with private vehicles
137

Gunma Foreign-Language Education Zone

Joint-Operation of Elementary and Middle School
Zone

SponsorDate of Approval

Ota City, Gunma Prefecture

Shinagawa Ward, Tokyo

st

August 29, 2003 (2nd admission)

April 21, 2003 (1 admission)

Date of Nationwide July 9, 2008
(63 months)
Application

July 9, 2008
(59 months)(Duration)Goals

To accommodate children of foreign workers better in To better integrate public education in elementary andpublic education.
Ota City is a manufacturing middle schools
powerhouse. It is home to the car manufacturer Subaru,
a subsidiary of Fuji Heavy Industries. Foreign workers
for manufacturing factories have significant presence inthe city

Deregulatory
Measures AppliedMore flexible school curriculum. The special measures Divided 9-year compulsory education into three phases
enabled English immersion program in every subject – 4 years of fundamental class, 3 years of intermediate
except Japanese and Social Science. Joint operation of class, and 2 years of advanced class. Introduction of newelementary, middle, and high school provided a more subjects: 1) “Citizenship” for 1st ~ 9th grades; 2) English
coherent English learning environment to the students

for 1st ~ 6th grades; and 3) “Step-Up Learning” for 5th ~9th grades. Step-Up Learning is an honor course in which
each student can pursue more rigorous curriculum forhis or her subjects of interests. To enroll in Step-Up
Learning, the student needs to demonstrate superior
academic performance in the introductory courses

138

(Shinagawa City 2008)

Progress

The English immersion program has demonstrated Increased applicants to the school. The percentage ofsome success; 12 third-graders passed intermediate parents in this school district who wish to enroll theirlevel of high school English exam (the number was children to the school increased from 17.0% to 29.8%
zero when they were first-grade). Likewise, 30 sixth
graders who transferred from other schools have passed
higher level of high school English exams (the number
was zero when they transferred in their fourth-grade)(Gunma Kokusai Academy 2007)

Nationwide

Greater flexibility on the school curriculum. The school Greater flexibility on the school curriculum. The school

Application

installed foreign language immersion program and does not need to adhere to the standard curriculum
pioneered English instruction for math and science requirement laid down by the Ministry of Education; theclassesschool created two new subjects (Citizenship and
Step-Up Learning) and allocated more time on English

139

Sponsor
Date of Approval

Iwate Homeland Revitalization Zone

Ozu-Uchinomi Olive Production Zone

Tono City, Iwate Prefecture

Uchinomi-Cho (Ozu Island), Kagawa PrefecturerdApril 21, 2003 (1st admission)

November 28, 2003 (3 admission)

Date of Nationwide July 9, 2008
(63 months)
Application

November 22, 2005
(17 months)(Duration)
Goals

To attract tourists from the urban area to experience To vitalize the town by utilizing olives, a local specialty
the lifestyle of the Japanese countryside. To promote product of Ozu
local economy through tourism

Deregulatory
Measures Applied

Allowed brewing of doburoku (Unrefined Sake); Allow corporate firms to enter agricultural-businesssolicitation of corporate firms to the agricultural through land-leasing
business through land-leasing; deregulation on theminimum farming area required, which was 1.25 acres

Progress

The doburoku brewing business increased the number 6 firms have entered the agricultural business andof tourists, from 1.50 million in 2002 to 1.53 million in utilized 28.4 acres of previously unused farmland. In
2008. For those who stayed overnight, the number 2008, the town earned ¥250 million from agricultural
increased from 57,000 in 2002 to 61,000 in 2008. output, a 25% growth from 2003, and ¥100 million from
Deregulation on the floor of required farming areas tourism
attracted more business to pursue agriculture in theregion – 4 new doburoku brewery and 5 new
agricultural firms

Nationwide

Brewing of doburoku, entry of for-profit corporations Allow for-profit firms to enter agricultural-business

Applicationin agricultural business through land-leasing, and through land-leasing140

deregulation on the minimum farming area required

Kobe
Biomedical
ClusterSponsorInnovation Mie
High-Tech
Revitalization Cluster

Kobe City, Hyogo Prefecture

Industry Kitakyushu
Exchange Zone

International

Yokkaichi City, Mie Prefecutre and Kitakyushu City, Fukuoka Prefecture
Yokkaichi City Port Authority

Date of Approval

stApril 21, 2003 (1st admission)

April 21, 2003 (1 admission)

April 21, 2003 (1st admission)

Date of Nationwide
Application(Duration)
Goals

To form an international cluster of To rejuvenate the town through Located midway between Tokyo andmedical-related industries

structural reform

Shanghai, Kitakyushu aims tobecome an international hub for
traffic and trade through deregulation

Deregulatory
Measures Applied

Progress

Foreigners who work in this special Relaxed layout requirement on Solicitation of foreign researchers;zone are prioritized in the petroleum
refineries.
24-hour deregulationofvisa-relatedvisa-acquiring process. The special customs clearance

procedures;

24-hourzone also waived the prohibition on

clearance;

subsidized

national university faculties
participate in additional jobs

overnight services; easier application
for the change of landfill usage

tocustomrate

for

177 companies have entered the The special zone increased the 24 hour clearance and reduced
Kobe special zone to pursue demand for overnight services. It also overnight rate facilitated a 50%
innovations in biomedical fields via facilitatedtheresearchand growth (from 2004 to 2009) inpartnerships among industry and development for fuel cell batteries. demand for harbor access. 27 firms
141academia. By 2013, the special zone By 2014, the special zone expects to have entered the special zones. The
expects to create 5,400 jobs and attract ¥75 billion in investment, gross investment as a result of the
produce ¥99 billion in output

create 1,800 jobs, and generate ¥40 new firm entry is projected to reachbillion additional output

Nationwide
Application

142¥190 billion and create 4,800 jobs

Table A6-1. Local Government Revenues: 1970-2010 (¥ trillion)
Fiscal Year

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

Total

10.10

12.18

15.09

18.22

23.49

26.04

29.50

34.01

39.13

43.13

Local Allocation Tax Grants

1.80

2.10

2.55

3.13

4.20

4.47

5.19

5.71

7.04

7.71

State Subsidies

2.08

2.55

3.35

3.76

4.98

5.82

6.61

7.78

8.93

9.72

Local Bonds

0.64

1.12

1.64

1.64

1.93

3.18

3.68

4.29

4.98

5.10

Local Taxes

3.75

4.24

5.00

6.49

8.24

8.15

9.56

11.01

12.24

14.03

Fiscal Year

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

Total

46.80

50.10

52.17

53.46

54.97

57.47

60.08

64.66

68.01

74.57

Local Allocation Tax Grants

8.11

8.72

9.18

8.87

8.55

9.45

9.83

10.56

11.21

13.46

State Subsidies

10.51

10.94

11.04

10.75

10.60

10.42

10.28

10.36

9.91

10.28

Local Bonds

4.73

4.91

4.92

5.23

5.01

4.50

5.26

5.97

5.63

5.62

Local Taxes

15.89

17.33

18.63

19.84

21.49

23.32

24.63

27.20

30.12

31.80

Fiscal Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

Total

80.41

85.71

91.42

95.31

95.99

101.32101.3599.89

102.87104.01

Local Allocation Tax Grants

14.33

14.89

15.68

15.44

15.53

16.15

16.89

17.13

18.05

20.86

State Subsidies

10.63

11.17

12.86

13.61

13.71

14.96

14.67

14.26

15.63

16.48

Local Bonds

6.26

7.26

10.20

13.37

14.30

16.98

15.62

14.08

15.14

13.07

Local Taxes

33.45

35.07

34.57

33.59

32.54

33.68

35.09

36.16

35.92

35.03

143

Table A6-1. Local Government Revenues: 1970-2010 (¥ trillion), continued
Fiscal Year

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009*

2010*

Total

100.28100.00

97.17

95.00

93.40

92.90

91.50

91.10

92.20

82.56

82.13

Local Allocation Tax Grants

21.78

20.35

19.55

18.06

17.00

17.00

16.00

15.20

15.40

15.82

16.89

State Subsidies

14.45

14.55

13.17

13.14

12.50

11.89

10.53

10.34

11.69

10.30

11.57

Local Bonds

11.11

11.82

13.32

13.79

12.37

10.37

9.62

9.58

9.92

11.83

13.49

Local Taxes

35.55

35.55

33.38

32.67

33.54

34.80

36.80

40.27

39.56

36.19

32.51

* The initial budget numbers are shown for fiscal years 2009 and 2010.

144