Masaru Hayami: The US and Japanese economies
reflections of a central banker
Speech given by Mr Masaru Hayami, Governor of the Bank of Japan, at the 32nd Annual Joint
Meeting of Japan-Midwest US Association and Midwest US-Japan Association, held in Tokyo, on
11 September 2000.
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I am honored to be invited today to the 32nd Annual Joint Meeting of Japan-Midwest US Association.
As some of you may know, after having worked at the Bank of Japan from 1947 through 1981, I then
entered the private sector where I spent about 17 years, during which time I often participated in
meetings of business leaders from both the United States and Japan. At this Annual Joint Meeting, I
am told that political and business leaders from both countries are going to discuss the problems that
the world economy faces, including the IT revolution and globalization. Needless to say, I am looking
forward to learning the results of the discussions.
Some ten to fifteen years ago, that is, in the late 1980s, one of the main topics at such conferences was
economic and trade friction between the United States and Japan. Indeed, I chaired a small group
established under the Japan-US Business Conference that discussed the resolution of disputes, which I
found an important, but not an easy job. One of the advantages of serving as chairman was that I had
the opportunity to visit a number of US cities, including Cleveland in the Midwest.
Fortunately, the economic and trade friction hotly debated at that time has been greatly alleviated,
partly because the cause has been removed and also partly because misunderstanding on both sides has
been resolved, which largely owes to the strenuous efforts made by those involved in solving the
problems underlying the friction. However, I think it also reflects the fact that over the past ten years
Japan's economy has stagnated while the US economy has revived.
Japan's economy saw the peak of the bubble about ten years ago. At that time, Japanese firms and
financial institutions were expanding their global market share and were full of confidence. Many of
you will remember a book entitled "Japan as Number One" written by a professor of Harvard
University which was published immediately before the bubble hit the peak. In contrast, ten years ago
the United States was suffering from twin deficits, a combination of huge budget deficits and the
expansion of current account deficits.
But that was ten years ago. Now, the US economy has been enjoying its longest ever period of
economic expansion. The unemployment rate has come down dramatically from 7.5% in 1992 to 4.1%
recently. On the other hand, Japan's economy has experienced severe trials since the bursting of the
bubble. Such contrasting development between the United States and Japan is most typically
witnessed in the movement of stock prices. The current Nikkei Stock Average is a little more than
40% of what it was at the end of 1989, which happened to be its peak, while the New York Dow-Jones
Industrial Average has risen four-fold during the same period.
Against this background, we Japanese have recently tended to become overly pessimistic about the
medium- to long-term growth potential of Japan's economy. However, I believe that Japan's economy
will be able to regain vitality if it firmly pursues economic reforms needed from a medium- to
long-term viewpoint, as witnessed by the revitalization of the US economy since the 1990s.
To that end, we should learn lessons from past mistakes. At the same time, it is crucial that we
steadfastly implement concrete reform measures while earnestly discussing how to revive Japan's
economy. In view of the current boom of the US economy, it may be useful for US participants in this
meeting to draw possible lessons from Japan's bitter experience which began when its economy was
still in a good condition.
Bearing all this in mind, let me talk about two issues. The first issue is, in the context of the US-Japan
economic relationship in the late 1980s, why did the bubble emerge and how did monetary policy
affect the emergence of the bubble? The second issue is, though it might sound a little bit vague, to
what extent do differences in economic and corporate management style, for example between the
United States and Japan, affect economic growth?
Regarding the first issue, there are various factors behind the stagnation of Japan's economy in the
1990s. The emergence of the huge bubble in the late 1980s and its subsequent bursting in the 1990s
was certainly one of the major factors. Although why the bubble emerged has not yet been fully
analyzed, we can obtain a few common observations if we look back on the history of bubbles
including the case of Japan.
One common observation is that it is inevitable that a bubble will emerge if public expectations
become extremely bullish for some reason. And, borrowing the expression of Fed Chairman
Greenspan, "irrational exuberance" prevails nationwide when a bubble emerges. However,
intensification of bullish expectations alone is not enough for the emergence of a bubble, for it has to
be financed, which is another common observation. As a matter of fact, during the bubble period in
Japan, the activity of financial institutions had become extremely aggressive and interest rates had
been kept low for a long period of time.
Now, in the aftermath of the bursting of the bubble, we hear various questions and criticisms such as
"Why did the Bank of Japan maintain monetary easing for a long period?" There were a couple of
reasons behind the delay in monetary tightening at that time. Above anything else, prices had been
very stable. Furthermore, Japan had a sizable current account surplus, reaching 4.2% of GDP in 1986.
And this strengthened the prevailing argument that Japan should continue monetary easing and expand
domestic demand to reduce the external surplus, which was another reason for the delay in raising
interest rates. The United States advocated that Japan's current account surplus should be reduced
through the expansion of domestic demand, but such an argument was widely discussed in Japan as
well.
The basic condition of the current account balance of a country is fundamentally determined by the
trend of the net balance between savings and investment which reflects demographic and other
underlying factors. Economic theory tells us that it is hardly possible for monetary policy to affect
such a basic condition of the current account balance. Nevertheless, in reality, not a few advocated the
erroneous argument which was not warranted by economic theory. I think this was partly because
some support was given to a misconception that microeconomic problems could be solved simply by
macroeconomic policy. In other words, there existed the mistaken notion that such problems as trade
friction between the United States and Japan could be solved by monetary policy.
Looking at the booming US economy while reviewing the experience of Japan's bubble period, I
cannot help but feel some difficulty in judging the arrival of the new economy, in other words, the
difficulty in differentiating between "irrational exuberance" and "rational exuberance."
Most central banks would perhaps say "no" to the question as to whether monetary policy could
prevent the emergence of a bubble. But, I think they would say "yes" to the assertion that monetary
policy can play a very important role in maintaining a stable macroeconomic environment. As we have
seen in the discussion based on the misconception about a reduction in the current account surplus, I
strongly believe it is important for both policy makers and business leaders to understand and share
some kind of basic logic in terms of macroeconomic theory for the conduct of sound economic policy.
Let me move on to the second issue I want to address which is to what extent differences in economic
and corporate management style, for example between the United States and Japan, affect economic
growth.
Against the backdrop of prolonged economic stagnation in recent years in Japan, there has been
growing recognition that we should further incorporate into our system the US style management
which emphasizes market-oriented economic management and shareholder-oriented corporate
management. Simply put, regarding economic management, competition should be further intensified.
The relaxation and lifting of regulations should be promoted. The financial system should be shifted
from one led by banks to one led by the capital market. And, on the corporate management front,
corporate governance should put more emphasis on shareholders. Needless to say, employment
adjustment should be more drastic.
From time to time such an argument goes to the extreme that further development of Japan's economy
cannot be expected unless we completely shift from Japanese style to US style management. I think
this is overly pessimistic because Japanese style management is not something which never changes,
but is rather something which has evolved in response to changes in the economic environment.
Of course, I am not saying that current Japanese style economic and corporate management has no
problems. Indeed, I often mention the importance of structural reform, and am sometimes criticized for
going beyond my position as central bank governor by making too strong a statement on the subject.
Nevertheless, I strongly believe Japan needs structural reform. First of all, let me emphasize that the
growth potential of the economy can be increased largely by improvements on the supply side, that is,
achieving steady productivity gains, rather than the short-term boosting on the demand side. For
example, if we compare the productivity of workers in 1998, the figure for Japan was about 40%
lower than that for the United States based on purchasing power parity in the IMF's World Economic
Outlook, and about 30% lower when based on the actual exchange rate. Of course, if the sole objective
is higher labor productivity, it can be achieved by investing a huge amount of capital and raising
capital per worker. But, in this case, capital productivity and return on capital would decline.
Furthermore, growth driven only by the huge investment of resources would eventually reach a limit.
For sustainable growth, we need to establish an indigenous mechanism that promotes growth by
combining labor and capital in an optimal manner under given prices and which generates innovation
in various fields.
Under such circumstances, we have to deal with the following three agendas.
First, the allocation of resources should be reviewed in light of changes in the economic environment
and resources should be invested in more productive areas. In this way, resources would be more
efficiently utilized. For example, labor and capital need to be reallocated from the public to the private
sector, from low growth to high growth industries, and from less efficient to more efficient firms. Such
redistribution would certainly be accompanied by pain, but without it we cannot expect the steady
development of Japan's economy.
Second, the legal, tax and accounting systems, some of which are outmoded and can be an obstacle to
innovation, should be reviewed. While I recognize that it is never easy to review any system, which
inevitably entails conflict of vested interest, we should know that we will not be able to take advantage
of the power of innovation unless systems are reviewed in response to changes in the economic
environment.
Third, what we really need to see is the emergence of innovators. Changes in the economic
environment will create a variety of opportunities for making profits. Transforming such opportunities
into profitable businesses cannot be achieved through a mechanical process. It can only be achieved if
innovators are allowed to pursue their entrepreneurial abilities to the full.
These three agendas boil down to the problem of how to improve the ability of the economy and
society to cope with various changes. Such an ability is always needed, but, when technological
innovation and economic globalization are rapidly progressing, economies and societies that can
respond to such changes have a considerable competitive edge.
I think the fact that the United States has recently recorded higher growth than Europe and Japan
reflects a greater ability to cope with changes which can be characterized by flexibility and diversity.
At a recent conference sponsored by the Federal Reserve Bank of Kansas City, Fed Chairman
Greenspan emphasized that the flexible US labor market had contributed to recent high economic
growth, by noting the seemingly paradoxical situation of low unemployment despite many layoffs.
From these viewpoints, we definitely observe the seeds of changes in the recent development of
Japan's economy. Let me give you some concrete examples of such change.
First, the reform of systems is proceeding rapidly. For example, a number of changes have been made
in the area of accounting, including mark-to-market valuation, more adequate pension liability
accounting, and the review of the relationship between subsidiaries and their parent companies. And,
importantly, the level of disclosure has been greatly improved. By accurately showing the performance
of a firm, these changes put strong pressure on corporate managers to pursue restructuring and higher
profits.
Second, corporate managers have become increasingly aware of return on capital.
Third, the mentality of employees has changed. Japan's labor market, which is characterized by
lifetime employment and the seniority-based wage system, used to be perceived by many as lacking
flexibility. However, recently we have seen gradual changes in the market as large-scale employment
adjustment has begun to be observed.
Fourth, reform of the financial system has been proceeding. Since the autumn of 1998, a legal
framework for the smooth dissolution of failed financial institutions has been established and public
funds have been injected into major banks to strengthen their capital base. Although there remain a lot
of things to be solved, the condition of Japanese financial institutions has significantly improved
thanks to the restructuring efforts on the part of financial institutions.
Related to these positive developments, direct investment into Japan has substantially increased in
recent years. In the past, inward direct investment was much smaller than outward direct investment.
In fact, it was only 200 million dollars in 1996. However, it has been on a rising trend, amounting to
12.8 billion dollars last year. I have great expectations for a continuing increase in direct investment
from abroad as it would stimulate Japan's economy through the transfer of managerial resources and
business expertise.
Before closing, if I may summarize, firstly, a stable macroeconomic environment is a prerequisite for
sustainable growth, and in this regard, monetary policy plays a very important role. Second, to raise
the economic growth rate over the medium to long run, structural reform affecting the supply side of
the economy is indispensable. I think that the contrast between the US and Japanese economies during
the past ten to fifteen years exactly proves this point.
Let me conclude my remarks by quoting the following prayer for "Serenity" by Dr Reinhold Niebuhr
which I cherish whenever I face challenging issues as Governor of the Bank of Japan:
God grant me the serenity to accept the things I cannot change, The courage to
change the things I can; And the wisdom to know the difference.
Thank you very much for your kind attention.