Masaaki Shirakawa: Toward a revitalization of Japan's economy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Foreign
Correspondents' Club of Japan, Tokyo, 7 February 2011.
* * *
I. Introduction
I am privileged to have the opportunity to speak before the distinguished Foreign
Correspondents' Club of Japan today. The topic I would like to talk about is the revitalization
of Japan's economy, focusing on the current state of the economy, the challenges it faces,
and the efforts necessary to address such challenges.
If one looks back at the history of any country's economy, one will find times full of
confidence and enthusiasm, and times where such confidence and enthusiasm were lacking.
The 1980s were a time when the strength of Japan's economy attracted attention from
around the world. However, starting in the 1990s, and especially from the latter half of the
1990s onward, Japan's economic conditions deteriorated due to the collapse of the bubble
economy and the subsequent financial crisis. The expression that came to represent the
state of Japan's economy was the "lost decade," which is commonly used both at home and
abroad. I suppose that anyone might lose heart if hearing such an expression often enough.
As you may know from experience in your own country, people tend to become overly
optimistic or overly pessimistic, depending on the perceived economic performance relative
to other countries.
Assessing the economy of one's own country through comparisons with other countries has
both its advantages and disadvantages. An advantage is that it provides an opportunity to
understand one's own country in a more objective way. A disadvantage is that there are risks
of becoming overly optimistic or overly pessimistic, depending on the economic situation at
the time. If comparisons are made only superficially, this may lead to a wrong assessment
and result in the wrong policy measures or the wrong corporate strategies. At any rate, even
in a time when globalization is advancing in leaps and bounds, mutual understanding across
borders is not easy. For that very reason, I imagine that the work of foreign correspondents
such as yourselves is challenging and exciting.
As a central bank governor, I myself have many opportunities to exchange views with the
overseas media and policy authorities abroad. On these occasions, I get asked a great many
questions about Japan's economy. Here are the questions I am most frequently asked. First,
why Japan's economy has lost its vitality. This is in fact the starting point for the subsequent
questions. The second question is why deflation has continued for a prolonged period.
Discussions on the severe economic conditions then lead to the third question: are Japan's
public finances sustainable? In this context, I am often asked why, despite the deterioration
in the fiscal balance, yields on Japanese government bonds (JGBs) have been stable at low
levels. Finally, a fourth question I am often asked is whether Japan's economy can really
regain its vitality.
It is an undeniable fact that Japan's economy faces many challenges. However, I believe that
Japan's economy can most definitely regain its vitality. Needless to say, we have to work
hard to achieve this. Obviously, the right prescriptions are also essential. To this end, it is
necessary to have an accurate understanding of both the strengths and the weaknesses of
Japan's economy. I am looking forward to exchanging views with you on this point later.
II. The current state of Japan's economy
I will start with short-term developments in economic activity in Japan. Japan's Economy
contracted severely following the failure of Lehman Brothers, but then started to improve
around spring 2009. It continued doing so until the summer of 2010, mainly due to the
increase in exports and production brought about by faster growth in emerging and
commodity-exporting economies as well as policy measures to promote the sale of
environment-friendly durable consumer goods. The improvement seems to have paused
from the fall of 2010, but recent data suggest that Japan's economy looks like it is about to
emerge from that pause. If we compare these short-term developments in Japan's economy
with those in other advanced countries, Japan is not doing badly.1 For example, according to
the latest projections by the International Monetary Fund, Japan's Economy was expected to
grow by 4.3 percent in 2010, the highest rate of growth among the G-7 countries (Chart 1).
Moreover, the unemployment rate in Japan, although higher than before the failure of
Lehman Brothers, is at 4.9 percent, which is far below the roughly 10 percent in the United
States and the euro area (Chart 2). Of course, the current level of economic activity is still
below that before the global financial crisis and therefore not satisfactory. However, this is a
problem common to many advanced economies. With regard to the degree of financial
system stability, Japan is the most stable. Thus, as far as short-term economic and financial
developments are concerned, Japan's situation is by no means worse than that of other
advanced economies.
Despite all this, why are pessimistic views on Japan's economy so widespread? Clearly, the
main reason is the downward trend in Japan's economic growth.
Why Japan's economy has lost its vitality
Let me now explore the first question I mentioned earlier, that is, why Japan's economy has
lost its vitality. From around 1955 to 1970, Japan continued to achieve high-speed growth,
registering annual rates of growth around 10 percent, which is similar to China's growth since
1990. Subsequently, Japan's economic growth rate declined gradually. Yet, in the 1980s, the
average annual growth rate was still around 4.5 percent, greatly exceeding that of other
advanced economies. However, in the 1990s, Japan's annual growth rate fell substantially,
dropping to around 1.5 percent, and in the 2000s, the economy grew at barely 1 percent per
year on average, although the latter is partly due to the economic plunge triggered by the
failure of Lehman Brothers (Chart 3).
The long-term trend of the economic growth rate is determined by two factors: the rate of
growth in the number of workers and the rate of growth in GDP per worker, or productivity
(Chart 4). Among these, the main factor behind the decline in the growth rate in the 1990s
was the decline in productivity growth. The first reason for this decline in productivity growth
is the burst of the bubble economy. Many firms had to focus on resolving the so-called "three
excesses" - in production capacity, employment, and debt - built up during the bubble
period, and as a result, Japan's growth rate declined. The second reason, overlapping with
the first in some respects, is that Japanese firms were slow to respond to the significant
changes in the global economic environment. Specifically, following the fall of the Berlin Wall
in 1989, the globalization of the market economy proceeded at a rapid pace and the world
entered an era of "mega competition." However, Japanese firms were not able to sufficiently
adapt to this changing environment. Looking back, during the high-speed growth era,
Japanese firms were able to grow rapidly thanks to a favorable environment such as an
abundant supply of labor and the expansion of the domestic market as a result of population
increases, as well as the absence of rivals from less industrialized countries. The business
model developed in this environment at the time was based on long-term, stable business
relationships and put emphasis on mass production and the sale of low-priced, high-quality
products for the domestic market and advanced economies. The model was suitable for the
business environment during the high-speed growth era, but because it had been so
successful, many Japanese firms were slow to adapt the model when faced with the
emergence of new markets and competitors in the 1990s.
In the 2000s, partly because the effects of the burst of the bubble had gradually subsided,
productivity growth stopped declining and Japan's productivity growth rate today in fact
remains among the highest among advanced countries (Chart 5). However, the rapid aging
of the population, at a pace that has no precedence around the world, started to significantly
affect economic growth. Specifically, the working-age population - which makes up the core
group in production as well as consumption and the payment of taxes - peaked around
1995. It then started to decline, with the pace of decrease accelerating since the turn of the
millennium (Chart 6). These trends reduce the growth in the labor force and weigh on
economic growth from the supply side. At the same time, population aging also affects
economic growth from the demand side. The shrinking of the working-age population, which
accounts for the bulk of consumption, will decrease the size of the domestic market.
Moreover, consumption by the working-age generation is likely to be further constrained by
the growing burden of supporting the elderly. Of course, the growing number of elderly
means that demand for such services as health care and nursing can be expected to rise.
However, if the supply capacity to meet such growing demand remains constrained,
domestic demand as a whole will likely be sluggish. Another subtle consequence of
demographic trends that cannot be ignored is that the aging of the electorate may affect
economic policy choices which in turn may have a negative impact on economic growth.
Why deflation has continued for a prolonged period
Next, I will discuss the second question, namely why deflation has continued for a prolonged
period. Although Japan's deflation is quite mild when compared with oft-quoted episodes of
deflation such as that in the 1930s, this is a question that has attracted a lot of attention. The
direct cause of deflation is the slack in the economy (Chart 7). I therefore attribute the most
recent price declines to the global plunge in demand following the failure of Lehman
Brothers. However, the prolonged, albeit moderate, deflation since the end of the 1990s
cannot be explained only by short-term and cyclical factors. A more fundamental cause is the
long-term downtrend in the growth potential of Japan's economy. When the growth rate
continues to decline for a protracted period, people's expectations for future income growth
are reduced and firms and households restrain their spending. As a result, downward
pressure on prices continues (Chart 8).
It is sometimes said that deflation will be solved only if the central bank provides liquidity
more aggressively. Provision of ample liquidity is important, of course, but this alone does
not solve the problem of deflation. In the United States, the Federal Reserve has expanded
its balance sheet by a factor of 2.5 since the second half of 2008, but the inflation rate has
continued to decline (Chart 9). Thus, to overcome deflation in Japan, two things - consistent
monetary easing and efforts to strengthen the foundations for economic growth - are
essential.
Why yields on JGBs have been stable at low levels
The third question in relation to the severe economic conditions in Japan is why yields on
Japanese government bonds (JGBs) have been stable at low levels despite the deterioration
in the fiscal balance (Chart 10). In fact, the average yield on 10-year JGBs since the
beginning of 2000 has been around 1.4 percent, an extremely low level.
Long-term interest rates are influenced by three factors: the expected growth rate, the
expected inflation rate, and the risk premium associated with holding government bonds.
Accordingly, one possible explanation for the low and stable long-term interest rates is that it
reflects the market's view that, for the time being, Japan's economy will continue to grow
slowly and have low inflation.
However, this explanation alone is not sufficient. Given continued large fiscal deficits, if
doubts about fiscal sustainability were to spread and investors were to become concerned
about the risks associated with holding JGBs, long-term interest rates would rise. So far this
has not happened, however. In this context, it is often pointed out that JGBs are largely
absorbed by domestic private savings, which contributes to the low and stable long-term
interest rates. However, as history shows, no country can continue to run fiscal deficits
forever. Viewed from this perspective, it appears that the reason why interest rates in Japan
have remained stable is that market participants believe that Japan ultimately has a strong
will to work on mid- to long-term fiscal consolidation through, for example, reform of the tax
and social security systems. And if I may add one more thing, I think another major reason is
that the Bank of Japan's conduct of monetary policy has been clearly focused on achieving
sustainable growth with price stability. To put it the other way around, Japan should
appreciate and make every effort to maintain the confidence shown by markets while working
on mid- to long-term fiscal consolidation.
III. Efforts needed to address Japan's economic problems
Next, let me turn to the fourth question, namely whether Japan's economy can really regain
its vitality. I mentioned earlier my belief that Japan's economy can regain its vitality. At the
same time, however, this of course cannot be achieved without any effort. The road toward
Japan's economic revitalization starts from a clear identification of the root cause of Japan's
economic problems. Understanding that this is the downtrend in the growth potential, it is
necessary to work on specific solutions.
In this context, some argue that the first thing to do is to overcome deflation. Needless to
say, overcoming deflation is a major issue for Japan's economy. In some instances, price
increases may of course precede an acceleration in growth, but this is typically only the case
when inflation is pushed up as a result of price increases in international commodities such
as natural resources, fuel, and food. However, such developments would entail a worsening
of the terms of trade and hence a fall in real purchasing power. People would not welcome
such price rises. The relationship between economic activity and prices in the past shows
that prices increase as growth accelerates and hence the output gap narrows. This is how
the economy usually works. Thus, Japan's moderate deflation is a manifestation of the
fundamental problem of the long-term downtrend in the growth potential of the economy.
I would now like to discuss efforts in three areas that I think are particularly important for
raising the growth potential of Japan's economy.
The first concerns effort to tackle rapid population aging. Based on current demographic
trends, the pace of decline in the working-age population will accelerate in the future. For this
reason, society as a whole needs to create a working environment that promotes an increase
in labor market participation, especially by the elderly and women. In this context, I would like
to note that female labor market participation in Japan remains low in international
comparison (Chart 11).
Second, it is necessary to raise productivity growth in the economy as a whole. In this
regard, Japanese firms have been diligent, of course. Typical examples are production and
inventory management through just-in-time systems as well as kaizen (continuous
improvement), a term that has made it into English. Following the burst of the bubble,
Japanese firms have also been working on reducing labor costs. For individual firms, efforts
to pursue operational efficiency are certainly important. However, in a world of increasingly
fierce global competition, these efforts alone do not lead to an improvement in productivity.
The reason why Japan's walkman once dominated markets around the world is that, in
addition to high product quality, it offered a new lifestyle, allowing users across all age
groups to listen to music outside the home. Taking this as an example, Japanese firms need
to make greater efforts not only to improve the functionality and quality of products from the
perspective of monozukuri, a Japanese expression for "creating substance," but also to
provide new value from the perspective of shikake zukuri, or going beyond developing a
product to create an environment that the product can thrive in.2 Thus, what is needed is for
firms to make greater efforts to tap latent consumer demand and create new added value. At
the same time, in terms of improving productivity in the economy as a whole, efforts at the
micro-level alone are not sufficient. What is also crucial is to enhance the metabolism of the
economy as a whole, that is, not to impede the smooth transfer of production resources such
as capital and labor from areas of shrinking demand to areas of growing demand.
Moreover, it is vital to make efforts to actively capture demand in overseas markets that are
enjoying high growth, and many firms have recently been striving for tapping such demand,
especially in Asian markets (Chart 12). In these markets, and especially in China, demand
for consumer goods is growing exponentially with the expansion of the middle class. At the
same time, while enjoying high growth, these countries suffer from problems such as
pollution and urban overpopulation, which Japan once experienced. In these areas, there
also exist great opportunities for Japanese firms to take advantage of their skills and
knowhow acquired over many years. In order to actually capture such overseas demand, it is
necessary to arrange an open trade system. The Japanese government announced last year
that it would accelerate the negotiation of free trade agreements and economic partnership
agreements. Developments in discussions on these agreements are of key importance for
increasing the productivity of Japan's economy. The government needs to play its part
- through deregulation, tax reform, and the opening of markets - to provide a business
environment that helps to increase productivity.
Third, efforts to improve the fiscal balance are also necessary. The deterioration in the fiscal
situation reduces expectations for future income growth, especially among the working-age
generation, and restrains spending by this generation. Moreover, as seen in the sovereign
debt problems in European peripheral countries since last year, once confidence in fiscal
sustainability erodes, this will result in an adverse feedback loop among fiscal conditions, the
financial system, and the real economy, with negative consequences for economic activity.
An improvement in the fiscal balance is not something that can be achieved through inflation.
It is true that if prices rise, tax revenues may increase. At the same time, however,
expenditures, such as those on social security and public works, would also increase. If
future inflation is factored into long-term interest rates, the burden of interest payments on
government bonds would also rise. It is therefore necessary to fully recognize that an
improvement in the fiscal balance cannot be achieved without efforts to both reduce
expenditures and increase revenues in real terms (Chart 13).
IV. Recognizing the need for reform and Japan's economic strengths
I talked at length about efforts that are needed to raise the growth potential of Japan's
economy. Unfortunately, however, such efforts have not made sufficient progress. One of the
reasons is that the need for reform cannot be immediately felt. This reflects the fact that
although the growth potential is declining, Japan's economy stands on relatively firm
foundations. For example, because Japan's domestic market is relatively large, firms have
been able to make some profit, even if their business focuses only on the domestic market.
With regard to the fiscal problem, long-term interest rates have not been rising, the yen has
not depreciated, and there has been no capital flight. In fact, even though the recession
following the failure of Lehman Brothers was more severe in Japan than in the United States
and Europe, in the foreign exchange markets, demand for the yen has actually increased, as
it is viewed as a safe-haven currency. This is attributable to the fact that Japan has been
running a large current account surplus and is the biggest creditor nation in the world, so that
Japan is perceived as among the most robust countries in the world in terms of foreign
currency funding.
Be that as it may, given that the decline in the growth rate is a problem that has plagued
Japan for a long period, a tremendous amount of human energy is needed to reverse this
trend. What concerns me in this regard is that Japanese society is losing a healthy sense of
optimism. Just as excessive optimism can generate an asset bubble, excessive pessimism
can depress the economy. What is necessary is a strong will for reform and overcoming
excessive pessimism. We should keep in mind that Japan's economy and society still have
many strengths.
The first strength is that Japan is in Asia, which is the very center of global growth. For
example, looking at trade developments with China, which is now Japan's largest trading
partner, Japan's exports to China have grown 4.7-fold since 2000, while imports from China
have grown 2.7-fold. Moreover, Japan's direct investment position in China has expanded by
a factor of more than 5 (Chart 14). Meanwhile, the number of visitors to Japan from Asian
countries has doubled in the past 10 years, to about 7 million, accounting for nearly
80 percent of all visitors. In the future, visitors from Asia are likely to increase further as their
living standards improve. This is also expected to provide a significant boost to the various
regions in Japan.
Japan's second strength is its high level of technological capabilities. Japan's technological
capabilities are particularly high in environmental and energy-related fields, and the energy
efficiency of Japan's economy is second to none (Chart 15). Given global trends such as the
substantial increase in demand for infrastructure in emerging economies, the shift to a
lowcarbon society, and the growing role of environmental protection, the need for Japan's
advanced technologies in such areas is bound to rise in the future. In fact, there are a
considerable number of Japanese firms that have gained a substantial global market share
by making use of advanced technologies in electricity generation and storage or water
purification and desalination. Moreover, in a recent new trend, electric power companies and
local governments, exploiting their ability to provide efficient and reliable service, have shown
great eagerness to enter overseas markets in the area of urban infrastructure development,
such as the distribution of electricity and water.
A third strength - although it is difficult to find the right word - is what may be called the "soft
power" of Japanese society.3 I am sure you yourself, as a foreign correspondent in Japan,
have probably experienced how safe Japan is, as demonstrated by the great number of
vending machines, how reliable business operations are, as epitomized by the bullet train,
which is always on time, or how courteous the service is one receives in retail stores. It
seems to me that soft power, such as safety and trust, is becoming an increasingly important
asset in a globalized economy.
Earlier, I mentioned that the rapid aging of the population is weighing on Japan's economy.
On the other hand, population aging, that is, an increase in longevity, should also generate
an increase in demand in areas such as health care and nursing, tourism and leisure. For
example, the turnover of fitness clubs has increased by nearly 40 percent in the past ten
years, reflecting the increase in health consciousness due to population aging. At the same
time, in areas that are regulated, such as health care and nursing care, supply capacity is
insufficient and there is a mismatch of demand and supply. In these areas, there seems to be
ample room for tapping potential demand in the domestic market. Japan is the country in the
world where the problem of aging and population decline is the most acute, but other
countries in Asia will face the same challenges in the not-so-distant future (Chart 16).
Looking back, the rapid development of energy-efficient technology in Japan was triggered
by major challenges, namely serious pollution and the rise in oil prices. The population aging
Japan is now experiencing also represents a major challenge. At the same time, however, if
Japan applies its technological capabilities, as epitomized by its robots, as well as its soft
power, this challenge can give rise to new business models such as in the provision of
personalized nursing care services and therefore also presents great business opportunities
for Japanese firms.
V. The Bank of Japan's policy response
Finally, I would like to briefly explain the policy responses the Bank of Japan has
implemented in order for Japan's economy to overcome deflation and return to a sustainable
growth path with price stability. To start with, the Bank is pursuing powerful monetary easing,
so-called "comprehensive monetary easing." The overnight call rate is virtually zero percent,
the lowest in the world, and the Bank has committed itself to continuing the virtually zero
interest rate policy until it judges, on the basis of the "understanding of medium- to long-term
price stability," that price stability is in sight. Moreover, although extraordinary for a central
bank, the Bank last autumn started purchasing risk assets such as exchange-traded funds
(ETFs) and Japan real estate investment trusts (J-REITs).
In addition, to strengthen the growth potential, the Bank has also introduced a new program.
Through this program, it provides long-term funds with JGBs and other assets as collateral at
a low interest rate, to support financial institutions' own initiatives in lending and investing in
new growth areas. The Bank strongly hopes that the program, by acting as a "catalyst," will
prompt vigorous efforts by financial institutions and firms.
In many respects, Japan has been the first among major economies to experience
challenges such as balance sheet adjustments, a financial system crisis or rapid population
aging. On the monetary policy front, many central banks in advanced countries have now
adopted policy measures such as a zero-interest rate policy, quantitative easing, or credit
easing. However, at the time, the Bank of Japan, the "forerunner" in implementing these
policies, needed to devise such policies on its own. I feel that such creativity and
innovativeness by the Bank deserves more recognition. Nonetheless, the Bank will continue
to consistently make contributions as the central bank toward the crucial objective of
achieving a revitalization of Japan's economy.
VI. Concluding remarks
Today, I have talked about the challenges facing Japan's economy and efforts needed for
economic revitalization. Looking back at modern economic history, there are many countries
that achieved economic revitalization once they earnestly addressed severe challenges that
were initially seen as difficult to resolve. To give an example of another advanced economy,
the United States, from the second half of the 1970s to the 1980s, faced the challenge of a
decline in the international competitiveness of its manufacturing industries, which had
enjoyed an overwhelming advantage. Another example is Korea. Its strong manufacturing
sector is currently attracting attention, but only about a decade ago it found itself in distress
in the face of a serious currency crisis. Korea took a hard look at the causes of the crisis and
reformed its economic structures to prevent such a crisis from recurring. Such efforts have
led today's rapid progress. These examples suggest that history is a constant process of the
rise and conquest of new challenges. Japan's Economy is not an exception. Each time a new
challenge arose, Japan overcame it through painstaking efforts and a strong sense of
urgency. I think that once people share a will for reform, they can press ahead with tackling
the critical issues Japan's economy faces.
In Japan, 2011 is the year of the rabbit. In our country, a rabbit running up a hill symbolizes a
situation where things are progressing smoothly. And in the West, it is the rabbit that brings
Easter eggs, which are a symbol of rebirth. For my part, I strongly hope that this year will be
a year of revitalization for Japan's economy.
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