Masaaki Shirakawa: Toward strengthening the competitiveness and
growth potential of Japan's economy
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at the Executive Member
Meeting of the Policy Board of Nippon Keidanren (Japan Business Federation), Tokyo,
28 February 2013.
* * *
Introduction
It is a great honor to have this opportunity to address the executive member meeting of the
Policy Board of Nippon Keidanren today. Before I start, let me express my deepest
appreciation for the information and views on current developments in economic and
financial activities as well as on policy conduct provided to us by all the member firms.
Today's speech is the last one I will give as Governor of the Bank of Japan. However, it was
not difficult for me to decide today's main topic, "toward strengthening the competitiveness
and growth potential of Japan's economy", because it is the most pressing issue for Japan at
present. It is also a very important theme for the Bank of Japan. As you know, at the
Monetary Policy Meeting in January, the Bank decided to introduce a "price stability target"
and set it at 2 percent.1 This target was introduced based on the recognition that progress
would be made by a wide range of entities in their efforts toward strengthening the
competitiveness and growth potential of Japan's economy (Chart 1). For this reason, it is
extremely important in conducting monetary policy whether such efforts will actually make
progress. In the following, I would like to talk about this theme while paying due regard to the
perspectives of macroeconomics, corporate behavior, and economic policymaking.
I. The aim of economic policy
While there has been active discussion regarding the conduct of economic policies in Japan,
I will first consider the aim of economic policy and the kind of situation we expect Japan's
economy to attain. Needless to say, the ultimate aim of economic policy is to raise the living
standard of each citizen. While there is no single indicator for gauging people's quality of life,
if we were to put this in approximate terms, the key aim of macroeconomic policy is to raise
the per capita consumption level, or to raise the real gross domestic product (GDP), which is
closely related to the former, in a sustainable manner (Chart 2). Having said this, a more
detailed discussion is necessary when considering the various options regarding economic
policy on the basis of the situation facing Japan's economy.
First, there is a need to consider the effects of the decline in the labor force due to the rapid
aging of Japan's population. Japan's current real GDP remains below the level seen prior to
the Lehman shock. Looking at per capita real GDP figures, the drop for Japan is relatively
small compared with countries such as those in Europe (Chart 3). Furthermore, in terms of
the level of real GDP per working-age person, Japan has exceeded the pre-crisis level,
which is a better performance than that of the United States. While "population decline" is
one of the clichés used in discussing Japan's economy, this fundamental fact is oftentimes
disregarded when discussing economic developments. Of course, figures do not differ
significantly within short time periods of a quarter or a year, but when considering Japan's
economic policy in the medium to long term, it is important to think in terms of changes in per
capita or per worker data.
Second, we need to take account of the progress in economic globalization. Specifically, it is
necessary to look not only at real GDP but also at real gross national income (GNI). Real
GNI is a concept of income that results from making the following two adjustments to real
GDP. One source of adjustment is the overseas income of Japanese nationals. Looking at
figures for 2012, overseas income amounts to 14.3 trillion yen - that is, 3.0 percent of
nominal GDP. In recent years, profits from outward direct investment have been increasing in
addition to profits from outward portfolio investment (Chart 4). The other source of
adjustment is the change in real purchasing power due to changes in the foreign terms of
trade. Japan's terms of trade have been deteriorating in recent years, mainly due to the rise
in commodity prices against the background of high growth in emerging economies. Trade
gains/losses - in other words, real purchasing power arising from changes in the terms of
trade - have thus been on a declining trend (Chart 5). Terms of trade undergo changes, not
only due to commodity prices but also in response to the pricing power of Japanese firms
through the non-price competitiveness of exports. Fluctuations in foreign exchange rates, for
example depreciation of the yen, will raise real GDP through an increase in exports but may
at times adversely affect trade gains/losses. Effects on real GNI depend on the net result that
takes into account these two adjustments (Chart 6). Setting 2000 as the base year, real
overseas income increased by about 2.5 times in 2012, pushing up real GDP for 2012 by
1.9 percent compared with that in 2000. On the other hand, the trade gains pushed real GDP
downward by 5.8 percent.
Third, another topic for discussion is how to treat nominal GDP and real GDP in considering
economic policy. On this point, both of these increase when the economy grows in a
sustainable manner, suggesting that the direction of medium- to long-term policy is not all
that different depending on which figure we take into account. What I must mention here is
the cause-and-effect relationship between the two. The basic causal relationship is that, as
real GDP rises, the output gap tightens and prices subsequently rise, resulting in a rise in
nominal GDP (Chart 7). There are situations, of course, where prices fluctuate first, as seen
during the time of the oil crises. In such a situation, however, economic conditions
deteriorate, and this is different from what we wish to see. What we are trying to achieve
through economic policy is to raise real GDP, as a result of which nominal GDP will rise.
In relation to this, the results of the Opinion Survey on the General Public's Views and
Behavior that the Bank conducts on individuals on a quarterly basis provide some interesting
findings. The survey results reveal that approximately 80 percent of the respondents
- irrespective of their sex, age, and occupation - have consistently viewed the price rise as
"rather unfavorable" throughout the past surveys (Chart 8). Underlying the survey results is
the concern that wages may not rise even if prices rise. A considerable portion of the
Japanese public is not simply looking for a situation in which prices rise. In the phrase
"overcoming deflation", people are looking for a situation in which one's salary rises,
employment is secured, and profits increase; in other words, a situation characterized by a
well-balanced improvement in economic conditions and consequent rise in prices.
The fourth point involves the problem of how to distribute the fruits of economic growth.
While market mechanism plays a key role in order for the economy to grow, this requires a
perspective of society as a whole that accepts such mechanism at large. On this point, the
situation surrounding income distribution is one of the crucial factors. In the United States,
during the period of economic expansion preceding the Lehman shock - from 2002 to 2007 -
the real incomes of the highest-income households in the top 1 percentile increased by
86 percent and household average income increased by 20 percent. In contrast, the
"median" household income - that is, the income that represents the middle of a series of all
household incomes arranged in order of size - increased only by 10 percent, which amounts
to just half the growth of the average income (Chart 9). The situation surrounding income
distribution partly depends on the proportion of the elderly that does not have any earnings,
and reviewing this through a single indicator can therefore be challenging. Japan's case may
not be as extreme as that in the United States. Nevertheless, awareness of the need to
achieve well-balanced economic growth, especially for the middle class, has increased
around the globe.
II. The need to strengthen competitiveness and growth potential
Bearing these issues related to the aim of economic policy in mind, let me now move on to
the need to strengthen competitiveness and growth potential.2
Looking at developments in a country's economic growth rate over the longer term, factors
affecting it can be broken down into real or supply-side factors - namely, capital stock, labor
force, and technological innovation. Explaining this within the framework of so-called growth
accounting, the growth rate can be broken down into growth in the number of workers and
that of value-added per worker, in other words, the labor productivity growth rate (Chart 10).
Mechanically estimating future growth in the number of workers, based on the assumption of
the most recent labor participation rate by gender and age, the number of workers in Japan
will change at a rate of -0.6 percent per annum in the 2010s and -0.8 percent in the 2020s.
Meanwhile, the labor productivity growth rate for the years 2000 through 2008 - a period
characterized by relatively favorable economic conditions - was 1.4 percent on an annual
basis. Adding this to the aforementioned growth in the number of workers, the average
growth will become 0.8 percent for the 2010s and 0.6 percent for the 2020s. This will merely
amount to maintaining positive growth over the next two decades. Japan's economy faces a
considerably strong headwind in the form of a decline in the labor force, and we need to
more seriously acknowledge its implications. Raising the labor productivity growth rate
further will alleviate the problem, of course. Japan has achieved a growth rate slightly
exceeding the average for the G-7 countries for the past 10 years, however, and it is not very
plausible to think that we can raise it by 1 percent or more at once (Chart 11).
At any rate, raising Japan's growth potential continuously into the future requires work,
especially strenuous work, on both the number of workers and the labor productivity growth
rate. While efforts by a wide range of entities are necessary in such case, the main actors
here, above all, are private firms. The corporate sector has consistently had a savings
surplus, together with households, since 1998 (Chart 12). A significant savings surplus by the
corporate sector is a phenomenon now observed outside of Japan as well: it has spread to
major advanced countries since the start of the 2000s. In terms of the amount of savings
surplus relative to GDP, figures for the United Kingdom, Japan, and the United States are
6.1 percent, 4.6 percent, and 4.1 percent, respectively. The most significant underlying cause
of this savings surplus is the lack of attractive investment opportunities at home amid
expanding investment opportunities in the emerging markets. Recently, other causes have
also been pointed out, including the securing of funds to offset additional costs that may arise
from a lack of funds for corporate pensions mainly resulting from a decline in interest rates.
I presume that in your day-to-day decision making, you cannot muster enough confidence to
invest at home despite having ample liquidity on hand (Chart 13). In fact, on-hand cash and
deposits at Japanese firms has been increasing steadily: the proportion of Japanese firms
listed on the First and Second Sections of the Tokyo Stock Exchange (TSE) holding cash
and deposits exceeding the amount of interest-bearing debt - in other words, firms without
net external borrowings - has recently become as high as 43 percent.
Of course, firms' ample on-hand liquidity itself is reasonable up to some level, taking into
account experiences such as the post-bubble financial crisis and the aftermath of the failure
of Lehman Brothers - that is, the shortage of U.S. dollar funds and the decline in the
functioning of the CP market. The current level of on-hand liquidity, however, appears to go
well beyond the amount of such precautionary demand. As for the use of excess funds, there
are only three options: making real or financial investments at home and abroad; disbursing
funds to employees in the form of wages; and returning them to stockholders through
dividend payments and share buybacks. The economy will not see positive outcomes unless
some kind of change is brought about to the increased liquidity via one of the aforementioned
routes. In that sense, it is extremely important to change the business environment, thereby
modifying firms' incentives. That is why in achieving sustainable growth with price stability,
efforts toward strengthening the competitiveness and growth potential of Japan's economy
are necessary as much as monetary policy is indispensable in this regard.
III. Outline of the course of future measures
Next, I would like to outline the course of future efforts toward strengthening the economy's
competitiveness and growth potential.
Capturing increasing overseas demand
The first course is to capture increasing overseas demand in the form of expanding
Japanese firms' overseas business activities. It is inappropriate to negatively describe such
efforts as the "hollowing-out" of industries in an environment where overseas economies
- mainly emerging economies - have grown much faster than Japan. With regard to
international division of labor, while manufacturing and assembly overseas expands,
increasing the export of intermediate goods from Japan and reinforcing domestic R&D
activity, whose value-added is relatively higher, will contribute to raising Japan's real GDP. In
addition, if surplus funds that have accumulated in the corporate sector are being used for
overseas investment with high returns, the benefit of such investment will be passed back to
Japan in the form of interests and dividends. This will not directly contribute to raising real
GDP, but it does raise real GNI. While globalization of the economy continues, it is deemed
imperative to make balanced efforts as a nation by combining domestic production with
exports as well as with foreign direct investment, or local production overseas.
Indeed, overseas investment by Japanese firms has been increasing, especially in Asia.
Such a trend has spread from large manufacturing firms to nonmanufacturing ones, as well
as small and medium-sized enterprises (Chart 14). Nevertheless, the outstanding amount of
Japan's foreign direct investment remains at a low level compared with that of other
advanced countries (Chart 15). Similarly, in terms of the profitability of foreign investment,
which is the combination of portfolio investment and direct investment, Japan falls a little
behind countries such as the United States, partly because of its small share of direct
investment, which has a high rate of return (Chart 16).
Huge potential demand exists in emerging economies, particularly Asia, in the area of
building core infrastructure for transportation systems, energy supply, and communication
systems. According to the estimates of the Asian Development Bank, such demand will
amount to approximately 8 trillion U.S. dollars from 2010 to 2020 (Chart 17). There are ample
business opportunities for Japanese firms to make use of their globally recognized
cuttingedge technologies and wealth of experience - such as upgrading metropolitan infrastructure
and implementing environmental and energy-saving technologies, as well as deploying
factory automation systems to address labor shortages and wage rises - that have been
nurtured in Japan over the years. It has become increasingly apparent that Japanese firms in
such sectors as retail, healthcare, and education, which have focused mainly on the
domestic market, are able to formulate sweeping business strategies in large Asian markets,
where consumer demand is increasing briskly as these countries' middle-income populations
continue to expand.
Responding to the aging population
The second course is to respond to the rapidly aging population. The long average life
expectancy of the Japanese people implies that health, the condition most vital to well-being,
is being fulfilled at a high level. Having said that, it is necessary to adjust the economic
structure and social infrastructure as the population continues to age. Otherwise, it becomes
difficult to maintain the current high quality of life. While this is sometimes misunderstood, the
demographic change of population aging itself is not triggering the problem for Japan's
economy; the real issue is that Japan's economic structure and social infrastructure have not
sufficiently caught up with such demographic changes.
The aging of the population brings about various changes to the economy. First, it will
become a downside factor for economic growth via the economy's supply side - namely, a
decline in the labor force. In order to counter this trend, it is most important to increase labor
participation, particularly of the elderly and women.3 The labor participation rate of
60-69 year-olds has increased continuously over the last few years (Chart 18). The labor
participation rate of women is also increasing, but remains at a relatively low level compared
with other advanced economies (Chart 19).
Aging will also substantially change the demand structure of the economy. The area of
medical and nursing care is one worth mentioning. In the United States, the elderly
population aged 65 and older increased by 13 percent in the ten years from 2000, and as a
result, the expenditure in medical and nursing care rose by 82 percent. By contrast, in Japan,
while the elderly population increased by 29 percent, such expenditure only rose by
17 percent (Chart 20). In relation to this, it has often been pointed out that, in Japan, due to a
number of regulations and a shortage in the workforce, sufficient service in this sector has
not been provided relative to demand. While one should be mindful of the fiscal implications,
appropriate system design and regulatory reforms are likely to turn the potential demand in
medical and nursing care, as well as in medical equipment and infrastructure, into actual
demand. At the same time, medical and nursing care could become one of the most
promising domestic employers as Japanese firms expand their overseas operations
(Chart 21).4
Population aging also brings about an expansion in demand in the housing market. For the
child-raising generation, potential demand for larger housing is believed to be high, but such
demand has not been satisfied, particularly in the metropolitan areas. On the contrary,
members of the elderly generation continue to live in large houses that had been acquired
during their working age. Indeed, in Japan, the share of second-hand dwellings in the total
housing market (i.e., combining new and second-hand dwellings together) is only 12 percent,
far less than the 79 percent in the United States and 86 percent in the United Kingdom
(Chart 22). Once the housing market is reorganized, potential demand for housing will be
cultivated by meeting the different needs in different stages of life, and this will eventually
invigorate related markets, such as electric home appliances and other household items, as
well as remodeling. Change is also desirable on the financial front. It is often pointed out that,
in Japan, household financial assets are concentrated in cash and deposits. This partly
reflects that the share of residential assets, that is, real assets with large price fluctuations
and low liquidity, among total household assets tends to be high (Chart 23). If household
assets start flowing into financial assets other than cash and deposits, we might enjoy an
increase in the supply of long-term risk money.
Promoting smooth transfer of resources
The third course is to promote the smooth transfer of resources. In the medical care and
housing areas that I just talked about, not a shortfall in demand but the mismatch between
demand and supply has become the essence of the problem in the sense that potential
demand and actual supply do not correspond to each other. In recent years, sales of
pre-packaged tours to the elderly and sales in health-related industries have shown marked
increases. This suggests that firms have succeeded in cultivating potential demand by
making efforts to develop new products through shifting their human resources and capital to
those businesses.
Changes will surely create new demand and promote the introduction of new goods and
services. It is imperative to realize the optimal resource allocation by shifting labor and
capital resources within a firm, as well as among firms, industries, and regions, in
accordance with a changing demand structure. In short, the metabolic process is also crucial
in achieving economic growth. Looking at the founding years of the top 300 firms in terms of
market capitalization, there are more firms with long corporate histories in Japan than in the
United States (Chart 24). This is evidence that firms themselves have made efforts to
self-transform and have successfully managed to cope with a series of environmental
changes. It can also be said that dynamism is absent in terms of birth of firms. Changes are
surely taking place, however. For instance, looking at developments in the stock market after
the Lehman shock, comparatively small firms have recently been performing relatively well
(Chart 25). The number of initial public offerings - which showed a large decline in recent
years - is gradually on a recovery trend, and such movements are now also being observed
outside large metropolitan areas. I am quite encouraged by this development.
IV. Regulatory and institutional reforms, corporate governance reform, and social
values
So far, I have talked about the outline of the measures toward strengthening competitiveness
and growth potential. In principle, this should happen in an economy as a result of individual
firms' rational choice. The fact that this is not happening in reality must be the result of
economic, institutional, or social factors. Accordingly, there is a need to improve the
economic environment, i.e., remove those obstructing factors.
Regulatory and institutional reforms
First, there needs to be an improvement, promoted by the government, in the environment
that will serve to back firms' efforts aimed at bringing about change. More specifically, it is
necessary for the government to carry out bold regulatory reform in order for firms to broaden
the areas in which they may embark on new challenges, and to make institutional
improvements to the labor market so as to allow workers to move more smoothly into
businesses and industries with high growth potential. In order to avoid an increase in
excessive social friction arising from responses to changes in the economic environment, it is
also necessary to provide support for career changes and to enhance the safety net.
Corporate governance reform
Second, it is necessary to ensure the appropriate functioning of corporate governance by
stockholders and investors.5 On this issue, Germany is a good source of reference. Until the
beginning of the 2000s, Germany was named as a country putting off essential structural
reforms, and the country indeed suffered from slow economic growth in the first half of the
2000s. Under such circumstances, however, it engaged in various reforms surrounding
corporate activity, including institutional reforms that allowed for flexible adjustments to
employment as well as enhanced information disclosure to investors. On this point, Japan
falls behind Germany, especially when it comes to reforming enterprise law in such areas as
corporate rehabilitation, as well as mergers and acquisitions. This is said to hinder dynamic
corporate restructuring, thereby eroding the international competitiveness of industries
across the board. It is also said that such an environment has accentuated the anxiousness
over legal liquidation or removed the fear of being taken over, and encouraged to some
extent the excessive accumulation of cash and deposits at firms.
Social values
Third, society needs to face possible trade-offs between stability and change. Japan has
been somewhat dominated so far by a perspective that stressed the importance of stability.
The method of adding gradual "improvements" to one's company's products in accordance
with consumer needs in the existing domestic market can be considered a business
management style that puts importance on stability. Merely making improvements focused
on the domestic market amid a population decline, however, carries the risk of the economy
falling into a shrinking cycle. Corporate profits will suffer even more in the long term if firms
continue to keenly compete in terms of prices while maintaining their commitment to securing
employment. If I may make a sweeping generalization, firms are facing a judgment call of
choosing between "improvement", which represents continuity, and "innovation", which
represents discontinuity. If the shock against the economy is temporary, there may be a point
to overcoming any difficulties in the immediate future via "improvements", thus prioritizing
stability in the long term. Confronting long-lasting shocks such as globalization and
population aging by means of the same "improvement" as before, however, may delay
responses to significant changes.
Reform cannot proceed without public consensus. Bringing about innovation requires firms'
willingness to take on challenges as well as the transfer and reallocation of necessary
resources. Frictions may well be experienced in the process. While this is not necessarily an
issue with one indisputable solution, if environmental change is long-lasting, I find it
extremely important for society as a whole to accept such changes and adopt a view that
encourages any and all efforts to take on new challenges, in order to successfully carry out
reforms toward strengthening growth potential.
V. Relationship with prices
So far, I have talked about the efforts to strengthen the economy's competitiveness and
growth potential. Next, getting slightly off track, I will touch upon the relationship between
economic growth and prices.
The year-on-year rate of change in the consumer price index (CPI) is currently around
0 percent, but is expected to reach 0.9 percent in fiscal 2014, according to the Bank's
forecasts. This is based on the view that Japan's economy will continue to grow above its
potential growth rate and the output gap will be filled, assuming that overseas economies
moderately improve. However, considering the fact that the output gap has narrowed
significantly compared with its peak, and given the sensitivity of prices to the gap, the closing
of the gap alone will not allow us to reach the target of 2 percent right away. What is the
general image of an economy that achieved 2 percent inflation, and what is the mechanism
behind the process leading up to this state? In theory, one can come up with several cases.
The first involves a push from rising import prices as a result of the yen's depreciation or
rising international commodity prices. The second is related to rising wages. In the medium
to long term, wages and prices are closely correlated. The third sees rising inflation
expectations. Finally, the fourth corresponds with rising growth expectations of firms and
households.
Which case are we looking for? In the case where import prices push up inflation, household
real income is squeezed. The ideal situation is that a rise in wages, a rise in inflation
expectations, and a heightening of firms' and households' growth expectations take place at
the same time. What should be noted here is the relationship between wages and prices.
One of the main factors behind low inflation rates in Japan relative to other economies is
Japan's employment practice. Specifically, Japanese society since the second half of the
1990s has prioritized securing employment, and it effected reductions in costs largely by
cutting back wages; consequently, prices fell (Chart 26). Looking at development patterns of
corporate profits, wages, and prices during economic recovery phases, these three indicators
moved together in the same direction during the high-growth era in the 1970s (Chart 27). At
present, neither wages nor prices have changed materially even in the economic recovery
phase, as corporate profits have acted as a buffer to absorb shocks, with the labor
distribution rate rising during economic recession phases and declining during recovery
periods. The primary cause for this is the decline in firms' profitability, which in turn reflects
the decline in the potential growth rate. On this point, looking at the relationship between
medium- to long-term inflation expectations and potential growth rates, there is a clear
positive correlation in Japan (Chart 28). If firms' and households' growth expectations
improve, this will have a positive effect on wages and prices in a sustainable manner.
Consequently, "deflationary expectations" that had taken hold over a prolonged period will
fade away.
VI. The will to reform
While it generally has been recognized that there is a need to work toward strengthening
competitiveness and growth potential, and that meeting these challenges is essential in
overcoming deflation and achieving sustainable growth with price stability, why is it that such
efforts have not made progress? On this point, the key lies in the sense of urgency regarding
the need for reform. The problems currently facing Japan's economy, namely, the rapid
aging of the population and accompanying issues, are not temporary. They are steadily
affecting the economy in the manner of a chronic illness. Deterioration of fiscal conditions is
a textbook example of such problems. In order to maintain fiscal sustainability, it is necessary
to reform the structure of expenditures and revenues as well as strengthening growth
potential. Unless the growth rate rises, a modest increase in the rate of inflation alone will
barely improve the fiscal balance. While such chronic symptoms exist in Japan, acute ones
have not appeared. The biggest reason for this lies in the fact that Japan holds a massive
amount of external net assets reflecting the current account surplus that has continued over
a prolonged period. Because of this, Japan tends to experience inflows of capital that search
for a safe haven, even in the event of a global economic shock, and enjoy stable long-term
interest rates while facing an appreciation of the yen. Japan has not experienced any sell-off
of its currency in a crisis.
In this regard, I would like to make reference to recent developments in financial markets.
The keywords to understanding movements in the global financial markets over the last
several years are risk-on and risk-off. When faced with a great amount of uncertainty about
the future, investors stay away from risks - in other words, they become risk-off - but when
such uncertainty is judged small, they become risk-on (Chart 29). The basic background to
the yen's appreciation that lasted until summer 2012 was investors' preference for safe
assets as the European debt problem intensified. Indeed, it was in late July that the yen hit
its recent peak in the nominal effective exchange rate and the Spanish and Italian sovereign
rates reached the most elevated levels. After that, a variety of safety valves to cope with the
European debt problem were put in place in Europe and the fiscal cliff was avoided in the
United States. Against the background of these developments, global investors' risk aversion
has substantially receded. Broadly speaking, the yen's recent depreciation and rise in stock
prices in Japan are also taking place amid such changes in those investors' risk aversion.
Put differently, investors' attitude toward risk may influence market conditions. I believe this
could be easily understood by looking back at the fact that yields on government securities of
member states of the euro area had remained at practically the same levels for nearly
ten years. What ultimately drives market developments is economic fundamentals. Over the
last 15 years in Japan, there were several phases when the yen depreciated. Although
exports and production increased during those phases, we regrettably did not succeed in
raising the potential growth rate (Charts 30 and 31). The important thing is to make use of
the current favorable conditions and make steady efforts to strengthen the competitiveness
and growth potential of the e