April 13, 2000

Policy Recommendations to Japanese Political Parties as General Election Approaches

Policy Recommendation Forum for Economic Revival of Japan (PRF Japan)
Shuntaro SHISHIDO, Chairman (Research Adviser of ERINA)
Hideaki KASE, Executive director (Foreign Policy Critic)
Haruki NIWA, Vice chairman (Professor of Economics, Osaka Gakuin University)

  Japanese economy is said to have managed to stop its downward plunge and to start showing signs of partial and slight upward trend, but the prospect for its full recovery and prosperity is not yet at all visible. Predicament of medium and small businesses remains extremely serious. Total assets including properties and stocks lost by the Japanese due to recession during the last decade is as much as 2,000 trillion yen, not to mention the plight of those who lost jobs or family businesses. Vast hardships suffered by each and every one of the populace are beyond description. Based on such awareness and in view of the approaching general election, we strongly recommend the following to the political world of Japan.

We recommend to all the political parities to publicly promise that they will secure the economic growth of at least 5 % per annum for the coming decade in order to secure fundamental recovery and revival of Japanese economy.

  You should not even say that "it is impossible". Because it is, on the contrary, extremely easy. We shall discuss the details of the reasons why it is "extremely easy".

Utilize Enormous Real Fiscal Resources
- Japan lost \4,000 trillion during two decades -

  Japanese economy currently has an extremely large surplus production capacity. It is estimated that the level of potential real GDP that could be achieved is 800 trillion yen once Japan's labor force and corporate capital equipment reach the state of full employment and full operation. Actually, however, GDP level that is realized is merely \500 trillion per year because of the insufficient total demand. In other words, it is only 60% of the 'ceiling' of potential maximum capacity, and the remaining 40% accounts for the deflationary gap. Potential real GDP of Y300 trillion a year is lost to no purpose. (The Economic Planning Agency has shielded this fact from people [as well as from politicians] by presenting figures and concepts that look similar but are different from deflationary gaps in the Economic White Paper.) Since the 'ceiling' itself still has an upward curve, the gap continues its tendency to escalate. This gap is, needless to say, surplus in production capacity and is none other than the 'real fiscal resources' of our society. So long as we have this enormous 'surplus production capacity', our economy will keep its growth without any difficulty so long as the aggregate demand is increased.

  This deflationary gap is not something that has appeared suddenly in recent years. As shown in the graph (cited at the end of the paper), it began to appear in or about 1974 and kept its trend of enlarging. Even during the period of bubble economy, the growth rate was not so largely accelerated in the real economy and the deflationary gap therefore hardly diminished. As the graph indicates, the gross total of potential real GDP that were lost during the increasing process of deflationary gap has become \4,000 trillion (in real value at 1990 prices) during the 20-odd years from the middle of 1970s. If this trend continues, another \4,000 trillion will be lost during the next decade. This will be an ultimate damage for our economy. This is the actual status of the so-called 'lost decade'(actually it is 'the lost two-and-half decades') of 'the defeat in the economic war'. This must be, at the same time, an extremely large negative factor for the economies of Asian countries as well as of the world. We would like to emphasize here that such result of accounting basically leaves no room for doubt. That is to say, if such result of deflationary gap were to be rejected, we would be forced to deny all of the national income statistics, the employment statistics and the enterprises' capital stock statistics.

  Japan should break away from such a stagnant trend of the aggregate demand that is creating a prolonged tendency of ever expanding enormous deflationary gap at the earliest possible opportunity and stop the huge potential loss in real GDP - 'real fiscal resource'. In other words, we must turn the level of aggregate demand upward from the current stagnant
situation to start growth with a quick tempo as soon as possible. In this context, maintaining the 5% annual growth in the aggregate demand is the minimum target we should strive for.

  So long as this enormous deflationary gap of 'surplus production capacity' continues, even a decade of the 5% annual growth in the aggregate demand will never create an inflationary gap where the supply cannot meet the demand. Accordingly, there is no fear of steep price hike. If the 5% annual growth in the aggregate demand is maintained, the annual growth of about 5% in real GDP can also be maintained.

No Problem in 'Structure' of Japanese Economy

  As mentioned above, if there were restrictions on 'the supply side' that hamper the production and supply of commodities to meet the increased demand such as a 'structural barrier' in Japanese economy, there is bound to occur an inflationary gap and the resulting steep climb of prices. However, there has been no such sign during the past two decades nor is there a sign of inflationary gap in the present-day economy. On the contrary, the business has quickly and optimally responded to the demands for production and supply of various commodities (including services) in Japan, and there have hardly been instances of 'short' or 'unsold' stocks due to imbalances of the supply and the demand. (This is clear from the fact that the ratio of inventory changes to GDP is only 0.2% to 0.5%.) There is thus no problem in 'the structure' of 'the supply side' in Japanese economy. In other words, its market mechanism is most effectively functioning, and there is a perfect balance between supply and demand. Because of the too low level of aggregate demand, however, the equilibrium between supply and demand also hovers low, creating the above-mentioned escalating trend of an enormous deflationary gap. In sum, depression and stagnation of Japanese economy is caused mainly by 'the demand side' - or by the short and insufficient aggregate demand. This means that so long as the aggregate demand is increased adequately, it is extremely easy to restore Japanese economy and lay a track for its vigorous growth.

  As is clear from the simple explanation given above, macroscopic 'structural depression' can never exist in economic theory or in reality apart from the lack of aggregate demand. And yet, the government, mass media, critics, business world, labor unions and others made up their mind that Japanese economy was in 'macro structural depression' having forgotten this most fundamental and least doubtful axiom of the economic theory, implemented the policy called 'supply side type' structural reform policies and supported them. However, such 'supply side type' structural reform policies are utterly wrong for Japanese economy that is gripped with the worst type of depression. 'Structural reform' trying to abandon 'the real fiscal resources' or enormous surplus in production capacity in Japanese economy is the worst type of error. Politicians of this country should face this reality squarely.

  Discussing the so-called slowing down of 'potential growth rate' is also non-sensical. 'Potential growth rate' is the upward slope of 'the ceiling' presumable as the possible maximum limit for potential real GDP corresponding to the full employment and the full operation as discussed above. However, as mentioned, since this 'ceiling' per se is far higher than the current actual level of real GDP, even if the slope of such 'ceiling' became somewhat flattened, there are no factors that would restrict the growth of Japanese economy in any way, at least for another ten years. The view of the Economic Strategy Conference (officially established by Mr. Obuchi's administration) is therefore entirely wrong in its insistent emphasis on enduring with nearly 'zero growth' as 'the potential growth rate has diminished'.

Fiscal Resources That Can Be Inexhaustible

  To raise the level of aggregate demand by a high margin based on the intent and policies of individual businesses are not possible. That individual businesses have to try to restructure and rationalize means that businesses have to vie and cut down their received values of orders from customers each other and that depression and stagnation macroscopically intensify. This is the so-called 'synthesis error'. But the (central) government can macroscopically manipulate the aggregate demand through its financial and monetary policies. Therefore, the government should be wholly responsible for determining and maintaining the macro-level of aggregate demand and its growth rate. Our recommendation to the political world as discussed above is based on this point. The government should be able to quite easily and radically raise the level of aggregate demand when the country's economy has a large-scale surplus in production capacity and no anxiety about exhausting the reserve of foreign currency as it does currently. Therefore, the government and the political world alike should not be so irresponsible as to act as a bystander and hope for 'natural recovery course' of economy.

  If the government were to pull up the aggregate demand on a full scale through its fiscal policies, it certainly would need huge monetary financial resources. And yet so long as Japanese economy retains the enormous 'real fiscal resources' of huge surplus production capacity, there are naturally several options, to utilize it, that place little burden on the government or people for raising fiscal resources in terms of 'money' needed for the fiscal policies. To use such options for achieving financial reconstruction of government should also be extremely easy. Treasury revenue increases dramatically and naturally and turns the government budget into black if the economic growth rate exceeds 5% per annum.

  As has become well known in recent years, since our government has enormous debts as well as huge credits, it may be said on purely theoretical basis that the government can still issue national bonds - particularly those of "construction bonds" for public works for building highly efficient and excellent social capital that may support Japanese economy. If these were to be 'consols' that need no capital repayments, the burden on the government would be considerably lifted. Alternatively, the Bank of Japan could be made to directly take over the new issues including deficit bonds, and the government could defer interest payments and capital repayments indefinitely. It would also be useful to invigorate social capital investments using private financing initiative (PFI) backed up by the official fund.

  A simpler and more effective method will be for the government to issue more 'money' (government note). This is legitimate under the present legal system, and is being implemented in the form of coins. At the time of the Meiji Restoration, the new government was guaranteed of its revenue by issuance of 'Dajo-kan-satsu' as irredeemable 'government currency notes' recommended by Yuri Kimimasa, which helped them to accomplish the Restoration successfully. Now, following this, the government should issue 'Dajo-kan-satsu of Heisei Era' (not the Bank of Japan notes) as 'government currency (notes)' by exercising a full-scale government's privilege of 'seigniorage' and earn huge fiscal revenue. It could be done more smartly by, for instance, selling to the Bank of Japan some value amount of the right to issue government currency (which can be considered as the intangible asset of the government) and receiving the payments therefor as the fiscal revenue.

  At any rate, such direct or indirect exercise of the state's (government's) privilege to issue currency does not entail interest payment or capital repayment no matter how big the amount to be earned is. It naturally becomes the genuine revenue of the government. With this huge fiscal revenue, the government can radically increase the aggregate demand - i.e. the total amount of effective demand expenditure. (Since the focus is on increases of the effective demand expenditure, our recommendation is not for 'reflative inflation policy'.) At any rate, a little wisdom secures almost inexhaustive fiscal resources quite easily. This will almost instantly reconstruct the affluent-sound national finance and will impose little burden on future generations.

Multiplier Effect is Still Going Strong

  Not only the political world but also people of Japan are trapped by a strange social mind control, and quite a many people including politicians are convinced that there is no longer effective policy for increasing the aggregate demand. However, such belief is not well founded, and is entirely wrong.

  For instance, the effects of several 'comprehensive economic measures for counter depression' taken by successive cabinets since Mr. Miyazawa's administration are considered almost nil even though they are claimed to have been implemented on a grand scale, and disappointments for such policies are prevalent throughout the political world and among the general public. The real situation is, however, that the government has only insufficiently and inadequately implemented such policies on the so-called 'fresh water'(i.e. net effective demand expenditure) basis. This is quite clear from the fact that the growth of the government expenditure (effective demand expenditure of the general governments, both central and local) was merely 1.17 times between 1991 and 1997 in terms of the real national income account (See Economic Planning Agency's series of year book, Annual Report on National Account). In a situation where real private investment expenditure is hovering low and the growth of government expenditure (i.e.,public investments and various final government consumption expenditures including those for a part of social security and welfare) is maintained as such low level, the total of these two items of expenditure cannot be expected to be better than flat. In fact, the total sum accounts for a large part of so-called 'autonomous' effective demand expenditures, and since GDP is formed through the multiplier effect acting on the 'autonomous' effective demand expenditures, GDP also remains stagnant and the economic growth is hardly attainable. This was the real cause for perpetuation of 'Heisei depression'. (We might say that Japan's bureaucracy has neglected to explain this to the political world.) Macro multiplication factor of GDP corresponding to total 'autonomous' effective demand expenditures is none other than 'Keynesian multiplier', and its value has been steadily and solidly maintained (at 2.4 - 2.5) throughout the period of 'Heisei depression'. We might say that 'multiplier effect' in Japanese economy is still alive.

  Even though the public fund infused to bankrupt financial institutions has already become huge, it is not the effective demand expenditure and it should be considered to be of little effect for business recovery. This would be also true of the case where the currency issue has been increased for the so-called 'reflative inflation policy'.

  Household consumption expenditure (or private final consumption expenditure) is characteristically dependent on the size of income and therefore cannot be treated as 'autonomous' effective demand expenditure, but the ratio of the consumption expenditure to household income - or 'the propensity to consume' - has risen since 'Heisei depression' started (See Economic Planning Agency's Annual Report on National Accounts,1999, pages 16 - 17). This means that the widely prevailing theory that "the lowered household propensity to consume has created Heisei depression" is entirely wrong.

Vision for Reconstruction of Japanese Economy
- Japanese people's "morale" and "moral" will improve -

  In the present day Japan where huge production capacity surplus exists in a form of super large-scale deflationary gap, production and supply of all kinds of commodities can be increased limitlessly to respond to the growth in demand. Therefore, implementation of such policy of escalating aggregate demand by the government which has acquired almost inexhaustible resources by the measure mentioned above will not be a burden for its people. On the contrary, business and income will increase and people's living standard will rise.

  Expansion of aggregate demand by such fiscal policies of the government should naturally be implemented more rationally by radically increasing the effective demand expenditures such as by construction of IT related infrastructure, which will become the basis of the Japanese economy in the 21st century, improving the transport system by building hub airports and new trunk lines, developing new energy sources, improving the defense force, extending social securities, improving the natural environment, etc. As mentioned above,'multiplier effect'is thriving, and the increased government expenditure such as the above will increase the aggregate demand and GDP that will reach the multiplier times.

  However, the current situation is such that the government ministries and local autonomous bodies are taking utterly negative posture because of the long lasting depression and stagnation. The radical and grandiose 'country building project' based on 'the long range national plan' has hardly been hatched. All we should do to overcome this situation and to secure the economic growth is to pay bonus of several hundred thousand yen to each and every one of the Japanese people from babies to old people as 'expense to invigorate potential economy' (by transfer to their bank accounts). This should be in a much larger scale than the previous 'coupons for community economy promotion'. This can be carried out in a far simpler and easier way in a much larger scale than the tax cuts, its effect large and immediate, and very fair. There is no fear that the government organization will become corpulent. Such measures can be described as most suitable for the current market economy system where the mechanism of consumerism ( i.e., consumer's sovereignty) is basically functioning. It will not bring any unnatural 'strain' to economy.'Multiplier effect' in such cases functions quite steadily. Once such a measure is taken, the Japanese economy will enjoy bright prosperity of high growth most easily. The interest rate can be returned to the normal level. People's morale will be boosted and their morals elevated. The government financial situation will unavoidably become very sound with a large natural increased budgetary revenue. This is 100% sure.

  As the growth rate of economy rises, the structural adjustment and reform of the industry will automatically and smoothly proceed. The most of so-called 'delinquent loans and bad assets' will instantly become fine loans and good assets and obviate the problems of insolvency of financial institutions. In sum, the priority should be placed on restoring the business conditions and realizing the growth economy. It should not be the reverse. (Therefore, if the current depression and stagnant situation were left un-rectified, there is no guarantee that liquidation at a great cost of delinquent finance institutions will recover the business trend.)

  Such economical conditions with a high growth rate were to be realized, the exchange rate of yen would become far lower than the current rate so long as the current floating exchange rate system is maintained. Thus, our industry will strengthen its competitiveness without efforts and Japan will be liberated from the bad dream of hollowing out of industries.

Politicians, Awake and Rise!!

  There is not the slightest doubt about correctness of the economical analysis made by us. Our policy proposals are bound to achieve more than satisfactory results. Therefore, once the politicians - and therefore the policy makers - make up their mind to adopt and implement them, it is possible to maintain our economic growth at no less than 5% per year (or even achieve 10% growth). It will also be quite easy to achieve reconstruction of our national finance. Only then, Japan will be able to utilize the huge 'real finance resources' of enormous production capacity surplus. This will be a great contribution to economical prosperity and welfare not only of the Japanese people but also of the entire mankind.

  If, on the contrary, policies that "stop the business recovery policies by increases of the aggregate demand and prioritize the structural reform in a most through way" were to be enforced, depression will further proceed and perpetuate, and 'the real finance resources' of '4,000 trillion yen of 10 years' dumped. Giving such a huge damage to our economy in no way guarantees restoring prosperity and growth to our economy. There is no logical guarantee that reconstruction of our state finance will be achieved. In this context, prioritizing structural reforms is a most perilous political attitude.

  We sincerely and strongly hope that political parties and politicians will see this risk, awaken and rise.


Note to Graph

  When the rate of increase in productivity of aggregate inputs (TFP) is described as the 'rate of technological progress',

GDP growth rate(%) = rate of technological progress (%) + growth rate of aggregate inputs of labor and capital(%).

If the ratio of 'technological progress rate(%) / GDP growth rate(%)' is given, the yearly growth rate(%) of potential 'full capacity GDP' can be obtained from the growth rate of aggregate inputs of 'full employment and full utilization'of labor force and fixed capital stock. Of course, the index of the level of potential 'full capacity GDP' can also be computed with ease as the link series of these growth rates.

  In the graph, the growth path of potential 'full capacity GDP' shown as 'high' is based on the assumption that the ratio of 'technological progress rate (%) / GDP growth rate (%)' is 1/3. The path is shown as 'middle' based on the assumed ratio of 1/3.5, and 'low' based on the assumed ratio of 1/4. Even in the conditions of potential 'full capacity GDP', there remains 3% deflationary gap due to frictions, etc.

  For details of the calculation process and the data used, refer to Niwa, H., : Economics of the Economic Revival of Japan, Hara Syobo, Tokyo 1999 (in Japanese),Chapter 16,pp.313-344. See also Niwa, H.,"The Recent Deflationary Gap in Japan: A Quantitative Measurement", Journal of Asian Economics, Vol. 11, No. 2, Summer, 2000 (forthcoming).