Takatoshi Kato
Former Vice Minister of Finance for International Relations, Japan

"Changing Fortunes in the U.S.-Japan Relations"

Until yesterday I took part in the IMF(International Monetary Fund)-World Bank annual meetings in Washington. This year’s focus of discussion was about the recent, sharp appreciation of the yen and its possible negative impact on Japan and other markets. Many people, including myself, are puzzled by recent exchange rate developments in light of economic fundamentals in Japan and the U.S. Respective economic might is exactly the subject I want to elaborate on in my address tonight.

In the last school year I taught as a visiting professor at Princeton. In my class, I had one Filipino-American student and one Korean-American student. Both of them are from California and dedicated to seizing the "American Dream." I myself was one of those aspiring students at Princeton some 30 years ago. I still remember quite vividly a remark by my classmate: "Why don’t you become an American, if you speak so highly of your experience?" Once you are born Japanese, you are always Japanese. This is very basic in our perception.

It may well be that the U.S. is an exception rather than a norm. Yet it seems to me that at the heart of U.S.-Japan relations there exists a sharp contrast in the perception of what kind of country it wants to be.

What I want to convey in the rest of my remarks is threefold. First I will review changing fortunes in U.S.-Japan relations. Second, I will assess the nature of challenges for Japan while keeping the current state of the U.S. in mind. Lastly, I will touch upon some essentials to better manage this bilateral relationship.

Let me start with this quotation: "The Japanese, as government policy, are trying to dismantle one American industry after another." The caption of the article by Theodore White, titled, "The Danger from Japan" in The New York Times, 1985, Sunday Magazine, notes: "Whether they are still only smart, or have finally learned to be wiser, will be tested in the next 10 years. Only then will we know who finally won the war...." Theodore White was right in predicting it would require another 10 years to definitely determine the relative shape of the two countries. Let me go over some basic figures.

1) Japan’s current unemployment rate of 4.9% is higher than the U.S. rate of 4.2%. This is a development that we in Japan never expected would happen.

2) Since 1992, 18 million jobs were created in the U.S. as compared to 2 million in Japan.

3) The Nikkei average is still at a level short of half of the peak reached in 1989. In the meantime, the Dow average quadrupled.

4) In 1992, the ratio of public debt to the GDP (Gross Domestic Product) was around 60% for the U.S. and Japan. As you are [aware], the U.S. achieved a budget surplus and is expected to reduce public debt to the GDP gradually. Japan’s ratio almost doubled in 7 years, and probably will surpass 120% of Japan’s GDP by the end of fiscal year 1999.

In fact, a sharp disparity in relative economic conditions is reflected in the outcome of the 1998 Survey of the Chicago Council on Foreign Relations. To cite one example, the number of U.S. leaders who see economic competition from Japan as a critical threat to the U.S. dropped from 63% in 1990 to 14% in 1998.

It is no wonder that American readers enjoyed a very funny piece by Tom Friedman [columnist for The New York Times]. Few months ago, I was particularly amused by one passage. Larry Summers, who [came] to Japan together with Secretary Rubin, said: "My predecessor, Douglas MacArthur, transformed Japan from a dictatorship to a democracy, and I will transform Japan from a producer-driven society to a consumer-driven society. MacArthur said, ‘Charge.’ I say, ‘Charge it’."

But the question is not this simple. As I suspect, Tom Friedman’s piece was not read light-heartedly in Japan. On the U.S. side, according to the same 1998 Survey of the Chicago Council on Foreign Relations, 75% of leaders in the U.S. believe Japan practices unfair trade. U.S. trade deficits vis-a-vis Japan surged to $64 billion in 1998, and look like they will rise further in 1999. Given this background, while a head-on collision is not likely, it seems to me that conscious efforts by both sides are needed to check a flare-up of pent-up frustrations.

In my view, constructive efforts start with assessing the current state of Japan, since you are more than familiar with the U.S. situation. If I might run the risk of oversimplification, Japan is in a phase of macro-pessimism and micro-opportunity in contrast to United States’ macro-optimism and micro-robustness.

1) Aging Society

In Japan, we are consciously concerned by the shadow of our rapidly aging society. Our production-age population has been shrinking since 1996. The total population is estimated to start declining in the next decade. Despite these demographic developments, accepting immigrants into Japan has yet to command broad political support. Former Prime Minister Takeshita is fond of producing the following numbers from memory as a way of warning: in 1997, Japan’s population was 126 million with a total fertility rate of 1.39. By 2050, the population is estimated to be 90 million. By the year 2300, Japan’s population will be 2 million. Based on our projection there will be only 2 Japanese in the year 3341, and 1 Japanese in the year 3379. Now the big question is -- will this person be a man or a woman?

Implications of a rapidly aging society are indeed far-reaching. My elder brother is a pediatrician. He has been complaining of declining numbers of patients year by year. Japanese universities, notorious for their bureaucratic conservatism, will have to compete among themselves for students. The Japanese business sector will face a stagnant or even declining sales environment in the domestic markets.

2) Dire Fiscal Situation

A recent article in The New York Times commented that Japan’s public trajectory looks more like that of a third-world country like Tanzania. I don’t know whether Tanzania’s Finance Minister felt offended by the article, but as far as Japan is concerned, there is no denying that that prospect is indeed scary. The said article describes how Japan’s public debt is expected to reach around 170-180% of the GDP, and public debt-to-revenue ratio is quickly approaching 1400%.

The grim picture clearly makes a sustained fiscal consolidation inevitable sooner or later--this is the anxiety commonly shared in Japan. I noticed an analysis in the 1999 IMF survey on the U.S. economy, which showed that 30% of secular decline of the U.S. household-saving rate in the ‘90s could be accounted for by regaining fiscal prudence in the U.S. The implication is a secular, psychological brake on Japanese household consumption, to the extent that economic logic works symmetrically on the other side of the Pacific.

3) Corporate Restructuring

The third element of macro-pessimism is corporate restructuring. Japan is a nation whose people feel comfortable being crowded passengers in a train rather than sitting idly in a vacant train. In this country corporate restructuring is becoming something like taking a crowded train. Japanese financial markets have come to either reward or punish businesses based on their assessment of the depth of the respective firm’s restructuring plan.

Japanese people are aware, through various media reports, that the economy is entering into a multi-year restructuring phase. Under these circumstances, it is hard to imagine that the Japanese household will be consistent with this forward mood as has been the case in the U.S.

Upon returning to Tokyo after one year in the U.S., I noticed a measurable increase in the number of homeless people. In contrast to a much safer New York than years ago, I think that urban decay is slowly creeping into downtown districts of Tokyo like Shinjuku or Ginza.

Having reviewed macro-pessimism, I have to admit that it is not as easy to present--in a convincing way--a sense of an emerging micro-opportunity. I will make my point short by using an favorite American expression, make a change from "not doable" to "maybe doable."

1) Foreign Direct Investment

Let me start with a quantifiable part. Incoming, foreign direct-investment stagnated over many years and was a source of concern for the two governments. In the 1998 fiscal year, this direct-investment doubled from the previous year to reach $13 billion. Examples of this are Nissan Motor’s acceptance of management by Renault executives and the sale of one of Toyota’s subsidiaries, a long-distance telephone company, to a British company in a competitive bidding. Japan’s top five performance mutual funds are managed by foreign mutual fund companies as of this August.

2) Strategic Consolidation

For the first time since the Zaibatsu partition right after World War II, Japanese businesses are seriously and strategically consolidating. Recent examples are the merger plan of Daiichi-Fuji-IBJ Bank and the management strategy plan of Tokyo-Mitsubishi Bank.

Media as well as financial market reaction has been favorable, the most visible example of which might be the share price development of Fuji Bank over the year. In my view, the impact of these plans is not limited to the Japanese financial sector and will trigger critical assessment of corporate strategy in the far-reaching business sector.

3). Sprouting Entrepreneurship

Now let me cite some examples of entrepreneurial spirit. Last month, I had a chance to meet an owner of an after-school, private teaching institution. He looks about early thirties in age and is highly critical of the Japanese primary and secondary education system. He said that serious students come to his institution to continue to study, after their regular classes. That may be the case, but his institution is a listed company and one wonders how wealthy he must be. In addition, I read an article featuring the seventeen-year-old president of an Internet service provider and the 21 year-old president of an online shopping assistance software company. Beginning in October (1999), brokerage commission will be liberalized. Right now many groups are scrambling to occupy a dominant place in a newly born e-trade market. Likewise, I am sure that the trend of deregulation will provide for the cultivation of young entrepreneurs.

Even if you accept my point that micro-opportunities can be spotted here and there, you might argue that the Japanese system is still plagued by the "too little, too late" syndrome. I certainly see the concern.

There are two aspects of information technology that I would like to discuss. First, Japan is about to enter -- one or two decades later than the U.S.-- a revolutionary change in life-style brought about by information technology. Second, market pressures are forcing Japan’s corporate sector to restructure "by going over the cliff"--borrowing the expression of Mr. Son, Japanese counterpart of Bill Gates in this week’s Newsweek interview. Having said this, it is quite obvious that Japan will have to prove those points.

Recently, I was a little agitated when I heard one noted American economist predict that Japan would become one of those inconsequential countries in the coming century. I felt as if not only our Prime Minister but Japan itself was [being compared to] a slice of "cold pizza." In spite of this, I believe that U.S.-Japan relations will never be boring. The degree of disparity in our relative economic situations and social structures is bound to produce constant tension. Looking ahead, simply managing the status quo will not be an easy task. I would like to point out, though very conventional, 3 essentials.

1) Do The Homework

It is quite obvious that Japan’s agenda is to revive its economy. It is essential not only for its own sake, but also for the global economy. Japan has tried using conventional measures during the ‘90s, but now accepts the fact that more fundamental transformation of Japan’s socio-economic structure is needed in order to produce a sustained economic recovery. Such a transformation will be a very painful process for the Japanese people. It will take time, perhaps five years or even a decade, to produce significant tangible results. To the U.S. I want simply to say, "Please continue." Some symbolic gesture of the U.S. to provide a helping hand to Japan would be genuinely appreciated.

2) Strengthen Key Lines of Communication

Despite floods of information crossing between borders, I am amazed at the extent of the perception gap. Japanese commonly view the American financial bubble is about to crash. In contrast, outside of Japan, Japan is viewed as being in the middle of a serious deflation and that Japanese people are getting desperate. But this year millions of Japanese will go overseas for sightseeing and, in fact, the number of Japanese tourists traveling abroad will be larger than last year. Among other things, it could be that the media tends to report what readers or viewers would like to believe. It is all the more important, then, to strengthen key lines of communication in order to deal effectively with any issue between the two countries. In particular what needs to be strengthened, in my view, is a better-organized dialogue between the Congressmen of [our] two countries.

3). Working Together

Even though I am not very knowledgeable on security issues, I will argue that the new Guidelines for a U.S.-Japan Defense Corporation is a significant step forward to strengthen collaboration in the area. Also, it seems to me that a framework of collaboration among U.S., Korea and Japan in developing policies vis-a-vis North Korea has progressed effectively.

Important to the U.S.-Japan collaboration is an economic agenda which assists the Asian countries with economic recovery. In my view, the role of the two countries is largely complementary in the sense that effectiveness of one country’s Asia policy is substantially diminished in the absence of the other. I do strongly hope that these precious experiences will be solidly extrapolated into the next century.