At last, Japan is facing up to the need for radical change

Two or three years ago many people in Japan spoke in favour of reform but were not really committed to it. Now it seems the mood has shifted
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Suddenly Japan is going Anglo-American. The failure of Japan to make a sustained recovery from the recession has lead to a radical rethinking of the way its economy is organised. From running a top-down, planned model with a high degree of regulation, dominated by very large firms and banks, it is moving to a bottom-up, market model much more like that of the US and UK.

It is a change similar to that which took place in the 1950s, when severe labour unrest in the mining and car industries led the shift from a confrontational approach to a co-operative one. While this brought many benefits, in particular securing employee support for continuing industrial change, it only helped restructuring in the giant corporations.

Much of the rest of the economy, that which was not exposed to foreign competition, failed to change and was in practice protected by the co- operative approach. The result is a two-tier economy, with a few world- class companies, almost entirely in manufacturing and driven largely by export demand, and a large number of less efficient enterprises particularly in the service sector, living off a protected domestic market.

While there was general economic growth this was acceptable. The world- class firms could pull up the living standards of the whole economy - though Japanese people were puzzled that they did not seem to enjoy as high a living standard as they might have expected from their country's position close to the top of the GDP-per-head league table.

But failure to restructure the part of the economy which is not internationally traded has meant that, unlike in the US and UK, domestic demand has not recovered and pulled the economy out of recession. The export sector has performed well, and will perform better now that the yen has fallen to a more acceptable level. But the export sector is not of sufficient size to pull up the whole economy.

One side-effect of the massive switch to overseas production by Japanese firms is that the amount of exports that are physically made in Japan has been shrinking. Japan now exports a much smaller percentage of GDP than it did in 1960, the only major developed country where this has occurred.

The result is that Japanese business and economic leaders have concluded that the only way to stimulate demand is to carry through a radical programme of structural change. Some aspects of that are already evident: the ending of the residual exchange controls, the granting of independence to the Bank of Japan from April next year, allowing small and medium-sized banks to fail, a series of financial market reforms modelled on the City of London's "Big Bang" of 1986, taxation changes including the introduction of a sales tax next month, increases in shopping hours, and so on.

But so far all these reforms have failed to stimulate domestic demand. This is partly because real wage growth has been very slow: only 1.8 per cent in 1995 and 1.7 per cent in 1996. It is also because of a rise in insecurity among the workforce. The chart shows how the official registered unemployment rate remains above 3 per cent. This sounds very low by European standards but it would probably translate to 6-7 per cent using other countries' methods of recording.

The chart also shows how the ratio between job seekers and job offers has improved recently to stand at roughly the level of the 1970s and early 1980s, which might look positive. But it has stabilised with unemployment, even published unemployment, at a much higher level. Anecdotal evidence from Japan suggests that this is because there is a mismatch between the demand for workers and the supply. The demand is apparently in lower- paid and part-time work, whereas the job-seekers are looking for higher- paid full time work. Consumer demand is stagnant partly because of rising insecurity, but also because of enforced down-shifting among employees.

These points will be familiar to anyone accustomed to looking at the US and UK, but they have shocked people in Japan. There has been much comment about the rise in corporate bankruptcies in Japan; much less about the impact on individuals. One effect of the combination of stagnant personal incomes and falling home and other asset prices has been a rise in personal bankruptcies.

It is against this background that the consensus among Japan's elite is now moving in favour of structural reform. Two or three years ago many people in Japan spoke in favour of reform but were not really committed to it. Now it seems the mood has shifted.

Evidence for this is still thin but there are some pointers. One concerns the Bank of Japan. Early analysis of the plans for independence concluded that, though the form would be independent, the substance of decision- making would still be controlled. Now the government is proposing that interest rate decisions will be transparent, with minutes disclosed, and the bank reporting twice a year directly to Japan's parliament, rather than to the government.

A second bit of evidence is the acceptance of the fall in share prices. For several years the government-inspired PKO, or price-keeping operation, supported share prices. But no one now believes it was wise to try to support prices. It would have been better to have had an early fall, which then could become a base for recovery.

The most substantial reason to expect change, though, comes from the cumulative impact of deregulation. Once one bit of the system is deregulated - say the hours that department stores stay open - this increases pressure for another bit of deregulation in an allied field. From conversations with senior Japanese government officials and financial leaders I am convinced that the cumulative impact of deregulation will become more than the sum of its parts. Japan now wants to change.