1. 'Capitalism without a referee'
2. 'Structural Reform' that accelerates the Deflationary Recession

[Translator's Note]

The shock waves from the events in New York and Washington on 11 September continue. With the collapse of the twin towers of the World Trade Center, the twin peaks of global capitalism, New York and Tokyo, are also shaken. Straddling the Pacific, two mountains of debt prop each other up, struggling to sustain the weight of the global economy and to prevent the slide into recession, or worse. The Japanese financial and economic crisis has deep roots and has steadily worsened in the months leading up to September. The Koizumi government promised major reforms when it assumed office in April 2001, but after five months it has still to act.

The following is part of the critical analysis offered by one group of Japanese economists and social scientists. The first section of their text, dealing mainly with the banking sector problems and the various official responses, is translated. Later sections go on to detail the group's alternative proposals for moving from 'destruction' to 'creation', with a new financial system, a new financial assessment law, policies for strengthening the autonomy of the subnational region, and proposals for building a new regional East Asian economic order.

Shortly after publication of this essay, it was announced that the IMF would be called in to conduct a 'special audit' of the Japanese economy. Nothing could better underline the seriousness of the problem, especially since the consequences of recent IMF interventions in other Asian economies are well-known. It seems that this intervention is deliberately sought by Tokyo to allow it to adopt 'reforms' in response to 'external pressure' that it lacks the will to initiate itself.

'Large-boned policies' and 'structural reform' without sanctuaries are fine slogans but utterly devoid of content. Crude marketism offers no solution to the problems of deflation and bad loans, and will do nothing to help fix up the economy of Japan's subnational regions and to establish an Asian economic zone.
1. The system of 'capitalism without a referee' leads to chaos. It is crucial that a real resolution of the bad debt problem through an infusion of public funds be undertaken, with the responsibility of bank management and supervisory officials clarified, and that a stop must be put to the chicanery of bad loan assessment. 
2. 'Structural reform' based on market fundamentalism will make structural deflation even worse. In order to prevent the Japanese economy from collapsing, detailed policies are needed to address the problems of small and medium business and the local and regional economy, and there needs to be a reform of the social welfare system to get rid of fears for the future. 
3. The policy of export dependence by inducing a cheap yen has failed and a systematic global strategy is needed in its place.

1. 'Capitalism without a referee'

The sickness of the Japanese economy worsens steadily. The Koizumi government says 'structural reform' accompanied by 'pain' is needed. Many people have come to believe, without any basis, that Prime Minister Koizumi will somehow find a way to cope. And as a matter of fact the Koizumi government's level of support has been consistently above 80 per cent. But people who no longer have time to think are liable to make great mistakes.

Let us think calmly. What sort of outcome can you expect if a sick person is subjected to a wrong operation, based on a mistaken diagnosis? Naturally, if to wait would mean that the patient is going to die anyway, you have to begin. Before doing the operation, you must make sure what is the cause of the illness.

It goes without saying that the cause of Japan's illness is the bad debts problem, and because the appropriate operation to deal with the causes has been delayed the illness has become serious. The problem is how to cut the vicious circle linking deflation and bad debt.

First we have to focus on the facts. The situation is akin to that of the Great Depression. There are various ideas about how to estimate the level of bad debt, but as of the end of March 2000 the amount was approximately 32 trillion yen on a Financial Reconstruction Law basis, or approximately 64 trillion yen according to the banks' self-assessment. The volume of bad debt has increased steadily since the time of the 1997 worries over the financial system. Under the banks' slightly enlarged 'self-assessment' of loans needing attention (loans needing to be supervised), problem loans amount to 150 trillion yen. 

The cumulative figures for March 2001 are now beginning to be published. The bad debt problem is worsening among local financial instruments. In the case of 70 banks, amounting to approximately 60 per cent of local and secondary local banks, an amount in excess of the 836.6 billion yen that was actually disposed of; but bad debts (as understood under the Financial Reconstruction Law) increased by 16 per cent or approximately one trillion yen. The balance of bad debt amounts to approximately 7 trillion yen.

In the case of the 16 major banks, an additional volume of approximately 3.4 trillion bad debt has accumulated, in the sense of loans to businesses at risk of collapse only. On the surface, the volume of bad debt decreased, with 4.3 trillion yen being disposed of, but a careful scrutiny of the accounts of Tokyo -Mitsubishi Bank, said to be one of the best banks, led to the 'Tokyo-Mitsubishi Bank Shock' when it was found that bad debts had increased by 1.58 trillion to 4.53 trillion yen since September 2000. Because of its relative strength, Tokyo-Mitsubishi Bank can allow its bad debts to be regularly published, but other banks, already in a debilitated state, cannot. Furthermore, many bad debts are hidden. The volume of bad debts that are sleeping and unacknowledged is much greater than that which is acknowledged. In the sense that the large banks at the center of the settlement system have been eroded by the curse of bad debts and that the necessary operation has not been performed because of the system of irresponsibility, it may well be that the crisis we are sliding into is even more serious than at the time of the Great Depression. 

The Koizumi government says it will make a final resolution of bad debts within two or three years. But let us not be deceived. The bad debt problem is already of too great a scale to be dealt with by the 'market principle'. The problem is that Japan's economic system has degenerated into one of 'capitalism without a referee'. Just imagine trying to run a sporting contest without an impartial referee. You could not have a baseball or soccer match where the umpire was in cahoots with the owner of one of the teams. 

In fact, as is clear when you look at the financial organs that have collapsed, the management of the banks has been engaging in breach of trust and accounting malpractice, the public accountants have been giving their approval to this, and the fiscal supervisory authorities have been covering it up. The bad debt problem has been surrounded by deception, with the management of the banks neglecting their management responsibility and the top officials of the financial supervisory authorities ignoring their responsibility to supervise. For YANAGISAWA Hakuo, now state minister responsible for financial affairs and formerly for long the Ministry of Finance official responsible for the administration of financial supervision, to speak of solving the bad debt problem by the 'market principle' is to continue precisely this deception. He speaks of 'a revolution that will draw blood', but it will not be the central bank management or the top brass of the financial supervisory authorities whose blood will flow. The 'market principle' means the 'irresponsibility principle'. 

The fact is that 70 per cent of recently failed businesses were cases of ordinary debt or debts needing attention (Nihon Keizai Shimbun, 26 June 2001). This means that even if just those debts whose collateral has either collapsed or is at risk of collapse are disposed of, the problem would still not be resolved. On 21 June the Economic and Fiscal Inquiry Council, consisting of the cabinet members in charge of economic and fiscal policies, some private business leaders, etc., announced a policy of publishing an index showing the banks' ratio of debt and credit extended, but that too will not amount to any solution, since it will be precisely those banks that have enough strength to assess their bad loans strictly whose index will worsen. In other words, such an index would be meaningless. 

It is precisely 'capitalism without a referee' that has brought these bad debts to such a sorry state. Measures to deal with the bad debt problem were continually put off, leading to the contraction of credit and the deflationary recession. Then the process went into reverse. The deflationary recession caused bad debts to increase and hidden bad debts to come to the surface. The one thing that did not change was that nothing was done to dispose of the bad debts. Time and time again various measures, supposedly for 'final disposal' of the bad debts, failed. 

In fact, because the final report (December 1998) of the Economic Strategy Council , an advisory body to the Prime Minister, shelved the responsibility of bank management for a period of three years prior to the infusion of 7.5 trillion yen of public funds, the vicious circle worsened. This is because it was an attempt to resolve the bad debt problem by ratcheting up the price of shares with slogans such as 'IT revolution' and 'IT national movement' so that the banks could use the profits thus generated to address their bad debts problem, while leaving up in the air the responsibility of bank management and fiscal supervisory authorities. It was a complete failure. The US economy continued its slowdown, and stock prices remained depressed. It is doubtful whether there could even be any assurance of procedural propriety covering purchases of bank-owned stocks by public funds. This did not amount to a real attempt at a resolution.

What the Koizumi government means by 'structural reform' is not an operation at all. The minimal requirements for an appropriate operation would include the following measures.

First, for a proper resolution, a strict accounting of the bad debts would have to be carried out. That would involve looking into the management responsibility of the banks particularly with regard to cooking of the books and breach of trust, and also into the supervisory responsibility of key figures among the fiscal supervisory authorities. Proper judicial process would be followed where appropriate. Then public funds would have to be compulsorily infused into those banks whose self-capital is insufficient. Judging by the state of the banks today, a substantial infusion of public funds is going to be necessary.

It is also going to be necessary for real estate that has turned into bad loans to be sold off at low price to the RCC (Resolution and Collection Corporation-- a semi-public corporation) in order to prevent new bad loans emerging through asset deflation as the 'off-balance' of bad loans develops. The Economic and Fiscal Inquiry Council has already taken steps in this direction. They say they are modeling themselves on the RTC (Resolution Trust Corporation) of the US, but in the US criminal punishments were applied against many bank executives, and the [properties] were purchased at a fair price based on an assessment process capable of standing up to judicial process. Substantial public funds were infused to support the process. Such a procedure is completely lacking in the Economic and Fiscal Advisory Council draft. Bad debts seem likely to be passed on to the public sector. 

Second, the establishment of a fiscal assessment law is indispensable to assure the flow of funds to healthy small and middle-sized businesses and thus to prevent the deflationary recession worsening. The idea of 'cultivation of the securities market', in practice ignoring the role of indirect finance, was without content. All it accomplished was to increase the number of bankruptcies of small and medium businesses and to worsen the recession.

Third, after the infusion of public funds, it will be necessary to move to the establishment of a debt-management state, setting a limit to the debt so that the total national debt as of that time is not exceeded. However, The Koizumi government's policy of limiting to 30 trillion yen the issue of new national bonds would mean an addition of 90 trillion to the national debt within three years. In this there would be no change over what happens now. In order to avoid the danger of a collapse in the price of national bonds, it is necessary to adopt policies designed to prevent any accumulation of national bonds above the existing level. If the present tendency for the trade surplus to decline continues, there is a danger that national bond prices will fall. Furthermore, together with the Third BIS [Bank of International Settlements] regulations that come into effect from 2004, a risk weight will be added to the grading of banks that have holdings of national bonds and stocks. An increase in their self-capitalization ratio is therefore necessary. As we have seen in the past, whenever there is a fall in the price of American stocks, the rating companies lower their ratings of Japanese national bonds. There is always the risk that this will trigger a collapse in national bond price.

The situation is far more difficult than it is represented to be by the Koizumi government. This is because policy mistakes are compounded by the present slowdown. Not only will there have to be short-term measures such as an extension of the period for receipt of unemployment insurance but more detailed regional economic policies are also necessary. And to that end, there will have to be bold policies for devolution, including a handing over of revenue sources to local governments. 

2. 'Structural Reform' that accelerates the Deflationary Recession

Looking at the situation from this perspective, the Basic Policy Outline published by the Economic and Fiscal Inquiry Council on 21 June merely intensifies deflationary pressures on the Japanese economy. Above all, apart from the Koizumi cabinet's incessant bashing of the Hashimoto faction and of the bureaucracy, its 'structural reform' has virtually no content. Typical is the Economic and Fiscal Inquiry Council's basic policy outline. It consists of seven pillars: 
          (1) Privatization and deregulation
          (2) Support for venture capitalists 
          (3) Reinforcement of the insurance function
          (4) Doubling of intellectual capital
          (5) A lifestyle revolution
          (6) Autonomy and invigoration of the local regions
          (7) Taxation reforms

But apart from fine-sounding slogans there is no sign of any 'large boned' content. To begin with, their perspective is flawed. TAKENAKA Heizo, State Minister for Economy and Finance, and nearly all of the main members of the Economic and Fiscal Inquiry Council, adopt the market principles of Thatcherism and Reaganomics. Former Prime Minister Thatcher is the most unpopular of politicians in Britain today, and even conceding some merit to Thatcherism and Reaganomics, these principles are completely inappropriate to the deflationary situation of the contemporary Japanese economy. Deregulatory policies based on market fundamentalism will lead to higher unemployment and falling prices.

For three years in a row the nominal growth rate has been minus. The Japanese economy is now in the unusual position of having a slight positive growth rate because of deflation (falling prices). Furthermore, if bad debts on the part of [firms that are] 'pre-bankrupt' or 'at some risk of bankruptcy' are disposed of by market principles, the think-tanks estimate that it will cause an additional half a million to 1.3 million unemployed. At present there are less than three and a half million unemployed and the unemployment rate is 4.8 per cent. The Economic and Fiscal Inquiry Council offers a baseless fantasy of 'creation of 5.3 million new jobs through deregulation'.

As can be seen in the Thatcher period, deregulation and privatization policies cause large-scale unemployment and price falls over a long period. As a matter of fact, in the four or five years after Thatcher took over as Prime Minister, the numbers of unemployed rose from approximately 1.2 million to more than 3 million people and the consumer price index suddenly dropped from 21 to 3 per cent. The idea that deregulation automatically leads to creation of business and jobs is just an irrational faith. If this baseless market fundamentalism is actually put into practice, there is no question but that the recession will get much worse and the deflationary spiral become more severe. It is no exaggeration to say that such policies based on a misreading of the times are the way to drag the Japanese economy into the mire beyond the point of no-return.   

Since concern about the future is a cause of deflation, what is called for is a reform of the system designed to create a stable social security, starting with the pension system. However, the Economic and Fiscal Inquiry Council has no policy other than the idea of a 'Social Welfare Individual Appraisal'. If this amounts just to levy of sales (consumption) tax on the basic pension or to pension fund privatization, as proposed by Takenaka, it is completely unnecessary. In any case it would only apply to cases under the new Japanese private pension scheme ('401k') [to come into operation in Japan from October 2001]. Even then the pension operation risk is shifted to the employee, in the name of 'self-responsibility', and this will serve to increase fears for the future. Furthermore, surely the rate of the consumption tax cannot be raised while consumption is at such low levels. The sort of reform that is called for is one which actually brings together into a single unit the contribution tax method that converts tax proportional to income and the pension under the old abolished pension.

Further problematic is the fact that the state of regional economies can be expected to worsen from now on. Firstly, there is a time lag of between six months and twelve months before trends in the market affect the regional economy, so that this process will take effect from now on. Secondly, as discussed below, regional financial institutions with insufficient collateral will suffer a heavy blow if loan write-offs continue. The pay-off scheduled to be implemented from the end of March 2002 will deliver a further blow on top of this. Thirdly, as the economy of the regions worsens, they no longer have the capacity to thrash out regional economic policies acting on their own. Fourthly, the price of agricultural commodities is rapidly falling.  

The development of a bold and comprehensive regional economic policy is called for. If all that is done is to reduce tax revenues transferred to local governments and merge towns and villages, or to turn special purpose road revenues into ordinary revenues, the state of regional finances and regional economies will just get worse. It is true that the special purpose road revenues should be converted to ordinary revenue, but if the special purpose road revenues are just diverted into urban renewal works while the bad debt problem is left up in the air, all that it will accomplish will be more aid for the general construction companies, as has happened in the past, and the slump in regional economies will accelerate.

Under such circumstances, the Japanese government is relying on a cheap yen policy to promote exports. But this tactic too has been blocked by the decline in the US economy. All it does is increase friction with neighbor Asian countries. A more fundamental, global strategy is called for. 

SEKAI, vol. 691 (August 2001), pp. 62-66, translated by Gavan McCormack.