JAPAN: IS TOKYO SERIOUS ABOUT BOOSTING DOMESTIC DEMAND?

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000706770001-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 15
• Document Creation Date: December 22, 2016
• Document Release Date: March 21, 2011
• Sequence Number: 1
• Publication Date: October 27, 1986
• Content Type: MEMO

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Central Intelligence Agency
DATE
DOC NO CA- M
01R3
P $ PD I
DIRECTORATE OF INTELLIGENCE
27 October 1986
Japan: Is Tokyo Serious About Boosting Domestic Demand?
Summary
Prime Minister Nakasone has generated little support for reorienting
economic policy in spite of his ringing endorsement six months ago of the
Maekawa Commission's proposals for reducing the Japanese economy's
dependence on exports. The momentum for turning growth inward, never
large, slowed considerably over the summer as Nakasone focused on
domestic politics and Tokyo's concern about imminent protectionist
measures waned. The Maekawa package has triggered little enthusiasm in
the ruling Liberal Democratic Party or the bureaucracy and will probably
die a quiet death once Nakasone leaves office. Nonetheless, we expect
the Japanese to continue to cite the Maekawa report at multilateral and
bilateral gatherings as a sign of Tokyo's good faith, as well as to continue
to emphasize that economic adjustment takes time. For example, the
Japanese will probably claim progress on the Maekawa front at next
week's economic sub-Cabinet talks with the United States, but the
implementation timetable Nakasone plans to announce at next spring's
economic summit will probably run well past 1990.
This memorandum was prepared by I Office of East
Asian Analysis. Information available as of 27 October 1986 was used in its preparation.
Comments and queries are welcome and may be directed to the Chief, Japan Branch,
Northeast Asia Division, OEA,
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Because the Japanese do not anticipate a severe and prolonged
recession or across-the-board trade restrictions, Tokyo is unlikely to make
a concerted effort to turn growth inward. Moreover, many Japanese
strongly believe that economic growth cannot be maintained by a reliance
on domestic demand. Japanese leaders who hold this view want to
implement those Maekawa recommendations that enhance international
competitiveness while channeling the proceeds of Japan's massive trade
surpluses into programs, such as foreign aid, that can reap public relations
benefits.
The Maekawa Recommendations: A Rocky Start
Last spring Prime Minister Nakasone hailed the report of the Maekawa
Commission--his blue ribbon panel on trade policy--as the first of many Japanese
steps to reduce the economy's dependence on exports. Many of the panel's
recommendations only replayed previous trade proposals (see table 1), but the report
contained one novel element--a preamble suggesting Japan set as a goal the reduction
of its current account surplus to an "internationally harmonious" level. Although
stopping short of recommending Tokyo end its six-year campaign of fiscal austerity, the
commission proposed reforms to increase domestic spending on goods and services,
reducing the need for Japanese business to seek foreign markets. This feature of the
Maekawa report gave it quick success on one level--from Tokyo's perspective--by
muting US and EC criticism of Japan's trade practices before and during the Tokyo
economic summit in May.
The initial lack of enthusiasm for the Maekawa proposals, however, was evident
in the Prime Minister's unsuccessful sales pitch at home. Instead of welcoming the
report, leading politicians attacked Nakasone's premature advertising of the
recommendations as government policy. And Nakasone himself has occasionally
wavered. During the Diet election campaign this summer, he retracted two key
planks--ending tax-free saving accounts and introducing an indirect tax that the Finance
Ministry considers essential to any large tax cuts the commission proposed. With a
landslide election victory behind him, Nakasone seems to be more resolved: he is
chairing the committee planning for implementation and has staffed it with top officials
from the government and the ruling party.
Widespread backing for the shift away from export-led growth has not
materialized. We see no evidence that the ruling party, key ministries, or leading
businessmen have taken the basic message to heart--that Japan must adopt reforms
that encourage a shift away from exports to the domestic market. As a case in point,
Tokyo has still not adopted as official policy the recommendation that the current
account surplus be reduced to "preserve international harmony," a phrase most often
interpreted as the setting of a target for the current account. Recent Embassy Tokyo
reporting suggests that a special advisory committee chaired by former Bank of Japan
Governor Maekawa may recommend a surplus reduction target by yearend, but we
doubt that Tokyo will officially adopt such a goal. The original Maekawa Commission
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Measures Proposed for
Study or Implementation
Standards and Certification
Improvements
Low-cost Import Financing
Financial Liberalization
Expand Agricultural Imports
Improve Distribution System
Increase Government Procurement
of Foreign Goods
Housing Incentives
Japan: Common Themes of Recent Trade Packages
May January October April
1982 1983 1983 1984
December April July Maekawa
1984 1985 1985 Report
X X X X
X X
X
X X
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decided against such a move, after examining MITI forecasts showing the current
account surplus would exceed 2.5 percent of GNP through 1990. It will probably top 4
percent of GNP this year.
But Selective Implementation
Despite the report's poor reception at home, Tokyo is moving ahead on several of
the Maekawa proposals for reasons having little to do with agreement on the need to
spark domestic growth. Government bureaucrats and politicians, for example, have used
the report's recommendations to argue for implementing items long on their agendas.
For example:
? The Japanese plan to begin a wide-ranging reform of their tax code next year.
The US Embassy in Tokyo notes that little consideration has been given to the
relationship between tax reform and the Maekawa proposals. Moreover, the
planned combination of income tax cuts and indirect tax increases will probably
result in little net stimulus to the economy.
? MITI is engaged in an industrial restructuring program designed to phase out
uncompetitive segments of the steel and textile industries and to shift the
resources to more productive sectors. These moves are designed to enhance
international competitiveness rather than to encourage firms to focus on the
domestic market.
? Tokyo is drafting a new five-year plan for the coal industry, which will probably
recommend sharp cutbacks in domestic production, to reduce high government
subsidies. But imports of US coal will rise little.
? Japanese companies are increasingly setting up manufacturing plants
overseas--a process accelerated by the strong yen, which makes producing
abroad cheaper. MITI sees this as a counterpart of industrial restructuring as
well as an outlet for funds generated by the trade surplus. It also suggests
Japanese companies see weak domestic demand as continuing and therefore
anticipate better profits elsewhere.
On balance, these steps, except for direct investment, will probably do more to
enhance Japan's international competitiveness than to reduce its trade surplus (see table
2). Measures more likely to expand domestic spending--such as reducing taxes,
increasing public investment, providing tax incentives for housing, streamlining the
costly distribution system, and liberalizing the now heavily subsidized agricultural sector
to lower prices, increase imports, and free up land for housing--show little sign of
being implemented soon.
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I I
Table 2
Key Maekawa Recommendations: A Report Card
Recommendation
Expand Domestic Demand by
-- Promoting housing construction O - - -
Boosting public works
-- Stimulating private consumption
by tax cuts, higher wages, shorter hours
Transform the Industrial Structure
Rationalize depressed industries, ! - m - ?
including textiles and coal
Ease restrictions on agricultural
imports, except rice and wheat
Current pump-priming plan contains a few minor housing incentives;
FY87 budgets--both at the local and national levels--may contain modest
increases in public works spending.
Little sign yet of consumer-led recovery. Impact of lower oil prices and
strong yen have not had major impact on consumer prices. Planned tax
cuts may have little impact on consumer spending because people expect a
comparable indirect tax to be implemented soon.
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Political pressure and special interest groups slowing government plans to
phase out uncompetitive industries like some textiles. MITI plans for
cutting coal production in half by early 1'990s also running into political
opposition, but will proceed in some form. New industrial restructuring
law likely to focus on enhancing competitiveness rather than encouraging
firms to switch from the export to the domestic market.
?m _ _ Most controversial Maekawa recommendation; Nakasone has expressed
interest in reforming the price support system for wheat and rice but 25X6
any change would be gradual and long-term.
will continue as long as the current account surplus remains large.
Improve Market Access
-- Implement measures in the 1985 Action Sticking to action program timetable. Imports of manufactures-- 25X6
Program designed to ease import barriers especially intermediate goods from Asian NICs--have risen briskly.
No substantive action taken. Lack of competition within the
multilayered distribution system has kept retail prices of imports from
falling in line with yen appreciation.
Currency Stabilization and Financial Liberalization
-- International cooperation to reduce ? - - - . Japanese economic policymakers and major corporations have resigned
exchange rate volatility themselves to a yen in the 150-to-160-per dollar range. Some businesses
-- Further liberalize financial markets I -
are planning for a 130 yen/dollar rate.
The Finance Ministry has moved extensively in recent months to liberalize
capital outflows--including allowing insurance companies and the huge
postal pension fund to hold a larger share of their assets overseas.
Continued foot-dragging on allowing overseas financial institutions into
the Japanese market reflects Tokyo's concerns over the stability of
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Recommendation
Increase International Cooperation
-- Expand imports from LDCs
Fiscal and Monetary Management
-- Implement fiscal policy flexibly
-- Abolish tax-free interest for
small savers accounts
-- Use monetary policy to support
domestic demand expansion
Yen appreciation has boosted imports of intermediate goods such as'steel
from Korea and Brazil. However, progress in raising imports of commodities
or final manufactured goods from LDCs has been minimal.
Tokyo has adopted goal of doubling overseas development assistance in the
next seven years--in dollar terms. If the yen remains strong, Tokyo should
have little trouble meeting this goal. At the same time the strong yen
increases the burden LOCs must bear to repay debt demoninated in yen.
Tokyo supports mos
ne otiations.
t US positions but is wary of multilateral agricultural
Economic slowdown has generated calls for temporary stimulus from
politicians and businessmen. Nonetheless, little shift in government
or big business desire for shrinking role of public sector in the long
term.
Tokyo's Tax System Advisory Council will probably recommend introduction of
low tax on interest income as part of 1987 tax reform package. Even with
bulk of small savers accounts "grandfathered," the proposal will face
tough political opposition.
Three cuts in discount rate in 1986 are "enough," according to Bank
of Japan Governor Sumita. Nonetheless, another cut is possible
if yen strengthens further.
Grades _
_ 8 indicates Tokyo is likely to move ahead with reform in a meaningful way in the next few years.
U indicates Tokyb will probably stonewall.
0 - - - 1 indicates that we believe that proposal, if implemented, would reduce Japan's trade surplus.
indicates that we believe trade impact--at least in short run--might be negative.
indicates that we are uncertain of the effect on trade flows.
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Maekawa Over the Long Haul
After Nakasone steps down as prime minister--his current term expires in
October 1987--the overall Maekawa package will probably fade away, as have many
other reports by Japanese study groups. In fact, the bias in favor of other, more widely
supported policies that would contribute to the demise of the Maekawa approach is
striking. In particular, the underpinnings of Japan's current economic policy--marked by
a focus on budget austerity and small government--remain strong.
? Keidanren--Japan's most prestigious big business organization--continues to
hold that the private sector would not be able to generate an acceptable level of
economic growth in the face of the higher taxes needed eventually to pay for
deficit financing.
? Japanese bureaucrats and politicians believe Tokyo must slow the growth of the
national debt now to prepare for the onslaught of additional payments necessary
because of the rapid aging of the population beginning in the 1990s. These
views were strongly represented this summer in the final report of the
Administrative Reform Council--the group largely responsible for "selling budget
austerity."
Moreover, there is a school of thought that argues Japan cannot afford to rely
largely on its domestic market to generate growth as it approaches a critical
demographic and economic juncture created by the "graying" of the population. Saburo
Okita, former Foreign Minister and a respected economics authority in Japan, is the most
prominent advocate of this view. Okita argues that institutional and cultural factors,
such as the high saving rate, keep domestic spending well below the level needed both
to approach full employment and to support productivity-enhancing investment. In his
view, growing exports represent the only alternative to slow growth and rising
unemployment. To fend off criticism from Japan's trading partners, Okita argues that
Japan must recycle its trade surpluses as increased foreign aid and overseas
investment.
If we and the Japanese who expect the economy to pick up by mid-1987 have
underestimated the negative impact of yen appreciation, a reorientation of economic
policy toward domestic growth could occur. Under tougher circumstances, the
departure of Nakasone--a staunch supporter of budget austeriry--may make it easier for
others to advocate policies, including fiscal stimulus, to offset the loss in export
markets. Nakasone's probable successors, with the possible exception of former Finance
Minister Takeshita, are not as philosophically wedded to fiscal conservatism. If gloomy
economic prospects coincide with a sharp upsurge in protectionism, the move to foster
domestic growth would gain considerable ground.
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An Alternative Outcome
Notwithstanding the factors that appear to call into question the staying power
of the Maekawa approach, we can envision a scenario--although we believe it
unlikely--that would generate a real shift in Japan's export orientation. In
particular, the combined threats of a prolonged recession and substantial new
overseas barriers to Japanese exports could produce a consensus that the
country's export markets were no longer reliable. Some economists argue that
the recent appreciation of the yen--up roughly 50 percent against the dollar
over the past year--sets the stage for a policy shift, although we disagree.
Despite the fact that yen appreciation is clearly hurting the economy today,
Japan--in our view and that of most observers--can adjust as effectively to the
strong yen as it did to the energy shocks of the 1970s (see the appendix). F1
Some additional fiscal stimulus is probable in the attempt to ease the impact of
the strong yen, but the overall approach in Tokyo will probably remain "business as
usual." We expect additional spending to be temporary and to concentrate on public
works--such as roads and bridges--that would minimize the long-term costs associated
with pump priming. Depending on the tactics of the opposition, the ruling party and
Finance Ministry might agree to accelerate planned income tax cuts and perhaps delay
the introduction of a revenue-enhancing indirect tax, hoping the net effect would
encourage consumer spending. The impact on the economy of such moves would be
minor, in our view.
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Japanese Economic Prospects: How Bad Are They?
The yen's strength is conditioning Japanese economic prospects for 1986, making
it unlikely. Japan could achieve the government's official forecast of 4-percent real GNP
growth, much less rival the 4.6 percent achieved last year (see figures 1-3). Indeed, we
expect economic growth to slow to approximately 2 percent this year, the worst
performance since 1975. Our pessimism is widely shared by private forecasters in
Japan and reflects the toll the strong yen is taking on the foreign sector's contribution
to growth, which in recent years has amounted to over half of the total.
? Despite Japanese manufacturers' willingness to lower the yen prices of their
goods to maintain overseas sales, Japanese export volumes have been declining
gradually for over six months. Price and quantity decreases are cutting
manufacturers' earnings and production. This in turn is forcing export-related
manufacturing firms--such as auto and electrical appliance manufactures--to
trim investment spending considerably.
? In addition, lower import prices are drawing in intermediate goods such as steel
from the Asian NICs, which also hurt Japanese manufacturing. Imports of US
manufactures have not increased much, however.
Domestic demand, moreover, has not risen to compensate for the yen's deflationary
impact on trade and growth. Low wage settlements have dampened private
consumption and Tokyo's austere fiscal policies have limited the stimulus provided by
the public sector.
The major question is whether over the next year or two the Japanese economy
will adjust sufficiently to a 150-yen-to-dollar exchange rate to allow growth to return to
the more politically palatable 3-percent level. At present, most observers expect it will,
a judgment with which we concur. Although weak exports will continue to restrain
growth in 1987, we anticipate domestic demand will rebound somewhat. Simulations
done using our econometric model of Japan suggest that real GNP will increase about 3
Underlying
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the relatively upbeat forecasts are assumptions that real incomes will rise as a result of
yen appreciation and that investment in nonexport-related industries--such as services
and gas and electric utilities--also will steadily increase.
Despite general agreement that Japan will probably--given time--be able to
digest a strong yen, some private forecasters are bearish about prospects for next year.
Mitsubishi Research Institute, for example, recently lowered its 1987 forecast to 1.7
percent, or 0.5 percentage point below its prediction for this year. If Mitsubishi is
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correct in its assessment that 1987 will be worse, Tokyo will face some tough
macroeconomic policy decisions. F--] 25X1
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Figure 1
Japan: Growth in Real GNP
1983
*CIA projection.
1984
1985
1986*
1987*
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Figure 2
Japan: Export and Import Volumes, 1986
Y
if
41
.a
BqM
Apr May Am .IA Aug S*
Iva
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Figure 3
Japan: Growth in Real Government Spending
1977 1978 1979 1980 1981 1982 1983 1984 1985
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SUBJECT: Japan:
Distribution:
Is Tokyo Serious About Turning Growth Inward?
- Joseph Massey, USTR
- Bob Park, Intelligence Liaison, USTR
- Donald Gregg, Office of the Vice President
- Thomas Hubbard, Department of State
- William Brooks, Department of State
- Chuck Kartman, Department of State
- Marshall Casse, Department of State
- Robert Reis, Department of State
- Nicholas Riegg, Department of State
- Allen Wallis, Department of State
- James Kelly, Special Assistant to the
- Cdr. (Ret.) James Auer, DOD/ISA/EAP
- Stephen Danzansky, National Security Council
- Louis Pugliariesi, National Security Council
- Bruce Smart, Department of Commerce
- H.P. Goldfield, Department of Commerce
- Byron Jackson, Department of Commerce
- Allen Lenz, Department of Commerce
- Mel Searles, Department of Commerce
- Maureen Smith, Department of Commerce
- David Mulford, Department of Treasury
- Robert Cornell, Department of Treasury
- Doug Mulholland, Department of Treasury
- Robert Fauver, Department of Treasury
- Richard Woodworth, Department of Treasury
- David Germany, Council of Economic Advisers
Central Intelligence Agency
1 - Director, DCI/DDCI Executive Staff
1 - NIO/EA
1 - NIO/Economics
1 - C/EA~O
1 - OGI/IIC/PI
1 - OEA/NEA/Korea Branch
1 - OEA/NEA/STI Branch
1 - OEA/NEA Division
1 - OEA/China Division
1 - OEA/SEA Division
1 - D/OEA
1 - C/Production/OEA
1 - FBIS Analysis Group
1 - DDI
1 - Senior Review Panel
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1 - PDB Staff
1 - C/PES
1 - CPAS/ILS
5 - CPAS/IMC/CB
1 - Branch
1 - LDA
1 - NIC/AG
1 - DDO/EA Division
2 - Author
1 - Chrono
DDI/OEA/NEA/Japan/
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