Launch of the 2008 OECD Economic Survey of Japan at the Japan Press Club
Statement by Angel Gurría, OECD Secretary-General
Tokyo, 7 April 2008
I am delighted to be here to present the 2008 OECD Economic Survey of Japan. When I came here in July 2006, I noted that the economic expansion was on track to become the longest in Japan’s post-war history by the end of 2006. Of course, the expansion continued not only through 2006 but through 2007 as well. The average annual growth rate since 2002 is a solid 2%. However, looking ahead, there is increasing concern about the health of the world economy and its impact on Japan.
i. There has been considerable financial turbulence in international financial markets, particularly in the United States, related to the sub-prime crisis. Consequently, US economic growth is expected to slow significantly during 2008.
ii. The Japanese yen has appreciated 10% against the dollar since mid-February. A stronger currency, combined with slower growth in the world economy, is likely to slow Japanese export growth, the main force driving this economic expansion.
iii. Soaring prices for energy and food are squeezing household income.
The ominous economic outlook raises questions about what policy makers in Japan can do to support the economic expansion. In the area of fiscal policy, there is little room for manoeuvre. The top priority is to reduce the government budget deficit and to stabilise the ratio of gross public debt to GDP, which soared to around 180% in 2007, the highest level ever recorded in the OECD area.
1. Addressing the fiscal situation: spending cuts and tax reform
Japan has made progress, reducing its budget deficit by half from 8% of GDP in 2002 to 4% in 2007. However, further progress is needed to meet the government’s goal of achieving a primary budget surplus for central and local governments by FY 2011. And this is only a first step to the longer-term objective of starting to reduce the debt ratio.
The 2008 OECD Economic Survey of Japan recommends a two-track strategy of spending cuts and tax reform to achieve the fiscal objectives. The government should improve the efficiency of public spending. Japan has achieved a significant cut in government spending. This effort should continue, in part through the outsourcing of activities in which the private sector may be more effective.
However, spending cuts by themselves are not enough. Population ageing is creating pressure to boost government expenditure on pensions, healthcare and long-term nursing care. At present, the number of persons over the age of 65 is equal to 28% of the working-age population, the fourth highest share among OECD countries. By 2050, that proportion is projected to reach 72%.
The tax burden in Japan is one of the lowest in the OECD area. If Japan is to maintain its social welfare system, increasing the tax burden is unavoidable. The 2008 OECD Economic Survey of Japan recommends a comprehensive tax reform that aims at four objectives:
i. Raising sufficient revenue to achieve a primary budget surplus and cope with population ageing.
ii. Supporting economic growth. We know that raising taxes can have a negative impact on economic activity. Given Japan’s already low level of potential growth, it is essential that tax reform be designed so as to support economic growth.
iii. Coping with the upward trend in income inequality, a problem that we see in a number of OECD countries.
iv. Improving the complicated local tax system and allowing more autonomy to local governments.
Randall Jones will summarise our recommendations for a comprehensive tax reform. Experience shows that tax reform is never easy to accomplish, especially when it aims at increasing tax revenue, as should be the case of Japan. However, delaying tax reform would only impose higher economic costs in the years to come. In addition to the urgent fiscal problem, tax reform is important for Japan’s competitiveness. Nearly all OECD countries have launched major tax reforms that are more conducive to growth. Failure to do so in Japan would risk letting the country fall behind in an increasingly integrated and competitive world economy.
2. Promoting economic growth by enhancing the productivity of the service sector
While a well-designed tax reform is important for Japan’s economic future, the key priority for long-term growth is to improve labour productivity. This requires reversing the decline in productivity growth in Japan’s service sector during the past few decades, in contrast to the relatively strong performance in manufacturing.
Competition is the key to accelerating productivity growth. This conclusion is based on a number of OECD studies that clearly demonstrate the “magic of competition”. Competition strengthens incentives for innovation and makes companies more creative and better able to compete in a globalised economy. Stronger competition induces firms to allocate inputs more efficiently and it forces less productive firms to improve or exit the market.
The 2008 OECD Economic Survey of Japan identifies a number of policy reforms aimed at strengthening competition policy. This requires:
i. Increasing penalties and fines on violations of competition law, which are relatively low compared to other countries.
ii. Reducing explicit exemptions from competition law for certain sectors.
iii. Scaling back the special treatment of small and medium-sized enterprises, which play a dominant role in the service sector.
Improved competition policy should be accompanied by a renewed commitment to regulatory reform, focusing on the key entry barriers that limit competition. One aspect of reform that we have followed very closely is the Special Zone for Structural Reform initiative that began in 2002. This approach allows certain zones to act as testing grounds for reforms that can be later introduced at the nationwide level. However, this initiative appears to be losing momentum and steps are needed to make it more effective.
Foreign competition is also important to boost productivity. However, the share of foreign-affiliated companies in total service turnover in Japan is the lowest among OECD countries. It is thus important to remove barriers to inward foreign direct investment, as well as domestic regulations that discourage foreign investors, in order to strengthen competition. In addition, Japan is relatively closed to international trade in services, indicating a need to reduce trade barriers.
Finally, I should say a word about the privatisation of Japan Post. This important initiative is expected to shift the flow of funds away from the public sector and towards the private sector, thus promoting the dynamism of the Japanese economy. The division of Japan Post into four companies, which began in October 2007, is a major step forward. We strongly encourage the government to fully implement the privatisation plan.
3. Labour market reform
Let me conclude by addressing the labour market issues, which is the focus of a third structural chapter in the 2008 OECD Economic Survey of Japan, along with tax reform and service sector productivity. We have been very concerned about the sharp rise in labour market dualism, with the share of non-regular workers rising from 20% in 1994 to 34% in 2007. It is easy to understand the factors driving dualism. Firms report that they hire non-regular workers, many of whom have temporary contracts, to achieve employment flexibility. In addition, firms hire non-regular workers to lower labour costs. The average wage of non-regular workers is only 40% of that of regular workers, and they are exempt from some social insurance systems.
While the incentives for firms to hire non-regular workers are strong, labour market dualism is a serious concern for several reasons. The rising share of non-regular workers is creating a large segment of the population, concentrated among young people, with only short-term employment experience. This limits opportunities to enhance their human capital, given that they do not benefit fully from firm-based training. Reduced training has negative implications for Japan’s growth potential. There are also serious equity problems, given that the difference in productivity between regular and non-regular workers is much smaller than the wage gap. Rising dualism thus has a negative effect on income equality.
Reversing the trend towards increased dualism requires a comprehensive approach. This should include enhancing the flexibility of regular employment and increasing the coverage of temporary workers by social security insurance schemes. This would reduce the incentives for firms to hire non-regular workers. In addition, it is important to upgrade training programmes to enhance the employment prospects of non-regular workers.
Reducing dualism may also encourage female labour force participation, given that women account for two-thirds of non-regular workers. Boosting female labour force participation is a key to coping with rapid population ageing. This requires a number of additional reforms, including greater availability of childcare facilities and improving work-life balance to encourage more family-friendly work practices. Such policies may also have a positive effect in raising the fertility rate.
At the beginning of my remarks, I posed the question of what the government should do in the current economic situation. The priority, I believe, is to move ahead with reforms that are key to Japan’s economic future. The more difficult economic environment is no justification for delaying reforms. The 2008 OECD Economic Survey of Japan provides a number of recommendations for reform. Moving ahead with these reforms is essential to sustain growth and meet the challenges of rapid population ageing and globalisation.