The OECD assessment and recommendations on the main economic challenges faced by Japan are available by clicking on each chapter heading below.
Key economic challenges facing Japan
This chapter discusses the key challenges facing the Japanese economy. Although the current expansion is encouraging, there are a number of problems that will make it difficult to sustain growth over the medium term and ensure rising living standards. Five key challenges are addressed in this chapter: i) bringing an end to deflation, which has negative implications for growth, and further rehabilitating the banking sector to sustain the expansion; ii) ensuring fiscal sustainability is the face of the sharp run-up in debt and population ageing; iii) improving relations between levels of government in order to benefit more fully from decentralisation and increasing the fiscal discipline of local governments; iv) raising Japan’s growth potential through structural reform and stronger competition; and v) improving the functioning of the labour market by addressing the trend toward greater dualism and encouraging greater labour force participation.
Ending deflation and achieving a self-sustained expansion
This chapter discusses the factors driving the current expansion and the economic outlook. Despite risks, such as rising oil prices and slowing demand in China, the upturn is projected to continue at a more moderate pace through 2006, helping to bring an end to deflation. The Bank of Japan should continue its quantitative easing policy until inflation is sufficiently high to make the risk of renewed deflation minimal. A clear exit strategy, including a significantly positive rate of inflation as a condition for changing monetary policy, would limit the possibility of a premature rise in long-term interest rates, which might have a negative impact on the banking sector. Further progress in rehabilitating the banking sector, through continued reductions in non-performing loans and a strengthening of their capital base, may help reverse the decline in bank lending. Regional banks should not be granted special treatment in this regard.
Achieving fiscal sustainability
This chapter discusses the deterioration in the fiscal situation and measures needed to restore fiscal sustainability in the light of future pressures for increased spending, notably from rising interest payments and the social security system. The government’s Medium-Term Economic and Fiscal Perspective should be improved to meet these challenges. Preventing a hike in the risk premium calls for a more credible and ambitious medium-term plan that includes a stronger link to specific spending cuts and revenue increases to reduce the budget deficit. Spending should be contained by further reform of pensions and healthcare, continued reductions in public investment and improvements in the public expenditure framework. On the revenue side, broadening the bases of personal and corporate income taxes is a priority, while the rate of the consumption tax (VAT) should be increased at some point. With growth projected to remain above potential, progress in fiscal consolidation should not be delayed.
Getting the most out of public sector decentralisation
This chapter discusses policies to improve fiscal relations between levels of government so as to better meet the needs of citizens while increasing the fiscal discipline of local authorities. It analyses a number of problems, including regulations that limit innovation and accountability at the local level, the inefficient system of intergovernmental grants and the complex structure of local taxes. The chapter concludes that it is essential to improve local governments’ ability and incentives to provide public services efficiently, in part by reducing reliance on earmarked grants, an objective of the “Trinity Reform”. It is necessary to go further by removing barriers to the effective use of sub-national governments’ taxing power and making the tax system more neutral. The framework for fiscal federalism and fiscal discipline should be strengthened through rules and market instruments, which in turn requires a clear signal that the central government will not bail out local governments.
See also ECO Working Paper 416 Getting the most out of public sector decentralisation in Japan
Removing the obstacles to faster growth
This chapter discusses policies to accelerate growth through regulatory reform and measures to strengthen competition. It looks at a number of major initiatives, including the privatisation of Japan Post, the Special Zones for Structural Reform and the use of market testing to allow a greater private-sector role in social welfare areas. The chapter concludes that improving regulatory tools, including the Administrative Procedure Law, the No-Action Letter system, the Public Comment Procedure and Regulatory Impact Analysis, would enhance transparency and encourage inflows of foreign direct investment. Strengthening competition requires upgrading the Japan Fair Trade Commission and increasing sanctions on violations of the Anti-Monopoly Act. In network industries, such as electricity and telecommunications, enhancing competition depends on improving the regulatory framework. Another priority is increasing openness to international trade through multilateral negotiations and free trade agreements with neighbouring countries. Progress in this regard will require reducing the high level of agricultural protection.
Improving the functioning of the labour market
This chapter discusses problems in the labour market, particularly the factors boosting the share of non-regular workers, such as part-time and temporary employees. While this enhances employment flexibility and reduces labour costs, increasing dualism creates both efficiency and equity concerns. A comprehensive approach, including relaxing the high degree of employment protection for regular workers and expanding the social security system’s coverage of non-regular workers would help limit the extent of segmentation in the labour market. The chapter also addresses policies to promote labour force participation to offset the on-going decline in the working-age population. It is important to eliminate features of the tax and social security system that discourage women from working full-time and to enhance the availability of childcare. Aspects of the pension system that encourage workers above age 60 to retire should be reformed in order to maintain the participation rate of older persons at its high level.
A printer-friendly Policy Brief (in PDF format) may also be downloaded. The Policy Brief contains the executive summary and the OECD assessment and recommendations.
The complete edition of the OECD Economic Survey for Japan is available from: