This Selected Issues paper analyzes macroeconomic developments and prospects for Japan during the 1990s. Following a surge in activity during 1996 and early 1997, the economy fell into recession in the second quarter of 1997. Real GDP fell by 3¾ percent during the four quarters ended March 1998; the unemployment rate reached historical highs; and deflationary pressures reemerged. The downturn was largely unexpected, and most forecasters had projected growth of about 2 percent in 1997. This paper also examines fiscal policy issues for Japan.


This Selected Issues paper analyzes macroeconomic developments and prospects for Japan during the 1990s. Following a surge in activity during 1996 and early 1997, the economy fell into recession in the second quarter of 1997. Real GDP fell by 3¾ percent during the four quarters ended March 1998; the unemployment rate reached historical highs; and deflationary pressures reemerged. The downturn was largely unexpected, and most forecasters had projected growth of about 2 percent in 1997. This paper also examines fiscal policy issues for Japan.

VI. Governance, Deregulation and Economic Performance1

1. Until the 1990s, Japan’s economic performance was viewed as a model for the rest of the world—the government’s success in fostering rapid industrialization was often used as an example for developing countries, and Japanese management practices were emulated by businesses in many other industrialized countries. The principal elements of the Japanese economic system considered to have contributed to its success included:2

  • closely knit relationships—cemented by cross shareholdings—between industrial companies, their suppliers, and banks;

  • stable labor relations, involving implicit guarantees of lifetime employment in exchange for low labor strife and costs, and high firm loyalty and productivity; and

  • a close coordination of government policies and business interests, including a policy environment that favored relatively protected domestic markets, low costs of capital, and rapid industrialization.

2. These features of the Japanese economic system were thought to have successfully assured businesses stable access to intermediate inputs, labor, and capital. Also, by insulating a large share of the economy from the need to focus on short-term profit maximization, the system enabled the business sector to focus on longer term goals, including achieving a large and stable market share.

3. However, with the sharp deterioration of Japan’s economic performance since the beginning of the 1990s, questions have grown regarding the benefits of the Japanese approach. As discussed in Chapter I, cyclical factors only explain part of the slowdown in output and productivity growth. It now appears that those features of the Japanese economy that had contributed to its earlier success may also have inhibited its ability to respond flexibly to the more recent challenges posed by the collapse of asset prices and associated weaknesses in the financial sector, globalization, demographic changes, and the rapid increase in information technology.

4. An important manifestation of the recent decline has been the fall in the rates of return earned on equity in Japan, to levels well below rates in other countries (Figure VI.1).3 Low rate of return, as well as the economy’s weak performance, have raised concern that, despite the high level of household savings, the economy is not productive enough to maintain standards of living in the face of the rapid increase in the proportion of the retired population that is projected to occur early in the next century. Indeed, concern on this front has been an important impetus for recent deregulation and reform initiatives, including the “big bang” deregulation of the financial sector.



(In percent of equity)

Citation: IMF Staff Country Reports 1998, 113; 10.5089/9781451820447.002.A006

Source: Morgan Stanley.

5. The discussion in this chapter highlights five causes for the recent deterioration in the performance of the Japanese economy:

  • First, the system of corporate governance in Japan has been undermined by weaknesses in the banking sector and other factors.

  • Second, a combination of high saving rates and capital market inefficiencies provided the Japanese business sector with cheap funding, reducing the need to ensure that investments yielded internationally comparable rates of return.

  • Third, labor market practices—including the lifetime employment system—and government employment policies have limited the ability of Japanese businesses to respond flexibly to recent technological and other shocks.

  • Fourth, low costs of capital have encouraged a large industrial base in Japan, which is adjusting relatively slowly to the pressures posed by globalization.

  • Fifth, regulatory and other constraints have undermined efficiency in the nontradeables sectors, which has lagged behind that in other sectors of the economy.

6. This chapter discusses each of these factors in turn. It then briefly reviews the progress that has been made in the area of deregulation, discusses the empirical evidence that suggests that the benefits could be significant, and notes a number of areas where more rapid progress could be sought. A more detailed description of recent deregulation initiatives is contained in the Appendix.

A. Weaknesses in Corporate Governance

7. Historically, corporate governance in Japan has been left mainly to the banking and corporate sectors, through the “main bank” and keiretsu systems. The main bank system—which involves close and long-standing relationships between a bank and its principal corporate clients—has been shown to have been relatively successful.4 The system assured firms of a steady source of funding, and centralized governance within the banking sector, which had an informational advantage that allowed it to effectively monitor performance. Banks were also well positioned to discipline corporate borrowers, by requiring management changes and financial restructuring in the case of firms that were performing inadequately. The keiretsu system—which also is typified by close relationships between corporations and their principal suppliers and distributors—had the advantage of assuring firms of a stable source of intermediate inputs and long-term access to distribution channels.

8. The main bank and keiretsu systems were cemented by pervasive cross shareholdings. The proportion of the shares of Japanese businesses held by other businesses has been around 50 percent during the past two decades, well above the rate in other industrial countries, and roughly 40 percent of listed shares were held by banks and nonbank financial institutions.5 The predominant ownership role of banks and life insurers has reflected the importance of these institutions in intermediating between households and the corporate sector and the relatively low rates of stock ownership by the household sector. Japanese households held just less than 7 percent of their financial assets in the form of stocks in 1995, compared to rates of stock ownership of 23 percent in the United States and 13 percent in Germany.

9. Extensive cross shareholdings have tended to reduce the role of noncorporate shareholders in corporate governance, and also has contributed to a corporate culture that emphasizes the rights of employees and management over shareholder rights. The fact that executive directors of Japanese companies are usually appointed from the management ranks of the firm, or from affiliated companies, has strengthened this connection.6 An often-cited illustration of the lack of shareholder rights in Japan is the fact that over 90 percent of companies’ shareholder meetings are held on the same day. The weakness of noncorporate oversight is also reflected in the influence of corporate racketeers (sokaiya)—who are reported to be paid large sums in order to avoid having embarrassing information revealed, including during shareholder meetings.7

10. Notwithstanding its successes, the effectiveness of the main bank system for achieving high rates of return on capital has been questioned. The fact that interest rate deregulation came relatively late to Japan meant that banks had a low-cost deposit base, implying that pressure by banks on the corporate sector to produce high rates of return was relatively mild.8 As a result of low loan rates, and relatively high leverage, the real after-tax cost of funds in Japan has been significantly below that in other industrial countries.9 The banking system also has been under relatively little pressure to achieve high rates of return on equity, since their major shareholders are life insurers, which are mostly organized as mutual societies and are themselves under relatively weak control by their owners.10

11. The ability of banks to discipline the corporate sector was eroded considerably during the 1980s and 1990s. During the bubble period in the late 1980s, the substantial capital gains earned on shares reduced further the pressure on banks to encourage corporate profitability and dividend payouts.11 Share price inflation also increased bank capital markedly, providing more room for low-cost bank financing. At the same time, liberalization of the domestic financial market meant that higher-quality borrowers were increasingly accessing capital markets directly, so that a greater proportion of bank lending was being directed to the small- and medium-sized enterprise (SME) sector, whose performance was harder to monitor. In lending to SMEs, banks relied heavily on the value of collateral in making loan decisions, despite the fact that asset prices were unsustainably high. The collapse of asset prices in 1991 further constrained the banks’ ability to enforce discipline on the corporate sector. The drop in share prices eroded bank capital, making it more difficult to meet Basle minimum capital adequacy standards that were adopted in March 1993. This situation created a strong incentive for banks to obscure the fragility of the financial health of their corporate clients and avoid bankruptcies or restructuring.

12. The absence of activity in the area of mergers and acquisitions (M&A) further reduced pressure to achieve satisfactory rates of return. M&As are relatively infrequent in Japan, compared with other industrial countries, in part because the sale of a firm creates a perception of financial weakness and undermines the firm’s relationships with its customers and suppliers, thereby eroding its franchise value.12 Moreover, hostile takeovers, which have been used to extract value from poorly performing firms in other countries, are difficult to achieve because the extensiveness of cross shareholdings make it difficult to obtain a controlling interest in a firm.

13. Weaknesses in accounting and disclosure standards have also adversely affected governance. Accounting standards in Japan are generally not considered to be as demanding as those of the Generally Accepted Accounting Practice of the United States or the International Accounting Standard.13 Internal audit and risk management systems are weak, and provide considerable scope for obscuring the financial situation of firms. Moreover, external examiners have sometimes been lax in ensuring proper disclosure, reflecting the effect of low accounting fees and insufficient recourse to the courts to punish auditors that have failed their fiduciary responsibilities. As a result of weaknesses in the external and internal auditing systems, questions have been raised about the extent to which the reports of outside auditors provide an accurate picture of the overall state of balance sheets. For example, when the fourth largest securities firm in Japan—Yamaichi Securities—failed in November 1997, long-standing accounting irregularities (shifting of losses to subsidiaries, or the practice of tobashi) came to light.14

14. Bankruptcy laws have not helped enforce corporate discipline in Japan, and have discouraged restructuring. Bankruptcy laws are cumbersome and time consuming—asset assessments for companies filing for court protection from creditors take three to seven months, and the resolution of bankruptcy proceedings can take over ten years. As a result of these delays, the underlying value of collateral is eroded, and considerable costs are imposed on both creditors and debtors. Another problem with existing legislation is that firms seeking protection are required to choose between liquidation or rehabilitation at the outset, and once this choice is made, it cannot be reversed. Also, existing legislation does not provide for bankruptcy proceedings to take into account extraterritorial assets, or does not recognize foreign bankruptcy proceedings. The existence of multiple liens is a further inhibition to foreclosure.15

B. Capital Market Inefficiencies

15. Japan’s domestic saving rate has averaged above 30 percent during the past decade, considerably higher than most industrial countries. High levels of saving have tended to lower the cost of capital and promote investment in industrial capacity.16 As a result, investment rates in Japan exceed by a substantial margin those in other industrial countries (Figure VI.2). High investment rates have contributed to rapid increases in the capital-output ratio compared with other major industrial countries, which in turn may have lowered the marginal rate of return on capital.17



Investment ratio (1986–97)

Citation: IMF Staff Country Reports 1998, 113; 10.5089/9781451820447.002.A006

16. Investor portfolios in Japan have tended to be relatively undiversified internationally. Direct holdings of foreign assets by household holdings represent only ¼ percent of their total financial assets, and indirect holdings (including through investment held by financial institutions) represent only a further 1¾ percent. To some extent, portfolio diversification has been discouraged by restrictions on capital mobility, as well as other regulatory constraints. Important examples of restrictions on international capital mobility included the so-called 5-3-2-2 regulation, which restricted pension funds’ and life insurers’ investments in overseas securities to no more than 30 percent of assets, and the Foreign Exchange Law, which required prior notification of all large foreign exchange transactions.

17. A number of these restrictions have been eased recently as part of the “big bang” financial sector reforms—limits on pension fund investments were lifted at the beginning of 1998, and the Foreign Exchange Law was liberalized in April 1998—but significant additional restrictions remain.18 For example, the tax treatment of household investments abroad also acts as a disincentive to portfolio diversification, since domestic investments are subject to only a 20 percent withholding at source and the income does not have to be reported, while all foreign income must be reported and marginal rates of up to 65 percent apply.

18. A range of other financial market regulations also have contributed to low rates of return. Liberalization of the Japanese capital market began considerably later than in other industrial countries. Notably, the process of deregulating interest rates was only completed in October 1994, and a host of other regulatory constraints are now only being lifted under the “big bang” initiative (see Chapter V for a more complete discussion). The process of unwinding cross shareholdings is also impeded by the Japanese Commercial Code, which restricts the ability of firms to purchase their own shares, except with the concurrence of two-thirds of its shareholders and with the use of funds that would have been paid out in the form of dividends.19

19. Government financial institutions also have played an important role in intermediating savings in Japan, and have contributed to low yields on capital.20 Outstanding loans by these institutions have grown rapidly and reached nearly 30 percent of GDP in 1997 compared with just over 10 percent in the mid-1970s. These institutions have relied on captive sources of funding—the social security and postal savings systems—and provide policy-based lending to both households and the business sector. Loans rates by these institutions are tied to the yield on government bonds, and so are well below the prime rates charged by banks (even more preferential rates are provided for housing loans). The provision of government loans at below market rates has undoubtedly helped distort domestic capital markets and reduce rates of return.

C. Employment Policies and Practices

20. The “lifetime employment system” in Japan involves implicit commitments by employers to avoid layoffs during periods of economic downturns in exchange for low labor strife and worker loyalty.21 The salary structure is consistent with this system—the age profile of the salary structure is relatively steep, so that long tenure is rewarded with higher salaries. For example, production workers in Japan with 20 or more years of experience earn roughly 75 percent more than those with less than two years’ experience, whereas the gap is only around 30 percent in Europe. As a result, employees are reluctant to change jobs and lose seniority and income, and turnover at Japanese firms is considerably less than in other industrial countries—for example, the OECD estimates that average job tenure in Japan is 11 years, versus 7 years in the United States.22

21. While this system was well suited for the rapid industrialization of Japanese manufacturing sector during the post-war period, it has impeded the ability of the business sector to respond flexibly to technological change or the pressures from globalization. In particular, the growing emphasis on information technology has increased the importance of highly-specialized, knowledge-intensive individuals, and has reduced the importance of firm-specific skills. This, in turn, has increased the importance of compensation systems that reward performance rather than seniority. However, despite some gains, only around 20 percent of Japanese firms base their pay scales on merit; the rest compensate employees on the basis of seniority. Moreover, while the system was successful in containing labor costs when employment was growing rapidly since the majority of the workforce was at the low end of the pay scale, demographic trends mean that a larger proportion of the population is now at the upper end of pay scales, placing further pressure on labor costs.

22. Government safety nets, and their emphasis on preserving employment rather than facilitating mobility, have inhibited structural adjustment. In particular, to a much greater degree than in other countries, employment policies in Japan are aimed at discouraging layoffs. An important example is the “employment adjustment aid” that is provided to firms, which provides firms with wage subsidies in exchange for companies’ assurances that they will maintain staffing levels.23 Empirical evidence has confirmed that this system has increased the extent which Japanese employers responded to demand shocks by adjusting employment hours rather than employment.24 By contrast, there is a relative lack of safety nets for the unemployed—the unemployment insurance system is relatively ungenerous, and government spending on social assistance is low by industrial country standards.25 The absence of adequate safety nets reduces the incentive for employees to search for alternative employment, and inhibits firms from to restructuring their labor forces by reneging on implicit commitments to lifetime employment.

23. Regulatory impediments constrain labor mobility. For example, private placement firms have been restricted from operating in fields already covered by governmental placement agencies, and limits were placed on the fees that could be charged by private agencies. Some of these restrictions were relaxed in 1997, but the sector remains subject to considerable regulation.26 Restrictions also have been placed on temporary employment agencies. From 1986, these agencies were only able to provide services in 16 job categories, and though more recent deregulation increased the number to 26, these are mainly in relatively skilled occupations.

24. The corporate pension system represents a further important constraint on labor mobility. Pension plans are typically on a defined-benefit basis, and tend to provide pension benefits in the form of a lump-sum payment. The tax system provides a large deduction for the recipient of lump sum benefits, which do not apply to periodic pension benefits, and the tax allowance is substantially larger for amounts received after 20 years of service. As a result, there is a significant financial impediment to employees seeking alternative employment.27

D. Globalization, Deindustrialization, and the Manufacturing Sector

25. Economic performance in the manufacturing and nonmanufacturing sectors in Japan has diverged markedly. Although economy-wide productivity growth in Japan has been extremely rapid, this has largely reflected gains in the nonmanufacturing sector, as manufacturing sector productivity appears to have grown broadly in line with other industrial countries (Chart VI.1). However, productivity growth in the nonmanufacturing sector has been largely the result of massive capital investment, and its underlying efficiency has been weak. By contrast, labor productivity gains in the manufacturing sector have tended to result from technological and other improvements rather than capital accumulation.28 For example, over the 1984–95 period, total factor productivity (TFP) growth in the manufacturing sector is estimated to have been strongly positive, while TFP growth was negative in the nonmanufacturing sector (see Table VI.1).



Citation: IMF Staff Country Reports 1998, 113; 10.5089/9781451820447.002.A006

Source: OECD, WEO Database, and staff estimates.
Table VI.1.

Estimates of Sectoral Productivity and Regulatory Burdens

(In percent)

article image

Ministry of Labor, White Paper on Labor: 1997- Summary (Tokyo: Government of Japan, 1997)

Economic Planning Agency, Economic Survey of Japan, 1994–1995 (Tokyo: Government of Japan, 1996)

26. Sectoral differences in efficiency appear to have been related to the regulatory burden placed on different industries. The EPA notes that 42 percent of all industries in Japan were subject to some form of regulation in 1990, only slightly lower than the 47 percent rate in 1965 (see Table VI.1). However, the regulatory burden in the manufacturing sector, which has been relatively efficient, was only 14 percent in 1990, while the regulatory burden on the rest of the economy averaged around 50 percent. Similarly, TFP growth in the wholesale and retail sectors was rapid, possibly reflecting the impact of deregulation in these sectors. Differences in sectoral efficiency also are related to differences in exposure to external competition. For example, TFP growth has been especially rapid within the electrical machinery industry, which has been exposed to external competition, but TFP growth has been negative since 1980 in the food industry, which is highly regulated and relatively protected.

27. Deindustrialization in Japan has proceeded less rapidly than in other advanced economies, possibly reflecting the structural and other rigidities that have contributed to low returns on capital. Unlike most other industrial countries, Japan has not responded to the globalization of markets by reducing the share of manufacturing employment in favor of service-sector employment (Chart VI.1).29 Recent empirical evidence suggests that productivity gains in the manufacturing sector, as well as higher per capita incomes, would normally be associated with a larger shift of resources into other sectors, as has been the case in many other industrial countries.30 While the strength of the manufacturing sector may reflect the comparative advantage of Japanese producers, regulatory and other impediments discussed above may also have constrained the ability of the Japanese economy to develop new, particularly knowledge-based industries.

E. What are the Likely Benefits of Deregulation?

28. Considerable progress has been made toward deregulation in recent years, spurred by an increasing awareness of the role that structural factors have played in the economy’s weak performance. A series of three-year Deregulation Action Plans (DAP) have been announced beginning in 1995, which have resulted in a number of important measures, and the authorities have responded to the downturn in economic activity that started in 1997 by attempting to accelerate these plans (details are provided in the Appendix). The latest DAP was announced in March 1998, and besides including a range of proposals, efforts have been made to improve the administration of the authorities’ reform effort by strengthening the role of the Deregulation Committee.

29. However, the deregulation process has suffered from a number of shortcomings. In particular, initiatives have often involved relaxing existing regulations rather than their complete elimination. For example, liberalization of the Large Scale Retail Stores (LSRS) Law tended to come in the form of gradual reductions in the size restrictions, rather than complete elimination, and restrictions on land use around factory areas (under the Factory Location Law) also have been relaxed but not withdrawn completely.31 At the same time, the pace of deregulation has been slow, and at times measures have been undermined by the introduction of new regulations.32 As a result, liberalization has appeared piecemeal and has not been accompanied by a significant reduction in red tape and other administrative burdens.

30. There is considerable evidence to suggest that the longer-run benefits from a bolder and more ambitious approach to deregulation in Japan could be significant. For example, a study by the Ministry of International Trade and Industry (MITI) suggests that deregulation measures that raised productivity to internationally comparable levels could increase GDP by 6 percent, compared to its baseline level, by the year 2001 (Table VI.2). This study is based on the assumption of full deregulation in five sectors (transportation, energy, telecommunications, finance, and distribution), and roughly one third of the estimated impact results from gains in the telecommunications field, with deregulation in the finance and distribution sectors also providing significant gains. A study by the EPA reached a similar conclusion on the overall magnitude of possible gains, placing greater emphasis on the retail, telecommunications, banking, and airline sectors.33 The OECD’s estimates of the potential gains to deregulation are roughly comparable, based on an assessment of gains to liberalization in the electricity, air and transport, telecommunications, and distribution sectors. They note that the gains from deregulation in these five areas would be significantly larger than the 3½–5 percent gains that would be obtained from similar deregulation in three major European countries.34

Table VI.2.

The Economic Benefits of Comprehensive Deregulation 1/

(In percent)

article image
Source: Seiji Shimpo and Fumihara Nishizaki, “Measuring the Effects of Regulatory Reform in Japan: A Review,” Discussion Paper No. 74, Economic Research Institute, Economic Planning Agency (March, 1997); MITI, “Summary of Report of the Study Group of the Effects of Deregulation,” from MITI Web site; Economic Planning Agency, Economic Survey of Japan: 1996–1997, (Tokyo: Government of Japan, 1997); Organization for Economic Cooperation and Development, OECD Economic Survey: Japan, 1997 (Paris: OECD, 1997).

Regulated sectors only.

Assumes that labor productivity in the nonmanufacturing sector relative to the manufacturing sector in Japan is raised to U.S. level, that markups over labor costs are the same in both countries are the same, and that the exchange rate is in equilibrium.

Assumes that productivity is raised by 20 percent geometrically over 5 years in those sectors in which labor productivity is lower than in the United States.

Assumes that unit labor costs in the nonmanufacturing sector relative to the manufacturing sector is reduced to that of the United States.


Recent Deregulation Initiatives

31. During the 1990s, the Government has implemented a series of deregulation packages and structural reform initiatives. In March 1995, a three-year Deregulation Action Plan (DAP) was announced to provide the framework for the government’s deregulation program. The DAP focussed on telecommunications, the distribution system, transportation, energy, and anti-monopoly legislation, and was updated in 1996 and 1997.35

32. A number of additional initiatives have been taken to accelerate DAP reforms in specific areas. These included “Structural Reform in Six Areas,” which was formulated in December 1996 by the Economic Council (an advisory panel to the Prime Minister), and the “Program for Economic Structure Reform,” which was adopted by the Cabinet in January 1997. An Administration Reform Law was approved by the Diet in 1998, which involved measures to reform the public sector. The various stimulus packages, including the November 1997 package, also included deregulation measures, including in areas such as information and telecommunication, education, and land use, although many of these measures involved acceleration of prior commitments rather than new initiatives.

Sectoral initiatives

33. In the area of telecommunications, restrictions on the sale of cellular phones were lifted in April 1994 and the price setting system was shifted from an approval to a registration system in December 1996. These initiatives contributed to the rapid growth in the mobile phone market—the number of customers increased by about 10 times between April 1994 and April 1997.36 The 1997 update of the DAP also included a commitment to divide Nippon Telegraph and Telephone (NTT) into three separate corporations (East, West, and long distance) under a holding company by end-1999. Restrictions on foreign ownership in the domestic telecommunications sector were eliminated (the maximum share of foreign ownership had been 20 percent), although the one-third limit on foreign ownership of NTT remains.

34. The Large Scale Retail Stores (LSRS) Law—which restricts the opening of larger retail outlets, subject to an approval process—was progressively relaxed in 1990, 1992, and 1994. As a result, the duration of the approval process was shortened, store space restrictions were liberalized, and store closing times were extended. Consequently, the number of LSRS openings increased from 794 in 1989 to 2,206 in 1995. Entry restrictions in the area of wholesale and retail sales of rice were also liberalized in June 1996, with a shift from an approval to a registration system.

35. As regards transportation, the Ministry of Transport (MOT) announced in December 1996 that all the supply-demand adjustment restrictions in taxi, railway, bus, ship, and aviation, were to be abolished, although the liberalization is not expected to be completed until end-FY2001.37 Taxi operators were given greater flexibility to set fares beginning in 1995, although full liberalization has not been achieved. In addition, supply-demand adjustment restrictions were partly liberalized in April 1997, including relaxation of the entry restriction, which set a minimum number of vehicles for new entrants. In the area of bus services, the requirement of government approval for building new stops was also lifted in favor of an ex post reporting system in April 1995.

36. A new civil aviation pact between the United States and Japan was completed in January 1998 to update the 1952 agreement on civil aviation under which three U.S. carriers (Northwest, United, and Federal Express) and only one Japanese carrier (Japan Air Lines) have unlimited rights to fly between the two countries and on to other Asian destinations. According to the agreement, All Nippon Airways and Nippon Cargo Airlines were granted unlimited access to the U.S. market, while 90 round-trip flights a week were added between the two nations by “nonincumbent” carriers, including American, Continental, and Delta. The two countries also agreed to begin talks on an “open skies pact” within three years.

37. The retail price setting system for electricity and gas supply was liberalized in January 1996, which has resulted in reductions in energy prices. Entry into the electric power generation industry was liberalized in December 1995, to allow sales by firms with co-generation capacity to sell to the power companies (but not directly to customers). As a result, about 15 percent of electricity is now generated by new entrants. Costs have declined, as electricity supplied by new firms is about 10–30 percent cheaper to produce than that generated by incumbent power generating firms. In addition, regulations restricting self-service gasoline stations were lifted in April 1998, which the Economic Planning Agency in Japan estimates will lower costs to consumers by about ¥18 billion.

38. As regards the labor market, the law for equal opportunity and treatment between men and women in employment was amended in June 1997, and will take effect in April 1999. The amendments include: prohibition of discrimination against women in recruitment, hiring, assignment, and promotion, which had previously been a “duty to endeavor;” the creation of a system to publish company names that violate the law; and the recognition of unilateral applications for mediation. Legislation also has relaxed restrictions that had been placed on over-time hours worked by women. Restrictions on the range of occupations where private placement firms could operate were relaxed from April 1997, and the 40-hour work week was made mandatory for all firms as of April 1997.

39. Restrictions on land use and real estate transactions were relaxed in the November 1997 economic stimulus package. For example, procedures for converting agricultural land into other use were simplified, regulations on floor space-to-plot ratios were also eased, and the requirement of six-week prior registration of land purchases was eliminated in favor of a system of ex post notification.

Corporate structure

40. The ban on non-financial holding companies was lifted on December 1997 when a revised Anti-Monopoly Law took effect. The revised Anti-Monopoly Law retains restrictions on three types of holding companies: large-scale corporate groups that own leading companies in several different fields; groups that include both large financial and nonfinancial companies; and groups that include leading companies in related business fields.38

41. The ban on financial holding companies was lifted in March 1998. The Fair Trade Commission (FTC) also provided guidelines for exceptions to a rule that otherwise limits banks to holding no more than 5 percent, and insurers no more than 10 percent, of the stock of other companies. The guidelines put no restrictions on the shareholdings of financial institutions, but a holding company and its subsidiaries may not hold more than 15 percent of the stock of other companies.

42. While these new bills will promote the formation of holding companies, the associated corporate tax issues remain unsolved. In particular, the government has still not introduced a system of consolidated taxation of holding companies, which would allow holding companies to deduct losses of subsidiaries against their profits. Some market observers have suggested that this lack of consolidated tax system is a major reason for the fact that to date there have been very few cases in which companies have formed holding companies.

Administrative reform

43. The Administrative Reform Act was enacted in June 1998, and aimed at improving the efficiency of government services. Under the Act, the number of ministries and agencies will be reduced by 2001 from the current 22 to 13, and the number of public servants will be reduced by at least 10 percent in the ten years from 2001. Notably the public works-related ministries and agencies are to be unified into a single ministry.

44. The role of the Prime Minister in the area of policy formulation will be strengthened, including by establishing a new Cabinet Secretariat that would plan and coordinate overall strategies for important policies, including foreign and fiscal policies. Overall responsibility for dealing with failed financial institutions will be maintained in the Ministry of Finance, while all other regulatory functions related to the financial market would be fully shifted to the Financial Supervision Agency in 2001.

45. Reforms to the system of public enterprises would require these agencies to use corporate accounting techniques. Although the three services run by the Ministry of Posts and Telecommunications—postal savings, postal life insurance, and mail delivery—will be maintained as government-run services, they will be transferred to a new public corporation in five years.39

FY1998–FY2000 Deregulation Action Plan

46. In March 1998, the Government approved a new three-year (FY1998–FY2000) DAP, which included 634 items. About 300 of the 624 items were new, and the remainder were carried over from the previous plan. The role of the Deregulation Committee has been expanded under the new DAP to include monitoring the pace of implementation of deregulation initiatives. In order to fulfil its new mandate, the number of members was increased from seven to eleven, and the committee has been assigned a staff of 15.

Some of the main elements of the new plan included:

  • Telecommunication and information: Access fees for long distance companies to use local telephone lines would be reduced in FY1999 by shifting from a historical-cost to a marginal-cost basis, and price setting in the telecommunication sector is to shift from an approval to a notification basis by end-1998.

  • Retail sales of electric power: Non-utility power companies are expected to be permitted to sell electricity directly to large-lot users, effective in FY1999 at the earliest. This measure would increase competition in the power sector, which is presently dominated by 10 vertically integrated corporations that hold regional monopolies.

  • Transportation: Supply-demand adjustments (i.e., entry and other restrictions) would be abolished in FY1999–FY2001 in all transportation sectors, including bus, taxi, ship, and domestic aviation. Truck licensing restrictions would be eased in FY1998, by shifting from a prefectural basis to a broader economic zone basis. Moreover, the minimum entry requirement for trucking companies would be reduced from 20 trucks to five trucks by FY2000.

  • Health care: Entry of private firms to visiting care business will be liberalized by end-FY1998. The liberalization of the nursing care sector also will be studied by end-FY1998.

  • Labor market: Restrictions on dispatched workers business will be liberalized by end-FY1998.40 In addition, more flexibility would be permitted regarding working hours—i.e., firms could flexibly apply the 40-hour work week—and internships are to be promoted.

  • Resale price maintenance: The resale price maintenance system had been gradually abolished in all areas but publishing and music. Although the FTC had recommended complete abolition, the new DAP only commits to appropriate measures, and the details including the timetable for further action remain unclear.


Prepared by Ichiro Oishi and Christopher Towe.


For a discussion of these issues see Yukio Noguchi, “The 1940 System: Japan under the Wartime Economy,” and Koichi Hamada, “The Incentive Structure of a Managed Market Economy: Can it Survive the Millennium?” in American Economic Review: Papers and Proceedings, Vol. 88 No. 2 (May 1998).


The return on equity is measured as dividends plus capital gains. Data showing the relatively low return on capital in Japan are also reported in Albert Ando, John Hancock, and Gary Sawchuck, “Cost of Capital for the United States, Japan, and Canada,” NBER Reprint No. 2162 (1998), but the authors also note that data limitations mean that this conclusion is somewhat tenuous.


See OECD Economic Surveys: Japan, 1996 (Paris: Organization for Economic Cooperation and Development, 1996), Chapter V for a discussion.


See “The Cost of Capital: Concepts and Estimation,” Bank of Japan Quarterly Bulletin, Vol. 4, No. 2 (May 1996).


For a more detailed discussion of this issue see OECD Economic Surveys: Japan, 1996.


A recent survey of company executives indicates that the timing of shareholder meetings is designed to avoid “turmoil” from shareholders, including from corporate extortioners (Nikkei News Internet Edition, June 25, 1998). Up to ¥20 billion annually is estimated to be paid to sokaiya organizations in the form of bogus magazine subscriptions (The Daily Yomiuri, May 5, 1998).


Japan’s Antimonopoly Law restricts a bank’s share ownership of a company to no more than 5 percent of the company’s capital.


“The Cost of Capital,” BOJ, 1996 presents estimates suggesting that the cost of capital in Japan was considerably lower than in the United States or the United Kingdom since the 1970s, but that the gap narrowed appreciably by the early 1990s.


A little over 11 percent of the major banks’ Tier-1 capital is owned by life insurers.


For a discussion, see Economic Planning Agency, Economic Survey of Japan: 1994–1995, (Tokyo: Government of Japan, 1995), pp. 155–157.


For a discussion, see Economic Planning Agency, Economic Survey of Japan: 1996–1997, (Tokyo: Government of Japan, 1995), p. 133.


For a discussion of the shortcomings of the Japanese accounting system, see Mitsuhiro Fukao, “Japanese Financial Instability and Weakness in the Corporate Governance Structure,” International Symposium on the Role of Markets and Governments, Conference Paper 98-2-6 (March 1998). One problem is the lack of consolidated accounts, although these will be required as of April 1, 1999. Sometime in 1998, the Business Accounting Council is expected to issue a report on measures to raise Japan’s accounting practices to international standards, including requiring firms to report the value of securities at market cost. For a discussion see Jon Choy, “Japan’s Financial Market Big Bang: The First Shock Waves,” Japan Economic Institute Report No. 22A (June 12, 1998).


Off balance sheet liabilities, particularly those of related to subsidiaries, are an important source of problems. For example, the failure of Daido Concrete in February 1998 was the result of its provision of implicit guarantees (“letters of awareness” or shido nensho) to the creditors of its overseas subsidiaries. For a discussion, see Kenichi Ohmae, “Five Strong Signals of Japan’s Coming Crash,” Washington Post, June 28, 1998.


Plans have been announced to overhaul bankruptcy legislation to address some of these problems, but revisions would not be enacted until FY 2003.


Cross country studies typically confirm the high degree of correlation between saving and investment rates. For example, see Martin Feldstein and C. Y. Horioka, “Domestic Saving and International Capital Flows,” Economic Journal, Vol. 90; and Economic Planning Agency, Economic Survey of Japan: 1994–1995, pp. 276–278.


The factors that have been identified as explaining Japan’s high saving rate include demographics and the large proportion of “prime savers” (i.e., those aged 45–64), the even distribution of income, housing costs, the bonus system, the importance of bequests in Japan, and differences in national accounting methodologies. While the Japanese saving and investment behavior appears unusual compared with other industrial countries, the more rapid rate of capital accumulation may simply reflect a catch up phenomenon, versus other factors. Nor does Japan’s capital accumulation appear excessive in economic efficiency terms. For a discussion of these issues, see U. Baumgartner and G. Meredith (eds.), Saving Behavior and the Asset Price “Bubble” in Japan: Analytical Studies, Occasional Paper 124 (Washington DC: International Monetary Fund, 1995).


It is unclear how significant a constraint the restrictions on foreign portfolio investment has been, since on average investments have been well below the 30 percent limit. For example, holdings of foreign assets by investment trusts were only about 6 percent of total assets, and the ratios for life insurers and nonlife insurers were 10 percent and 15 percent, respectively.


The preferred means of reducing cross shareholdings is through buy backs (i.e., a firm’s purchase of its stock from another corporation), since sales of stocks to the market risks further depressing already weak market valuations (for a discussion of the issue, see Fuka, “Japanese Financial Instability.” However, buy backs have increased in recent years, encouraged by the changes to the tax treatment of imputed dividends, as well as legislation in June 1997 that permitted firms to buy back shares mid-fiscal year with the concurrence of their board of directors.


These institutions include the Export-Import Bank of Japan (which provides export financing), the Japan Development Bank (which finances business investment), the Japan Finance Corporation for Small Business (which provides investment financing for small businesses) and the Housing Loan Corporation (which provides mortgage loans). Other financial institutions provide loans to specific geographical regions or sectors of the economy. For a discussion, see Akihiko Suzuki, “Facts and Problems in the Administration of Government Financial Institutions,” LTCBR Monthly (March 1998).


See OECD Economic Surveys: Japan 1996, Chapter IV for a discussion of employment practices in Japan.


More recent data published by the U.S. Bureau of Labor Statistics suggests that average tenure in the United States is less than 4 years, while EPA points out that tenure at large Japanese firms is considerably higher than the average (closer to 12 years).


The program subsidizes 50 percent of eligible firms’ salaries for furloughed workers—workers that remain on a firm’s payroll but are otherwise unemployed. This system was expanded in 1995 to cover small enterprises, and for small and medium-sized firms this assistance can reach up to two-thirds of a person’s salary. For example, at the cyclical trough, roughly 30 percent of all industries received some form of adjustment aid (Monthly Labor Statistics and Research Bulletin, May 1998; for a discussion of this program, see Nikkei News, March 4, 1998). Recently, the government has introduced schemes that have aimed at promoting labor mobility, including by subsidizing moving expenses, but the take up has been small.


Masanori Hashimoto, “Aspects of Labor Market Adjustment in Japan,” Journal of Labor Economics, Vol. 1 (1987), pp. 168–94.


Douglas Ostrom, “Prospects for Economic Reform in Japan: Where is the Safety Net?” Japan Economic Institute Report No 37A (October 3, 1997), cites OECD statistics that suggest that unemployment benefits in Japan are almost 20 percent less generous than in the United States and 70 percent less generous than in the other OECD countries. OECD Economic Surveys: Japan, 1996, notes that Japan’s expenditures on active labor market policies is only about 0.1 percent of GDP, considerably below the 0.7 percent average for the G-7, even taking into account the low level of unemployment in Japan.


A number of these restrictions have been relaxed recently, or in the process of being phased out. For example, restrictions on fees were relaxed in the Labor Standards Law of 1997, and the positive list of occupations that such firms could handle was converted to a negative list, which included positions usually filled by new graduates. The new Law also eased barriers to entry for employment agencies, but still maintained a number of requirements. For a discussion see Kojima Noriaki, “Japanese Employment and Labor Laws in Transition,” Journal of Japanese Trade & Industry, No. 4, 1997, pp. 8–11; and OECD Economic Surveys: Japan, 1996.


The authorities have recently announced their intention to review the tax treatment of pensions and promote defined-contribution pension plans. There is also a need to address the significant underfunding of the corporate pension system.


Economic Planning Agency, Economic Survey of Japan, 1994–95, pp. 214–216.


For example, although manufacturing employment among OECD countries fell from around 27 percent in the early 1970s to close to 15 percent in recent years, the share of manufacturing employment in Japan has remained relatively stable at between 20–25 percent. For a discussion see the World Economic Outlook, May 1997, Chapter III. The slow adjustment of the manufacturing sector may also partly reflect the fact that the average age of Japan’s capital stock is considerably less than in other industrial countries, owing to relatively rapid rates of capital accumulation in Japan.


Robert Rowthorn and Ramana Ramaswamy, “Deindustrialization: Causes and Implications,” IMF Working Paper, WP/97/42 (April 1997). Productivity gains would be expected to cause the relative price of manufactures to fall, and encourage workers to move into the service sector. The demand for services is often considered to have a higher income elasticity, so that as income per capita rise, the demand for services rise faster than the demand for manufactured goods. For a discussion, see W. J. Baumol, S. Blackman, and E. N. Wolff, in Productivity and American Leadership: The Long View (Cambridge, MA: MIT Press, 1989).


Another example, is the governmental restriction on the number of lawyers passing the annual bar exam—although the Diet is considering raising the annual limit from 700 to 1,000, the question arises whether governmental restrictions are necessary at all.


In the new DAP, for example, the target dates for a number of commitments remain vague or unambitious. Notably, the DAP only proposes consideration of deregulation in some areas, including the home nursing care industry and the construction sector, and does not address still-burdensome resale price maintenance restrictions in the area of publishing. Moreover, reforms to the postal saving system were less extensive than originally proposed, and the DAP does not substantively address the need to reduce the public sector’s provision of loans to the private sector. Reform of bankruptcy legislation also is likely to take considerable time to complete, and the tax legislation necessary to complement the new holding company legislation has not been passed. Although the LSRS Law is to be eliminated, it is to be replaced with new legislation that would provide local governments with the authority to block stores from opening for environmental reasons.


The EPA recently examined the effect of the privatization of the public telecommunications company (NTT) and the entry of the private competitor (NCC) in 1987, as well as the privatization of Japan Airlines, and the entry of a private competitor in 1986. The EPA’s estimates suggest that roughly half the increase in the total factor productivity during 1987–95 in both the telecommunications and airlines sectors was due to the increased competition that followed deregulation. In addition, deregulation was associated with a more than 70 percent drop in the cost per telephone call, and a roughly 25 percent drop in per mile costs of air travel.


The OECD Report on Regulatory Reform, Vol. II, (Paris: Organization for Economic Cooperation and Development, 1997).


The DAP originally included 1,091 measures, and when the DAP was revised in 1996 and 1997, the number of items was revised to 1,797 and to 2,823, respectively.


See “Kisei-Kanwa no Genkyo 1997” (Progress in Deregulation) by the Management and Coordination Agency


The supply-demand adjustment system involves restrictions on licencing of new entrants when the Ministry of Transport judges that there are already sufficient suppliers in the market.


Guidelines released by the Fair Trade Commission provided detailed standards for the three cases. First, they prohibit formation of holding companies with assets exceeding ¥15 trillion or with companies having assets of more than ¥300 billion in more than five business fields. Second, they prohibit formation of a holding company with financial components having assets of more than ¥15 trillion and nonfinancial components of more than ¥300 billion. Finally, the guidelines prohibit formation of a holding company with more than five companies in related business fields, each of which holds more than 10 percent market share or lies within the top three companies in each business field.


Earlier recommendations for full prioritization were dropped owing to political resistance.


Dispatched worker agencies act as temporary employment agencies. Currently, the range of occupations they are permitted deal is restricted.

Japan: Selected Issues
Author: International Monetary Fund