This paper provides a brief overview of the causes of the poor economic performance of Japan in the 1990s, and a more detailed analysis of developments in the real sector during 1999. The paper highlights that the collapse of the asset price bubble in 1990–91 provided the trigger for the downturn in 1992, and compounded the economic problems thereafter through its effects on the banking system. This paper also analyzes the fiscal policy developments and the monetary developments in Japan.


This paper provides a brief overview of the causes of the poor economic performance of Japan in the 1990s, and a more detailed analysis of developments in the real sector during 1999. The paper highlights that the collapse of the asset price bubble in 1990–91 provided the trigger for the downturn in 1992, and compounded the economic problems thereafter through its effects on the banking system. This paper also analyzes the fiscal policy developments and the monetary developments in Japan.

V. Structural Reform and Deregulation1

A. Background

1. Structural reform and deregulation have been actively pursued since the Hosokawa government in 1993, reflecting an increasing awareness of the role that structural factors can play in improving the economy’s performance. The Government has implemented a series of deregulation packages, including the two three-year deregulation initiatives (1995–97 and 1998–2000), several economic stimulus packages which included elimination of remaining measures, and the “big bang” initiative to liberalize financial markets, including restrictions on foreign exchange transactions. In addition, the Administrative Reform Act was enacted in 1998, outlining a plan to improve the efficiency of the government, including the reduction in the numbers of ministries and agencies from the current 22 to 13 by 2000. Moreover, the Economic Strategic Council, which was formed in 1998 at the initiative of Prime Minister Obuchi, submitted a set of proposals for broader structural reform for the next 10 years to the Prime Minister in March 1999.

2. Particular progress has been made in deregulation and structural reform in financial services, telecommunications, and retail sales. In addition, there has been a slow but steady shift toward making regulatory practices more transparent and shifting from ex ante approval to ex post monitoring of compliance within general rules. Several institutions, including the Economic Planning Agency (EPA), the Ministry of International Trade and Industry (MITI), and the OECD have concluded that there have been significant benefits for consumers.2

3. Notwithstanding these successes, a recent OECD report concluded that the deregulation process in Japan appears to have been largely ineffective, with markets remaining distorted and uncompetitive and foreign participation continuing to be discouraged. The report concludes that too much emphasis has been placed on reducing specific regulations rather than comprehensive overall plans, implying that deregulation has been piecemeal and episodic (Box V.1). An important exception has been the recent “big bang” reforms of the financial industry, where a comprehensive reform initiative is leading to significant structural changes.

OECD Report on Regulatory Reforms

Recent analysis of regulatory reforms in Japan by the OECD concludes that the process has been largely ineffective. While considerable progress has been made in deregulation and structural reform, there is a concern that regulatory reform has been too episodic, slow, and incomplete to contribute significantly to strong sustainable economic growth, The OECD review reached the following main conclusions:

  • Excessive state intervention in many forms still distorts and blocks market functioning in many sectors, while current regulations are insufficient to adequately protect competition and consumer interests.

  • “Behind the border” regulatory barriers remain a major impediment to realizing benefits from open multilateral trade and investment systems. Japan has improved market access at the border to a level equal to or better than may OECD countries. However, internal barriers in the form of non-transparent and restrictive application of regulatory and administrative procedures remain a major deterrent to foreign traders and investors.

  • Regulatory reform should be expanded and accelerated through development of comprehensive reform plans containing the full set of steps needed to introduce effective competition, followed by rapid implementation. To maximize the positive impact on economic performance, reforms should proceed simultaneously in key infrastructure and service sectors, and in factor markets.

  • Government-wide reforms are needed to improve the framework conditions such as administrative transparency, accountability, adaptability, and competition policy and enforcement. A core problem is lack of adaptability in the public administration. Like some other countries, Japan suffers from a deeply conservative policy process that slows decision-making, discourages open policy debate, encourages clientelism, allows special interests to block needed change, and results in the famous “incrementalism.” New incentives, participants, and controls in regulatory reform processes are needed to re-orient old relationships with producer groups, break up information monopolies in the ministries, and reduce wide administrative discretion to regulate “in the public interest.”

  • Too much focus on the size of government, rather than its role, can divert reform efforts without addressing underlying problems. Japan’s current administration reform program is mainly directed at streamlining the number of institutions and cutting national non-defense employees by 25 percent in ten years. However, regulatory reform should aim to establish the basis for adjustable and high-quality regulatory regimes that protect public interests in competitive markets. Radical and comprehensive deregulation is needed, but this by itself is insufficient because necessary market institutions are not yet in place. In many areas, such as prudential oversight of the financial sector, consumer protection, and environmental protection, cost-effective and market-oriented regulations are also needed.

Source: Organization for Economic Cooperation and Development (1999)

B. Recent Developments

4. Over the past year, continuing progress has been made in deregulation and structural reform. A number of regulations have been relaxed or abolished, in line with the second three-year deregulation plan for FY1998–2000 and the “big bang” initiative. Major items included the abolition of minimum prices for international air fares, relaxation of geographic restrictions for truck services, and permission for private nursing care companies to operate.

5. As part of the “big bang” initiative, foreign exchange transactions were almost entirely deregulated in April 1998.3 The progressive liberalization of the foreign exchange regime has been a significant component of Japan’s deregulation over the last 20 years, as is documented in Table V.1. This process culminated in the general liberalization of foreign exchange transactions in April 1998 contained in the Foreign Exchange Law. More specifically, the Foreign Exchange Law included the following measures:

  • The system of authorized foreign exchange institutions has been abolished. Any firm or individual can now buy foreign currencies and engage in currency swaps and forward transactions, Previously these transactions had only been permitted for authorized financial institutions and a limited number of other entities, such as hotels. In addition, foreign exchange lending and borrowing among residents, or between residents and nonresidents, have been completely liberalized.4

  • The system of designated security firms was abolished. Investment in foreign securities by residents and domestic securities by nonresidents can be done through any securities company with no ceiling.

  • Regulations on bond issuance were liberalized. Foreign and Euroyen bond issuance in foreign and Euroyen markets by residents were moved to ex post notification, as were foreign and yen denominated bond issuance in domestic markets by nonresidents.

  • Outward foreign direct investment by residents was liberalized. Foreign direct investment by residents now requires only ex post notification.

Table V.1:

Foreign Exchange Liberalization During the 1980s and 1990s

article image
Sources: Fukao (1990), Nikko Research Center (1997), and Ministry of Finance (1998).

The 5-3-3-2 rule requires 50 percent or more of a funds’ assets to be invested in domestic bank deposits, bonds or loans; up to 30 percent in stocks; up to 30 percent in foreign currency assets; and up to 20 percent in real estate.

6. To further provide the internationalization of the yen, withholding taxes on government paper for nonresidents are being lifted. Withholding taxes on appropriately registered Treasury Bills and Finance Bills were suspended from this April, while withholding taxes on appropriately registered JGBs will be eliminated for nonresidents from this September.

7. The progressive liberalization of foreign exchange restrictions since 1980 has been associated with a gradual increase in holdings of international assets and liabilities. As seen in Figure V.1, portfolio investment by domestic residents rose tenfold as a ratio to GDP, from around 2 percentage points of GDP in 1980 to over 20 percentage points by 1990. There were also less dramatic increases in other investment (mainly bank loans) and outward FDI. While some of this expansion may have reflected the impact of the domestic bubble economy—the ratios dipped somewhat in the early 1990s—renewed liberalization measures appear to have spurred a fresh increase in the ratio of foreign assets to GDP after 1995. Foreign liabilities have followed a similar path, although the changes, particularly as regards the portfolio investment ratio, are smaller.



Citation: IMF Staff Country Reports 1999, 114; 10.5089/9781451820584.002.A005

Source: IMF, International Financial Statistics.

8. However, Japanese portfolios remain relatively undiversified internationally. An estimate by a private analyst (Fujii, 1997) indicates that the ratio of foreign assets in total household securities holdings at end-1996 (including indirect holdings through institutional investors) was 5.2 percent for Japan, compared to 9.2 percent for the United Kingdom and 9.9 percent for Italy. Given this low level of international diversification, it appears likely that the ratio of assets and liabilities to GDP will both increase over the next few years, and that Japanese rates of return will gradually converge with those in the rest of the world.

9. The April 1998 liberalization did not cause the rapid outpouring of domestic savings into foreign assets that some had feared. The liberalization appears to be having the kind of gradual impact on foreign assets and liabilities seen in the wake of earlier measures in the 1980s and mid-1990s, rather than an immediate and swift change in portfolio allocations. However, the liberalization does appear to have led to a wider group of purchases of foreign securities, with rapid increases in the amount of foreign assets held by the Postal Saving and Postal Life Insurance systems, certain trusts, and private pension plans (Table V.2).5 In addition, it remains possible that more open international capital markets could interact with other financial changes to generate significant short-term shifts in international asset allocations flows in the future. In particular, if large amounts of the high yielding long-term deposits currently in the postal saving system but coming due by the end of 2001 are switched to other assets, this could result in a significant outflow of capital abroad over the next two years.

Table V.2.

Japan: Foreign Securities Holdings, March 1998–March 1999

(Percentage, unless otherwise indicated)

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Source: Young and others (1999) using Bank of Japan, Flow of Funds data.

Data are adjusted for valuation/changes.

10. Turning to domestic measures, the Deregulation Committee, which reports directly to the Prime Minister, revised the three-year deregulation plan for FY1998–2000 at the end of March 1999.6 A further 292 items were added to the original 634 items, largely aimed at switching prior approval to ex post checking of compliance with regulations and encouraging new entry into various business fields. Major additions include:

  • Easing regulation on private job-placement services. Under the current system, private job-placement companies can only operate in a limited number of sectors. For example, job-placement is not allowed in the manufacturing, transportation, telecommunications, and construction sectors. However, bills that have been submitted to the Diet will deregulate the industry, allowing job placement in all industries except dock work. Labor standards are also being revised to lift most existing regulations on overtime work by women.

  • Liberalization of vehicle inspections. At present, vehicle inspections are done at government-managed sites or at a limited number of designated private facilities with centrally-determined fees. Plans are currently underway to increase competition by allowing more private-sector companies to provide these services, and to set their own charges, probably by end-FY1999.

  • Partial liberalization of electric power sales. Under the current system, retail sales of electricity can only be purchased from 10 vertically monopolized firms. Retail sales to large scale customers (such as factories) are to be liberalized by end-FY1999.

11. A deregulation strategy the next 10 years has been produced by the Economic Strategy Council (ESC). The ESC was established in August 1998 at the behest of the Prime Minister. The ESC, comprising 10 business leaders and academics, released its report at the end of February 1999, which included 234 proposals, and presented a list of laws that need to be revised.

12. The report divided its recommendations into those with the highest priority, those to be implemented as soon as possible, and those to be implemented after recovery has occurred. However, the report did not provide any specific timetables for key proposals, including those dealing with taxes, social welfare programs, and the FILP:

  • Proposals to be taken as soon as possible (some of which have already been acted upon) include:

    • Promotion of securitization and provision of tax exemptions on debt-equity swaps to foster the liquidation of real estate held as collateral in order to resolve non-performing loan problems.

    • Assisting industrial revitalization by changing in tax laws and the commercial code to encourage disposal of excess capacity and increase innovation in industrial organization.

    • Strengthening of the social safety net including the introduction of a “career development voucher,” which would provide public funds to subsidize retraining for those who wish to move industries, thereby promoting liquidity in the job market.

  • Other proposals to be considered without delay include:

    • Encouraging greater local government autonomy by decentralizing the tax system and bond issuance. More transparent accounting systems are also recommended for the central government and local governments, including consolidated balance sheets and accrual accounting.

    • Tax reforms to make the tax system more neutral and to reward effort. The tax system should be adjusted to reduce inequalities and Increase incentives.

    • Fundamental reform of the Fiscal Investment and Loan Program. Privatization should be considered for all FILP institutions, unless a compelling case for continued public involvement can be found. In addition, the financial accounting used in the private sector should be comprehensively applied to the FILP.

    • Reform of the public pension and health care system. The basic portion of public pension benefits—a minimum standard guaranteed for everyone—should be funded entirely by general tax revenues, and the salary-linked additional portion of the system should be privatized within 30 years.

  • Proposals to be delayed until economic recovery takes hold include:

    • Providing a clear plan for fiscal sustainability through raising the share of indirect taxes (including a possible hike in the consumption tax rate), introducing a taxpayer number system, and cutting expenditure.

13. In June 1999, the government announced a package of measures designed to support employment and assist corporate restructuring. The measures relating to corporate restructuring were guided by the recommendations by the Industrial Competitiveness Council, which was established in March 1999 and consists of ministers and business leaders, mainly from Keidanren (business association), as well as recommendations from a MITI report published in late January and the ESC’s report. The package is being funded by a supplementary budget of around ¥520 billion (0.1 percent of GDP), already approved by the lower house. The main elements of the package are:

  • Creation of 300,000 temporary (two-year) jobs at local and central governments. An example given for such jobs would be employing businessmen with foreign language skills as teachers.

  • Support for private sector job creation. Measures include: subsidizing the hiring of workers in growth sectors; outsourcing some local government services to the private sector; providing grants to companies that hire the unemployed; and setting up new government retraining programs aimed at the middle aged unemployed.

  • Steps to assist corporate restructuring. Regulations are to be changed to facilitate debt for equity swaps and assist companies to spin-off new enterprises. The new “Chapter 11” -type bankruptcy legislation, which had already been announced, was also included in the package.7

14. Plans for the reorganization of government are also moving forward. The Diet has passed most of the bills needed to reorganize the national government by reducing the number of ministries and agencies from 22 to 13, and slimming down the bureaucracy. The plans build on a basic government reform law enacted last year whose provisions included integrating the Construction and Transport ministries and the National Land and Hokkaido Development agencies into one ministry, and merging the Postal and Home Affairs ministries and the Management and Coordination Agency to form another new ministry. The maximum number of national government employees is expected to be reduced by one-quarter over the 10-year period beginning in fiscal 2000.


  • Fujii, Tomoko., “Will Individuals Rush into Foreign Assets,” Salomon Brothers Japan, Economic and Market Analysis, November 11, 1997.

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  • Fukao, M. (1990), “Liberalization of Japan’s Foreign Exchange Controls and Structural Changes in the Balance of Payments,” Monetary and Economic Studies, 8:2, pp. 10165, Bank of Japan, September 1990.

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  • Ministry of Finance, “Tokei Geppou,” (MOF Monthly Report on Fiscal and Financial Statistics), December 1998.

  • Nikko Research Center, “Kinyu-Dai Kaikaku no Subete,” (Details of Japanese Big Bang), 1997.

  • Oishi, Ichiro and Christopher Towe, “Governance, Deregulation, and Economic Performance,” in Japan—Selected Issues, IMF Staff Country Report 98/113 (IMF: Washington), 1998.

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  • Organization of Economic Cooperation and Development, The OECD Review of Regulatory Reform in Japan, (Organization for Economic Cooperation and Development: Paris), 1999.

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  • Young, Jeffrey D., Tomoko Fujii, and Yukari Sato, “Cross-Border Investment: Securities Flow Sandwich,” Nikko Salomon Smith Barney Japan, Economic and Market Analysis, July 15, 1999.

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This chapter was prepared by Ichiro Oishi.


Empirical estimates of these benefits are discussed in Oishi and Towe (1998) in last year’s Selected Issues paper.


General progress on the “big bang” is reviewed in Chapter IV.


Before April 1998, only lending or borrowing between residents and nonresidents of below ¥100 million had been permitted without authorization.


The very small proportion of foreign assets directly held by households (0.4 percent) is another striking feature of Table V.2.


The mandate of the Deregulation Committee (renamed the Regulatory Reform Committee in April 1999) was widened in early 1999 to include assisting in the transition from a regulatory system of prior approval to ex post checking of compliance with rules.


Bankruptcy reform is discussed in Chapter VI by Levy in the accompanying Selected Issues.

Japan: Economic and Policy Developments
Author: International Monetary Fund