October 2003
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When Japanese government officials in the late 1990s fervently promoted the Big Bang slogan of "free, fair, and global," they sounded like Japan finally had embraced economic "liberalism" after many decades of nationalistic policies designed to protect Japanese financial markets from foreign competition. The words "free" and "fair" created visions of a government allowing domestic financial firms, along with foreign ones, to compete with a minimum of governmental restriction, intervention, and support. Since Prime Minister Hashimoto's bold declaration in November 1996, the government's interference in some areas and the lack of action in other areas have shown that the Big Bang catch phrase did not change Japan's mercantilistic perspective, which Gilpin (1975, 25) defines as the "subservience of the economy to the state and its interests-interests that range from matters of domestic welfare to those of international security." This paper focuses on the effects on Japanese consumers of the changes implemented as part of the financial Big Bang. The first section looks at the financial crisis of the 1990s that precipitated the Big Bang and summarizes the major reforms designed to benefit Japanese consumers. The next three sections discuss the Big Bang's effects on individual asset allocation, employment, and consumer income and costs. When examining some specific effects of Big Bang reforms on consumers, this paper also considers examples of the "mercantilistic" actions taken by the Japanese government to mitigate the impact of some of the reforms. The final section provides conclusions and some reflections on future effects of governmental actions and reforms in financial markets. 1. Financial Crisis and Big Bang During Japan's bubble economy from 1985 to 1989, banks extended a huge amount of credit with land or buildings as collateral. The stock and real estate bubble burst in 1990 and left financial institutions exposed to significant amounts of non-performing loans. Throughout the 1990s, the Ministry of Finance delayed recognition of Japanese banks’ bad loan losses and expressed reluctance to take actions against troubled or insolvent financial institutions. Japan’s position as a major international financial market rapidly declined in the 1990s. For example, the Tokyo Stock Exchange’s share of global stock trading dropped to 17 percent in 1995 from 41 percent in 1990 (Katayama 1997). From June 1997 to January 1999, the Japanese government announced details of the financial system Big Bang. The government implemented the key elements of the Big Bang between 1997 and 2001. A principal objective of the reforms was to turn Tokyo into a world-class financial center on par with New York and London. Japan’s Big Bang sought to break down barriers between banks, insurance companies, and securities firms; liberalize brokerage commissions and foreign exchange laws; reform the corporate accounting system; open the doors to foreign competitors and new financial products; and institute other measures to deregulate financial markets. Although Japan began the Big Bang implementation in 1997, special interests and government bureaucracies remained powerful. For example, the Japanese government continued to protect weaker financial institutions by extending complete government guarantees for all bank deposits and other claims on banks until March 2001. Also, the government continued to manipulate the bank's financial reporting rules for political purposes. For example, in 1998 and 1999 the government approved two major temporary changes in accounting requirements in order to provide relief for banks and insurance companies (Hiramatsu 1998, 26-9; Isoyama 1999, 19). 2. Individual Asset Allocation This section looks at the effects of the Big Bang on the allocation of assets held by Japanese households. At June 30, 2003, Japanese consumers had financial assets worth 1,385 trillion yen ($12.5 trillion[1]), but 56.5% consisted of currency and bank deposits earning extremely low interest (Bank of Japan 2003a). Foreign currency deposits increased when the Big Bang lifted foreign exchange restrictions, but their percentage of total deposits by Japanese households remains quite low due to exchange rate risk (Hoshi and Kashyap 2001, 314). The heavily subsidized state postal savings bank has 36% of the savings deposits of Japanese citizens (Bremner 2001), because they view it as the only completely safe bank, especially after the failure of several banks, insurance companies, and securities firms since 1997. The interest and services fees offered by the postal savings bank compare favorably with those of other Japanese banks, and the numerous nationwide branches nationwide offer convenient access. The bank uses much of its funds for loans "based more on political than on economic considerations" (Kwan 2000). Bremner (2001) explains that the government "uses the deposit money to manipulate markets. In the '90s, the funds went into stocks to boost prices, into government bonds to depress interest rates, and into public works to stimulate the economy." The privatization of the postal savings bank would improve the allocation of capital, but vested interest groups continue to obstruct this proposal. Even though former Prime Minister Hashimoto near the time of the Big Bang announcement and current Prime Minister Koizumi in his policy platform announced in October 2003 (Economist 2003b) have sought to privatize the postal savings bank, they faced fierce opposition from fellow Liberal Democratic Party (LDP) members and government bureaucrats who wanted to continue to use the bank for funding public works projects and for propping up struggling companies, many which represent special interests supporting the LDP. Investment in individual stocks and mutual funds (called "investment trusts" in Japan) only make up 8.7% of individual financial assets in Japan as of June 30, 2003, whereas U.S. consumers invest 43.9% (Bank of Japan 2003a). Japanese officials expected that the ratio of individual financial assets invested in stocks and mutual funds would increase sharply as a result of the Big Bang financial reforms, such as the liberalization of stock commission fees (Nakagawa and Shimizu 2000, iii) and a greater variety of investments offered by financial institutions. However, the percentage of stocks and mutual funds has dropped from 9.3% in 1998 (Branstetter 2003, 7; original data from Bank of Japan) to 8.7% in June 2003. The ratio of risky assets, such as stocks and mutual funds, has not increased since 1998 for several reasons. Since the Nikkei stock price index declined from nearly 40,000 in 1989 to 7,600 in April 2003, Japanese households remain hesitant to jump into the equity market. Only about one-fifth of Japanese households attach great importance to "profitability," whereas about four-fifths put great importance on "safety" and "liquidity" of assets (Nakagawa and Shimizu 2000, 8). In addition, potential Japanese investors may not yet fully understand the risks and rewards of various financial products, and investments in small amounts incur relatively higher commission fees. The income tax system favors savings deposits over stock investments, but in 2003 the government reduced the tax rates on capital gains on the sales of listed shares from 26% to 10% in order to encourage more individuals to participate in the stock market (PricewaterhouseCoopers 2003, 5). However, this effort may have limited effectiveness since the capital gains tax rate on stocks goes up in 2008 to 20% and since Japanese consumers remain unconvinced that profits can be made in the stock market. 3. Employment Since late 2001, Japan's unemployment rate has remained above 5%, the highest since the government started keeping statistics in 1953. This section examines some of the short-term and long-term implications of the Japanese government's failure to deal decisively with non-performing bank loans and to implement more than the "letter" of Big Bang reform measures. Banks continue to be saddled with massive amounts of bad loans, much of which has not been recognized or reported. Even using government numbers, which continue to be understated, problematic loans total from 20% to 30% of GNP, or from 100 million yen ($0.9 trillion) to 140 trillion yen ($1.3 trillion). Moody's estimates that non-performing loans, including those not recognized by the authorities, exceed the banks' capital (Katz 2003, 82). The failure to recognize these bad loans and institute collection procedures allows inefficient companies (termed "zombies" by many writers) to remain in business long after they should have restructured or gone out of business. The money used to prop up these "zombie" companies and keep them from dying could be redirected to promising growth areas to create new companies and more productive jobs. This government policy to support weak banks and the "zombie" companies with loans from these banks has been "inadequate job creation for young entrants into the labor force" and "too slow exit of inefficient, uncompetitive firms" (Patrick 2003, 7). Although the Japanese government's support of noncompetitive industries and companies promotes economic inefficiency, this policy does provide employment opportunities in the short-term. Japan has a less generous unemployment program than both Europe and the U.S., and Japan spends less on social welfare as a percentage of GDP than any of the other 29 member countries in the OECD (Gao 2001, 245). The government also provides very limited worker retraining programs to smooth the transition between jobs, and Japan does not have an active labor market for mid-career workers. Any solution to the problem of the banks' non-performing loans must consider the effects on employees of the banks and the "zombie" companies with these loans. The bureaucracy continues to fight reform proposals. In October 2002, Prime Minister Koizumi appointed Heizo Takenaka as the Minister of the Financial Services Agency (FSA). Takenaka, former chief economics adviser in the Koizumi cabinet, recommended several changes to accelerate the pace of bank reform. However, by the time he announced his official plan at the end of his first month in office, he had been forced by the Ministry of Finance, conservative elements in the LDP, and the banking bureaucracy to water down many of his more aggressive proposals. Some of the ideas shot down by the bureaucracy and politicians included prosecution of bankers who misrepresented their accounts, prohibition of banks to artificially boost their capital bases through deferred tax assets and other schemes, and injection of public funds into the banks (Tett 2003, 267). The Japanese government continues to intervene in many other ways to minimize the impact of the Big Bang reforms to create "free, fair, and global" financial markets. In May 2003, the government effectively nationalized Resona Bank when the bank fell below the minimum four percent capital requirement, but bank shareholders suffered no loss since the government injection of funds was so generous (Patrick 2003, 23). The government continues to manipulate the stock market in order that stocks will be valued as high as possible at the end of the fiscal year on March 31 in order to help their valuation for banks, insurance companies, and other companies. Although some foreign companies have purchased Japanese financial institutions since the Big Bang, Japanese political leaders and bureaucracy continue to use a variety of "mercantilistic" measures to reduce the chances of foreign firms purchasing Japanese banks, insurance companies, and securities firms (Katz 2003, 186, 198). 4. Consumer Income and Costs Big Bang financial reforms generally have not led to increased consumer income or decreased expenses, but the changes have provided some specific benefits to certain Japanese households. Worries about job security, questions about social welfare programs, and the lack of confidence in the economy and its future have led Japanese consumers to slow spending. The Japanese public remains unconvinced on the effectiveness of actions taken by the government to improve the economy and address problems in the financial industry, with 71% responding to a March 2003 survey by the Bank of Japan (2003b) that economic conditions are worsening and with 56% saying that their income has decreased compared with a year ago. About half of survey respondents have decreased their spending over the past year, and 46% plan to decrease their spending over the next year. Only 1% of consumers plan to increase their spending next year. A few employees have benefited from pension law changes under the Big Bang. In 2001, the government allowed the provision of two types of defined-contribution plans (company-contribution type and individual-contribution type), similar to the 401(k) plans so popular in the U.S. These plans serve as alternatives to the defined-benefit pensions currently used by many large companies to complement the public pension system. Employees can decide how funds are invested under these plans, and the continuity of the plans is guaranteed if they change employers (Kwan 2000). The Big Bang reforms provide wealthy households with a wider range of options for their asset portfolios. However, the reforms in some cases may have had a somewhat negative impact on small savers, who "suffer from deregulation as the various rates (brokerage commissions, insurance premiums, bank monthly fees)" are relatively higher (Ito and Melvin 2001, 165). However, the deregulation of brokerage commissions has benefited all consumers by the drastic reduction in commissions for Internet transactions, and many individual investors now participate in online trading. 5. Prospects for Future and Conclusions Although Japan remains extremely wealthy, it has continued to suffer from low economic growth since 1990. Overall progress achieved by Big Bang financial reforms has been modest, and the Japanese government has taken subsequent actions to weaken or delay the effects of some changes. Even though Japan implemented several financial market changes since 1997, Japanese banks, insurance companies, and other financial institutions remain weak with many non-performing loans and with inadequate capital. Although Prime Minister Koizumi has pressed for the rapid disposal of bad loans at banks since he started in April 2001, many within his own party, the LDP, fiercely resist his proposed changes (Economist 2001; 2003a). Together with Koizumi's proposed policy to dispose of the bad loans, Japan requires improvements in unemployment assistance and worker retraining in order to address the resulting unemployment from weak companies that must restructure or go out of business when required to pay outstanding loans. Little has been accomplished yet to improve social welfare. Several economists (for example, Kwan 2000; Mikuni and Murphy 2002, 213; Patrick 2003, 26; Reszat 2003, 4) have reached similar conclusions on what Japan must do to solve its deep financial problems that have lingered for 13 years after the bursting of the speculative bubble in the last half of the 1980s. The Japanese financial authorities must abandon some long-established practices and values to make significant and lasting changes, but they must do this with consideration of special interest groups, which continue to constitute a major barrier to serious reform. Although many leaders outside and inside Japan recommend more significant steps by the government to reform financial markets and banks, Japan probably will continue to make only incremental changes until some crisis, such as very high unemployment or an imminent banking system collapse, forces the country to implement more serious reforms. 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