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(D)-Suppressed to avoid disclosing data of individual companies Source: U.S. Department of Commerce, Survey of Current Business

August 1991, Vol. 71, No. 8, Table 11.3

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Balance of Payments and Trade (Billions of dollars)

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1/ Calendar year unless otherwise indicated. 27 Jan-Sep seasonally adjusted annual rate (S.A.A.R.) 3/ Estimated from production indexes. 4/ End of Sept N.S.A. 5/ Percent of household income. 6/ Domestic fixed capital formation and inventory/GNP. 77 Jan-Nov average, non-seasonally-adjusted (N.S.A.) 8/ Gross official development assistance (ODA) flows; Japanese government projection.

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The Japanese economy in 1991 continues to be the world's

JAPAN

second largest. Gross National Product (GNP) in nominal terms at $2.8 trillion (1990) is 54 percent that of the United States. Japan's large, persistent external trade and current account surpluses have evoked international appeals for Japan to adopt policies that advance structural adjustment. Frustrated trading partners point out that Japan is home to inefficient transport, agricultural, construction and distribution sectors which it hesitates to expose to foreign competition. Transition to greater competition in these sectors is underway, although more slowly than trading partners generally feel is necessary.

Since 1987, Japan has recorded 18 quarters (through 1991's second quarter) of strong real economic growth, highlighted by low inflation and low unemployment. However, the growth pattern began shifting in late 1990, as growth of domestic demand slowed and net foreign demand reappeared, bringing about a rising current account surplus. Prior to 1991, Japanese external surpluses had been declining in dollar terms since 1988, reaching a low point of 1.2 percent of GNP in 1990.

Easy credit and equity conditions played an important role through 1989 in sustaining expansion of Japanese domestic demand, while falling import prices and a measure of deregulation kept inflation at bay. In response to worsening asset inflation, Japan began tightening credit conditions late in 1989. The subsequent climb in interest rates brought capital costs from historic lows to levels comparable to those in the U.S., which together with a change in earnings expectations, prompted reduced net capital outflows from Japan. Japanese monetary tightening coincided with two distinct periods of broad equity market devaluation, the first in the early spring of 1990 and the latter following the Iraqi invasion of Kuwait. The higher cost of equity financing and more stringent monetary policy have dampened growth in corporate investment and residential housing, two of the mainstays of the long-lived expansion. Consumer spending has advanced steadily, thanks in part to wage growth sustained by a tight labor market. This feature of the Japanese economy has a long term character, as the potential labor force will begin to shrink in the mid-1990s.

Japan has pursued relatively tight fiscal policies since 1982 to constrain growth in government debt, which had expanded to about 35 percent of nominal GNP by that year. However, responding to appeals from other summit countries to contribute to the reduction of international imbalances, the Japanese government in June 1987 initiated a $35 billion multi-sector public works spending package and followed up with tax cuts worth about $10 billion. Notwithstanding these stimulative measures, Japan's budget balance continued to improve, and in 1987 the general government budget balance (central and local governments, and social insurance) went into surplus. In the June 1990 report of the U.S.-Japan Structural Impediments Initiative (SII), the Japanese Government agreed to formulate a ten-year plan to boost significantly social infrastructure spending. Japanese Government budget actions in FY 1991 were consistent with the trend line investment growth implied by the plan.

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The Japanese Government reduced personal and corporate income tax rates and introduced an indirect value-added tax (VAT)-type consumption tax in April 1989. The consumption tax, intended to broaden the tax base and thereby improve the Government's ability to respond to prospective future claims on the national purse in one of the world's fastest aging societies, evoked widespread popular opposition. However, imports continued to rise after imposition of the new tax, due in large part to the overall surge in domestic demand.

In recent years, Japan's economic policy has been formulated in coordination with the economic policies of the six other economic summit countries. In cooperation with the United States, Japan is playing a leading role in increasing official development assistance (ODA) flows, and became the world's largest donor in 1989. (It reverted to second place in 1990.) Japan has committed to double ODA to at least $50 billion over the five years 1988-92 and to improve the "quality" of that aid by boosting the share of grant and untied aid. Japan also committed to support financial flows to highly indebted countries through its $20 billion "yen recycling" program, which includes loans to debtor countries as well as increased funding for international financial institutions and multilateral development banks.

Japan's private sector continues to play the greater role in recycling Japan's large current account surpluses, although in 1990 private outflows to less developed countries were scaled back as direct investment flows diminished. The pattern of capital flows has undergone shifts as well. Long-term capital outflows exceeded Japan's current account surplus from 1984 through 1990, and Japanese overseas direct investment grew steadily. In the first three quarters of 1991 the composition of outflows shifted predominantly to short-term capital, and overseas direct investment slowed. Japan became a net borrower of long-term capital, due to high offshore borrowing and also to strong inward portfolio investment by foreigners, attracted by high yields and attractive prices for Japanese securities.

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Japan ended most but not all of its foreign exchange controls in the 1970s, culminating in a major simplification of the foreign exchange and foreign trade control law in 1980. Currently, pursuant to the international understandings launched under the 1985 Plaza Accord and refined since then, Japan actively coordinates economic policies with the U.S. and its other Group of Seven (G-7) partners. The appreciation of the yen since 1985 increased the competitiveness of American products and contributed to the reduction of Japan's external imbalances through 1990.

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The Japanese economy continues to undergo transition and structural change. This has primarily been a market-driven response to the fundamental exchange-rate realignment of the mid-to-late 1980s. Another central factor has been the focus on deregulation of the economy, particularly the privatization

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of public telecommunications and railway companies and simplification of product standards. Despite progress in this area, Japan's economy remains heavily regulated, reinforcing business practices that restrict competition and thus keep prices high. Price controls remain on certain agricultural products, and bureaucratic obstacles to the entry of new firms into businesses like trucking, retail sales and telecommunications also have slowed the economy's structural adjustment. The 1989 Structural Impediments Initiative (SII) identified structural problems in both countries that stand as impediments to reduction of payments imbalances. In the Joint Report of June 1990, Japan undertook to resolve a range of structural issues.

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The U.s. achieved progress in the SII, which is aimed at removing impediments to trade, balance of payments adjustments, and opening markets. Although further government of Japan actions are clearly needed, progress has been made. In 1991 the government of Japan took budgetary decisions to implement the first year of a 430 trillion Yen (US$3.6 trillion), ten year public infrastructure investment plan. The Government is deregulating portions of its distribution system, including reform of the Large Scale Retail Store Law, liberalizing its foreign direct investment regime, improving various disclosure rules that should help make business practices more transparent, and strengthening antimonopoly enforcement. In the area of land use, action was taken to eliminate tax preferences for agricultural land in major urban

Additional progress in all areas is necessary in order to contribute further to the goals of opening markets and reducing trade and current account imbalances. In particular, Japan should take additional steps to reinforce the antimonopoly enforcement regime so that it will effectively deter anti-competitive practices. Substantial additional actions are also needed to make business relationships more open and transparent by; for example, addressing anti-competitive aspects of cross-shareholding, strengthening shareholders' rights, and improving corporate accounting and disclosure practices. Furthermore, it remains important that the Japanese government follow through steadily on its ten-year public investment plan, support a more rapid phase-in of lease law reform, continue to streamline customs clearance procedures, and take other measures to remove impediments to structural adjustment.

Government spending policy has given an indirect boost to the competitiveness of a number of Japanese industries. In the past, the government directed considerable public and private resources to targeted priority areas, but has been moving away from such industrial policy measures, partly in response to criticism of export-oriented policies by Japan's trading partners. The Japanese government continues to promote high technology cooperation among firms and plays a direct role in organizing these efforts, using off-budget resources and small amounts of appropriated funds to contribute to investment projects and government-private sector efforts.

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