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Recent Economic and Financial Developments in Japan
Summary of a speech given by Toshikatsu Fukuma, Member of the Policy Board, at a meeting with business leaders in Shimane on September 30, 2004
October 27, 2004
Bank of Japan
Contents
- I. Developments in Overseas Economies and Prices
- II. Economic and Price Developments in Japan
- III. Conduct of Monetary Policy
- IV. Issues Arising from the Declining Birth Rate and Population Aging
Today I will discuss recent economic and financial developments at home and abroad, and the Bank's conduct of monetary policy. I would like to start with developments in overseas economies, which form the background to the current economic situation in Japan.
I. Developments in Overseas Economies and Prices
A. Economic Developments
Economic expansion continues in many parts of the world, namely the United States, Europe, Japan, NIEs, ASEAN, and the BRICs consisting of Brazil, Russia, India, and China.
Economic growth in NIEs, ASEAN, and the BRICs has been exceptionally strong. In recent years, the substantial rise in their shares of global GDP and international trade has come to affect the United States, Europe, and Japan in terms of economic activity, jobs, and prices, particularly of fuel and materials. Furthermore, the increased trade within East Asia, consisting of NIEs, ASEAN, China, and Japan, has strengthened economic interdependency within the region, helping to give rise to an autonomous economic growth mechanism.
B. Price Developments
Commodity prices and shipping freight rates have surged both at home and abroad reflecting a tight supply and demand situation worldwide. In particular, the rise in demand for fuel and materials has been led by economies in the BRICs, NIEs, and ASEAN countries. China, which used to be a net exporter of fuel and mineral resources, has become a net importer since the latter half of the 1990s due to increasing domestic demand and a rise in foreign firms establishing production bases in China. China's net imports have been growing year by year, influencing commodity prices both in Japan and abroad.
Producer prices (or corporate goods prices) in the United States, Europe, and Japan have been rising rapidly since the beginning of spring 2004 reflecting the sharp rise in fuel and materials prices. Consumer prices downstream, however, have remained stable.
Various structural changes in the economy have contributed to the stability of consumer prices. First, the pricing power of producers has weakened with intensified global competition due to the emerging economic strength of NIEs, ASEAN, and the BRICs; efforts by the WTO to liberalize trade; and deregulation in many countries. Second, U.S. and Japanese firms have been able to absorb the rise in fuel and materials prices through reduction in unit labor costs (labor cost per unit of output), application of new technologies, and cutbacks in energy consumption. And third, consumers have become increasingly price-conscious, having expanded their sources of price information through the Internet.
With regard to reduction in unit labor costs, the extension of working hours without corresponding rises in wages is becoming more widespread in Europe, particularly in Germany. Since Europe has lagged behind in structural reforms, I think the recent move aiming at a productivity increase of more than 10 percent may indeed be termed epoch-making. It is hoped that such developments will contribute to price stability and will support the economic growth of the region.
The rate of growth in consumer prices has declined steadily over a long period of time in the United States, the United Kingdom, the Euro area, China, and Japan. This may also be accounted for by the same factors cited early on: intensified global competition, higher productivity, changes in consumer behavior, and other structural changes have combined to exert downward pressure on consumer prices. This has been the case in Japan also, as I will discuss later on.
C. Risk Factors
For the present, among overseas risk factors, I take particular note of developments in the U.S. and Chinese economies, and the effect of higher crude oil prices.
1. Developments in the U.S. Economy
In the United States, economic expansion has slowed from its previously high tempo due mainly to the continued widening of the current account deficit (a decrease in the external balance), and a deceleration in private consumption growth since spring 2004 as a result of the tapering off of the effect of tax cuts and the surge in gasoline prices. Given that there are no indications of a major change in the basic trend of expansion, the current phase can be interpreted as a transitional period of consolidation prior to a steady growth period. However, the extent and length of the current economic deceleration are still unclear and thus require further monitoring, with a number of uncertainties still remaining for the U.S. economy, such as crude oil prices, geopolitical risks, developments in housing prices and household debts, and the unpredictable outlook of the presidential election.
2. Developments in the Chinese Economy
Regarding China, the risk of economic growth accelerating further and exceeding 10 percent has receded as a result of the central government's policies aimed at cooling the overheated economy. However, it will take some more time for the policies to fully permeate the economy because the government needs to implement stringent administrative measures in addition to macroeconomic policies. The current growth rate of around 9.5 percent still, therefore, seems to suggest a degree of overheating. In addition, problems with the country's infrastructure, such as shortages of electric power and water, traffic congestion, and environmental regulations, are causing bottlenecks in production. As for the outlook for the future, a hard landing is unlikely given government policies to cool the overheating economy, as well as the hosting of the 2008 Olympic Games in Beijing. Nevertheless, the economy may be held back by possible increases in imports of fuels and other materials due to limited domestic production capacity and the inefficient distribution system.
3. The Effect of High Crude Oil Prices
Many hold the view that crude oil prices will remain at high levels because an increase in supply capacity to meet the rapid growth in demand is unlikely.
After the two oil crises in the 1970s, major oil companies expected demand for crude oil and other natural resources first to slow and then to remain subdued. This view was based on the expectation that as economies matured they would become increasingly energy-conscious, and there would be a greater emphasis on information and services industries. Taking this into account, the oil industry underwent a major shakeup and oil field development and oil refinery construction were drastically curtailed. Since the second half of the 1980s, the number of oil fields developed has consistently been less than half that in previous peak periods. Moreover, the production capacity of the world's oil refineries remains unchanged from its level in 1980, 25 years ago. It is true that the production capacity of refineries in China and other Asian countries has soared, but this has been offset by the capacity decline in U.S. and European refineries that had previously held a dominant share of the global market. In addition, the heightening of geopolitical risks represented by recent terrorist attacks in major oil producing countries, such as Iraq and Saudi Arabia, and concerns about the business condition of a Russian oil giant have added to market anxieties on the supply side.
It is certainly encouraging that the mining and extraction of oil sand--a new oil resource--has now become available on a commercial basis, after 30 long years of development. However, it generally takes about five to ten years to discover and develop an oil field. With oil demand from countries such as BRICs expanding rapidly, there is little doubt the sharp cut in oil field development in the past has contributed to the current rise in crude oil prices. Dispelling anxiety about higher oil prices will therefore require somewhat more time.
The impact of high crude oil prices on corporate profits and consumer prices downstream has so far been relatively small, because, as I mentioned earlier, firms have made efforts to absorb the hike in energy costs. The future impact, meanwhile, differs somewhat from country to country depending on levels of energy efficiency, industrial structure, and economic and price developments. Monetary policy has therefore varied accordingly, from raising the policy interest rate to calm concerns about inflationary risks to cutting the rate to ease concerns about deflationary effects. More recently, heavy speculative buying by hedge funds triggered by the onslaught of a record number of hurricanes has added to the persistently bullish outlook for crude oil prices, indicating greater price volatility for some time to come. Therefore, the effect of oil prices on business conditions, prices, and corporate profits will continue to require constant and careful monitoring.
II. Economic and Price Developments in Japan
A. Economic Developments
1. The Current State of the Economy
As I have explained, overseas economies are expanding in general, but there remain risk factors such as developments in the U.S. and Chinese economies and soaring crude oil prices. Turning to Japan, disparities in business conditions remain between regions, types of industry, and different sizes of firm even in the same industry. The overall economy, however, is getting ready to enter a period of sustained growth, with both domestic and overseas demand acting as engines of growth, on the back of the great progress that has been made in micro-level structural reforms.
Regarding domestic demand, business fixed investment is increasing steadily, with positive signs more widely apparent across firms of various sizes and from various industry sectors. Industries related to digital products and medical and nursing care--the areas with bright prospects for medium to long-term demand growth--are adding to their production capacity while construction of shopping centers in suburban areas is also increasing. In traditional heavy industries that enjoy strong domestic and overseas demand, such as steel, chemicals and other materials, and transportation equipment and industrial machinery, investment is brisk both for repairs and for renovations of existing facilities to increase production capacity. According to a recent survey by Shoko Chukin Bank, business fixed investment by small and medium-sized firms is also buoyant.
Private consumption remains firm due to a number of contributing factors: the receding of employment concerns, the rise in the propensity to consume among the elderly, stable or declining prices, the extremely hot summer, and the favorable effect generated by the Olympic Games in Athens. The overall increase in private consumption is supported by spending on services, for example, travel, recreation, nursing care, and housekeeping services, and this suggests that the weight of spending is shifting from goods to services. Increases in consumption taking place through new distribution channels, such as the Internet, shopping catalogues, and television (so-called business-to-consumer transactions), also appear to be contributing to the recovery in overall private consumption, although such developments cannot be verified in the monthly economic indicators. Regarding external demand, exports of electronic components, such as semiconductors, and digital household appliances to the United States have recently been tending to decrease. However, the overall picture continues to be favorable due to the buoyancy among heavy industries, as mentioned earlier.
2. Strong Corporate Profits-Progress in Micro--Level Structural Reforms
Corporate profits continue to be favorable both at manufacturers and nonmanufacturers. The consolidated current profits of firms listed on the first section of the Tokyo Stock Exchange, excluding financial institutions, are forecast to increase by a hefty 20 percent in the fiscal year ending in March 2005. Some firms, however, point to a degree of uncertainty arising from rising fuel and materials costs as well as softening prices for digital products. A further upward swing in crude oil prices in particular could produce a negative effect on corporate profits. Therefore, as I mentioned earlier, due attention should be paid to developments in oil prices.
Substantial progress in micro-level structural reforms forms the basis for the strength in corporate profits. The break-even point for large manufacturers has declined to the levels of the first half of the 1980s, the period before the emergence of the economic bubble. The break-even points for small and medium-sized manufacturers and nonmanufacturers of all sizes are also declining. These developments show that firms have been able to resolve the problems of their "three excesses," namely, numbers of employees, production capacity, and debts, while generally shoring up their profit bases. "The Toyota Way" of Toyota Motor Corporation is an example of the kind of production systems that are being constructed by many manufacturers and tailored to their own specific needs.
The development of new technologies and products, as well as cost reductions, has been instrumental in strengthening profit bases. But equally important have been the improved efficiency and increasing globalization of management that have made it possible for firms to take advantage of the economic expansion both at home and abroad. Globalization of management has been advanced through the establishment of stronger ties particularly with China, ASEAN, and NIEs. Many European and U.S. firms withdrew from Asia after the outbreak of the Asian financial crisis. By contrast, however, most Japanese firms have stayed, with some firms even expanding their operations in East Asia, perceiving an opportunity in the difficult time. Today, Japanese firms with overseas operations have built efficient and integrated production and sales systems, linking together their entire East Asian operations, including those in Japan. Overseas sales account for about 20 percent of total sales of all Japanese firms. The share rises to about 40 percent for firms with overseas operations. In the case of major international firms, such as Sony Corporation, Canon Inc., Honda Motor Co., Ltd., and Yamaha Corporation, the share rises further to levels of some 70 to 80 percent. It is likely that the need to respond speedily to an ever-changing business environment will lead firms to further increase mergers and acquisitions.
I will now expand on the issue of the "three excesses." According to a survey by the Ministry of Health, Labour and Welfare, the excess in the number of employees had largely been resolved by early autumn 2003. Since then, a labor shortage has occurred mainly due to a mismatch between the jobs available and the skills of job seekers. Regarding excess production capacity, with the deadline for the introduction of impairment accounting due at the end of March 2006, impairment losses exceeding 1 trillion yen were realized during fiscal 2003, and more are expected for the current fiscal year. As for excess debts, firms have been repaying debts on a net basis since 1997, the year the financial crisis in Japan broke out, right up to the present, even in years when they marked favorable profits. Pressure for repayment has eased recently, however, following a resurgence in demand for funds for both investment and working capital.
The reorganization, transformation, and rehabilitation of firms, or put differently, the resolution of the NPL problem by banks, have been facilitated by various factors, namely, enactment of the laws concerning corporate reorganization, transformation, and rehabilitation; adoption of international accounting standards; strengthening of corporate governance and increased emphasis on corporate social responsibility (CSR); deregulation in the area of corporate finance; and last but not least, the Bank's continuation of its extremely easy monetary policy. An estimation of the positive effect of the extremely easy monetary policy on interest payments by firms states the cumulative value of the reduction during the period 1990-2002 to be 250 trillion yen. The interest rate burden on firms would have been much heavier if they had paid at a fixed lending rate from 1990, instead of at the low rates they actually paid. Furthermore, the number of corporate bankruptcies decreased by more than 30 percent from its peak level due in part to the great progress in micro-level structural reforms.
3. The Economic Outlook
Amid these major advances in micro-level structural reforms, firms that have established new business models through a "selection and concentration" process are expanding their businesses in line with the economic expansion at home and abroad. With the adoption of such aggressive management stances more and more common among firms, there is a greater likelihood of increased investment in research and development, as well as the expansion of production capacity. This in turn will support private consumption by increasing employment.
Firms that have lowered their break-even points and succeeded in increasing demand and prices for core business products have a natural tendency to invest aggressively in expanding production capacity. Indeed, an increasing number of firms have started to think that capital and assets can be more efficiently utilized by using cash flow to boost production capacity, in addition to repaying debts and rewarding shareholders. An example is provided by heavy industries. The steel industry in particular is enjoying growth in domestic and overseas demand, and such industries have recently further increased investment to boost capacity. According to the results of a questionnaire by an economic organization released about a week ago, about half of the manufacturers planning to increase capital investment this fiscal year quote the expansion of production capacity as the main reason.
Investment decisions on production capacity are, however, made only after careful monitoring of the supply and demand situation. Firms have learnt the risks of capacity expansion from their experiences of the collapse of the economic bubble and are generally cautious about large-scale investment for the expansion of production capacity. This has tended to put a brake on the recovery in business and the economy.
Judging from recent developments, however, business fixed investment is likely to remain firm, although any more definite statement must wait for the September 2004 results of the Bank's Tankan (Short-Term Economic Survey of Enterprises in Japan) to be published on October 1, 2004.
Exports are very likely to remain buoyant. With increases in production capacity for machinery, steel, and other materials industries having been held in check, just as in the oil industry, the recent expansion in international demand has made domestic and overseas supply conditions for these products extremely tight. For example, over the past ten years, although China's output of crude steel has more than doubled, that of Japan, the United States, and Europe has hardly changed, with the result that the overall increase in world output has been minimal. Despite this situation, Japan's traditional heavy and capital-intensive industries have continued to improve product quality while also pursuing a horizontal division of labor with East Asian countries, even during difficult economic periods. With the use of information technology (IT), their international competitiveness has further increased, putting them in a position to be a major supply base not just to East Asian countries but to the rest of the world. They are to be relied on as a major force for Japan's export growth.
Looking at the current situation, inventory adjustment of IT-related products, developments in the economies of the United States and China, and soaring crude oil prices are generating cautious sentiment among people engaged in business and investment. I think, however, that the economy will continue to expand at a faster rate than that forecast by the Bank in April this year, although maintaining an annualized growth rate of 6 to 7 percent, as was registered in the second half of fiscal 2003, might be difficult. The expansion at a faster rate than the forecast in April will be possible because inventory adjustment of IT-related products has started earlier than previously as a result of the adoption of supply chain management. In addition, the economy is now being driven by a number of engines, namely, business fixed investment, private consumption, and exports. I believe the foundation for sustainable growth will become more secure if firms, whatever region or sector they belong to, and whatever the size of their operation, avoid complacency and continue to proceed with micro-level structural reforms.
B. Price Developments
The domestic corporate goods price index has been rising reflecting the surge in fuel and materials prices, such as crude oil prices. The index is expected to remain high, deviating substantially from the forecasts made in April 2004. Close attention should be paid to developments in crude oil prices. However, in considering the effects of oil price rises on the economy and other prices, we should not simply compare the current situation with that in past oil crises, because the economic structure in Japan has changed. For example, crude oil consumption per production unit has been cut to almost half of its peak in the early 1970s, as firms have made efforts to save energy. In addition, although high oil prices brought about an increase in wages causing inflation rates to rise after the first oil crisis, firms have recently been pressing ahead with reduction of their unit labor costs by improving productivity and lowering overall employment costs through diversified employment.
The year-on-year rate of change in the core consumer price index (CPI), excluding fresh food, has been moving at around zero percent. I think downward pressure on the CPI stemming from structural factors seems to have helped keep the CPI stable despite the economic recovery. In particular, the presence of tough competitors to Japan, such as China, Taiwan, and South Korea, is one of the primary factors encouraging Japanese firms to continuously reduce costs and come up with innovative new business models. Moreover, the yen has recently been moving at around 110 yen against the U.S. dollar, and there is no sign of a negative cycle, such as those seen in the past, in which high oil prices cause an appreciation of the U.S. dollar and a depreciation of the yen, thereby heightening inflationary expectations. Therefore, I think the year-on-year rate of change in the core CPI is likely to continue moving at around zero percent, even setting aside additional and temporary factors, such as the decline in rice prices and the cut in electricity charges.
While there are still those who take a pessimistic view of efforts to stop the decline in the CPI, in my opinion, the following factors make it unlikely that the CPI will continue to fall. First, the upstream domestic corporate goods price index has been showing a relatively high rate of increase. Second, the upward pressure on prices will also gradually increase if the Japanese economy continues to strengthen at a pace exceeding its potential growth rate. And third, the decline in unit labor costs is to some extent slowing. Recently, yields on ten-year Japanese government bonds (JGBs) and the Nikkei 225 Stock Average have been moving mostly within a narrow and predictable range, and I take this to reflect the markets' view that deflation has eased.
III. Conduct of Monetary Policy
Three and a half years have passed since the Bank introduced the quantitative easing policy in March 2001, with a view to putting an end to the continuous price decline as well as preparing the ground for sustainable economic growth. The Bank will continue the current quantitative easing policy until the year-on-year change in the core CPI registers zero percent or higher on a sustainable basis.
A. The Current Monetary Policy Framework
1. The Importance of a Comprehensive Evaluation of the Economy and Price Developments
There are two contrasting views regarding the future of the Bank's quantitative easing policy, as the core CPI continues to fall slightly on a year-on-year basis despite the gradual strengthening of the economic recovery. The first view is based on the thinking that it is inappropriate to continue linking the quantitative easing policy to developments in consumer prices when the economy is recovering. Proponents of this view believe that the Bank should lower the target range for the outstanding balance of current accounts held at the Bank by financial institutions and raise interest rates in line with the economic recovery. The second view springs from concern that prices are continuing to fall despite the economic recovery. Proponents of this view believe that the Bank should reinforce its commitment to the quantitative easing policy in terms of policy duration, by, for example, setting an inflation target and tightening the conditions for the termination of the policy.
I believe, however, that it is important to maintain the current conditions for the termination of the quantitative easing policy. This is because, at this point, changing conditions to which it has committed publicly will impair the credibility of the Bank and may also cause disruption in the financial markets. The same applies to setting an inflation target. Consumer prices have been falling in major economies. In Japan, the average rate of increase in consumer prices over the last two decades (from 1985 to July 2004) is 0.7 percent, while for the last decade (from 1995 to July 2004) the equivalent figure is minus 0.2 percent. In such a situation, directly targeting one specific price indicator in the Bank's money market operations is likely to distort the economy in the medium to long term. Rather, in order to generate a positive rate of change in prices, the Bank should persistently support structural reforms on the microeconomic level and continue to lay the foundations for economic recovery.
I believe that it is appropriate for the Bank to continue its quantitative easing policy within the current framework. It is also important, when judging whether the core CPI is increasing on a sustainable basis, to make a comprehensive evaluation of the economy and price developments, taking into account not only the current situation but also the various factors affecting it. From this viewpoint, the Bank includes in its conditions for the termination of the quantitative easing policy, a comprehensive evaluation of the economy and price developments.
It is difficult to determine in advance what factors should carry how much weight in the comprehensive evaluation. One thing that can be said, however, is that the quantitative easing policy, through the Bank's money market operations, has provided market participants with funds with longer maturities, which had become difficult to obtain in the money market due to the heightening of concern among banks about the creditworthiness of trade counterparties. The policy has supported banks' financing, and as a result, it has prevented financial developments from exerting deflationary pressure on the overall economy. The situation therefore requires that attention be paid to developments in the financial system when making the comprehensive evaluation. The stability of the financial system has improved with the establishment of the appropriate safety nets, although nonperforming loan (NPL) problems at individual banks remain. In this regard, banks are pressing ahead with the disposal of NPLs in view of the full removal of blanket deposit insurance scheduled for the end of March 2005, and, for their part, borrower firms continue writing down fixed assets at a rapid pace.
In a situation where the year-on-year change in the core CPI has not yet registered zero percent or higher on a sustainable basis, I believe it is vital to continue, with patience, the current quantitative easing policy even during the economic recovery. In the future, when the year-on-year change in the core CPI has registered zero percent or higher on average over a few months, the Bank will examine carefully whether the quantitative easing policy should be terminated, by making a comprehensive evaluation of whether the registered core CPI growth is truly sustainable, and whether a sustainable economic recovery can be confirmed, taking into account the soundness of the financial system.
2. The Importance of Communicating with the Market
Communication with the market is another factor as important as comprehensive evaluation of the economy and price developments to the conduct of the current monetary policy. The Bank released a document entitled "Enhancement of Monetary Policy Transparency" in October 2003, which clarified its thinking regarding the importance of the comprehensive evaluation.
The Bank has been working to enhance monetary policy transparency so as to deepen market participants' understanding of the Bank's comprehensive evaluation of the economy and price developments. A deeper understanding of the Bank's policies by market participants should help prevent major disruptions from occurring in the financial markets when, in the future, the time comes to terminate the quantitative easing policy. My own belief, however, is that the one-way dissemination of information by the Bank will not, by itself, be sufficient in this regard. The Bank must clearly present its view on the economy and price developments; conduct monetary operations based on the presented view; and assess market participants' responses by examining developments in bond prices, implied volatility, which shows market participants' expectations of the degree of future fluctuation in bond prices, short-term interest rate futures, and other market rates. Then, should there be any inconsistency between the Bank's view and the expectations of market participants, the Bank must return to the start line, reassess the economy, and reexamine its own view. It is essential to maintain this kind of communication with the market.
B. Restoring the Functioning of Market Mechanisms--A Challenge for Future Monetary Policy
An important issue confronting future monetary policy is to restore the money market to full functionality. The trading volume of overnight funds has increased, and departments in charge of financing at some banks and securities companies have started conducting stress tests to assess their credit lines.
However, transactions involving longer-term funds with maturities of over 3 months are still rarely being carried out in the market, and financial institutions continue to rely on the Bank's operations for financing. I believe this is mainly because banks are still unable to be fully confident of other banks' creditworthiness, although some say it is because interest rates, including those on term instruments, have been virtually zero percent, and the increasing frequency of mergers and tie-ups have meant that the overall number of banks is decreasing. Given this situation, it is important that efforts are made to improve banks' credit ratings, through the resolution of the NPL problem and the strengthening of their profitability. This, in turn, will hopefully lead to the resumption and expansion of the credit lines that enable banks to carry out financing in a flexible and self-sustained manner.
C. Financial Developments
The Bank has provided ample funds to the money market based on its quantitative easing policy, and as a result, the ratio of the monetary base (the sum of currency in circulation and current account balances at the Bank) to nominal GDP has been extremely high in historical terms. On the other hand, growth in the money stock (M2+CDs), or the amount of money held by firms and households, has been relatively small, and the ratio of the money stock to the monetary base, namely the "money multiplier," which captures the capacity of banks to create credit, actually followed a downward trend from the latter half of the 1990s until around fall 2003.
Recently, however, banks have become more active in extending loans, especially to small and medium-sized firms and households, with loans to the latter mainly in the form of housing loans. This pick up in lending reflects the recovery in stock prices and progress in the disposal of NPLs. On the borrowers' side, firms have started to increase business fixed investment, in line with their more aggressive stance mentioned earlier. Pressure on firms to reduce debts has therefore weakened somewhat. Consequently, the pace of year-on-year decline in bank loans has been slowing, and the fall in the money multiplier has come to a halt. Given the slowdown in the pace of decline in bank loans and the significant narrowing of credit spreads, I believe that the effects of the quantitative easing policy have recently been spreading not only to the money market but also to the lending and corporate bonds markets.
IV. Issues Arising from the Declining Birth Rate and Population Aging
Among the various issues facing the Japanese economy as the birth rate continues to fall and the population to age, I would like to touch briefly upon a few points that I consider of particular current relevance.
A. Maintenance of Fiscal Discipline
The first of these is the maintenance of fiscal discipline. The combined long-term debt of the central and regional governments in Japan already exceeds 700 trillion yen. When we add to this the increased social security burden from pensions, medical costs, and nursing care that will accompany population aging, the importance of maintaining future fiscal discipline is self-evident. This will require us not only to secure increases in revenue, by achieving longer-term and higher economic growth through improved productivity and regulatory and tax reform, but also to carry out a comprehensive reform of government expenditure.
In order for this fiscal discipline to be pursued against a background of low interest rates to minimize the costs of reconstructing the public finances, it is desirable to maintain a course that preserves the balance between the current economic recovery and price stability. A "non-inflationary consistently expansionary--or 'NICE'--decade" was the term Governor King of the Bank of England used to describe the experience of the United Kingdom in the 1990s when the economy grew steadily without putting upward pressure on inflation. Japan should pursue such "NICE" growth. Conversely, a policy that makes prices a direct target of money market operations would upset the delicate balance between these two, and would therefore not be appropriate given current economic conditions in Japan.
B. Further Improvements in Productivity
The second point is that, further rises in firms' productivity are needed for the economic recovery to continue without destabilizing prices. With the exception of the first half of the 1990s, there has been an almost constant upward trend in labor productivity in Japan, although, when we turn to productivity among office workers in administrative and other services (hereafter "office services"), there is still room for improvement. According to a survey by the Ministry of Health, Labour and Welfare, engineers and skilled workers have become relatively scarce and are suddenly in high demand, while the sense that there are excess numbers of managers and office workers has taken increasingly firm hold.
In order to raise productivity in office services, we need to see not only further use of IT in business process reengineering and the continued standardization of business practices, but also, where the same business task is being carried out in every office, increased concentration (a wider use of shared services) and more outsourcing. The government is currently pushing forward with the digitalization of its administrative services, the so-called "e-Japan" framework. In addition, the wide-ranging introduction of competitive bidding for the right to supply public services is currently under consideration. Such measures are expected to help raise the productivity of the public sector.
The manufacturing sector has seen leaping improvements in productivity, due to the fusion of IT, advanced manufacturing technologies, and also innovative production process technologies at individual firms. These improvements have not been restricted to large firms, but have also begun to be seen in small and medium-sized firms. This is an extremely encouraging development for the Japanese economy. It is to be hoped that this continuous striving for improvements in productivity will become even more widespread in future.
C. Response to the Decline in the Quality of the Labor Force
The third issue is how to put a stop to the recent decline in the quality of the labor force, and to ensure that Japan's tradition of labor force skills, the source of its firms' international competitiveness, is firmly passed on.
As one way of reducing labor's share of income, firms have been increasing the proportion of part-time workers employed. This proportion, however, has increased too far, with the result that, in the workplace in particular, firms have experienced difficulties in making improvements and passing on traditional skills, leading to a situation inviting incidents involving the management of product quality and safety. To deal with this, there has recently been a growing tendency to increase numbers of regular employees from the younger age group, and to concentrate energies on nurturing engineers and skilled workers by establishing training programs for specialists. Such developments should be welcomed.
However, it is not uncommon to hear from firms that they are unable to fill up their desired complement of younger workers, because the young people who apply do not make the employment grade in terms of their levels of knowledge and their attitudes toward work. There appears to be a major social issue here: namely, the need to foster human resources rich in both creativity and a sense of community that also include within their number those of the younger generation who are not looking for work, attending school, or in job training programs, i.e., those termed generically NEET (Not in Employment, Education, or Training).
D. Deregulation Geared toward Generating Demand
The fourth issue, looking toward raising the country's overall ability to generate value-added, is to proceed with deregulation in the agricultural sector and in the sectors where mid- and long-term expansion in demand are anticipated, such as health, welfare, the environment, and education. It is also important to push on with efforts to promote the development of new industries. Expansion of the overall industrial spectrum will not only act to absorb excess labor, it will also help raise the potential for economic growth.
Thank you for your kind attention.