Time for Change

Comments on the EBC's 2009 EBC Report on the Business Environment
Tommy Kullberg, EBC Chairman

I am delighted to launch the EBC’s 2009 report on the Japanese business environment.

Also, ironically, the areas where change is needed have remained remarkably consistent over the years, revealing that there has been too little progress. This alone would account for the sense of urgency that underlines this report.

However, clearly there is also the fact that we produced this report during what proved to be a major shift in Japanese politics and we are hopeful that shift - in the form of a new Government, elected on a platform of change, enjoying huge public support, and benefiting from large majorities in both Houses – will offer sufficient momentum to provoke significant economic reform.

The first major change we are advocating is for Japan to break with the model of central government promoting export-driven growth, redistributing the profits at home, and so protecting domestic industry from competition. That model used to work, but it doesn’t any more, now that markets, and indeed consumers, have gone global. The old ways cannot deliver economic stability, they cannot deliver sustainable jobs, and they cannot deliver competitive products. Voters recognised this way back in 2005, when the elected Mr Koizumi on the promise that his Postal Privatisation policy would kick-off a new era of economic reform. In the event, however, successive Liberal Democratic Party (LDP) prime ministers failed to deliver, and so the voters have now passed the problem to the Democratic Party of Japan (DPJ) to solve.  The message to LDP from the voters was clear: enough is enough!

Saying this, we should not overlook what Prime Minister Koizumi and his colleagues did achieve, because there are important lessons here. They introduced important reforms, such as:

• the new Corporation Law, modernising legal structures for firms in Japan;
• a new non-interventionist approach, forcing financial institutions to deal with bad debts and non-performing loans;
• streamlining of financial services regulators and the introduction of a no-action letter system;
• the new company law, relaxing restrictions on using foreign stocks as consideration in a merger or acquisition; and
• a drastic cut in public spending on infrastructure projects – after many years of throwing money at projects as a way to stimulate the economy out of recession.

I could also mention recent efforts to boost Tokyo's position as a global financial centre, liberalise airline pricing, and reduce delays in introducing new drugs and medical devices to the market.

The problem has been that, with few exceptions, the reforms did not live up to expectations, because anticipated improvements got lost in excessive bureaucracy, concessions to vested interests and painfully slow implementation. In particular, they fell victim to the long-standing fear of exposing domestic companies to open competition in Japanese markets. Politicians have worried that this could lead to bankruptcies and job losses – and a backlash at the polls. But what actually happened was even worse: the fact that there was no competitive domestic economy meant that demand amongst Japanese consumers was too weak to compensate when global demand for Japanese products fell, and so pushed the country even further into the crisis that cost the LDP the election. And that should be a lesson for the DPJ.

So here we are in December 2009 and the new Government has inherited a country in which output is declining, unemployment rising, wages falling and deflation entrenched. What is to be done?

We argue that the Government should avoid the mistakes of its timid predecessors and opt instead for bold and effective reform. It must focus on creating new drivers for sustainable growth, and especially on stimulating a long-term increase in private domestic demand. This means opening up markets, so that greater competition stimulates the design and supply of products more closely matched to consumer demand, and reinvigorates the economy. It can only happen if the Government secures control of the policy-making process and removes regulation and bureaucracy inhibiting competition. Essentially, it must put the interests of consumers first.

We have already seen signs that the Government is keen to move in the right direction. It has announced ambitious targets of reducing wasteful spending and providing “value for money”.  A number of areas look particularly promising:

• Firstly, special accounts: The Government says it will review these accounts and eliminate all but the most essential. This is good news, since they have long been used by ministries to entrench their own power and protect special interest groups. They also distort costs. For example, the EBC report argues that elimination of the special account for airport development would greatly reduce air transport costs in Japan and make airports far more competitive.
• Secondly, procurement: The Government has announced it will review the contracts and procurement policies of all government agencies with a view to cutting costs. This might damage a few special interests but for everyone else, it would be beneficial. For instance, the EBC report points out that aligning Japanese procurement practices in the defence field with those in Europe would not only deliver a better product for a lower price, but would also strengthen the Japanese defence industry. The same argument is also made for the aeronautics, space and construction industries.
• Thirdly, healthcare: the DPJ has promised to prioritise and rationalise medical services. The EBC recognizes the need and stresses rewarding innovation as a way to both improve patient welfare and cut overall costs to society. The Pharmaceuticals, Vaccines, Medical Equipment and Medical Diagnostics chapters of our report all emphasise that streamlining Japan’s certification process will be crucial to the process.
• Finally, taxation: The Government’s plan to lower corporate tax to 11 per cent for SMEs is welcome news.  The same can be said for abolition of the vehicle acquisition tax, and the call for increased transparency. The EBC report shows how taking on issues such as secret comparables and introducing an unlimited tax loss carry forward period could provide an effective and immediate stimulus to companies, without undermining the tax base.

The EBC’s support for the new Government’s proposed reforms is not, however, unlimited. Several DPJ plans are highlighted in our report, which we believe risk taking Japan in the wrong direction.

For example, the DPJ’s ideas for creating an independent regulator for the telecommunications and broadcasting industries, with a mandate of overseeing regulation and business practices from a consumer perspective, may focus too much on network competition rather than a mix of network- and service-based competition and so fail to deliver much-needed improvements to the competitive environment.

We also have doubts about the DPJ’s call for a renewed food labelling system, which would made it mandatory to include the country-of-origin of every ingredient. This is frankly unrealistic, given that a necessary condition for being able to provide processed food on a global basis is having a flexible procurement regime. 

Finally, we are concerned about what we have heard in terms of a possible revision of the privatisation of Japan Post. Though the privatisation process has been far from ideal, returning to the situation prior to privatisation would raise serious questions about the role of the state in the economy. Merging the four, now separate, units (Bank, Kampo, Delivery and Offices) back into one unit on the pretext of improved service provision is not viable. The risk of up-front state competition with private sector companies must be avoided.

At the broader level, this EBC annual report continues the arguments of its predecessors that the Government needs to develop a new economic vision for Japan that could be shared by the public, administration and political parties, and translated into a model for future prosperity. The old post-war model really is broken, but as yet there is nothing to replace it. We believe that an EU-Japan Economic Integration Agreement (or EIA for short) could play a vital role, by boosting reforms both in Japan and the EU through the process of policy alignment, based on a shared approach to global trade and on common values. The approach to agreeing the Single Market rules and regulations that have boosted trade within the EU could easily serve as a model.

The agreement envisaged by the EBC is based on the EU concept of a free market for goods, people, services and capital, reflecting fairly and equally the interests of both the EU and Japan. Businesses would benefit from the harmonisation of rules and standards, thereby reducing administrative costs, giving consumers faster access to new products without compromising on safety, and improving the competitiveness of domestic industries. Consumers should get access to a wider choice of quality goods and services, as well as the opportunity to move across borders for work without foregoing welfare protection. We note that Japanese business groups are now looking at such an Agreement with the EU as a way to stimulate competition, growth and welfare at home, and we are encouraging the Government to look at the potential of relations with the EU from this same perspective.

The EBC report sounds a note both of hope, and of warning. Despite everything, there are still powerful people in Japan who believe there might yet be life in the old economic model, and that reform can, once again, be postponed. This new Government has been elected on a platform of change. It has promised to break the control of vested interests working through special ministries, which is a promising start, but that’s all it is – a start. So we are urging the Government not to delay: it must quickly use its mandate for reform to free up the economy; get rid of structural barriers to growth; foster free and open competition; and put consumer interests first. Previous governments may have intended much, but they delivered too little. This Government should not make the same mistakes. We believe this is the time for change.