Dr. Naoyuki Yoshino is Dean of the Asian Development Bank Institute (ADBI) and a Professor of Economics at Keio University, Japan. He recently sat down to discuss Abenomics and Japan’s overall economic trajectory, as well as economic trends in the region and possible new paths for growth.
You’ve argued that it was a mistake for Japan to focus too much on monetary policy 20 years ago, and not enough on structural reform. Do you think that still applies today? Do you feel that the “third arrow” of Abenomics is going to be sufficient to return Japan to growth?
First, in the late 1980s, Japan experienced an asset price inflation bubble, and stock and land prices went up roughly tripled. At that time, the Bank of Japan was focusing on inflation as a target, and the Japanese exchange rate had appreciated very severely since 1985 and ‘86, and the value of the yen almost doubled, which means the import price of oil and natural materials was almost halved. So the rate of inflation in Japan was very stable, close to zero in the late 1980s, and the inflation target of the BOJ was [appropriate]. However, stock prices and land prices went up dramatically, which means inflation targeting alone may not have been sufficient for Japan. The yen is not an international currency, if it were the U.S., inflation would not be affected by the exchange rate, but for Japan and other countries, the inflation rate affects the import price. So I think that is one of the mistakes Japan made in the late 1980s.
Then, in the 1990s and 2000s, many American economists were talking about Japan being in a liquidity trap, which means even though the interest rates were very low, close to zero, monetary policy was not effective. That was the argument. And many American economists were talking about rescuing Japan through its monetary policy.
The deep cause of the Japanese recession over the past twenty years [was two-fold]. The first part is banking behavior. The second part comes from structural problems. The Basel capital requirements were applied to all countries at the same ratio, 8 percent, so if banks want to lend money to riskier borrowers, then they have to keep 8 percent of capital. The reason is so that each country will have an equal background, so that all banks which are competing internationally follow the same rules. That was the original idea. However, my research showed that the optimal Japanese capital ratio should have been 5.4 percent, rather than 8 percent. And my research showed that the Basel capital requirement should have been varied from country to country. The reason is that the share of the banking sector compared to the stock market and bond market differs from country to country. In the case of Japan, we relied heavily on bank loans. Then, in the face of recession, banks have to lend more for the Japanese economy to recover. Eight percent was applied to every country, no matter what the business conditions were. So two conditions should have been introduced: First, when the economy is in recession, capital requirements should have been lowered to encourage banks to lend more. Moreover, financial structures are different from one country to another, so the minimum capital requirements should have been different, and the Japanese optimal ratio should have been 5.4 percent. That’s why the credit crunch occurred in Japan. Second, the Japanese economy had a huge problem with non-performing loans. The Japanese government wanted to inject capital into the banking sector, but again many overseas economists opposed this. That was a moral hazard for banks. Because banks were creating non-performing loans, they were the banks’ responsibility. Why should taxpayer money be used to rescue banks? After the Lehman Brothers crisis, the U.S. and Europe did the same thing, and they injected capital as quickly as possible. So I think those two structural problems, especially banking and Basel capital requirements, made the recovery of the Japanese economy very slow.
Second, concerning structural reforms, Japan’s biggest problem is its aging population, and this problem cannot be dealt with through monetary policy. The number of elderly and retired people is rising, and the younger generation is shrinking, and monetary policy can’t do anything about that. So we either have to ask older people to keep on working, or get people to have more children. Those are structural reforms, but this has never been discussed at international meetings like the G20 until recently.
Japan has the highest government debt levels in the developed world, at a time when it has a shrinking tax base. How do you see that ultimately being resolved? Do you think that measures such as raising the retirement age (which you have suggested) and increasing the consumption tax will be sufficient? Or does Japan run the risk of a collapse in the yen and very high inflation?
I wrote the government rules (guidelines) in order to sustain our budget deficits. The rule has to be a simultaneous equation of government spending and tax revenue, together. In the past, Japan wanted a good social welfare system like Sweden, but the tax revenue was kept at a very low level, and so it did not match [the spending]. Spending and tax revenue have to go together, and we lacked those discussions. We prefer a Swedish-type social welfare system, [but] Sweden has a 24 percent consumption tax and Germany has 19 percent, [while Japan is] talking about 5 or 8 percent. Europeans are laughing, saying why are you giving such good benefits at such a low tax rate.
So if you prefer a lower tax rate of 5 or 8 percent, or at most 10 percent, we should reduce our welfare benefits. In order to do this we have to postpone our retirement age, and the wage rate [cannot] be based on a seniority wage rate. Currently the wage rate at many Japanese companies is the seniority wage rate, so the rate becomes higher as people work longer, but if we change it to a productivity-based wage rate, then it becomes easier for companies to hire old people because their wage rate is lower. I think companies should consider what is the best way to share work between old and young, the retirement age should be postponed, and the wage rate should be based on productivity.
You’ve written on the concept of hometown investment trust funds. What role do you see these funds playing in rural development/redevelopment in Asia in the coming years?
In many Western countries like the U.S. and Europe, there are venture capital markets, but Japan and other Asian countries are dominated by the banking system. So it is much more difficult for banks to make risky loans because of the Basel capital requirements. Basel decided that banks should be healthy so that they can make safer loans, but in the old days there were no capital requirements, so Japanese banks could lend to big companies and also growing industries, from the riskiest to the safest. So there was a very wide range of bank loans, but the new capital requirements stopped this. However, the U.S. and Europe have venture capital, so new money is still allowed to come in, but in Japan and Asia, it became very difficult to provide risky loans to start-up companies. Hometown investment funds are designed to fill those gaps. The main banks cannot lend money, but the branch office of the banks can provide hometown investment trust funds. And these funds grew very rapidly, especially after the earthquake and tsunami in 2011. Some fishermen used to borrow money from banks, and now their boats have been destroyed, but banks couldn’t lend money anymore because the fishermen already had existing loans, which they could not pay back. So then they started to raise money from all over Japan, and people put in 10,000 to 30,000 yen ($98 – $295), and the lenders knew who was doing the borrowing. Then the fishermen repaired their boats, and started to catch fish, at which point they could start repaying money to their investors.
Do you think these investment trust funds would be able to operate on the scale of venture capital funds in the U.S. or in Europe?
It could be possible. Many regional banks know their customers, and they can lend money to safer customers, but they know the risky projects too. Now they usually just reject them, so those new businesses are not grown. But these hometown investment funds could be sold through the branch offices of the banks, which can then collect money from individuals in the region, and these are the borrowers too, so the investors know who is borrowing. So for example, in railway stations many shops have started to close because many large-scale stores have begun to open nearby. However, many people want to see the stations become lively again, and many young people want to open new shops, like bakeries and so on, but they cannot borrow money from banks because they are risky, so the hometown investment fund was created. In the Kobe area, many people have invested 10,000 or 30,000 yen, and people have started new businesses. These people know the borrowers, and sometimes they go to eat at the new restaurants, so it’s a good way to help each other in the community.
Chinese corporate debt has recently topped the U.S. equivalent, and many would argue that Chinese debt is inherently riskier, given its shadow banking association. Do you see China heading in the same direction as Japan in the late 1980s?
The Chinese local finance structure is a little bit different than other countries. I was in China about a month ago, and we discussed the local finances. Local government in Japan usually [collects] corporate or income tax, which is much higher than property tax income. But in China’s case, property tax revenue is about 20 percent of the total local government’s revenue. So, property tax revenue is very important for them, to keep their infrastructure investment and so on. The reason for this is that income and corporate taxes are very difficult to detect if it is just going into people’s pockets. But for property tax, you know who owns it, since the property is there. Then shadow banks played an important role, because land prices in the rural and city regions went up very high. Which means the property tax income became higher and higher. So I think that is what partly accelerated this non-bank financing in the regions. Then, would it be very difficult to solve this problem? These are not banks, they are non-banks. So by definition, they don’t have to guarantee those asset holders. If they were banks, then deposits would be guaranteed. That is why nonperforming loans have accumulated in the banking sector. So, if the Chinese government takes a very strict stance, then the performance of these shadow banks will not affect the banks as a whole, because they are not deposit-taking institutions, they are just investment banks. So if China takes that position, Chinese debt will never increase, because it remains personal debt.
A number of Asian countries have experienced sharply declining birthrates. How do you see demographics influencing the region’s economic performance over the coming decades?
I think all Asian countries should encourage their people to work as much as they can. This will keep the working population up, even though people become older. Wage rates should be based on performance, and the young and old should collaborate. [Countries] should look for the best combination. That is the first key. The next is that the childcare system has to be [effective], so that young women can ask elderly people or nursery homes to take care of their children. That is very important. If both [are in place], the decline in the population will slow, and the aging population will not be such a serious problem. Lastly, government spending and tax revenue always have to be looked at together. If they prefer a good social welfare system, then the tax rate has to be high. If they don’t want a high tax rate, then the social welfare system has to be diminished. Japan has lost this simultaneous combination.
What role is there for the Asian Development Bank to play in the ASEAN Economic Community, due to be formed next year?
In Asian countries, especially in ASEAN countries, there is a lack of infrastructure investment and small and medium enterprises (SMEs). SMEs also have difficulty borrowing money. The ADB is now creating infrastructure funds and infrastructure finance. So that can make connectivity among Asian countries much better. And then there is SME finance, which is what we are doing at ADBI, to include these hometown investment trust funds. These will prove to be beneficial to the community and SMEs in the region.