JPRI Working Paper No. 21: June 1996
Afterbubble: Fizz and Concrete in Japan's Political Economy
by Gavan McCormack


At the end of the 1980s, the Japanese economy suffered a severe setback with the bursting of the so-called 'bubble,' the ensuing collapse of land and stock prices, and its entry upon prolonged recession. Many analysts have argued, however, that in terms of fundamentals Japan's economy is still sound, that the decline is cyclical, and that a recovery will begin in due course, with Japan's resuming its role as a powerhouse in the regional and world economy. Here I want to explore some possible reasons this may not come to pass. Even after four years in the trough of recession, Japan may not yet have leeched the poison engendered by the bubble from its system; and its economic problems, rather than being cyclical, may instead be deep-rooted and structural.

In short, can Japan can be expected to assume in the near future anything like the global role it seemed headed for in the 1980s? Or does it carry the more dangerous potential of henceforth infecting the global economy with a virulent 'Japan disease.' As the special December 18, 1995, issue of the Japanese weekly financial paper, Ekonomisuto, (ominously entitled, without benefit of a question-mark, 'Fiscal Collapse') put it: what is the likelihood of a global financial panic emanating from Tokyo?

The Japanese economy remains impressive in scale--accounting for around 17 percent of the world's gross domestic product (GDP) and 65 percent of Asia-Pacific regional GDP. It obviously possesses great industrial and financial strength, as reflected in its current account surpluses running at well over a hundred billion dollars per year. It commands nearly one trillion (i.e., one thousand billion, or one followed by 12 zeros) dollars worth of foreign assets; and its currency rose steadily in value against the world's major currencies, reaching a peak of around 80 yen to the U.S. dollar in April 1995 (although subsequently declining again to around 108 yen by early 1996). The top ten banks in the world in terms of (1995) assets are all Japanese, while the highest-ranking U.S. bank, Citicorp, is Number 26. There are 29 Japanese banks among the top 100, as compared to only 9 American ones. Mergers underway and on the drawing board in Japan are designed to create even bigger, super-banks. In social terms, the Japanese seem to have avoided or overcome the chronic problem of the other OECD countries--unemployment--since the commonly quoted figure is around 3 percent.

Yet all of these statistical claims bear exploration. They are not false but need to be seen in context, and that context casts a significant shadow over them. The contrast between the relative health and wealth of the Japanese private sector (at least certain segments of it) and the desperate plight, verging on bankruptcy, of the Japanese public sector, is particularly stark. The level of Japanese public indebtedness is only slowly coming to light. At the end of 1994 it stood at a staggering 782 trillion yen (roughly 6.5 million yen, or $65,000 per head); and consisted of 291 trillion yen in direct central government debt, 181 yen trillion in local government and public corporation debt, and an additional 310 yen trillion in outstanding sums diverted from (and in due course having to be repaid to) repositories of people's savings such as the Postal Savings fund and various pension funds. A level of public indebtedness running at around a quarter of a country's GDP would be regarded as serious wherever it occurred; Japan's is running at more than a quarter of global GDP.

Public debt has been a problem faced by many, if not most, of the OECD countries. In the U.S., the profligacy of the 1980s turned it into the world's greatest debtor, but at least a political consensus has now been forged on the seriousness of the problem. Budget deficits are being cut, and as of the mid-1990s the Democratic and Republican camps seem to be divided primarily on whether seven or nine years should constitute the target date for total elimination of the federal deficit. In Europe, an explicit clause of the Maastricht Treaty limits national deficits to a maximum of 3 percent of GDP.

By such standards, Japan's finances are already in crisis, with the 1995 deficit ratio standing at 7.6 percent of GDP (compared to 2.8 percent, reducing to 1.9 in 1996, in the U.S.). Japan's cumulative debt figure was 59.1 percent, which is almost identical with the U.S.'s 60.2 percent in 1994. Even the Ministry of Finance, employing very conservative projections and ignoring certain categories of debt, in January 1996 was forecasting that outstanding direct central government debt would reach 482.4 trillion yen by the year 2006-7, by which time outstanding loan issues would constitute 68.9 percent of GDP. Australia in September 1995 had a foreign debt (public and private sector combined) of around $140 billion ($A180 billion, or 39.3 per cent of GDP), but at approximately $7,800 for every man, woman and child, it was still in per capita terms less than one sixth of Japan's public debt.

Although Finance Minister Takemura referred explicitly to Japan being in a state of 'fiscal crisis' late in 1995, the budget he drew up for 1996 was 28 percent deficit-financed, including a further issue of nearly 47 trillion yen in bonds, of which 20 trillion yen would be new and the rest merely meeting repayments on previous loans. The largest shares of government expenditure were, as they have been for thirty years, reserved for public works, although future debt payments will swallow a rapidly rising share. There was no evidence in this budget of anything resembling a crisis measure--in the sense of a measure designed to address the crisis rather than simply one forced by it.

This Japanese public debt is not owed to foreigners. In abstract terms, it is offset, if only partly, by very large Japanese public and private foreign assets. It is a debt nonetheless--one that gets steadily deeper and that must be paid off by this and future generations by either higher rates of growth (unlikely), higher taxes (certain, but politically risky), or (at least theoretical possibilities with strong historical precedents) chronic inflation or war.

Japan's low (official) unemployment rate likewise does not bear close scrutiny. The official figure (as of January 1996) was 3.4 percent-- over two million people but exceptionally low by OECD standards. But Japan's official mode of calculation includes only the 'completely unemployed.' The Economic Planning Agency estimates that after four years in a row of zero real growth the actual figure of unemployed is between 5.5 and 6.0 percent (around five million people). And when Japan's Statistics Bureau of the Management and Coordination Agency tried using the methodology of its American counterpart, the Bureau of Labor Standards, it found an actual unemployment rate of 8.9 percent, about the same as Australia's, slightly above the U.S.'s and almost three times the official rate.

Most economic commentators also agree that Japanese companies conceal a large 'surplus' group of people who are employed but in effect have no work. The number of these in-house jobless is variously put at another one to two million (by Takeuchi Yasuo), or as high as 6.5 million, by Robert Feldman, who refers to them as workers 'in excess of the number required to produce the GDP.' The prominent business consultant Ohmae Ken'ichi believes the official unemployment rate will have to rise from three to six percent in the course of 1996, in order to get rid of Japan's corporate slack, and that the society might have to be accept a rate as high as 10 percent in order to become internationally competitive in the information age.

So far as the ranking of Japanese banks is concerned, this too is not quite what it seems. When Moody's Investors' Services reported in August 1995, they found only one Japanese bank (Shizuoka Bank) worthy of 'B' ranking, three were on 'C' level, 26 on 'D,' and three virtual banking pariahs, their credit lines in effect severed, at 'E.' Clearly, Moody's was casting doubt on any ranking of banks that relies solely on assets, ignoring liabilities, not to mention profitability, openness, and management accountability. Of Japan's 11 City Banks, only five had assets in excess of bad loans. In terms of profitability, Japan's banks rate dismally, with the best performing Japanese bank (Bank of Tokyo) having a profit ratio equal to only 14.9 per cent of Citicorp's. All of JapanÍs big banks rank below the world's top 200 in terms of profitability. In October 1955, Moody's issued a similar ratings table for countries. Alone of OECD members, Japan was rated a 'D,' on a level with China, Mexico and Brazil.[1]

Peering into the Abyss

What happened in 1995? Among other things, two major credit unions (Cosmo and Kizu) and a bank (Hyogo) collapsed. Hyogo Bank left behind 1.5 trillion yen of bad debts, 25 times higher than its previously declared rate. Virtually all of the bad debts stem from speculative real estate loans during the 'bubble' years of the late 1980s. It was also revealed that the New York branch of Daiwa Bank (nineteenth in world ranking in terms of nominal assets) had somehow 'lost' US$ 1.1 billion. Various of Daiwa's senior officials were arrested and charged with fraud, concealment of a major crime, and other serious offences, and the bank itself was ordered to cease business in the U.S. In the January 1996 issue of Tokyo Business Today, the editor commented on the "total lack of responsibility at the heart of Japan's financial system. . . both the bank officials and the Ministry of Finance officials should be in handcuffs."

In September, the Ministry of Finance began to tackle the massive losses in another section of the banking industry: the Housing Loan (Jusen) companies. These institutions were established by the banks during the 1970s in order to cash in on the lucrative home loan market. In the 1980s, like other Japanese institutions, they plunged indiscriminately into speculative lending to property companies; golf, leisure, and resort developers; and even organized crime. When the bubble burst, they found themselves holding about eight trillion yen worth of bad debts. To compound the Ministry's problem, most of the Jusen were headed by former officials from the Ministry. To restore the banking system to credibility and credit worthiness, the government, in December 1995, suddenly produced a scheme to appropriate an initial «685 billion out of the 1996 budget--i.e., money from the tax-payers--to cover the losses and close down the Jusen. As of early 1996, that huge sum was beginning to look more like a down-payment than a settlement; and despite the involvement of the Ministry of Finance, the question of ultimate responsibility was being fudged. It remains a minefield for politicians and bureaucrats in coming months.

As the crisis of bad debt and cover-up spread, involving the Ministry of Finance both in terms of lax supervision and collusion in disguising it, an official figure of 40 trillion yen was put on bad or unrecoverable debt within the Japanese banking system as a whole. Well-informed independent observers thought it more likely to be at least double that figure, and perhaps as much as 100 trillion yen. The respected chief economist at Deutsche Bank Capital Markets, Kenneth Courtis, declared Japan's banks to be 'virtually bankrupt.' Miyao Takahiro, in the November 1995 issue of Ekonomisuto, called 1995 Japan's year of defeat, as catastrophic in its way as 1945, and inaugurating a financial 'postwar' period.

The opacity and collusiveness of the Japanese system may make it impossible to know where to draw the 'bottom line.' But it is certain that the Japanese banking losses of the 1990s exceed the U.S.'s 'Savings and Loan' disaster of the 1980s by a magnitude of at least four, and their shadow over the entire Japanese economy will not be easily dispelled. The problem is rooted in the extraordinary collective lunacy of the 1980s which saw Japan's land, especially its urban land, inflated to the point where it was said that the real estate value of Tokyo alone was worth three times more on paper than all the land and buildings in America, or the Imperial Palace worth more than California. The nominal value of Japan's land soared from the mid-1980s, more than doubling in value and trebling in the case of commercial land, before commencing its downward slide in 1991. How much the bubble land values have been reduced can only be speculated, as the process still continues, but 1,000 trillion yen would seem to be a conservative estimate.

Inflating with the same sort of fizzy frenzy that fired the land madness, Japan's stock exchange also reached a vertiginous 39,000 yen in December 1989. Then it collapsed, and several hundreds of trillion of yen value was wiped off those assets. Stocks have subsequently slightly recovered, but only to about half of their 1989 peak. Land values know no bottom, and since both stocks and land were used as collateral for borrowing (often to finance further speculative investments) the entire system has been reeling and continues to face unresolved questions of adjustment.

Internationally, a premium has been imposed on all loans to Japanese banks, and the U.S. Federal Reserve has put in place a 'liquidity buffer' in the event of a total collapse of the Japanese financial system. The real threat of 'Armageddon,' in the eyes of the small fraternity of economic specialists who follow these matters, came not from Asahara Shoko and his 'Aum' sect, but from the elite bureaucrats in the Ministry of Finance. They are considered to be the real outlaws, and the cataclysmic possibility of a Japanese financial meltdown continues to be taken very seriously by the Federal Reserve.

The failure of Japanese political and bureaucratic circles to come to grips with their problems is starkly evident from the fact that they have no prescriptions other than massive deficit funding of construction and public works. These are in the tradition of public finance adopted in the early 1970s, which gave rise to the bubble in the first place. Between March 1992 and September 1995, pump priming, or 'expansion of domestic demand,' guided the commitment of vast sums of borrowed public money, to a total of 60 trillion yen. Interest rates were also progressively reduced, to an unprecedented 0.5 percent late in 1995.

The 60 trillion yen debt-funded set of packages came out of the approximately 200 trillion yen of people's savings accumulated in the Postal Savings Fund (the world's largest financial institution). The allocation of such funds is determined by the Ministry of Finance, through what is known as the Fiscal Investment and Loan Program (FILP), sometimes described as the 'Second Budget.' In this way, private savings are doled out on the advice of Ministry of Finance bureaucrats, subject to minimal public scrutiny, to support public works programs, shore up the stock market, provide loans to government bodies, even to refinance other countries' debts. It is, however, borrowed money that must be repaid, eventually, with interest. While close attention has begun to focus on the Ministry of Finance's role in the Jusen scandal, its much larger responsibility remains for the most part unrecognized.

Reliance on deficit financing by 'construction bonds' began in the 1965 fiscal year. Since then, this single-minded concentration on bonds (whether known as 'construction' or 'deficit') as a revenue source for public works, in good times and bad, has become an established feature of Japan's fiscal structure. The national debt remained insignificant until the 1970s, when it began to burgeon under Prime Minister Tanaka's economic expansion policies. It grew still more in the 1980s, when Nakasone relied on private sector policies to create an expansion of domestic demand. This led directly to the bubble itself, but the contribution of the post-bubble, especially the so-called 'reform' governments of the 1990s, has been at least as great. The 60-trillion yen emergency fiscal measures of the Miyazawa, Hosokawa, Hata, and Murayama governments have made Japan's debt problem chronic and apparently irreversible, yet failed in the avowed purpose of stimulating the economy. Whatever Keynesian benefits on the real economy were achieved in the 1970s, they have steadily diminished since then.

If one puts together existing debt, its natural expansion through interest accrual, and known commitments such as the 1994 Japanese government commitment to spend 630 trillion yen on public works within the decade--leaving aside other possible ventures such as moving the entire government to a new capital--the cumulative public debt that Japan can expect as of the year 2005 is 1400 trillion yen, or 11 million yen per head (approximately two years' salary for an average worker). To repay such a sum with interest, by another calculation, would call for every citizen to pay 1.7 million yen per year every year for sixty years. The finances of the 'economic superpower,' boasting of the world's largest surpluses, thus are mired in intractable fiscal sands with the prospect of sinking more deeply into them the more the fiscal engine is 'revved' to try to escape.

For this debt to be repaid smoothly, Japan would have to maintain a steadily upward trajectory of economic growth. However, there are any number of factors that may cause economic stagnation or even decline, including the saturation of the consumer market, the filling-up of places to dump refuse, a drastic decline in the young labor force accompanying the aging of the population, and the rapid hollowing-out of industry due to the appreciation of the yen and loss of competitiveness to neighboring Asian countries. Indeed, it may be that the conditions to implement an 'expansionary equilibrium' such as the Japanese economy used to have no longer exist. Throughout the postwar decades, whether at the household, corporate, or government level, planning was based on the assumption that land prices would go up, but never down; it was in the event an unwarranted assumption.

Kingdom of Concrete

The core of the Japanese economy is not manufacturing, or even services, but construction. In the 'doken kokka' (construction state), money flows through the system guided by the bureaucrats to benefit those who form part of the privileged national grid of politicians, bureaucrats, and business people. These are the circuits of shared interest and advantage that underlie the political economy as a whole and are centered in the 'public works' sector: the building of dams, highways, express rail lines, nuclear power stations, and the concreting of rivers and coastlines.

The 'construction state' complex functions more-or-less as the 'military-industrial complex' in the United States--sucking in the country's wealth, using it inefficiently, and producing mostly junk, indebtedness, and social and environmental devastation. One measure of the transformation of the economy as a whole is the diminishing capacity of such gigantic works, with their accompanying flows of money, to affect it. By the time of the adoption of the 14 trillion yen package of September 1995 (which completed the 60 trillion yen post-bubble 'stimulus' package), the common response was that it amounted, in Robert Feldman's words, to 'a lot of sugar, but not much protein.'

Thanks to this system, Japan's construction activity has grown to a scale unequalled in any other country, employing six million people and eating up around 80 trillion yen per year, about the equivalent of the national budget. Construction investment between 1960 and 1991 amounted to approximately 1,084 trillion yen, of which more than 30 percent, or 360 trillion yen, came from government. In fiscal 1992 alone, a total of 87.5 trillion yen was poured into construction investment. This was more than the United States spent, although the United States has double the Japanese population and 25 times its land area. Converted to investment per head of population, Japanese construction investment amounted to 2.6 that of the U.S. In terms of land area, it was a staggering 32 times that of the United States. The economic structure in which construction investment centered on public works accounts regularly for about 20 per cent of GDP is a truly distinctive, if little noted, feature of the Japanese political economy. Straddling the world as an industrial colossus, at home the Japanese economy is a junkie, hooked on massive infusions of public subsidy to its core industry.

Characteristic of the 'public works' agenda has been a steady flow of projects of sufficiently gargantuan scale to warrant similarly gargantuan outlays of public moneys. The Kyoto University economist, Sawa Takamitsu, compares the process to the construction of Egyptian-style pyramids, more-or-less useless but capable of absorbing resources on a vast scale. The reclamation of huge stretches of the country's coastline--proceeding during the 1980s at the rate of 100 kilometers per year, the dumping of giant 'tetrapot' concrete breakwaters around the remainder, and the straightening out and damming of rivers have been characteristic 'public works.' The massive dam across the Nagara River, built at a cost of about 1.5 trillion yen between 1988 and 1995 (after plans dating back to 1960) is one typical example: the evidence that it was unnecessary, and the fear that it would lead to the death of the last free-flowing river in Honshu, were insufficient to dent the resolve of those with a vested interest in its construction.

During 1995, with Japan still deep in recession and following the catastrophic January Kobe Earthquake, with criminal actions proceeding against corrupt city officials and construction company executives in half a dozen cities, a mood of sobriety and realism became evident in some quarters. It was captured politically by the maverick actor-politician Aoshima Yukio, who was elected governor of Tokyo in April 1995 and promptly shocked the 'construction state' lobby by cancelling the projected 'World City Exposition--Tokyo 1996.' Instead of the grandiose plans for new frontiers of reclamation and high-rise development to envelop Tokyo Bay, he talked of creating a forest or a park.

But such a mood was short-lived. The forces of the 'construction state' are nothing if not resilient. Events in both Tokyo and Kobe, which might have been expected to weaken them, were actually quickly turned to their advantage. The devastation of Kobe--where the collapse of buildings, bridges, and highways might have been expected to discredit both the industry and the city authorities who had sacrificed safety and welfare to growth--instead provided a springboard for massive expansion. Not only the opportunity to rebuild Kobe, but a new effort to reinforce bridges, tunnels, and railways throughout the country will bolster public works budgets well into the next millennium. Significant, too, in the planned reconstruction of Kobe is a new Kobe Airport, to be built on an off-shore artificial island, a few kilometers across Osaka Bay from the just completed and already vastly uneconomic Kansai (Osaka) Airport.

As for Tokyo, the brief reverse marked by the sudden cancellation of the 1996 'Expo' was followed within a matter of months by a truly mind-boggling new venture: the idea of actually shifting the capital. While over 30 million people currently live in the megalopolis of Tokyo, experts warn that sooner or later it is bound to be devastated by either an earthquake (as last happened in 1923) or a northward-facing eruption of Mt. Fuji (as last occurred in 1707). Historical precedents also indicate that since the late 8th century Japan has shifted its 'national' capital at about 400 year intervals. So the time was judged to be ripe for another 'big move.' 'Relocation of the capital' had been the subject of desultory discussion for over a decade or so, but in December 1995 a special Diet committee to investigate the matter recommended launching a search for an appropriate site, which should be chosen before the end of the century so that the transfer could be accomplished by the year 2010. The prospect of a Japanese 'Brasilia,' 'Washington D.C.,' 'Islamabad, or 'Canberra'-type project was sufficient to galvanize rival candidate sites, and to excite those anticipating another massive real estate and development bonanza.

Perhaps Tokyo is nearing its limits, but the remedy that is being considered--a city to accommodate a population of 600,000 on a site with a minimum of 2,000 hectares (around 9,000 when all related facilities are taken into consideration) within a radius of between 60 and 300 kilometers of the existing capital--suggests that Tokyo's capital functions would only very slowly, if ever, be displaced. The important thing, however, is that even the initial estimate of basic costs has been put at around 14 trillion yen. If railway, port, airport, and other costs were added, that figure could easily be expected to double or treble. Even if a new capital never emerges, reactions to the project are such as to suggest that it would provide sustenance to the beneficiaries of the 'construction state' for a long time to come. And the society-wide framework of assumptions and values upon which the system has long rested will thus survive intact the countless scandals rooted in it.

Hashimoto and Ozawa, the two political leaders who confront each other in 1996, are rival heirs to the corrupt Tanaka-Takeshita core of the old LDP, which bears the greatest responsibility for the construction-led expansion and the fiscal irresponsibility that created the present crisis. They, as much as anyone, inflated the bubble, and nothing so far indicates that their thinking has radically changed. Ozawa, indeed, has turned his own electoral base of Iwate into a veritable mini-'construction state.'

Dissipation, 1930s and 1990s

Japan is responsible for the world's greatest savings, but it is also the world's most profligate dissipater of its people's savings. The deflation that followed the extraordinary bout of debt-induced inflation of the 1980s will not be solved by returning to the strategies that created the problem in the first place: namely, more debt. Sooner or later, fiscal limits will assert themselves. The inequity implicit in passing on the debts of this generation to a generation yet unborn, 'snowballing' them as they go, will become a public issue of the first order, dwarfing the relatively small, if symptomatic, matter of the Jusen.

Regardless of whether outright bankruptcy or the adoption of drastic fiscal, economic, and industrial structural reforms follow, all will involve potentially serious social consequences in Japan. Together with the global shock waves that will accompany a withdrawal of Japanese capital from around the world, it is certain that Japan's 'after-bubble' will have continuing global, disruptive consequences.

One of the better, if not the best, of Japan's 20th century Finance Ministers was Takahashi Korekiyo. After struggling in the mid-1930s to hold in check deficit-financed military expansion, he was assassinated in February 1936. His death ushered in Japan's era of unrestricted war-fueled growth that was liquidated, along with the savings of his generation, only in the collapse of 1945. The real underlying issue Japan faces today is the same fiscal one that Takahashi failed to resolve in 1936. Then it was the forces of military expansion. Today it is the forces of Japan's construction state--together with their political, fiscal and banking supports--that threaten not only the accumulated savings of post-war generations but also the entire global system with which Japan is now so finely enmeshed.

Despite the uninterrupted glitter of Japan's contemporary prosperity, the 'losses' contingent upon the collapse of the bubble are comparable in financial terms to those of fifty years ago caused by war and defeat. About one quarter of the nation's wealth was destroyed in the war. In the 1990s, although nothing has been physically destroyed, in financial terms the devastation is comparable.

[1]. Moody's (newly adopted) ratings of A to E designate respectively excellent, strong, good, weak, and extremely weak countries. No country got an 'A' rating, and the U.S., Australia, France, and Germany were all listed as C+.

GAVAN McCORMACK is Professor of Japanese History in the Research School of Pacific & Asian Studies of the Australian National University, Canberra. He has written a dozen books on aspects of modern Japanese, Korean, and Chinese history, including Chang Tso-lin in Northeast China, 1911-1928 and The Japanese Trajectory: Modernization and Beyond (edited with Yoshio Sugimoto). His latest book is The Emptiness of Japanese Affluence (M.E. Sharpe, 1996), an excerpt from which, "Paving Over the Kansai," appeared in JPRI Occasional Paper No. 1 (November 1994).

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