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How to Reshape Post-Crisis Japan

Authors: Brian P. Klein, Former International Affairs Fellow in Japan, Sponsored by Hitachi, Ltd., and David S. Abraham, International Affairs Fellow in Japan, Sponsored by Hitachi, Ltd. 2010-2011
April 13, 2011

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†It may be difficult to imagine a Japan out of crisis. Substantial aftershocks still shake the country; several hundred thousand affected people will take years to get back their livelihoods; and the discovery of further radiation effects from an unstable nuclear plant raise the specter of long-term environmental, health, and safety issues.

Yet recovery is underway. Business expectations are slowly reverting to pre-quake levels and the Nikkei 225 stock index has gained 12 percent after having fallen 18.5 percent on the initial overreaction to events in March. Many economists estimate the quake will impact growth by less than half a percent of GDP, dropping to slightly less than 1 percent for 2011. And although it is of little solace to those 163,000 people living in shelters, it is roughly half as many people who were rendered homeless during the Kobe earthquake in 1995.

It is imperative that any recovery plan do more than just rebuild. Japan is the world's third-largest economy and a major source for high precision technological products. Many countries rely on a secure and robust Japan feeding into the global supply chain.

An effective policy would focus on short-term humanitarian needs as well as foster economic growth and address vulnerabilities, including the future threat of natural disasters, inefficient allocation of capital, and a coddled agriculture sector that has stymied trade liberalization policy. Although much work needs to be done, it is important for the government to address at least four areas to lift the country out of twenty years of economic malaise and provide new development opportunities.

1. Improving Energy Policies

Japan's energy focus has been on developing multiple sources of power generation and boosting import security. Less attention has been paid to its distribution network. For example, to move electricity from southern Japan to Tokyo, where limited supplies have led to rationing, power must be converted from 50 Hertz to 60 Hertz. This costly anomaly of separate regional grids is the result of rivalries between power companies and the lack of a unifying national policy. Power cannot be transported from one zone to another unless converted by facilities that are very expensive to build. Present conversion capability at just one gigawatt (representing 12 percent of Fukushima Daiichi output) falls far short of demand. Harmonizing northern and southern electric grids on the same cycle so that energy can be directed to where it is needed will help protect against power failures.

The significant drop in northern electricity supply, however, will not be short lived. Corrosive sea water used to cool the reactors has made them unusable for electricity generation and at least four of Daiichi's six reactors are permanently out of commission. A shortfall of twelve gigawatts, or roughly 20 percent for northern Japan, which includes the Tokyo metropolitan area of thirty million people, is predicted by the summer. This will limit air conditioning and electricity usage during peak hours while forcing manufacturers to alter their production methods to maximize limited power.

An effective policy would focus on short-term humanitarian needs as well as foster economic growth and address vulnerabilities, including the future threat of natural disasters, inefficient allocation of capital, and a coddled agriculture sector.

Japan's "cool biz" program, which encourages companies to limit air conditioning by keeping summertime office temperatures at 82 degrees Fahrenheit, has shown a government campaign can help reduce demand at the margin. Although general energy use per capita in Japan is far lower than many advanced industrialized countries, in part due to lower energy-consuming appliances, per capita energy use still increased 25 percent from 1987-2007.

Sustained changes in business culture can help. Workers should be encouraged to leave the office when their work is finished rather than staying late to placate superiors. A campaign to turn off lights and computers by 7 p.m., along with more flexible work and production hours to spread out energy demand, would help reduce power consumption. Over the mid- to long-term, the government should strengthen building codes to increase energy conservation in the residential and commercial sector, which makes up over 25 percent of total Japanese energy consumption.

2. Focusing on small and medium-sized enterprises

Japan's financial system historically has skewed toward bank lending to big business at the expense of entrepreneurs and small to medium-sized enterprises, the largest source of job creation. Many small business owners and entrepreneurs must rely on personal savings to fund their companies or bring new ideas to market.

Last week, after rightly fighting off calls by some in government for the Bank of Japan to underwrite the debt by buying government reconstruction bonds, the bank announced a modest package of $12 billion in loans to lenders in the region. This comes two weeks after the government announced it would extend loan guarantees for some small and medium-sized businesses. These moves will provide some support, but authorities will need to ensure that as regional lenders' loan portfolios deteriorate, funds actually get to businesses in need until they regain footing. However, over the long term, the government should also work with the financial sector to use any loan program as the basis for a more sustained effort to target funds to small and medium-sized businesses.

But loans are not the only way businesses access funds. The government should use the crisis to encourage both foreign and domestic private capital to smaller and medium-sized firms more broadly to reduce the sector's reliance on loans.

3. Deemphasizing Tokyo as Economic Hub

Although the Tohoku magnitude 9.0 quake was the fourth biggest ever recorded, this was not "the big one" Japan had been expecting. Seismologists have long predicted that the capital will be hit by the Tokai, a recurring quake southwest of the capital. By some estimates, pressure to geological plates that might lead to this devastating quake has increased as a result of the recent catastrophe. This looming threat should give policymakers the impetus to reverse the growing trend of dependence on Tokyo as the country's economic center.

Managing the current disaster response in a region with roughly 6-7 percent of the country's population and GDP has been a significant challenge. A quake closer to the city of Tokyo, which contributes roughly 16 percent to the country's GDP and is where government and business decisions are made, would be devastating to Japan, and slow the global economy.

Government relocation has been considered for decades. Tokyo needs to spur decentralization efforts, providing local governments with greater fiscal autonomy. Such a move could lead to a more responsive government, especially in a time of crisis, and provide jobs in local areas.

The private sector should be encouraged to follow its lead. Government policies have allowed cities at severe risk to earthquakes grow both in size and population. For example, Odaiba, literally built on reclaimed land in Tokyo Bay for commercial use, is exceptionally susceptible to effects from earthquakes. The development of business centers outside of major cities can be encouraged based on Japan's already extensive, although underutilized, high-speed railway system.

4. Agricultural Sector Reform

Finally, it is time for Japan to reform its agricultural sector and join the free trade bandwagon. Japanese farmers, shielded from lower-cost imports by high tariffs, produce some of the world's highest quality, albeit expensive, produce. Japan has been slow to address this inefficient sector due to a small, but politically powerful agricultural community, and a population timid about food quality and safety concerns of imported foods. Now domestic food safety concerns are limiting some supplies, and raising prices, while radiation fears reduce demand and cost for others, like fish. These market disruptions should force a change in Japan's agriculture policy, which would bring about several benefits.

First, an agriculture plan that lowers import barriers would increase the supply and reduce the price of foods, putting pressure on farmers to be more efficient. This would lead some of the farmers, whose average age is in the mid-sixties, to retire, but would also lead to a sector focusing on higher-grade exports such as Wagyu beef.

Second, cutting tariffs--long a stumbling block for Japan to enter economic partnerships--would allow the country to enter more trade deals, spurring economic growth by increasing the size of the export markets and facilitating cross-border investment.

Finally, a new plan could be part of a multi-pronged strategy to show its citizens and neighbors its food is safe especially in markets such as India, China, and South Korea, where some Japanese food exports are being banned. New clear policies on food safety and monitoring could also ward off other countries unnecessarily continuing this trend.

No doubt Japan has one of the largest tasks of any government over the past fifty years: to restore the devastated country after a tragedy costing tens of thousands of lives and roughly $300 billion in damage. This crisis may tempt officials to focus on restoring business as usual quickly, but reshaping the economy rather than simply rebuilding will leave Japan far better off.

Brian P. Klein, an international economist and consultant, was a 2008-2009 CFR International Affairs Fellow based in Tokyo and a former U.S. diplomat.

David S. Abraham is a current CFR International Affairs Fellow based in Tokyo.

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