The structural problems facing the Japanese economy-the so-called "hollowing out" of industry, fears of further deflation, the NPL problem, etc-can be resolved by means of a correction of the economy's high-cost structure, in our view. This high-cost structure, which stems from Japanese companies' low productivity, is speeding up the hollowing-out of industry and reducing the competitiveness of the economy as a whole. The increase in cheap imports from overseas is also adding to fears of further deflation in Japan. We think a radical solution to the economy's structural problems will be difficult to achieve unless the high-cost structure is corrected.

A key element of Japan's high-cost structure is the extremely high price, relative to other countries, of the services used by manufacturing companies. In our opinion, this high-cost structure cannot be corrected without an improvement in the productivity of inefficient areas, of which there are many within Japan's nonmanufacturing industry, by means of further deregulation and privatization, and also by making more efficient use of human resources. As well as lowering input costs and leading to a revitalization of manufacturing industry in the form of increased capital investment, including R & D investment, this should also reduce the gap between prices in Japan and overseas and limit any further hollowing-out of industry.

It could be argued that the disposal of NPLs, many of which are loans to nonmanufacturing companies, is a means of half-forcing inefficient companies to become more efficient. If, in an extreme scenario, all the 43 trillion worth of loans disclosed under the Financial Reconstruction Law are disposed of in one go, this would push the unemployment rate up to 7% and result in negative economic growth. If, however, at the same time, the government implements measures aimed at stimulating consumer spending, which we have been recommending for some time, and also carries out further deregulation and privatization in close collaboration with the fiscal and monetary authorities, then the country should be able in four or five years' time to achieve higher real economic growth than would be the case with little progress being made in improving efficiency.

Another cause for concern regarding the outlook for the Japanese economy is the country's aging population and low birth rate. If, however, the necessary steps are taken, such as the provision of daycare centres for young children, and women are therefore able to play a more active role in the labor market, it should be possible to maintain the size of the labor force at current levels for at least the next 20 years. If the labor force is thus preserved, and companies are revitalized by means of a correction of the high-cost structure, this should make technical innovations easier, and Japan's potential growth rate might even rise as a result of improving total factor productivity. If the social infrastructure required to cope with an aging population is put in place, and the government maintains fiscal restraint by decentralizing power, privatizing state industries, and employing practices such as work-sharing, the Japanese economy should once again be able to achieve sustainable growth.

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Inquires to: Economic Research Department, Nomura Research Institute
Telephone. 81-3-5255-1800

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