More Bang For the Yen?

Japan's financial reforms are more cosmetic than real.

Michael J. Oakes from the April 1998 issue

(Page 2 of 2)

Though clearly good, these reforms by themselves are not good enough. Certainly, they are not worthy of the "Big Bang" label and do not constitute the kind of wholesale reform needed to modernize the financial industry. They consist of a gradual and "organic" reform process, according to Alicia Ogawa, managing director and head of equity research at Salomon Brothers Asia Ltd. At a forum in Tokyo last summer, Ogawa noted the drawn-out pace of the reforms and suggested that the phrase "Long Bang" is more accurate. Akio Mikuni, president of an independent bond rating agency in Tokyo, called the reforms "mostly cosmetic policy changes dished up largely for the purpose of mollifying Japan's trading partners."

How is eliminating fixed commissions and removing barriers between industries just "cosmetic"? Because critical, older game rules, responsible for shaping the current system, haven't been touched.

Taxes, for instance. Japanese haven't accumulated large savings merely because of cultural preferences. The tax system encourages savings and discourages participation by individuals in stock and bond markets. (Dividends are double-taxed, while interest income is taxed at a flat 20 percent.) Tax treatment for corporate ownership of stock encourages stock holding. Companies can use unrealized gains or losses to their advantage on balance sheets, while capital gains on sale of stock are taxed at an effective corporate income tax rate of almost 50 percent.

The tax structure, however, remains untouched by reform. So do accounting practices designed primarily for Ministry of Finance controls and not for public disclosure. In fact, most firms don't even regularly issue detailed reports to the public. The MOF gets the details and releases its own reports weeks later. Firms issue summarized versions to shareholders and prospective investors.

Without a tax system which at least treats savings and investment more evenly, and without meaningful public financial reporting, even aggressive companies like Merrill Lynch may find it difficult to either attract new customers or adequately evaluate the health of the firms in which those customers might invest.

But these are small matters compared to the impact on the financial industry of [yen]230 trillion ($1.8 trillion) held in postal savings accounts run by the government and untouched by any deregulation. One-third of Japan's total savings is thus under government control. These funds, together with an additional [yen]100 trillion ($800 billion) from postal insurance contracts, are managed by the Ministry of Finance. Special tax treatment--it's the government post office, so there are no taxes paid on those revenues--give postal savings accounts higher interest rates and a clear advantage compared to banks.

Then there is the finance ministry itself. MOF officials establish financial policy, license financial institutions, and supervise their performance. Until recently, the ministry ran the Bank of Japan too (and many believe it still will, though more indirectly, under a revised law). As the financial reporting practices illustrate, institutional management systems are designed with MOF control in mind. Revealing serious problems with banks, brokerages, or insurance firms is, in practice, the same as revealing bad news about the MOF itself. No wonder that, as the end of the decade approaches, there is still little accounting of the bad loans stemming from the crash of the bubble economy in 1991.

While the supervision of institutions will later be folded into a new agency reporting directly to the prime minister's office, no one believes the MOF has given up its control of financial markets. Staffers at the new agency, for example, will come from the MOF. Critical decisions will be a collaborative effort between the finance minister and the head of the agency. But the MOF controls the agency's budget.

None of this is especially surprising. The Big Bang is a political initiative. Prime Minister Ryutaro Hashimoto announced it in late 1996 as one of six areas of reform to which his administration had dedicated itself. Reform proved a popular theme in that year's national campaign.

A year and a half later, the final shape of the Big Bang proposals reflects their political roots. The reforms opening up banks and securities markets to greater competition targeted two industries politically weakened by scandals and a massive public bailout of failed housing loan corporations. But as the proposals targeted areas with more political clout, they were either delayed or dismissed altogether. Threatened with having their well-protected industry opened to bankers and stock brokers, insurance industry leaders pressed their case to ruling Liberal Democratic Party members receiving considerable financial support from the industry. Any significant move to spur more competition in insurance was delayed until fiscal 2001.

Postal services employ 300,000 people eager to work for LDP candidates during elections and fund-raising events. Their objections to privatizing postal operations gained support from several party members. Thus, there's not even a tiny bang for postal savings and postal insurance. These funds are scheduled to be transferred to a special government corporation in 2003. But that's just shifting them around the bureaucratic table.

Political influence may even yield some unexpected benefits. Evolving scandals, which led to the recent arrests of MOF officials and the subsequent resignation of the finance minister, are eroding the ministry's ability to shape details of the reforms to suit its purposes.

It's still common for observers of Japan to speak of a unique governing system, one that rather mysteriously lacks input from its large, free electorate. Of course Japan is different, as all countries have unique characteristics. But the financial reform process suggests Japan's system is not unrecognizable. Special interests, including middle-class savers (who wanted hands kept off their privileged postal savings accounts), applied as much pressure as they could to preserve their protections and handouts. Japan's government responded in essentially the same way other modern democracies would.

Think of the half dozen or so "reforms" of the American Social Security system in the past 20 years. Think of the Contract with America. You'll see Japan's Big Bang picture clearly enough.