Column

Japanese Economy Update

By Jun Saito
Senior Research Fellow
Japan Center for Economic Research


What OECD and IMF recommend to Japan


(September 4, 2017)

Recently published reports by the two international organizations

International organizations periodically publish how they see the Japanese economy and what they recommend the country to do. For instance, the Organization for Economic Cooperation and Development (OECD) publishes Economic Survey of Japan every two years, and the International Monetary Fund (IMF) publishes Staff Report for the Article IV Consultation every year. To know their views should be beneficial in designing the economic policies that Japan should pursue.

This year saw the two reports published before summer: the OECD Economic Survey was published in April and the IMF Staff Report in July. They have much in common, but there are also differences in perspectives and emphasis. In this month's column, the policy recommendations provided by the two reports will be taken up.

Recommendations common to the two reports

Based on orthodox economic analysis of the Japanese economy, the two reports have much in common with regards their recommendation on the Japanese economic policies.

First, both OECD and IMF support the current monetary policy stance and suggests that the monetary easing be sustained until the inflation rate reaches the 2 percent target.

They both note that bold initiatives have been taken by the Bank of Japan (BOJ) since 2013 and their positive impacts on the economy. However, they also acknowledge that the progress in achieving the inflation target has been slower than expected.

They also recognize that there are risks in pursuing such unconventional policy. The risks are identified in such areas as; profitability of financial institutions; excess pricing of real and financial assets; and dominance of the central bank in asset markets.

Second, both organizations emphasize the importance of fiscal consolidation in order to bring the government debt to GDP ratio under control.

More specifically, they agree in the need to engage in gradual implementation of consolidation measures that would be consistent with sustained economic growth: OECD proposes to reduce primary balance by 3/4 percent every year; and IMF proposes to consolidate the structural primary balance by 0.5 percent on average over the medium-term.

As for the consolidation measures on the revenue side, OECD recommends, together with other measures, to raise the consumption tax rate by 1 percentage point every year. Similarly, IMF advocates consumption tax rate hikes of 0.5-1.0 percentage points in regular intervals, among others.

On the expenditure side, both emphasizes the need to contain the growth of social security expenditures. The focus is in health-care and ling-term care expenditures. OECD argues for: more use of generics; a shift from fee-for-service to a pay-for-performance approach; an increase in out-of-pocket payments; reducing the number of hospital beds; and taking long-term care out of hospitals. IMF, on the other hand, argues for the strengthening of the role of prefectures in macro- and micro-level reforms of the health-care system, and for the introduction of multiple copayment rates in order to control the demand-side.

Third, they both emphasize the need to accelerate structural reforms when the economic conditions are favorable. The main aim of structural reform is considered to be in increasing productivity that is low in levels and slow in rising.

The areas that should be addressed by strengthened reform efforts include; reforming the labor market so as to reduce duality, increase mobility, and enhance labor supply; deregulating product and service market; promoting entrepreneurship and firm creation; improving innovation framework; upgrading human capital: strengthening small and medium-sized enterprises (SMEs); strengthening corporate governance; and encouraging free trade agreements and FDI inflows.

For example, with regards labor market reform, both institutions agree that "equal pay for equal work" is important and should be further promoted. However, OECD consider it to be difficult to achieve without eliminating the factors underpinning dualism (needs to cut labor costs and enhance employment flexibility), while IMF proposes to introduce job descriptions to facilitate such initiative.

The also agree that reducing employment protection of regular workers and expanding that of the non-regular workers are essential in addressing labor market duality. In this connection, OECD argues for a wider coverage of social insurance coverage and training for non-regular workers, while IMF suggests that clarification of legal framework for "intermediate" contracts is important in this respect.

Different recommendations by the organizations

While the two international organizations are in broad agreement with regards the direction of policy initiatives that the Japanese authorities should follow, there are also difference. The difference in recommendation partly comes from the difference in the perspectives of the two institutions, but it also reflects the difference in their time horizons.

First, there are differences in the range of policies the two institutions cover.

Since IMF is essentially an institution whose responsibility lies in overseeing the stability and soundness of the international financial situation, their recommendation covers areas such as financial sector stability and external balance sustainability. More specifically, they draw attention to the risks in the financial sector that is created as a result of low interest rate policy and aging and shrinking of the population; and the implication of possible inward spillovers from rise in protectionism and exchange rate developments.

In comparison, OECD is involved in issues related to the quality of economic growth and development. For instance, it approaches fiscal consolidation and productivity issues from the point of view of their implication on inequality: They discuss the ways to achieve fiscal consolidation and increase in productivity that are consistent with inclusive growth. Consequently, they include in their recommendations such measures as the introduction of earned income tax credit. In addition, their policy recommendation covers promotion of green growth by relying more on environmentally-related taxes, among others.

Second, there are differences in their emphasis of short-term and medium-term policies.

OECD does not have immediate responsibility over the short-term management of macroeconomic policies, and is, therefore, more focused on medium- to long-term issues. Therefore, there are only relatively limited discussion on the short-term economic issues.

On the other hand, IMF are more committed to the short-term economic performance and macroeconomic policy management. In particular, recent interest is focused on the limited increase in wages and the ways to make wages more responsive to tighter labor market. The interest has led the institution to advocate, last year, the introduction of incomes policy to Japan.

This year's Staff Report includes a list of measure that should form part of the recommended incomes policy. They include; minimum wage increase; expanding tax incentives for wage growth, and increasing public wages.

Recommendations as important inputs to policy making

There are similarities and differences between the recommendations put forward by the two international organizations. But whatever the recommendations may happen to be, they are policy recommendations based on thorough analyses of the Japanese economic situation, making use of the rich resources that the organizations have.

The Japanese authorities, of course, do not have to accept their recommendations because Japan is not borrowing any resources from any of the IMF facilities, for instance. And it is also natural that the authorities have different views about the recommendations, especially when political economy factors need to be taken into consideration.

Nevertheless, the reports can be regarded as important inputs for future policy making. The authorities should welcome any useful inputs in designing and pursuing the best available policies that opens up a brighter future for the Japanese economy.

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Jun Saito is a Senior Research Fellow in Japan Center for Economic Research (JCER).
After receiving Bachelor and Master of Economics degrees from the University of Tokyo, he joined the Economic Planning Agency in 1978. He held a number of senior positions in the Government before serving as the Director-General of the Cabinet Office's Economic Research Bureau between 2007 and 2012. He also has spent some time outside the Government; studying at the University of Oxford, and working as economists in the International Monetary Fund (IMF) and the JCER. He is currently a Visiting Professor at the International Christian University (ICU), and also teaches at Aoyama Gakuin, Keio, and Tokyo Universities. He assumed the current position at the JCER in 2012.



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