Challenges and Prescriptions for the Japanese Economy from the Perspective of Balance of Payments: Insights from the July 2024 Expert Panel Report Hosted by the Ministry of Finance

長年停滞し続けている日本の経済は正念場を迎えています。2024/7/2に実施された財務官主催の経済専門家懇談会報告書に提言された記述内容（財務省HPにて和文公開）がよくまとまっていますので英語で紹介します。

Introduction

Japan’s current account balance has consistently recorded a surplus, with the surplus for fiscal year 2023 reaching an all-time high. Additionally, Japan’s net external assets at the end of 2023 amounted to a record 471 trillion yen, making it the world’s largest net creditor nation for 33 consecutive years.

While Japan’s position appears solid from the perspective of its balance of payments, a detailed analysis reveals a less optimistic picture. For example:

• When broken down by category, only the primary income balance shows a surplus, while the trade balance remains in deficit and the service balance sees widening deficits in advanced areas such as the digital sector.
• Although the primary income balance has reached an all-time high, a significant portion of this income is reinvested abroad rather than being repatriated to Japan.
• Regarding the financial account, inward direct investment remains remarkably low by international standards. Moreover, influenced by the new NISA, Japanese households are increasingly investing in foreign assets such as foreign stocks.
• According to forecasts from major think tanks, the current account surplus is expected to shrink or even turn into a deficit in the future as the population continues to age and shrink.

The balance of payments encapsulates the structure of the Japanese economy, and these trends highlight the structural challenges it faces. Neglecting necessary reforms could exacerbate the situation, whereas tackling these challenges head-on offers significant potential for improvement. By addressing these issues, Japan can regain its competitiveness in the global market and build a richer, more sustainable society.

Issues:

1. Decline in International Competitiveness of Export Industries, Expansion of Digital Deficit, and Outflow of Personal Financial Assets Abroad
2. Industrial Hollowing Out and Significant Stagnation of Domestic Investment Compared to Foreign Direct Investment
3. Dependence on Imported Fossil Fuels
4. Lack of Preparation for Further Interest Rate Increases

Solutions

(1) Enhancing Productivity through Promotion of Renewal and Facilitation of Labor Mobility

Currently, positive trends such as high-level wage increases and active capital investments are observed. On the other hand, reviewing the 30-year trajectory of the Japanese economy since the bubble burst, we see that policies focusing on protecting existing jobs and companies for the sake of social stability have been long implemented. This has resulted in capital and labor being stuck in low-productivity sectors, causing stagnation in wage growth and capital enhancement. Consequently, even as global economies have transformed and expanded significantly due to technological innovations and the rise of emerging markets, Japan’s wages, capital stock, and economic scale have remained mostly flat, leading to a continuous decline in Japan’s international competitiveness and a dramatic fall in its share of the global economy (1994: 17.8%, 2023: 4.0%).

Looking ahead, it is expected that low-profit, low-wage companies that have been preserved despite not being able to sustain themselves will increase their exits due to rising interest rates and wages. While providing appropriate safety nets for vulnerable individuals is a crucial role of the state, policies aiming to maintain the status quo should not be adopted. Instead, it is essential to promote corporate competition through regulatory reforms, thereby stimulating renewal, and to facilitate labor mobility to growth sectors through neutral institutional design concerning job changes. Additionally, raising the currently low minimum wage compared to other countries not only contributes to wage increases but also promotes labor movement to more productive, high-wage-paying companies.

Internationally, it has been confirmed that countries with fluid labor markets tend to have higher productivity and wages. A notable recent example is the United States, where temporary unemployment surged during the COVID-19 pandemic, but this served as a catalyst for active labor movement to growth sectors, resulting in increased productivity and wages. Furthermore, a fluid labor market provides workers with numerous employment opportunities, making it desirable to facilitate labor mobility for individuals to achieve optimal careers.

As Japan faces a declining working-age population, it is indispensable to enhance labor productivity and increase the added value per capita through these efforts to achieve sustainable economic growth. Moreover, enhancing the attractiveness of Japanese companies as investment targets through these measures and corporate governance reforms could lead to increased domestic and foreign investment, including through the new NISA.

(2) Investment in Human Capital, Technology Development, and Utilization

To regain international competitiveness in advanced and high-value-added sectors such as AI and digital technologies, in addition to the aforementioned facilitation of resource movement, it is also crucial to promote investment in human capital and technology development and utilization.

From this perspective, it is necessary to promote capacity-building support through reskilling and, in higher education and research institutions, to eliminate barriers and allocate resources to high-risk areas, including new and interdisciplinary fields, while strongly supporting innovative research by young researchers. Naturally, strengthening basic research, which serves as the foundation for future development, is also important.

The development and utilization of technology are essential for Japan to break away from dependence on fossil fuels. Specifically, it is an urgent task to effectively utilize existing technologies to expand renewable energy and restart nuclear power plants with safety as a paramount consideration. According to estimates by a private think tank, the reduction in energy imports due to nuclear power plant operations could reach 4.7 trillion yen in coal equivalent, surpassing the 2023 trade deficit of 3.6 trillion yen. This indicates the significant impact of nuclear power utilization on the balance of payments.

Additionally, it is necessary to promote the replacement of current reactors with next-generation innovative reactors incorporating new safety mechanisms, as well as innovative technologies such as nuclear fusion and superconducting power transmission.

These energy issues are not only crucial for the balance of trade but also for domestic investment and inward direct investment, which will be discussed next. Semiconductor factories and AI-oriented data centers have extremely high power demands. Therefore, ensuring a stable and affordable power supply is indispensable for promoting investment in these strategic areas.

Regarding the “digital deficit” mentioned earlier, Japan is expected to foster domestic digital platforms utilizing its own technologies. However, considering the short-term feasibility, it is essential to create high-value-added products and services while leveraging digital services from overseas operators, thereby enhancing the competitiveness of Japan’s overall industry.

(3) Promoting Domestic Investment and Inward Direct Investment

The fundamental reason for the stagnation of investment within Japan, whether it be capital investment by Japanese companies or inward direct investment by foreign companies, is the perception that the expected return on investment within Japan is low. Therefore, to promote investment, it is essential to steadily implement the reforms pointed out in and above to raise the expected growth rate.

Moreover, if the current trend of wage increases continues, the introduction of capital such as machinery and equipment will become cheaper relative to labor input, inducing capital investment. Increased capital investment, in turn, raises the capital equipment ratio, which improves labor productivity and leads to further wage increases, creating a “virtuous cycle of wage increases and capital investment.”

For inward direct investment, as mentioned earlier, the current situation presents an opportunity, and to capitalize on this, it is crucial to improve the domestic business environment through measures and regulatory easing mentioned so far, cultivate global talent, and promote organizational diversity, including the utilization of highly skilled foreign talent and gender diversity.

Growth sectors are generated and developed through risky investments by individual companies. The government, with only incomplete information, identifying growth sectors and guiding investment through subsidies poses risks of moral hazard and rent-seeking and should be approached with caution. In strategic areas such as semiconductors, given the substantial subsidies provided by other countries, some level of support may be justified. However, moving forward, it is essential to strengthen international efforts to ensure fair competition conditions among nations.

In the field of corporate taxation, to avoid the “race to the bottom” among nations, the OECD/G20 “Inclusive Framework on BEPS” has reached an international agreement on global minimum tax (a system to impose a minimum tax rate of 15% on multinational enterprises). Such initiatives serve as a good precedent for considering international cooperation to ensure fair competition conditions related to subsidies.

(4) Fiscal Consolidation

Currently, long-term interest rates are on an upward trend, and given the aforementioned domestic and international factors, interest rates may rise further in the future. In preparation for such situations, it is urgent to strengthen fiscal resilience.

Japan’s government bond rating by major rating agencies is A to A+, which, excluding Italy, is the lowest among the G7 countries and is approximately the same level as China, slightly below South Korea and Taiwan among East Asian countries. While ratings are currently considered “stable” and immediate downgrades are not expected, it is known that once downgrades begin, the process can be swift, as observed in other countries facing fiscal crises.

Should Japanese government bonds be further downgraded, the impact would not be limited to direct effects on fiscal through rising interest rates. Government bonds are used as collateral when financial institutions raise foreign currency and their ratings also affect the ratings of private companies, meaning downgrades of Japanese government bonds could adversely affect private capital raising costs as well.

In addition, considering Japan’s future prospects of increasing aging population, the need to secure fiscal leeway to prepare for natural disasters and changes in the security environment, it is imperative to swiftly work on constructing a sustainable fiscal structure through rationalizing and enhancing efficiency in spending and social security reforms, ensuring market confidence in fiscal management.

When reviewing expenditures, it is crucial to implement “wise spending,” shifting fiscal resources to projects that yield results, and maximizing private sector vitality.