CIAO DATE: 1/00

The Road To Public Deficit:A Comparative Institutional Analysis Of Post–War Japanese And German Economic Policy

Kenji Hirashima

Working Paper
October 1999

The Cornell University Institute for European Studies

 

© Kenji Hirashima, October 1999. This paper should not be reproduced in whole or in part without the prior permission of the author. All papers published are exact reproductions of the author’s text.

 

Acknowledgements

This paper is a product of my project, which started with my research stay at the Max– Planck–Institut fuer Gesellschaftsforschung in Cologne. I am grateful to the two directors, Fritz W. Scharpf and Wolfgang Streeck for generously giving me financial support and permitting me to share the stimulating academic environment there. Subsequently, the Cornell University East Asia Program offered me an ideal place for framing and writing the project. Research grants from the Japan Foundation and the Matsushita International Foundation made my stay in Ithaca possible. On earlier drafts of the paper, I received extremely helpful comments from Peter J. Katzenstein and Gerhard Lehmbruch. I am also indebted to Lisa Sansoucy for her careful editing.

 

Introduction

Facing the challenge of economic globalization, advanced countries are commonly under pressure to open up their national markets and to reduce the size of their governments. Even the smaller European countries that have developed social democratic arrangements seem incapable of maintaining their Keynesian macroeconomic policies. Market–oriented policies are favored over public spending programs, which could enhance inflationary pressures and trigger capital outflows. Thus, after the Reagan administration and the Thatcher government had taken the lead in making government smaller in the nineteen–eighties, most of the European Union(EU) member states followed suit and recently succeeded in containing their national deficits below sixty percent of Gross Domestic Product(GDP) in order to fulfill conditions for the currency union membership.

Above all, Germany has also finally managed to override the onvergence criteria as the prime mover towards an ever–closer union. Germany achievement was all the more remarkable, as a huge amount of public borrowing had become unavoidable in the wake of the unification.

After a series of economic measures had left an enormous amount of public deficit in this decade, Japan also resumed targeting its deficit level to the same degree, stipulating the middle range structural reform of public finance. Nevertheless, apparently because of additional measures to boost the economy and bail out financial institutions, the public deficit continues to accumulate, almost to the point where it has surpassed Japan entire GDP. The Fiscal Structural Reform Law has thus been suspended.

Unique problems for the Japanese national economy, or external pressures from other advanced countries of the G–7, and especially U.S. as the predominant trade partner, may have significantly influenced Japan responses. Yet, as will be argued below, Japan persistent policy patterns lead one to expect it is rather Japan unique institutional structure that conditions its responses. As Hall has demonstrated in the British and the French cases, what a government can do in the economic sphere is significantly constrained by the way state intervention has been structured in the past. ₁   Or, even what a government will prefer to do might be profoundly rooted in institutions. Drawing on these insights, this study addresses the questions of why Japan has come to face a huge amount of public deficit, and how its past successive responses in economic policies have produced such outcomes. In setting out a nuanced explanation to these questions, my investigation takes a historical approach, but in order to avoid a articularistic over–determination of single nation history ₂   the German case is provided for comparison.

There are two reasons why Germany is an appropriate case for comparison in reconstructing Japan economic policy history. First, Japan and Germany share the historical tradition of odernization from above in which bureaucracies play a substantial role in public policy–making. Accordingly, policy networks are more clearly demarcated along ministerial jurisdictions than in other countries, where establishment of parliamentary rule or party politicization preceded the making of a bureaucratic apparatus. ₃   Although the initial conditions party politicians encountered were quite different, and the ways in which they enhanced their influence significantly differed, as latecomers, they have in common the fact that they successfully eroded the postwar preeminence of bureaucrats in the policy making process. For instance, the emergence of the Japanese oku parliamentarians, who match bureaucrats with their technocratic expertise, could be likened to the formation of the orking Groups of the Coalition Parties which play important roles in the enactment of specific laws in Germany. ₄

The second reason why Germany is an apt case for comparison is that American hegemony posed similar challenges for the postwar development of the Japanese and German political economies. ₅   After having pursued a policy of democratization in the two countries, America occupation priorities were soon superseded by the imperatives of economic recovery in the face of a deepening Cold War. The two domestic economies began to grow remarkably, led by expanding exports under a liberalized international trade regime. The Korean War marked the common turning point in this regard, and fiscal policy remained virtually classical in the succeeding high growth period. On the other hand, Germany balance of payments began to show a surplus as early as 1951, and that of Japan in 1965. This caused recurrent appreciation debates of the Deutsche Mark and the Japanese Yen that resulted in two reevaluations of the former currency in 1961 and 1969. However, the Japanese and German trade surpluses signaled a turning point in American economic hegemony. Triggered by the Nixon Shock in 1971, the turbulence in the international monetary relations ended in the transition to floating exchange rate system. This enhanced the influence of monetary policy on the domestic economy as a whole.

The succeeding oil shock turned the economic policy agenda in both countries from controlling creeping inflation to combating stagflation with fiscal and monetary policies. Both countries were thus forced to undertake large–scale counter–cyclical demand management, especially since they were expected to play the role of locomotive in spurring the world economy. The centralized small state of Japan turned to fiscal intervention in the domestic market, while the German federal state embarked on deliberate policy concertation among societal actors. Following the second oil shock, the nineteen–eighties brought new challenges in the form of changing international conditions and similar political agendas for Japan and Germany. Together with Thatcherite Britain, American Reaganomics provided them with a neoliberal model of privatized governmental agencies and deregulated domestic markets. Above all, political priority was now given to the consolidation of public deficit.

Surely, the two countries have come to face diverging external conditions since then. While Germany tried to manage its trade and currency problems more and more on a European dimension, Japan continued to rely on exports for economic growth, keeping its domestic markets still mostly inaccessible. As a result, Japan incurred political pressure from America, which culminated in frontal demands for deregulation of markets since the mid nineteen–eighties and the Structural Impediments Initiative(SII) talks of 1989. The unforeseen national enterprise of German unification imposed another unique political and economic challenge on Germany, of which the longer term effects are still difficult to assess. On the other hand, Japan, at the end of nineties, remains unable to come to grips with its deep recession and the tremendous amount of bad loans caused by the soaring asset inflation of the late eighties.

Keeping these diverging external conditions in mind, this study tries to explain why Japanese economic policies have resulted in such an enormous amount of public deficit politically in comparison with the German experience. I do so by focusing on the economic policy structures that have been institutionalized in the postwar period. The term policy structure is used here to refer to institutional configurations in which cabinets, state bureaucracies, governing parties, and autonomous agencies formulate and implement policies. By economic policies, I mean foremost fiscal and monetary policies, which are thought to be the main policy components for Keynesian policy mix. In Keynesian theory, classical budget balancing is replaced with budget formulation with an eye toward aggregate–demand management. Through monetary policy, the central bank manages the money supply so that the balance of payments and internal prices are kept stable. Monetary policy is evaluated differently according to the two main conceptions of the central banking: Keynesianism and Monetarism. Herein there always arise coordination necessities for economic policy to be effective as a whole. In connection with monetary policy, financial policy is treated insofar as financial institutions affect the monetary policy of the central bank. In Japan, the Ministry of Finance(MOF) has subordinated financial institutions through its formal and informal administrative regulations. Foreign economic policies, such as trade policy or exchange rate policy under the fixed rate system are also included, as exports were considered to be the main factor in Japan economic growth.

In spite of the inter–war experiments of homegrown Keynesian policies, aggregate–demand management arrived relatively late in West Germany and Japan. Macro– economic policies had to be practiced, therefore, within the preexisting institutional settings. Both of the ministries of finance not only allocates money among requesting ministries, but also decides the overall size and composition of the budget, estimating tax yields and shaping the budget in accordance with the debt policy with the central bank. Here, the German Economics Ministry intervenes as an indispensable coordination partner for the Finance Ministry, supplying the national economic surveys and prognosis on which the budget should be based. ₆   It further brings different perspectives into the budget formulation, embodying the respective traditional philosophy on the relationships between state and market. In the following section, we begin with the Economic Ministry in the turbulent years from wartime mobilization under totalitarian rule to the economic recovery under foreign occupation.

 

State and Economy and Economic Ministry in Postwar Japan and Germany ₇

After having experienced years of totalitarian and military rule, Germany and Japan surrendered to the allied powers. Whereas America put Germany under direct military rule along with England, Russia, and France, the U.S. occupied Japan basically alone, allowing it to maintain its own government.

As is well known, with the intensification of the Cold War, America shifted the focus of its occupation policy toward Japan and Germany from political democratization to economic stabilization. At first, America rigorously pursued the dismantlement of their past totalitarian legacies and urged them to design constitutional orders under which democracy could develop. But then, the two countries came to be rather regarded as stabilizing factors to the economy of the Western World.

Once the occupation relaxed its grip on the country, domestic actors saw their room for political choices increasingly enlarged. Although Americans tried to implant their own model of democracy, Japan and Germany accepted the American model only selectively with considerable modifications. In the process of formulating specific institutions, which was often extended after the occupation period, domestic actors thus exploited their range of maneuver, taking advantage of conflict and confusion within the Occupation bureaucratic machinery.

Notwithstanding such favorable changes on the side of America, Japan and Germany were forced to find solutions for the pressing economic problems they confronted continuously. Especially in the early postwar period, they were constrained by those reforms of economic institutions that were changing the societies of both countries fundamentally: the dissolution of economic combines, the reform of labor relations, and land reform in Japan. Thus, in their struggles to overcome the urgent problems of starvation and of resuming industrial production, Germany and Japan commonly resorted to dirigism in controlling economy, making use of wartime planning instruments. As a result, coal and steel production were resumed and food rationing was achieved during the winter crisis 1946/47 in Germany. The Japanese government also gave first priority to production in the same sectors, using such measures as the distribution of raw materials, public financing, and price control from 1946 to 1949 that occurred at the expense of causing hyperinflation. ₈

In Germany, state control over the economy was mostly abolished after the currency reform in 1948, which was politically consequential in uniting three western zones together. As the bourgeois forces led by Adenauer barely won the first federal election against the Social Democratic Party(SPD) that appealed for socializing basic industries, its success was all the more trumpeted as the sheer triumph of the free market economy.

But the idea of the Social Market Economy, as was formulated by the ordoliberal thinkers of the Freiburg school, presupposed the state to secure a competitive order in markets and to remedy the social imbalances caused by market malfunctions. ₉   In reality, the German State remained active in such policy areas as rehabilitation of refugees or housing. Although Ludwig Erhard represented the free market version of the Social Market Economy vehemently as the Director for Economy in the Bizone, his concept met with modification as early as the post–Korean War period, when America required the Adenauer government to contribute to the Western security alliance in producing more coal and steel. Unwilling to intervene in market economy, Erhard solved the problem by entrusting the peak industrial association (BDI) to autonomously allocate resources in order to meet the American demands. Still later, he saw his Ministry charged of supplying subsidies for small–scale enterprises or declining sectors. Moreover, the Anti–Monopoly Act, whose enactment was delayed until 1957, was far from effective in securing free market competition because many concessions had been made to interest groups. Thus, competition policy(Wettbewerbspolitik) and structural policy(Strukturpolitik) became the two main policy pillars of the Ministry of Economics. ₁₀

Somewhat differently from Germany, the Japanese government adapted its economic policies to the changes in U.S. occupation policy. A set of U.S. policy measures known as the Dodge Line put an end to various kinds of state intervention, which had given rise to soaring budget deficits and public finance expansion. Hyperinflation was thus brought under control. The American military demands for the Korean War entailed an export rush, yet the temporary nature of the boom brought the weakness of the Japanese industry to light. Under such drastically changing environments, MITI, reorganized from its predecessor MCI, adapted its policy goals to promoting rationalization in such sectors as steel, mining, energy and shipbuilding, combining various kinds of policy instruments such as tax exemption, public financing, and quota allocation of foreign currency. ₁₁   Although not all of these policies fulfilled their purposes, and the style and means of policy continued to change thereafter, the early nineteen–fifties could be said to be the heyday of the Japanese developmental state. As the Anti–Monopoly Act was revised in 1953 to allow for the recession cartels, policy measures formulated at that time were based on the concept of avoiding xcessive competition but were specific in scope in targeting specific sectors.

There is thus a striking difference between Germany and Japan in their stance toward foreign economic relations. For the divided nation that lost its agricultural hinterland in the eastern part of the former Preussen and close trade ties between the eastern Europe, reentry into the Western World was an economic imperative. Its membership in the OEEC since 1949 and in the European Payment Union marked a break with traditional trade protectionism, and Germany had already lowered trade tariffs to a considerable extent by the time of its entry into the GATT in 1951.

On the contrary, although Japan stepped into the international trade system after the Dodge Line and participated in the IMF and the GATT in the fifties, it was only since the sixties that Japan abolished quota allocation for imported goods. However, tariffs were retained as an effective policy instrument into the nineteen–seventies until protected industries grew competitive enough in the world market. Liberalization of foreign direct investment still lagged after Japan gained membership to the OECD in 1964. Thus, while similarly mbedded within the liberalism of postwar American hegemony, an internationally enetrated trading state developed in Germany, ₁₂   the Japanese state became a highly protectionist one. The Japanese responses can be partly attributed to the fact that its domestic economy was still on the verge of taking off for heavy industrialization. The MITI bureaucrats found no difficulties in inheriting the prewar tradition of the state intervention into the economy, if not wartime direct control. On the other hand, Germany emerged from the war with its high industrial production potential still intact. Partly because of the lack of foreign trade controls, the Federal Ministry of Economics(Bundesministerium fuer Wirtschaft)came to be furnished with limited forms of intervention instruments in comparison to the Japanese counterpart. Instead the Ministry of Economics monopolized the ideological stronghold and propagated social market economy thinking to the other ministries. ₁₃

 

Institutional Actors in Economic Policy

The Federal Ministry of Finance and the Japanese Ministry of Finance

Insofar as budgeting is concerned, which determines how the resources the government extracts are allocated, ministries of finance are basically spared from direct contacts with societal interests. In Japan and Germany, ministries of finance prepare annual budget proposal, negotiating with requesting ministries. Hence, compared with other ministries, ministries of finance are more resilient institutionally against socioeconomic changes. ₁₄   Yet, what were the consequences of external pressures of the American occupation for ministries of finance? Their institutional structure at a time of critical changes warrants a closer examination.

It is true that the German political leaders succumbed to the Allied powers in stipulating a decentralized fiscal administration for the newly emerging federal state in 1949. The U.S., in particular, asserted a rigid separation of legislative powers concerning the tax revenues and their administration between the Federation and the Laender (German states). In this sense, the prewar tradition of centralized fiscal state that characterized the Weimar Republic failed to be restored for the West Germany, which the Finance Minister Mathias Erzberger had adroitly realized. However, the overall structure of the financial federalism proved to inherit a still older legacy of the German polity: whereas tax legislation came to be increasingly concentrated on the federal level, state governments continued to participate in the law–making process there through the Bundesrat(Federal Council). ₁₅   After laborious negotiations among themselves, German political leaders chose this as a second chamber instead of the U.S. Senate model.

Furthermore, the constitutional postulate of niformity of living conditions led the Legislature to a closer sharing of tax revenues between the Federation and the states. Along with the institutional amalgamation of tax administration between them, all these elements of interlocking federalism could be said to represent the German tradition of power sharing (The Oberfinanzdirektion, the middle level institution of the federal financial administration, functions as the same level of administration for the Laender). In this way, the Federal Ministry of Finance (BMF), which is substantially responsible for designing nationwide tax programs, undertakes the tax administration in cooperation with the finance ministries of the individual Land. This is one of the most striking contrasts in comparison to the Japanese case which is characterized by a centralized system. ₁₆

Another institutional difference between Japan and Germany lies in the privileged position of the Finance Minister in the cabinet. ₁₇   He is endowed with veto power in any decision that has financial consequences and his veto power can only be overridden by the Federal Chancellor. This codification by the Reich Budget Code of 1922 originated from the consideration that the cabinet should be kept integrated as a decision–making entity against expenditure pressures from other requesting ministers. As described below, the locus of the Japanese budgetary decision making shifted from the disintegrating cabinet to the Budget Bureau in a very similar situation in the 1930s. Contrary to this, as the potential veto by the Federal Minister of Finance contributes to maintaining the cabinet as the budgetary decision making body, the Federal Ministry of Finance is prevented from politicizing itself excessively.

As it did in Germany, America regarded fiscal and local government reforms as essential means for democratizing Japan. ₁₈   In fact, through the enactment of the new Constitution and the Public Finance Law, the Diet was empowered considerably in budget formulation and subsequently the principle of fiscal democracy was established. Likewise the Home Ministry, which had supervised local governments through governors of prefectures (similar to the French prefet), was dissolved and governors came to be elected by local residents. Yet, far from successfully introducing America institutions, America failed in decentralizing the Japanese fiscal system. ₁₉   After the political leaders had followed America initiative in enacting a new constitution, which poses a remarkable contrast to the German case, first the Home Ministry, and then later the MOF, tried to preserve the centralized system which had developed under wartime mobilization. The MOF thus intentionally modified the reform plans of the General Headquarters. Thus, whereas the German party leaders selected path dependent institutional solutions, it was the bureaucrats in Japan that molded the tradition of centralism.

With the dissolution of the Home Ministry, the MOF came to play the pivotal role in the control of local governments. Although the local governments were ensured adequate revenues under the tax distribution system of 1940, they were not only deprived of the means to levy tax themselves but also restricted in their ability to raise funds autonomously. They were thus prone to depend on specific national subsidies for which the respective central ministries were responsible. For the allocation of such subsidies, treasury control by the MOF remained decisive. Fully aware of the leverage of such measures, the MOF later hindered the consistent realization of the Shoup Report, which had been prepared for tax system reform in favor of local autonomy.

The Ministry of Finance itself was no exception in facing the danger of being stripped of its competence. ₂₀   Under the highly fragmented system of Meiji Constitution, budgeting was one of the few measures for political integration. When it became almost impossible for the cabinet to formulate budgets during the critical years around the Manchurian Incidents, facing the military demands for the issuance of an unreasonable amount of deficit–ridden government bonds, the Budget Bureau is said to have become the last citadel against those demands. ₂₁   For the officials of the Ministry, their statistical knowledge of the national economy deduced from the digestion of public bonds in the domestic market served as a political weapon against the military. The deficit spending practiced under the then Minister of Finance Takahashi could be said to be a kind of homegrown Keynesian policy.

In the postwar period, the Economy Stabilization Board, which was equipped with planning and supervision authority for public works, appeared as the first rival of the MOF under the Katayama government. The former threatened the latter monopoly over the budget function. Then, after the Board had lost significance under the Dodge Line, the General Headquarters proposed that the budget formulation function be combined with the administration management function, the latter of which had been taken out of the abolished Home Ministry. Apparently, this proposal was conceived along the American model of Office of Management and Budget. However, it was not realized because of resistance from the MOF.

The Bank of Japan and the Bundesbank

Similarly, the American occupation policy toward Germany and Japan failed in both cases to replace old structures with American models of financial institutions and central banks. The new constellations that emerged in the postwar years are better understood as the results of adaptations by wartime or even prewar institutions to changing environments.

In accordance with the overall occupation policy, America, together with the other Allied powers, divided the centralized Reichsbank under the Nazi regime into the State Central Banks(Landeszentralbanken) for each state in the three Western occupational zones. Similarly, the three largest commercial banks ( ig three were broken down into thirty successor banks, of which branch networks were restricted to operations within each individual state. ₂₂

Indeed, the Allies went even further in shaping the legal framework of West Germany central banking structure so that the former power center of the economy would no longer be subject to the governmental instructions. Hence, the Bank deutscher Laender was guaranteed full autonomy in pursuing its monetary policy, which was founded in 1948 as the federal–wide organization for central banking.

The reintroduction of the central bank independence was strongly approved by the West German society at large which had been twice disillusioned by the disastrous inflation brought on by the central banks subordinate to the government. In fact, the Bundesbank was later created as a similarly independent successor in spite of the then government members intention to make the Bundesbank more responsive to their preferences. On the other hand, the federal two–tier structure under the Bank deutscher Laender was also revised for the Bundesbank, under which the State Central Banks were amalgamated into the unified Bundesbank. Consequently, the strictly federative model of the American Federal Reserve System was abandoned in favor of another institutional construction which was reminiscent of German executive federalism. ₂₃

Following the occupation, the German authorities, which were interested in protecting depositors confidence in the overall stability of the banking system, also permitted mergers among commercial banks. Exempted from the full enforcement of the Competition Law, the banking sector thus re–concentrated itself in the subsequent decade. The German financial market, which is composed of stable credit institutions, that operate mainly as universal banks, sets the terms for the monetary policy through which the Bundesbank aims foremost at maintaining a stable currency.

In contrast to the German occupation, the Japanese financial institutions were spared from de–concentration by the General Headquarters, which otherwise rigorously pursued the dissolution of the economic combines (zaibatsu) as a means to demilitarize Japan economically. ₂₄   Highest priority was first given to controlling hyperinflation without endangering the fragile financial networks, and the antimonopoly policy was not strictly applied in the following years after the occupation policy had been geared to stabilization. Internal divisions within Headquarters contributed to the inconsistency among concrete measures throughout the occupation, with the result that the prewar commercial banking system was reestablished. Furthermore, the plan calling for the establishment of a anking Board a carbon copy of the Board of Governors of the American Federal Reserve, met with strong resistance from both the Ministry of Finance and the Bank of Japan. As a result, the reform was diluted to the amendment of the Bank of Japan Law, which merely established a new Policy Board within the Bank of Japan. This new committee was simply nominal, and the Governor of the Bank retained substantial discretionary power in the making of monetary policy. Besides, the MOF not only maintained its legal control over the Bank of Japan, it still held regulatory competence over the financial institutions as before. These included the examination and supervision of banks, grant of licenses, and branch regulations, of which execution was left to the MOF discretion. ₂₅

In this way, the hierarchy of financial control by the government, which mobilized the long–term credit for wartime production, was widely restored for the purpose of economic recovery and of the promotion of high economic growth. For instance, the Industrial Bank, which operated as the main wartime distributor of strategic loans under government orders, continued to exist as the long–term credit bank for basic industries. The MOF kept the Yokinbu at its disposal, through which collected postal savings were used for the purchase of governmental bonds. Combined with several pension funds and other trust funds, the Yokinbu was later reorganized into the FILP (Fiscal Investment and Loan Program).

Under the wartime system of financial control, the Bank of Japan allocated governmental bonds to financial institutions, allowing special discount rates for them under a regulated interest rate system. As the Bank of Japan Law (1942), which was modeled after the German Reichsbank Act of 1939, remained unaltered until 1997, the Japanese central bank has failed to acquire an independent position legally. The BOJ was subject to the MOF supervision including the right to issue general directives and to dismiss BOJ officials. The old law further stipulated that the Bank should be engaged in commercial or industrial finance, when it came to the maintenance of the currency or credit system.

Political Parties as Latecomers

Although one can trace the increasing influence of political parties in the respective prewar regimes in Japan and Germany, it was only after the occupation that they came to function as the main democratic intermediaries between state and society. While the Japanese prewar parties never endeavored to establish parliamentary government under the Meiji Constitution, their German counterparts could not prevent the Weimar parliamentary democracy from being a brief interlude in a long history of bureaucratic dominance. Moreover, even under the full–fledged democracy after World War II, the political parties, as latecomers, could not achieve their policy goals without accommodating themselves to the institutional configuration of the state. Every active economic policy entails complex coordination among administrative organizations. ₂₆

In Germany, the Social Democratic Party, which had failed to inject full–fledged Keynesian instruments into the fiscal and federal reforms under the Grand Coalition, attempted aggregate demand management later in the seventies only to founder on various kinds of institutional barriers. One of them was the majority in the Federal Council, which was then led by the Christian Union state governments. The Christian Unions not only made the state governments co–operation for the federal fiscal policy troublesome, but further blocked federal legislation necessary for tax hikes and revenue sharing in the Federal Council.

Neither was the monetarist economic policy, which was avowed by the neo– conservative coalition government in the succeeding decade, free from institutional barriers. Although the Christian Unions (the Christian Democratic Union in alliance with the Christian Social Union of Bavaria) held the majority in the Federal Council, the federal government faced resistance from some Christian Union state governments when it introduced a tax cut at the expense of the states revenues. Furthermore, their Catholic tendency toward state intervention stood in contrast with the market liberalism of the junior coalition partner, Free Democratic Party. The fiscal policy by the Christian Union Ministers of Finance met with occasional criticism from liberal Ministers of Economics.

Thus, the German political parties have intensified the inter–organizational coordination difficulties in competing with each other over economic policy for electorate support. The Japanese counterparts make a striking contrast to this. They did have great ideological conflicts, but these were not presented as serious alternatives to the existing order of capitalist democracy. Far from that, the rapid economic growth, which minimized distributional conflicts in society at large, kept economic policy from becoming a salient political issue that could divide their programs. This induced the long–time governing Liberal Democratic Party to be less program–oriented in favor of representing clientelistic interests. Furthermore, the dissolution of the Home Ministry at the end of 1947 gave the LDP opportunities to maintain great influence in such policy areas as regional and public works. The party thus became most active in canalizing budgetary compensation for a specific clientele or constituency in exchange for electoral support for individual parliamentarians. Consequently, the LDP economic policy tended to be fragmented into incremental adjustments through the central government budgeting. ₂₇

For policy making in general, the LDP has developed the Policy Affairs Research Council, a party organization whose divisions are most intensively involved in the budgeting process. However, these divisions are segmented along ministerial jurisdictions and do not integrate policies beyond jurisdictions. No special division for the overall budget formulation can be found. As, on the other hand, neither the Prime Minister nor the Cabinet is equipped with enough staff resources, a substantial proportion of fiscal policy decisions is left to intra–ministerial coordination within the Ministry of Finance.

In the German case, the Ministry of Finance prepares budget proposal for the Federal Minister of Finance. Yet, along with other economic forecasts and projections, the Economics Ministry prepares the yearly economic report, upon which the Cabinet finalizes its budget proposal. Besides, as the Federal Ministry of Finance takes the lead in coordinating the yearly and multiyear federal and state budgets, the Ministry shares the information on tax yields and economic forecasts with the State Ministries of Finance.

Contrary to this, the Japanese counterpart monopolizes the information on tax yields, and although MITI and the Economic Planning Agency join in preparing the economic forecast, this is rather a product of bureaucratic politics among the relevant ministries. The EPA, the Japanese equivalent of the German Council of Economic Experts, enjoys no comparable reputation for academic analysis of trends in the economy. It is the Ministry of Finance, especially the Budget Bureau that formulates the budget, estimating tax yields, deciding the overall size of expenditures, coordinating debt policy with the Bank of Japan and financial institutions, with an accurate eye on political pressures from the governing party. It is no exaggeration that the role of the governing party in the budgeting process was substantially confined to revival negotiations for a long time, which preceded deliberation by the Diet.

 

Economic Policies in the High Growth Period

We start with the period of high economic growth, which was destabilized by the collapse of the postwar international monetary system and then terminated by the first oil shock. During this period, the German GDP increased at an average rate of 6.3 percent annually from 1950 to 1967, while the Japanese average annual growth rate of Gross National Expenditure(GNE) for the period from 1946 to 1973 reached above 9 percent. This almost uninterrupted growth not only surpassed that of the other advanced countries, but was also unprecedented in the light of Japan and Germany own experiences. ₂₈   In both countries, a consensus arose that first priority should be accorded to economic growth which should mitigate various kinds of distributive conflicts in society. The institutional actors, that had undergone critical years of wartime mobilization and foreign occupation, now adjusted their strategies to the newly emerging situation and the basic contours of the economic policy structure were shaped.

Tax policies were geared toward increasing capital formation. As private savings were still small in spite of the strong demand for investment, such kinds of measures as depreciation allowances and tax exemptions were taken to give incentives to reinvestment. In Germany, along with the social security reform of 1957, the high rate of income tax, which had been introduced as a means of confiscation under the occupation, kept the public sector sizable. Yet, adhering to the classical principles of a balanced budget, the CSU Minister of Finance went on to reserve budget surplus ( uliusturm for the purpose of preparing military expenditures for participation in NATO. In this way, public finances constrained private consumption in favor of a high rate of capital formation. ₂₉

Similarly, the Japanese Government granted special liberal tax advantages to specific industries in the fifties, which constituted a wide array of the sectoral policy instruments of the protectionist MITI. ₃₀   Furthermore, positively upholding the stabilization policy under the direction of Joseph Dodge, the MOF Tax Bureau successfully achieved income tax reduction, which substantially contributed to keeping the government small. Thereafter, a constant tax burden of around 20 percent of GNP came to be regarded as one of the primary rules for macroeconomic policy management. Surely the Keynesian oriented politicians gradually held dominance within the ruling party, and MOF followed opportunistically the high growth policy in expanding its annual budgets. However, at least the general account budget of the central government was kept balanced until the abandonment of this principle occurred in 1966. As a result, the basic stance of the fiscal policy remained classical rather than Keynesian.

In Germany, sparse as they might have been, fiscal interventions were readily practiced in the fields of agriculture, transportation, coal mining and housing construction. ₃₁   Conceived as structural policies for the purpose of restoring the competitive order of markets, they were congruent with the concept of a social market economy. However, these expenditures were incoherently programmed and their impact on the business cycle was haphazard.

Likewise in Japan, activist expenditures for public works in constructing industry–related infrastructure were only admitted insofar as unexpectedly high tax yields left a budget surplus for the following year. Indeed, government economic plans, which always underestimated real growth rates, were instrumental rather in nourishing expectations for high growth among business. The long remembered ational Income Doubling Plan announced by the Ikeda cabinet in 1961 was no exception in this respect. Economic plans were mostly general in character, of which drafts the Economic Council designated by the cabinet prepared. The Economic Planning Agency served as secretariat for the Council, but it was merely a consultative organ never strong enough to force the MOF to abandon the principle of a balanced budget.

When no active role was to be expected from fiscal policy, it was monetary policy by the Bank of Japan that burdened the control of economic fluctuations. As any other central bank, inflation was most unwelcome at the BOJ. Yet during the high growth period, consumer prices rose five or six percent annually, which is to be estimated high in the light of German performances. Indeed, the BOJ sought to keep supplying money and accordingly the discount rate was raised solely when the current account position deteriorated. ₃₂   In pursuing its monetary policy, the BOJ also mobilized discretionary control means towards specific credit institutions, as it stood on the top of the bank hierarchy as the lender of last resort. Banks were quite obedient to these controls, as they, presiding over loans to the corporate sector, were highly dependent on BOJ loans. Therefore, the BOJ could also make use of the chain of control for its other primary goal of supplying enough money to facilitate a smooth expansion of the economy. In either case, the monetary policy was not practiced according to the price mechanisms provided by the financial markets. The financial markets were highly insulated by the government, which controlled foreign exchange transactions and capital movements tightly.

Contrary to its Japanese counterpart, the BOJ, the Bank deutscher Laender(BdL), and its successor, German Federal Bank, gave utmost priority to price stability. Although the first Chancellor, Konrad Adenauer was at times critical of its monetary policy, arguing that the central bank be responsible for assisting the Government economic policy, the guardian of a stable currency could pursue its own anti–inflation policy independently. Its function was clearly spelled out by the Bundesbank Act of 1957 and there was adequate support for central bank independence in the German society at large. Even the obligation to support the federal government general economic policy is subordinate to its duty to defend the value of the currency. Indeed in contrast to the impressive record of price stability in the fifties, the Bundesbank tight monetary policy was sometimes counterproductive in aggravating recessions. Insisting on the appreciation of the D Mark, the Bundesbank went on further to confront the federal government in the sixties. The effects of monetary restrictions came to be increasingly offset by free capital movements, and the inflationary pressures were no longer avoidable through continued balance of payments surpluses under the fixed exchange rates. At that time, the determination of the exchange rate was at the discretion of the federal government. ₃₃

Thus, while fiscal policies were similarly managed in accordance with classical budget principles, central banks embedded in different institutional settings pursued different goals for their monetary policies. The different roles that foreign trade played in Japanese high growth explain their contrasting stances. ₃₄   Although foreign trade was commonly instrumental for their rapid economic growth, the effects foreign trade had on domestic society differed considerably. Postwar Germany experienced a decline in the agricultural sector, and such branches as chemicals, machinery, and automobile machinery gradually took the lead in place of the traditional coal–mining, iron, and steel sectors. These industries expanded their share of total production, simultaneously increasing exports to foreign countries. The growth of foreign trade, of which the total share in GDP rose from nine to nineteen percent within the first decade, was achieved through Germany integration into such international organizations as OEEC, GATT, IMF. Germany itself contributed to the trade liberalization as an active advocate of free market doctrine.

While the German export–led growth produced continuous trade surplus, still more rapid growth of Japanese economy was made possible by industries, which maximized production, making the most of imported raw materials. Japan balance of payments never recorded a stable surplus until the mid–sixties. Growing exports were further accompanied by rapid heavy industrialization, which extended to the expansion of the automobile and electronics industries. Consequently, the postwar traditional society rapidly transformed itself into an industrial one with a substantially expanding tertiary sector. Massive waves of urbanization ensued. As is seen from the decreasing share of exports in GDP, it was expanding domestic demand that sustained Japan economic growth.

 

Towards Institutional Reforms in the Sixties

As economic growth became sluggish in Germany and trade surpluses were no longer offset by budget surpluses due to the central government military outlays and local authorities investment expenditures, accelerating inflation came to occupy public concern. The Bundesbank argued for more appreciation of the currency, after it had vainly tried to sterilize the inflow of foreign capital. On the governmental side, it was the Economics Ministry led by Erhard that formulated new economic policies to dampen the inflation.

Erhard initiated an official inquiry to find out how far the policy instruments at the disposal of public authorities were capable of managing business fluctuations. He further set up the Council of Economic Experts as an independent agency with the task of macroeconomic analysis and of presenting economic policy alternatives to the government. However, while Erhard kept himself away from economic planning and remained bound up in the classical principles of a balanced budget, he was toppled by the first recession in the postwar German economy. ₃₅

After the fall of the Erhard government, the SPD joined the Grand Coalition government with the conservatives, and injected some Keynesian elements into the stabilization policy proposals prepared by Erhard. Consequently, the focus shifted from a fight against inflation to one against depression. Along with the revisions of the Fundamental Law, the Economic Stability and Growth Law of 1967 endowed the federal government with fiscal policy instruments to vary expenditures and certain taxes within specified limits. Largely compromised as it was, the Law made the ideal combination of monetary and fiscal policies possible to bring about an immediate upswing in the business cycle. ₃₆

On the other hand, notwithstanding this official acceptance of Keynesian demand management, it should not be forgotten that the new law left the institutional structures characteristic of the German polity almost intact. In taking the lead in macroeconomic policies, the federal government needs to jointly deliberate on anti–cyclical measures with state and local representatives. Putting together its medium term fiscal planning, the federal government was further required to coordinate its plan with those of state governments. The imperative for coordination extends further into public–private relations. The so–called oncerted action Konzertierte Aktion) was created to promote exchanges of information among representatives of employer associations and labor unions, of the government and Bundesbank representatives and independent experts for the annual wage negotiations. This enterprise meant nothing more than building a forum where the federal government never enjoyed the position of sovereign commander. ₃₇

While the 1967 recession in Germany was engineered by the tightened monetary policy of the Bundesbank, the Japanese government was urged to issue deficit–ridden bonds in 1966, after its pro–cyclical policies had aggravated depression. Then it was no longer possible for the MOF to keep the budget balanced depending on former budget surpluses or increasing estimated tax yields. In the face of the expanding expenditures since the Ikeda government, the then Minister of Finance Fukuda decided to depart from the principles of a balanced budget. ₃₈   He was a former MOF bureaucrat, whose Keynesian ideas went back to the days when he was in the service of the Budget Bureau under Minister of Finance Takahashi. Although the Budget Bureau lost no time in launching a campaign to contain expansion of expenditures under the slogan of reducing fiscal rigidities, the MOF saw its orthodoxy broken by a prototype of the oku parliamentarians of the governing party.

Here, reference should be made to the Fiscal Investment and Loan Program (FILP), which is an important policy instrument of the MOF. ₃₉   The FILP is a complicated unique financing system administered by the Trust Fund Bureau of the Ministry. The sources are composed of various funds collected by the government, mainly through the postal savings, welfare insurance and pension systems. A whole array of activities has been financed through FILP. Other than governmental special accounts, government–affiliated financial institutions, local governments, public corporations that undertake public works, such as railways, telecommunications, and highway construction have received long–term financial support at a low interest rate.

Requests for finances through FILP are filed by ministries and reviewed by MOF as in the case of a regular budget. The FILP as a whole is formulated in tandem with the compilation of budget. However, the FILP is virtually free from parliamentary control, and has been used as leeway for circumventing the principles of a balanced budget. In fact, during the rapid growth period, the FILP focused its financing on such basic industries as electric power, shipping, coal, iron, and steel, which eased the burden on the general account budget significantly.

Furthermore, the FILP is also regarded as a policy device by which the central government causes significant influence over financial markets. Insulating domestic financial markets from foreign capital movements and segmenting credit institutions, Japan strict governmental controls pose striking contrasts to the German case. In Germany, the savings banks help state governments finance and operate as instruments of their industrial policies. Cooperative banks stand in similar relation to local and municipal governments. The Reconstruction Credit Agency (Kreditanstalt fuer Wiederaufbau), set up in 1948 to administer European Recovery Special Fund, was originally used to provide reconstruction credits to enterprises on preferential terms. As one of the specialized banks, it was later deployed to supply exports or smaller businesses with long–term credits. ₄₀   Yet, in fostering longer–term growth, the banking system as a whole gained importance later in place of government savings. Starting with the full convertibility of the currency in 1958, cross–border capital movements liberalized and divisions within the banking sector were dismantled. Such steps as the decontrol of interest rate were further taken in the sixties so that all types of banks were allowed to operate as universal banks.

For the first time in the postwar period, Japan current account turned to a stable surplus in 1967. In 1969/70, despite of the presence of an external surplus, the BOJ tightened monetary supply in order to curb the inflationary pressures only to enlarge the surplus. Along with the chronic trade surpluses in Germany, this contributed to the announcement of the ew Economic Policy by the Nixon administration in 1971. Facing similar conditions, however, the BOJ neither proposed to appreciate the Yen or to loosen restrictions on foreign financial controls. The subsequent turbulence in the international economy and the developments of economic policies in the seventies are the topics in the following section.

 

Turbulent Seventies

German Responses

In contrast to the turbulent seventies, the German economy in the former decade was nearly characterized by the fulfillment of the major goals of economic policy. Growth was high enough to ensure full employment except for the short recession in 1966/67. Consumer prices rose at an average as low as 2.5% per year. ₄₁

Yet, from the perspective of the Bundesbank, inflation got increasingly unmanageable. The long awaited 1969 revaluation proved to be a temporary respite. The tightened monetary policy incurred a still larger speculative inflow of foreign capital, which neutralized the Bundesbank monetary restrictions. In domestic politics as well, the newly established social–liberal coalition government appeared as an unreliable partner, as it proclaimed activist reform policies on all fronts, which entailed increasing expenditures. One of the ominous signs was the resignation of the Minister of Finance Alex Moeller, who failed to defend his position against the spending demands from requesting ministers in 1971. Moreover, wage policy by the trade unions tended to be unstable, as the Concerted Action presided over by the Minister of Economics diminished whatever function it had. In 1972, Karl Schiller resigned from the Minister of Economics and Finance protesting that the above revaluation was cosmetic. In this way the Concerted Action lost its central place and the portfolio of the Minister of Economics was conceded to the FDP.

Therefore, the collapse of the Bretton Woods regime was rather welcome in the Bundesbank view. Although the guardian of the currency was overwhelmed by the turbulence in the exchange market, it regained control over the domestic money supply in the end. Following the May 1971 announcement of the ew Economic Policy by the Nixon administration, exchange rates began floating. The transition to flexible exchange rate system was finalized in March 1973, after the floating exchange rates were temporarily frozen by the Smithonian Agreements of December 1971. As a result, the exchange rate discretion was handed from the government to the central bank.

Seeing the consumer prices rising up to as high as seven percent in the spring of 1973, the Bundesbank made full use of its newly acquired policy instruments. Furthermore, as the trade unions carried through their demand of double–digit wage increase in the spring of 1974, the Bundesbank continued its tight monetary policy beyond the first oil crisis through most of the year. The German economy faced its most serious crisis, with foreign demand waning, real GNP down by 1.6 percent, and the number of unemployed registering a record of over one million.

Accused of contributing to this stabilization crisis, the Bundesbank later eased the money supply cautiously, until in the autumn of 1975 the discount rate was lowered to the level of 1972. On the other hand, it newly announced a medium–term monetary target, which was congruent with its basic orientation towards price stability. This new strategy made the intention of the Bundesbank unequivocally clear, simultaneously assigning the responsibility for the fulfillment of economic policy goals to other governmental and societal actors.

Thus, although the Bundesbank supported the governmental expansionary fiscal policy from 1977 through 1978, with its moderate monetary policy, it again resorted to money supply restriction in the wake of the second oil crisis. In 1981 interest rates escalated over ten percent, with the result of an even deeper recession in 1981 and 1982. The Bundesbank would not allow import prices to rise by passively accepting the currency to be depreciated. Had it first tolerated trade account to deteriorate without inducing foreign capital inflow, then depreciated D–Mark would have spurred the German exports, improving the current account subsequently. As it turned out, however, the Bundesbank tightened monetary policy to attract capital imports for stabilizing the exchange rate. The worldwide increase in the dollar interest rate, which had been caused by America restrictive monetary policy since the end of seventies, were also justifications for its policy choice.

While the Bundesbank thus influenced the macroeconomy directly through its monetary policy, the federal government was far from being able to strategically mobilize its budget for short–term demand management. Although it is the central government that is assigned the political responsibility for combating unemployment and inflation, the bulk of public investments lie in state or municipality expenditures. Therefore, the federal government often resorted to providing fiscal incentives, which were included in the antirecession programs as financial grants in aid. ₄₂

Nevertheless, the so called Joint Tasks, which had originated as postwar categorical investment grants programs and were legitimized as co–financing schemes through the 1969 Finance Reform, are not suitable for that purpose. They are designed as long–term funds for infrastructure amendments for some specific areas and are executed by highly insulated bureaucratic joint–planning commissions. Of greater importance are Financial Aid Programs. They are conceived as flexible enough to be given to states for short–term stabilization purposes. In fact the administrative agreements between the Federal and states extended the antirecession programs in 1974/75 to cover the wider aspects of local infrastructure building.

Yet federal financial aid didn correct the procyclical tendencies of state and local government investments. The total outlays through a series of spending programs had no significant influence on the macroeconomy as a whole. Furthermore, their investments in such public works as public buildings, traffic systems, schools, hospitals brought extreme fluctuations in local labor market to the detriment of the construction industry. In this sense, federal financial aid is only successful when it is planned in longer terms and composed of various kinds of spending programs, as the rogram of Investment in the Future in 1977 demonstrated.

Taking such institutional barriers into account that constrain instrumentalizing public budgets for macroeconomic management, it is plausible that the automatic stabilizers built in the public finance compensated for the demand gap. Indeed, although the German welfare state is most inappropriate for spending additional funds to flexibly expand public sector employment, federal social welfare provisions had already been improved substantially and state public services for health care and education expanded under the Grand and social–liberal coalition governments. ₄₃   Far from that, by the time Helmut Schmidt took the federal Chancellor office, he thought the federal budget was in a structural deficit that should be remedied as soon as possible. ₄₄   He soon realized this intention by the Budget Structure Act in 1976, which focused on the curtailment of the federal subsidy to the unemployment insurance fund among others.

In the midst of the economic crisis after the second oil shock, the social–liberal coalition government met with increasing pressures to reduce the public deficit. The Bundesbank raised interest rates to burden increasing debt service on the government. On the other hand, the FDP strengthened its strategic position as a changing coalition partner after the 1980 election to urge tax reduction in favor of business interests. Clearly, supply–side economics was taking preponderance over the Keynesian demand management in the background. To balance the budget, the Schmidt government was forced to raise whatever taxes it could. However, since the opposition parties majority in the upper house blocked unpopular sales tax hike, the coalition government had no other way than to reduce expenditures through cutting such social provisions as unemployment benefit, job creation program, or family allowances. Consequently almost no social scheme was left untouched in the austerity programs. ₄₅   Notwithstanding these measures, the federal deficit worsened considerably, which jeopardized the government all the more. The fiscal year 1981 closed with a deficit of 37.4 billion marks, and the year 1982, 37.7 billion marks.

Japanese Responses

In 1969, for the first time in the postwar period, the BOJ raised the discount rate for the purpose of curbing inflationary pressure in spite of the presence of trade surplus. ₄₆   Subsequently, this tightened monetary policy depressed the domestic economy, simultaneously expanding the trade surplus. However, almost overwhelmed by the unanimous aversion against revaluation of the Yen among the policy actors, the BOJ clung to the fixed exchange rate as it always had. In fact, the announcement of the ew Economic Policy by the United States was referred to as the ixon Shock Moreover, fearing itself that the Smithonian parity rate of \303 per $1 would endanger Japanese exports, the BOJ went so far as to recklessly expand the money supply to compensate for the depression it assumed would be caused by the appreciation. Even the shift to the floating exchange rate system changed nothing, as it gave priority to cheap exports prices over stable domestic ones. In addition to commodity price inflation, which had already set in after the money supply expansion, explosion of the oil price aggravated the overall trend. Extreme hyperinflation followed in 1973/74.

Yet, when the governmental policy was geared to anti–inflation afterwards, the BOJ mobilized all of its policy instruments to combat the hyperinflation of the spring of 1973. ₄₇   Its rigorous monetary restriction was effective, as the BOJ still maintained various kinds of control measures over the foreign capital movement. Besides, the BOJ made extensive use of informal indow guidance over city bank lending. Along with the postponed budgetary expenditures, a series of these restrictive measures caused a serious recession in 1975. In rigorously restricting the money supply, the BOJ made constant and close contact with the MOF, albeit as a subordinate to the Ministry.

Although the official discount rate was sharply raised again after the second oil shock, reflecting the BOJ cautious stance against the revived hyperinflation, Japan interest rate began to lower thereafter as early as 1980. Thus the monetary policy basically maintained an expansionary course throughout the years after the 1975 recession. The London economic summit meeting in 1977 exerted additional international pressure in favor of this, demanding that Japan play the role of another locomotive in the world economy.

Due to such expansionary measures, the Japanese dollar exchange rate went downwards subsequently. The parity rate of \170 in October 1978 lowered through \ 220 in September to \250 in October 1979. Japanese policy makers still tried to maintain the traditional pattern of growth, which is led by private investment in boom periods and supported by exports in recession at the cost of inflation. The subsequent increase of Japanese exports after the second oil shock prohibited Germany indirectly from taking the cheap currency strategy as a result.

As mentioned earlier, the principle of a balanced budget was abandoned in 1965, when a special bond was issued to finance the budget deficit. ₄₈   After that, the government issues bonds every year, but those bonds are restricted to government spending for public works (Art.4 Finance Law). The degree of dependence on bond issuance is also kept small. In fact, far from turning to Keynesian fiscal policy, MOF officials continually try to restrain natural expenditure increase, concentrating their efforts on reforming such intractable special spending programs as the Food Stuff Control, the National Health Insurance, and the National Railways. ₄₉

Yet, the budget grew steadily in absolute terms, partly because the economic growth rate remained high from 1968 to 1972, ranging from 16 to 18 percent in nominal terms (even 1971, the year of mild recession marked 11.2 percent). The corporate and personal income tax system, which was highly elastic vis–a–vis nominal growth, brought about increasing revenues in spite of its occasional adjustments for reduction. On the other hand, intensifying factional struggles within the LDP gradually outweighed the decaying ability of the Prime Minister Sato to put additional pressure on expenditures.

Subsequently, still stronger pressure came through the leadership by the Prime Minister Tanaka, who had won the presidency of the LDP setting up the most activist emodeling of the Japanese Archipelago plan. ₅₀   Forming enormous supplementary budgets, he resolutely expanded the expenditures for public works and social welfare. The growth rates of these expenditures in the FY 1973 general account were 32.3 and 28.8 per cent respectively. Although public works expenditure was constrained immediately in the FY 1974, a long– term upward trend in social security expenditure was built in at that time. The year was called he first year of the welfare era with the pension benefits remarkably improved and such new programs as free medical care for the aged introduced. Thus substantial changes were structured regarding the social security system in Japan. ₅₁

As Tanaka undertook another income tax reduction for the FY 1974 from electoral consideration, public finance accelerated the ongoing inflation as a whole. Then in line with the tight monetary policy, such measures as postponing expenditures were taken on the fiscal side to combat the hyperinflation. As noted above, this caused a serious recession in 1975. Accordingly tax revenues dropped sharply, which, as a result, necessitated issuance of a deficit–ridden bond in the supplementary budget of FY 1975. A special law was enacted to legitimize the issuance of bonds for deficit financing.

Although the successor Miki cabinet put emphasis on improving social security provisions, and expanding public works spending for the management of aggregate demand, the 1975 and 1976 budget influenced the macroeconomy only modestly. The positive effect upon the business cycle came rather from the monetary policy or export increase. It was the Fukuda cabinet that remarkably expanded public works spending for the 1977 supplementary and the 1978 budget for the purpose of enlarging domestic demands. As a result, the bond dependency ratio exceeded the symbolic threshold of 30 per cent in 1977. ₅₂

Facing the first issuance of the deficit–ridden bond in 1975, the MOF officials had already begun preparation for introducing a new tax. Later a governmental council released a report recommending the introduction of a European type of general consumption tax in 1977. However, the Ohira cabinet, which publicly aimed at introducing a new tax in the FY 1980, had to experience a serious setback for the general election in 1979. Thereafter, introduction of a new tax was excluded from political agendas, which made fiscal reconstruction without tax increases unavoidable in the following decade.

Although public opinion was significantly changing in favor of smaller government after the second oil shock, no clear shift from Keynesianism to monetarism occurred in Japan. Despite hazardous economic changes, traditional policy ideas and role perceptions were firmly entrenched in each of the institutional actors. While the governing party remained unable to articulate policy paradigms of a coherent alternative, the MOF again drew on traditional tenets of fiscal conservatism. Furthermore, notwithstanding the alleged adoption of monetarism, the BOJ remained susceptible to political pressures as before.

With regard to the selling of bonds, the BOJ played another subordinate role to the MOF. In Germany, the Bundesbank assists the Federal Government (and its special funds) in issuing Federal securities through Federal Bond Consortium. ₅₃   This Consortium headed by the Bundesbank is composed of syndicate banks and other credit institutions. Although the individual syndicate banks underwrite the entire new issue, the Bundesbank is legally allowed to acquire floating public debt securities only according to the market conditions and for the purpose of regulating the market. In this way Bundesbank lending to the public sector is strictly limited.

By contrast, starting in FY 1964 the MOF allotted national bonds to financial institutions under its regulation at below market cost. ₅₄   In spite of the marketing principle provided by Article 5 of the Public Finance Law, a significant portion of bonds was neither purchased by financial institutions nor held by individual buyers. Substantially, there exited no bonds floating in the market. Yet, when it became unbearable for the financial institutions to hold bonds and the Trust Fund Bureau had no sufficient funds to accept bonds, the BOJ was called for reabsorbing issued bonds from financial institutions one year after issuance. At any rate, the amount of bonds allotted to financial institutions was small. However, from the latter half of the seventies, when an enormous amount of deficit covering bonds were issued every year, the MOF gradually succumbed to pressures from banks to allow bonds to float, which had been prohibited to retail government bonds. This contributed to the momentum for the liberalization of financial market in the eighties.

 

Two Ways towards Monetarist Economic Policies

Under pressure of huge public debts and worsening unemployment after the second oil shock, the social–liberal coalition collapsed. Urged to cut social expenditures, Chancellor Schmidt met with increasing criticism from trade unions. The dissenting group within the FDP dealt the fatal blow to the social–liberal collaboration. Their plea for supply–side economics was manifested in the so–called Lambsdorff paper, which had been long prepared within the Ministry of Economics. ₅₅   Joining in the market–oriented blames of the predecessors for Keynesian spending habits, the CDU/CSU renewed the coalition with the FDP after sixteen years interval in favor of budget cutbacks and fiscal consolidation. The party economic philosophy of the ocial market economy state creates favorable conditions for economic activity while relying on the market to act as the motive force found its natural ally in a newly invigorated economic liberalism.

As things turned out, although economic growth did not recover the robustness of sixties (2.5 percent annual growth of GNP for the years 1982–86) and the long–time unemployment was never improved, business cycle turned upwards since 1983. Owing to the worldwide boom and the lower interest rates, higher investment and profits brought about more tax revenues and the Bundesbank further contributed foreign exchange reserves to the federal budget. ₅₆   Consequently the first Kohl administration could boast lower public deficits. While the average growth rate of the federal budget was around 9 per cent in seventies and still remained 6 percent despite the late social–liberal cutback efforts in 1980/82, that of 1983, 84, 85 decreased to 0.9, 2.0, 2.5 percent respectively.

The federal net borrowing exceeded 30 billion Mark in 1988 again due to income tax relief in 1986,1988 and higher contribution to the EC. The coalition partner, FDP further pressed for more drastic tax cut in favor of higher earners and small businesses, which was realized to a modest degree in 1990. These tax cuts rendered the budget balancing all the more difficult. Nevertheless, the borrowing policy was now endorsed by the Bundesbank on the grounds that its growth rate did not surpass that of the GDP. ₅₇

Leaving aside the question of such a justification here, the federal government took the lead in containing the annual budget growth within three percent. Other than personnel expenses cut on the state level, the federal outlay reductions came mainly at the expense of such social expenditure as child benefits. In this context, it should be borne in mind that the Christian–liberal coalition was no exception in being constrained by the institutional obstacles of German politics in changing public policies. ₅₈   One of the typical examples might be found in the coalition decision to lay brakes on the rising costs of health insurance in favor of a thoroughgoing reform. Facing resistance from all quarters of coalition partners, federal ministries, state governments, insurance funds, doctors association, or pharmaceuticals industry, the Chancellor initial proposal for a structural reform was more than watered down to a mixture of marginal measures. Therefore, any initiative of federal government in social policy reform, which was meant for expenditure cut, was only to be realized within its own jurisdiction and so far as the social component of the ocial market economy was not seriously jeopardized.

The same holds true for subsidy cuts for the private sector. ₅₉   For the purpose of reducing government involvement in business and reviving market forces, the Christian–liberal coalition aimed at substituting tax allowances for financial subsidies. Accordingly while special depreciation for promotion of research and development or for small and medium sized enterprise assistance was newly introduced, subsidies for agriculture in the form of Joint Tasks were decreased. Nevertheless, despite the alleged principle to limit such subsidies that merely support unsustainable industries, those for such sectors as coal mining or railroads were not entirely abolished. Similarly, with regard to subsidies for housing, property house building was further promoted through the expansion of tax allowance instead of financial aid, while subsidies for low–income housing benefits were left to increase.

By contrast, for the purpose of decreasing total government outlays, the federal government took advantage of reducing the size of joint tasks or cutting financial aids at the expense of states and localities. ₆₀   Consequently, university construction came to be significantly restrained, which belonged to the central tasks by the states. Even by means of legislative inaction towards the unemployment, the federal government shifted the burden of poverty to localities. The long–term unemployed, which were no longer entitled to receive unemployment insurance benefits, had no other ways than to depend on the public assistance by localities. ₆₁

For the MOF, reducing the deficit has been its foremost concern since the increase in the budget deficit in FY 1975. The Budget Bureau introduced the ceiling for budget requests for the first time in FY 1978, to prevent the growth of certain kinds of expenses. Subsequently, as the introduction of a new general consumption tax turned out to be politically unfeasible, the Suzuki administration, which took office in July 1980, declared its middle term plan to terminate the issuance of deficit–ridden bonds without tax increases by FY 1984. This led to the cabinet authorization of the ceiling and its further reduction to 10 per cent in FY 1980. In FY 1982, it was still further lowered to zero, and even the minus ceiling was imposed in FY 1983. ₆₂

In the meantime, the MOF efforts to reconstruct the budget through enforcing a Gramm–Rudman–Hollings type of automatic restraint on expenditures were supported by the establishment of the Ad Hoc Council on Administrative Reform in March 1981. The former Keidanren chairman Doko took the chairmanship of this Council under the condition that the government should not attempt to reduce the deficit by raising taxes. Therefore, the zero–growth ceiling was included among the recommendations released by the Council. Still more instrumental was Nakasone political strategy that succeeded Suzuki as Prime Minister in 1983. Emulating the political style of the contemporary American President Reagan, Nakasone aimed at changing postwar Japanese politics through the deregulation of domestic markets and propagating symbols of strong Japan. His plea for a small government gained influence especially among businessmen, who posed a potential threat to such vested interests as small business and agriculture that had been protected by the LDP public works tribes( oku politicians by means of pork barrel politics. ₆₃

Under these favorable circumstances, the MOF succeeded in reducing the rate of increase in general expenditures of national government. ₆₄   The general expenditures consist of major government programs in the general account budget, such as social security, education and science, national defense, public works and so forth. Regarded as uncontrollable, debt servicing costs and grants–in–aid to local governments were excluded. The rate fell down successively from 13.9 percent in FY 1979 through 5.1 percent in FY 1980, to 1.8 percent in FY 1982 and then to .1 percent in FY 1984. This surely contributed to the steady decline in bond issuance since FY 1980. Although the initial middle–term plan proclaimed by the Suzuki administration turned out to be infeasible due to the stagnant tax revenues in FY 1981–82, termination of deficit–ridden bond issuance was later realized in FY 1990.

Nevertheless, the alleged budget consolidation contained lots of mere cosmetic measures. Among the social security programs, national subsidies to the employees pension were reduced for three successive fiscal years beginning with FY 1982. This measure was prolonged in a modified form after the employees pension was integrated with the other two types of pension into a new public pension system in 1986. Thus, it should be kept in mind that the temporary expenditure cut was undertaken in the wider context of structural improvement of the pension system. ₆₅

According to the recommendation by the Ad Hoc Council, the expenditure for public works, which was the second largest item in the general expenditures, was severely constrained from increasing. However, broken down into expenses for individual programs, such as roads, housing, amenities, port, harbor, airport improvement, and agriculture, the share of the respective program has remained almost unchanged, which exactly reflects the consolidation strategy of automatic restraint. Seen from the view of the requesting ministries, each share was equally secured as their intangible domains, and a substantial part of the restrained public work programs was merely postponed to the following fiscal year to be implemented. Furthermore, even such a superficial management of cutback gave way later to straightforward expenditures, when the government met with both foreign and domestic pressures calling for expansion of domestic demands after the FY 1987.

Even though ceilings were not set upon expenditures for local public finance, the MOF, far from securing enough funds for local governments, shifted the deficit burden of the national government to them. ₆₆   Already since the first oil shock, the local finance had deteriorated significantly due to the drastic shortage of local taxes and local allocation tax revenues. The latter tax was transferred from the national government to guarantee sufficient revenue to execute local administration. The fixed rate of 32 percent of the total revenue from personal income tax, corporation tax, and liquor tax was granted, to which 24 percent of the revenue from the consumption tax and 25 percent of that from the tobacco tax was added later. Although the relevant clause stipulates that the allocation rate be raised in case of chronic substantial shortage for local revenues, the MOF denied the necessary revision of the system for the reason of still graver condition of the national finance. Instead the revenue shortage was overcome through issuance of local public bonds or short–term finance from the Trust Fund Bureau over the allocation tax special account. This poses a striking contrast to the German federal system, where the sales tax distribution entails loud political disputes between federal and state governments every other year.

Despite the temporary ease due to the increase of local allocation tax revenues in the latter half of the eighties, the fiscal rigidities of local governments were not mitigated. For the purpose of consolidating national budget, the MOF cut national government subsidies uniformly, which had been indispensable for local governments to undertake various types of local public works. Subsequently bond dependency of local governments further increased.

Among other measures, the outright suspension of debt–servicing cost transfer from the general account to the special account of the bond consolidation fund made a greater contribution to the apparent reduction of bond dependency. Despite the significant amount of revenue brought about by the sale of NTT stocks, however, the suspension of transfer payments since FY 1982 onwards eroded the fund of the special account remarkably. Accordingly, market operation by the Finance Bureau for the purpose of supporting prices of outstanding bonds was significantly constrained.

Furthermore, faced with uninterrupted budgetary difficulties, the government simply gave up cash redemption of deficit–ridden bonds, which had been issued in large scale since FY 1975 and came to maturity in FY 1985. This led to an accelerating increase in the amount of outstanding bonds with an inevitable increase in interest payment to follow. Simultaneously, the distinction between the construction bonds and deficit–ridden bonds was substantially blurred.

The accumulation of outstanding bonds outside of the general account budget made the government more dependent on financial institutions, which underwrote issues of bonds. As described above, after consultation with private financial institutions, the MOF could allocate part of the total bond issue to a syndicate of financial institutions of which the Trust Fund Bureau absorbed the remaining part. Prior to FY 1975, there was only one single type of bond, which corresponded to the preference of the MOF for the stability and predictability of long–term debt. Nevertheless, as larger issues became unavoidable to finance larger national debts, MOF was forced to increase the kinds of bonds and to diversify the methods of issuing. ₆₇   Seeking to meet demands of various groups of purchasers, short–term or small–denominated bonds were issued and part of the bonds came to be sold by public bidding, although the main part of issues remained to be syndicated. The outstanding bonds gradually matured in the secondary market, which in turn set conditions for the price of new issues.

On the other hand, banks that had mainly burdened the holding of low–yielding bonds in the syndicate urged the MOF to allow for issuance of certificates of deposit (CDs), of which terms were further liberalized later in the interest of banks. ₆₈   Overriding the resistance from the security industry, the banks still succeeded in gaining concessions from the MOF, to make an inroad into government bonds retailing and selling, which had been hitherto monopolized by the security houses.

Behind the concession towards banks was a strategy shift by the MOF from the extremely tight regime of capital controls, which closely matched the Japanese economy that suffered from chronic balance–of–payments problems. ₆₉   However, as a production maximizing growth strategy became gradually obsolete with accumulated foreign currency reserves, capital controls lost their effectiveness. Along with an increasing outflow of foreign direct investment by the externally oriented forms, financial institutions expanded overseas operations and added enormous volumes of inward as well as outward capital flows. As was exemplified by the institutionalization of the Euro–yen market, it became exceptionally difficult for the MOF to insulate the domestic market from cross–border capital flows. Thus, cautiously retaining control provisions for eventualities, the MOF abandoned the concept of capital flow interdiction in favor of the automaticity–in–principle with the revision of the Foreign Exchange and Foreign Trade Control Law in 1980.

Although the MOF further liberalized capital transactions in many respects significantly responding to the so–called yen–dollar negotiations in 1984, it also managed to fend off American demands for the development of a short–term government bill markets which the BOJ could have used for its open market operation. ₇₀   In fact, in the following international negotiations to reduce trade imbalances by cutting the value of the dollar, the MOF continued to resist a fiscal policy change. Instead, the MOF first shifted the burden of coordination to the low interest monetary policy by the BOJ after the Plaza Agreement in 1985. It was only under the expansionary Minister of Finance, Miyazawa, and in the face of increasing political pressure for reviving domestic demands, that the Ministry acquiesced in the formulation of a supplementary budget in 1987, which marked the end of fiscal consolidation in the eighties.

Nevertheless, the financial liberalization of the eighties never left the policy instruments of the MOF untouched under which the unique financing system of the FILP should be counted. ₇₁   First, when the interest rate was completely deregulated and the interest income tax was introduced for postal saving deposits as well, the Ministry of Posts and Telecommunications (MPT) was allowed to invest a portion of funds from the postal savings special account. This compensation for the MPT, which resulted from the political deal among LDP politicians, eroded the principle of unitary management of the funds by the Trust Fund Bureau. This meant also, that, besides the short–term portfolio management, a greater portion of the funds came to be directly invested in financial markets. A substantial part of these had been formerly applied for long–term loans through government–affiliated financial institutions or public corporations. Secondly, and more importantly, through a partial amendment of the relevant law, the lending rate to the Trust Fund Bureau from such special accounts as the postal savings, public pensions, and postal life insurance came to fluctuate in connection with the coupon rate of the ten–year maturity government bond. Equally, the lending rate from the Trust Fund Bureau to the government–affiliated financial institutions and public corporations was adjusted to the long–term prime rate in the market. Thus, through financial liberalization, the FILP became substantially subordinate to the interest rate mechanism of markets.

 

Towards Uncontrollable Debt Accumulation?

Fiscal Consequences of German Unification

In retrospect, the German unification caused multi–faceted problems, which, for their solutions, should need by far a longer process of gradual changes than anyone had anticipated. Historically a liberal order of market capitalism evolved where state and society developed in a closely interrelated way. In fact, the German order of ocial market economy is no exception in consisting of mutually entangled components of ndustrial governance such as competitive market, business organizations, industrial relations or industrial policy on the side of Laender governments. ₇₂   Thus it was impossible simply to implant this version of market capitalism into the former GDR to revitalize the obsolete economy of the state socialism.

However, in the face of the relentless flow of migrants, Chancellor Kohl almost arbitrarily opted for a rapid unification breaking usual communication channels and undertaking no negotiations with other corporate actors in the German polity. ₇₃   Accordingly, a new Federal Republic was established within one year after the fall of the Wall. During this highly politicized context, the Chancellor dictated the terms of Monetary Union, through which the Deutsche Mark was introduced with a parity conversion rate for wages and prices. Regarding its statutory independence as breached by the Chancellor, the Bundesbank President Karl Otto Pohl resigned later from the office prematurely. Furthermore, by the time, when the Unification Treaty was concluded to lay down the legal and institutional bases for the unification, the federal government strengthened its political dominance vis–a–vis state governments. While the old western states adhered to a preventive stance against bearing the burden through incorporating the newly born eastern counterparts into the financial equalization scheme, the latter were completely dependent on the federal government. Besides the Treuhandanstalt was charged with privatization, of which task should have been entrusted to the new states for their regional and industrial policy. In place of them a state holding company stood directly under the federal government for the industrial restructuring. ₇₄

In making these strategic decisions, the Chancellor office also superseded the Ministries of Economics and Finance, which had prepared more gradualist proposals. The rationale behind such a centralized decision–making rested on the assumption that the currency union would catalyze the economic take–off in the new states, just like the conomic miracle followed after the 1948 currency reform. It was expected that after the initial reconstruction, receipts from privatization as well as increased tax revenues generated by growth would cover the financial cost.

However, this expectation proved to be over–optimistic. In the five new states, production and employment virtually collapsed. Subsequently, through an array of special funds, financial transfers from the federal government to the East ballooned. ₇₅   Along with the German Unity Fund, which was put in place to meet the revenue needs of the eastern states with its DM 115 billion endowment, several special funds were created in order to solve the debt problems by the former GDR. Other than the Treuhandanstalt, which offered liquidity credits and investment injections, special funds were placed at the disposal of the Deutshce Bundespost and Deutsche Bundesbahn to enable the long–term infrastructure replacement programs. A regional development assistance program was further introduced to cover the investment costs of earlier projects in the east. To provide incentives for reluctant private capital, the European Recovery Program was equally employed to finance investment credits and subsidies. In addition, the social security funds enabled enormous amount of benefits transfer to the east and that in an almost unobserved way. Alone, the sum of benefits, which the Federal Office for Employment paid to the unemployed in the east, surpassed that of financial transfers through the German Unity Fund.

The total sum of net public sector transfer into the eastern states during the first five years after unification reached over DM 1,000 billion. Accordingly, the public deficit enlarged from DM 929 billion in 1989 to DM 2,135 billion in 1996. Borrowing on this scale and outside the confines of the federal government budget represented a sharp deviation from the conservative principles of Germany past fiscal policy.

As the transfer payments to the East tended to boost consumption under the parity exchange rate and the deficit spending on the above scale had inflationary consequences in the West as well in the summer 1991, the Bundesbank made full use of its discount rate policy. Although its claim to independence had not been sustained in the context of unification, the Bundesbank then reversed the roles to dictate policy preferences in pursuing its own policy goals. The rate was raised abruptly from 6.0 to 8.5 percent, which, on the other hand, was intended to attract foreign purchasers for the newly issued huge amount of bonds.

The Bundesbank determined fight against inflationary overheating aggravated the domestic recession and caused turbulence in the European Monetary System, which, nevertheless, marked a turning point in post–unification politics. Facing the contracting economy and steeply climbing budget deficit, Kohl embarked on negotiating economic package deals with state governments, corporate actors, and oppositions. Through a series of numerous talks from the fall 1992 till the spring 1993, the participants arrived at multiple agreements subsumed under the olidarity Pact ₇₆

Above all the eastern states got incorporated into the financial equalization system, as a result of which the exceptional arrangements of German Unity Fund came to an end. ₇₇   Instead of exploiting financial disparities between old and new states for the good of the federation, the federal government accepted the demands from the common front of all states. Consequently, while the new states were provided with a far greater volume of their own revenues, the old poor states were promised extra funds for covering their budget deficits as well. The rich states in the west agreed to contribute payments to the extended scheme for the sake of interest of all states.

The tax increases, which had been delayed because of electoral calculations, also began to be addressed. Following the one–year solidarity surcharge of 7.5 percent on income tax of 1991, and sales tax as well as petrol tax increases of 1992, the solidarity tax of the same rate was introduced again in January 1995. Furthermore, a neo–liberal austerity policy was revived under the disguise of flexibilizing the German labor market rigidities. Social security reforms came to be rigorously pursued for the purpose of lessening budgetary burdens, which were equally supported by the employers that required reduction of non–wage labor costs.

In this context, the Federal Ministry of Finance announced middle–term fiscal policy guidelines anew, which aimed at recovering a ymmetrical relationship between a competent state and the competitive economy after unification. ₇₈   Aiming to strike a new fiscal balance between the public sector and the private economy, the guidelines described policy goals that the federal fiscal policy should be steered for. However, as the formal institutional structure of the German polity was extended eastwards through the informal negotiations centered on the Chancellor, the unification has changed nothing essential with the role of the federation vis–a–vis states in the fiscal policy as genda setter. In fact, although the successor organization of Treuhandanstalt was absorbed under the Federal Ministry of Finance, the federation stood against the sixteen states that came to enjoy no less fiscal autonomy than before.

Besides, the olidarity Pact exemplified that the federeal fiscal policy remains confined not only by other independant authorities but also in the wider context of goverment-corporate actor relations. ₇₉   The Federal Constitutional Court had set the legal imperative on amendment of the financial equalization scheme, and the Bundesbank urged the federal government to address the expenditure cut through its high discount policy. Moreover, the pact could not be viable without the cooperation on the side of corporate actors. For the federal government, even the trade union cooperative income policy was indispensable, which should induce the Bundesbank to ease its monetary policy. Although the trade unions have not finally altered their initial policy that foresaw wage convergence in the new states, they conceded to the federal government, in that they displayed wage moderation in West Germany in return for the reoriented Treuhandanstalt policy, which extended financial support to the firms before privatization.

Looming Fiscal Crisis in Japan

As in Germany, the Japanese economic policy has followed its distinct path in the nineties, whereby the continuously eroding but still enduring predominance of the MOF and the LDP has left a huge amount of public debt. The sum of the accumulated deficit is presently estimated to well exceed Japan GDP.

Since the bursting of the ubble economy in the late eighties to early nineties, as was seen in the sudden fall of asset prices in the property and stock markets, highest priority has been given to the recovery of economic growth. ₈₀   Although the economy first bottomed out in the late 1993, and then FY 1995 and FY 1996 witnessed slight recoveries, FY 1997 and FY 1998 successively recorded macroeconomic contraction for the first time in Japan postwar economic history. During the decade, the official annual economic forecast erred in overestimating real GDP growth. Although the MOF had regarded the consumption tax hike as indispensable compensation for the income and local tax cut in FY 1994, the introduction of the tax hike in FY1997 damaged the economy considerably to deepen a serious recession.

Under pressure from other G–7 countries, above all from the U.S., that called for fiscal measures to boost domestic demands, the Japanese government expanded spending in several steps focusing on public works expansion, which exactly exemplified the resiliency of the past policy–making pattern. Even the brief period of coalition governments 1993–1996 added nothing new in this regard. For instance, the JSP joined willingly its coalition partner LDP in distributing compensatory funds to farmers under the Murayama government, after Japan had finally conceded to open up the markets for agricultural products in the GATT Uruguay Round negotiations. Governing parties thus remained to be articulate at protecting local constituency interests. Accordingly, for the period from 1992 through 1995(since the Miyazawa government) the aggregate sum of spending measures for the economic recovery totaled more than 66 trillion yen in all, the relative size of which in relation to the respective GDP ranged between 1.28 and 3.21 percent. ₈₁

Given the unprecedented fiscal crisis, it was the Budget Bureau of the MOF that took the initiative again to prompt the Hashimoto government to announce the consumption tax hike from FY 1997. The Bureau further initiated a plan to move towards fiscal consolidation with the aim of reducing the budget deficit to three percent of GDP by FY 2003. Despite its failure to introduce a consumption tax hike under the disguise of a ational welfare tax under the Hosokawa non–LDP coalition government, the Budget Bureau thus temporarily succeeded in addressing the fiscal reconstruction. The Fiscal Structural Reform Law of November 1997 was enacted overriding the resistance from LDP ublic works tribe parliamentarians by extraordinary means of establishing a special governmental committee that authorized the strategy for the overall fiscal reconstruction with the membership of former Prime Ministers.

However, as the tight fiscal policy along the new law worsened the downward trend of the economy, the Hashimoto government was soon forced to perform a U–turn to introduce a special income tax cut worth of 2 trillion yen, following a series of corporate tax cuts. Subsequently, the present Obuchi government further formulated a distinctly eynesian national budget for FY 1999, the sum of which surpassed 80 trillion yen. The growth rate of the general expenditures reached 13.9 percent, which was the highest since FY 1979. The expanded expenditures were to be covered by government bond issuance, as the tax revenues further decreased because of the tax cut and recession. The borrowing ratio of FY 1999 is expected to exceed that of FY 1998, which recorded 38.6 percent due to the additional spending measures in the three supplementary budgets.

The planned issuance of an enormous amount of new bonds led immediately to the price fall of the outstanding bonds, which corresponded to a higher long–term interest rate. Along with the downgrading of the Japanese government bonds by the American rating companies, the prospect for the higher long–term interest rate even promoted the government to pressure the BOJ to purchase government bond directly despite the law stipulation. ₈₂   This still seems to support the case for the subservient status given to the BOJ despite the recent amendment of the Bank of Japan Law for the purpose of increasing its independence. ₈₃   At any rate, as the official discount rate has been renewing the lowest record level, the room for monetary policy has remained extremely limited.

The BOJ was not the only institution that was forced to burden the cost of spending policy by the government. Confined by its own deficit problems, the MOF increasingly shifted the financial burden of public works to local governments. With their chronic revenue shortages under the present local financial scheme unsolved, the local governments are forced to undertake a substantial part of public works, issuing local public bonds or depending on national finance over the allocation tax special account. Subsequently, the spread between the interest rate of the national bond and that of the local bonds is distinctively enlarging. ₈₄

Furthermore, the governing LDP has currently announced a new plan to issue five–g–year interest–bearing bond, which should directly compete against the debentures to be issued by the long–term credit banks. ₈₅   Thus, for the purpose of securing revenues form bond issuance, the MOF is almost sacrificing its traditional onvoy style of banking administration, under which the interest of segmented financial industry has been protected.

Equally, in the wider context of the huge bad loan problems the Japanese banking system faces, the MOF has been gradually losing its leverage for problem solutions. Along with a series of corruption scandals by the MOF officials, the injection of the taxpayers money to cover the non–performing loan by the housing loan corporations (jusen) incurred severe public criticism. Furthermore, its traditional method of bailout through injecting public fund and prompting healthier banks to merge bad ones has been proving less and less effective and gathering graver distrust from foreign investors. The MOF attempts to reform the systems for bad loan write–offs and deposit insurance arrangements have been extremely late and piecemeal.

Recently, the newly established inancial Renewal Committee which is headed by the minister that is in charge of financial affairs, has decided to inject the public money worth of 7.46 trillion yen to 15 city banks for promoting their bad loan write–offs and capital improvement. ₈₆   The independent inancial Supervisory Agency which assumes such roles as of licensing, inspection, supervision and concrete resolution of problem solution of financial institutions, stands now under this Committee. The MOF, of which jurisdiction over regulation of financial institutions has thus been considerably curtailed, is no longer able to monopolize the crisis management policy–making in case of systemic financial destabilization in the future.

As was exemplified by the emporal nationalization of the Long–Term Credit Bank of Japan, the more fundamental change might as well be seen in the eroding problem solving capacity once possessed by the MOF and LDP. Losing information channels vis–a–vis the financial institutions, the MOF can no longer forge solutions that could meet with approval from them, while the LDP is weakening whatever mechanisms it had for integrating and coordinating policy within the party. Besides, the majority that the opposition parties presently hold in the Upper House, make it all the more difficult for the LDP to strike feasible political deals. The emporal nationalization meant a denial of injecting taxpayers money in the traditional way, against which one of the opposition party Minshuto strongly protested in 1998. However, there is no guarantee that the bailout of financial institutions would not eventually turn out to be another version of the olitics of compensation and entail serious fiscal burden.

 

Conclusion

In the wake of the two oil crises that put an end to the unprecedented economic boom, the advanced countries have gradually converged in shifting their economic policies towards monetarism. The Keynesian consensus that was widely held during the economic boom broke down. Privatization, tax reform, and expenditure cuts were counted as the key policy measures. In terms of macroeconomic policy, the advanced countries abandoned active fiscal intervention in favor of small government, which was expected to activate market forces.

It is well known that in combating their common economic problems, each country moved along a different path that reflects its past policy legacy. Yet, why has Japan alone come to accumulate such an enormous amount of public debt in the nineties? Resuming large–scale fiscal stimulus packages, Japan now accounts for more than ninety percent of net government bond issuance among the advanced countries. ₈₇   This puzzle seems all the more paradoxical because the centralized state of Japan has traditionally boasted a powerful finance ministry which is supposed to strictly control government expenditures. As argued above, we cannot answer this question adequately without looking closely at the historical trajectory of economic policy and its overall institutional configurations. In the face of similar external challenges in the postwar period, prewar institutional legacies prompted Japan and Germany to build in different economic policy structures during the high growth period. The increasingly divergent institutional constellations conditioned, in turn, subsequent responses in the last two decades.

It is conventional wisdom that institutional independence allows central banks to pursue tight monetary policies, which can counteract expansive fiscal policy by the government. The German Bundesbank is a good case in point. The independent central bank tends to constrain the fiscal policy of the federal government, which, for its part, has to coordinate with the state governments in the framework of ooperative federalism Moreover, the ideology of a social market economy deeply permeates the conservative parties and economic experts, and has prevented the development of a full–blown Keynesianism in Germany. By contrast, the subservient BOJ has been forced to adjust its monetary policy to the fiscal policy of the government which consistently favors economic growth. In fact, within the Japanese developmental state, there is no significant institution that can constrain state intervention in markets like the German Ministry of Economics. ₈₈   With its extended control over the central bank, financial institutions, and local finance, the MOF is the only possible institution that can constrain the government from prolonged intervention in the private sphere. Nevertheless, its principle of a balanced budget has been successively eroded by party politics. Behind the reconstruction of the general accounts in the eighties, the MOF, making use of funds from the FILP, substantially increased the hidden deficits of numerous special accounts and of local finance. The German postwar decentralized state poses a striking contrast to this. Far from being subordinate to the federation, the German states have retained a certain degree of maneuverability vis–a–vis the federation in the revenue sharing system. They have successfully prevented the federation from consolidating its finance at the expense of states, if not of localities. The industrial finance system is even more strongly regionalized and is therefore not subservient to the federal finance.

Despite its broad jurisdiction, the MOF power is passive in nature and its influence is essentially confined to the inter–ministerial level. The problematic experiences in the nineteen–eighties and, more recently, of the Hashimoto administration, show that the MOF remains ineffective without the political support of the governing party. However, the LDP has never been integrated enough to pursue a policy of fiscal consolidation consistently. As the LDP adjusted to the centralized bureaucratic state practicing the politics of ompensation its parliamentarians consolidated their distribution coalitions among sectional interests and requesting ministries. Promoting fiscal compensation, the LDP has failed to develop a consistent economic ideology comparable to the social market economy of Germany and has tended to expand aggregate government outlays.

Along with the vast expense of bailing out private banks, the planned fiscal stimulus packages will surely deepen the crisis of Japan public finances. On the other hand, increasing pressures of global financial markets make it more troublesome to issue bonds. However, with the budget tenaciously captured by clientele interests and the national debt densely interwoven with local debt and public work projects through the complex web of the FILP, institutional inertia against reforms is expected to be extremely strong. Hence, in light of fiscal consolidation, the future success of the ongoing institutional reforms of Japan central government is subject to serious doubt, which have been negotiated within the government. Deprived of party political channels for reform, the Japanese centralized state is still in search of strategies that can break the present political stalemate.

 

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Endnotes

Note 1:  Hall 1986.   Back.

Note 2:  Castles (1989, 12).   Back.

Note 3:  Campbell characterizes the Japanese policy communities as confined by their ureaucratic primacy in comparison with the American cases despite their commonality of fragmented decision–making (Campbell, 1989). Likewise, von Beyme attributes the German distinctiveness in the overall policy making to the clearly demarcated ministerial jurisdictions (von Beyme 1990).   Back.

Note 4:  According to Manow (1996), the locus of the policy coordination in the federal government has gradually shifted from in–between the ministerial bureaucracies to the specific working groups of the coalition parties(Koalitionsarbeitsgruppen), which means the declining importance of the coordination through such classical ministries as Finance, Justice or Interior. On the coordination within the federal ministries in the early seventies see the study by Mayntz/Scharpf (1975).   Back.

Note 5:  One of the few examples to compare the postwar political economies of Japan and Germany is Haruhiro Fukui/Peter H.Merkl/Hubertus Muller–Groehling/Akio Watanabe(eds.), The Politics of Economic Change in Postwar Japan and Germany Vol.1, New York: St.Martin Press, 1993. However, most of the contributions therein cover the developments only up to the seventies and the common external factor of the American hegemony for both Japan and Germany is not aptly taken into account. See Keohane (1984).   Back.

Note 6:  On the often–neglected aspects of relationships between the MOF and the MITI see Mabuchi (1997). Although confined to the developments in the seventies, Knott (1981) elucidates the roles played by the Ministry of Economics in the federal budgeting process.   Back.

Note 7:  The historical scope of this essay is limited to the postwar period. Due to the late onset of the Western modernization in Japan, developmental comparison further back to the 19th century obviously needs another framework of concepts. At least the crisis models or threshold processes elaborated for the long–term developments in European cases are not to be applied for the postwar political developments in Japan(Calder, 1988). Nevertheless, this does not deny that the historical origins of institutions which came to constitute the stable political economy during the high growth period, could be traced backward to the wartime or prewar periods. See Noguchi (1995). As for the German case, see the interesting discussions by Lehmbruch (1997).   Back.

Note 8:  On the state interventions into the market during the early years of postwar Germany and Japan see Abelshauser (1983) and Kosai (1984); Nakamura (1980) respectively.   Back.

Note 9:  Grosser et al 1988.   Back.

Note 10:  According to Peters(1977,123–7), the Ministry of Economics shifted its focus to business–cycle policy in the mid–nineteen–fifties. Until then, competition policy had occupied its foremost concern. It was in the mid–nineteen–sixties that structural policy got salience and the federal government prepared guidelines for its formulation, when the growth of the German economy became sluggish and, subsequently, problems of declining sectors emerged.   Back.

Note 11:  The role the evelopmental state played for the postwar high growth has been increasingly neutralized by recent literatures. In contrast to Johnson, those literatures emphasize the roles of business or the negotiated relationships/networks between state and business in the industiral policy (Wilks/Wright 1991). However, Johnson arguments still remain valid that the activist MITI has developed policy tools from the prewar intervention experiences of its precedent MCI(Johnson 1982). Uchiyama offers the up to date overview on those literatures (Uchiyama 1998).   Back.

Note 12:  Katzenstein 1991; Hardach 1993.   Back.

Note 13:  Lehmbruch stresses the ideological importance of the in–house expertise within the Ministry of Economics for preparing the neo–conservative policy changes in the eighties. Cf. Lehmbruch 1992.   Back.

Note 14:  In contrast to budgeting, the MOF has also nourished dense networks vis–a–vis banking, security, insurance businesses for its financial regulations.   Back.

Note 15:  Lehmbruch 1997. On the chronological developments see (Benz 1984).   Back.

Note 16:  Tax revenues are estimated by the orking Party on Tax Revenue Estimates to which experts from the state governments and economic research institutes also belong. Aided by the entrale Datenstelle der Landesfinanzminister for financial statistics, the experts from the state ministries of finance keep their eyes on the federal legislation, which would have financial consequences for the states. This institution provided an indispensable base for the all states alliance against the federation by the olidarity Pact Altemeier 1998: 46f.).   Back.

Note 17:  Witt 1975.   Back.

Note 18:  Tanaka 1975; Gotoh/Uchida/Ishikawa 1982.   Back.

Note 19:  Amakawa 1987. It commonly pointed out that the Japanese government lacks the capacity for coordination. As the cabinet or the Prime Minister office is institutionally weak, bureaucratic power is concentrated at the ministry level(ministerial sectionalism), which makes the passive coordination by the MOF through annual budgeting all the more indispensable. Makihara revises this conventional wisdom for the period after the Occupation, when the secretariats of such ministries as finance, industry and trade, agriculture and forestry were capable of positive coordination based on their common experiences under the wartime mobilization (Makihara 1995/96).   Back.

Note 20:  On a series of plans to dissolve the MOF see (Mabuchi 1994: 170–82)   Back.

Note 21:  Itoh 1980.   Back.

Note 22:  Holtfrerich (1988: 139–50 )   Back.

Note 23:  Deutsche Bundesbank (1995: 12–5).   Back.

Note 24:  Tsutsui 1988.   Back.

Note 25:  Ueda 1993.   Back.

Note 26:  Katzenstein succinctly defines the role played by political parties as odes which intermediate between emi–sovereign state and society in Germany(Katzenstein 1987:). By contrast, the Japanese LDP has been most articulate in representing clientele interests in policy–making, of which tradition goes back to the prewar era. Even the scope for oku parliamentarians is confined within specific ministerial jurisdictions. However, if the LDP has not developed any kind of overall economic policy that would integrate wide array of individual policies should be theme worth to be reinvestigated. See (Mikuriya 1988).   Back.

Note 27:  Calder 1988; Campbell 1977.   Back.

Note 28:  Hardach (1993 ); Nakamura(1993 ).   Back.

Note 29:  Schmidt (1990 ).   Back.

Note 30:  Kosai 1984. On the consequences of the mall government on the competition among parties see (Hiwatari 1991).   Back.

Note 31:  Dreissig 1976.   Back.

Note 32:  Nakamura (1980, 280–6 ).   Back.

Note 33:  Hennings (1982, ).   Back.

Note 34:  Nakamura (1980, 252 ).   Back.

Note 35:  Shonfield (1965, 290–4).   Back.

Note 36:  Under the institutional reforms during the Grand Coalition, one should distinguish Keynesian elements from those which had originated from other considerations to overcome the specific problems pertinent to the German federalism. I owe this insight to Gerhard Lehmbruch. See further on detail (Allen 1989), (Sato 1983, 142–57).   Back.

Note 37:  It should be kept in mind that not the Minister of Finance but the Minister of Economics presided over the oncerted Action.   Back.

Note 38:  On the responses by the MOF bureaucrats when the national government bond was issued for the first time in the postwar period see (Yamaguchi 1987).   Back.

Note 39:  Noguchi 1995.   Back.

Note 40:  On the Reconstruction Credit Agency, see Shonfield(1965: 279–82), Czada(1990: 297–9 ).   Back.

Note 41:  Hennings 1982. Scharpf persuasively reconstructs the Keynesian macro economic policies during the social–liberal coalitions as the interplay among governmental fiscal policy, monetary policy by the Bundesbank and the income policy by the trade unions( Scharpf 1987: 151–98 ), on which this section heavily draws.   Back.

Note 42:  On the institutional constraints for the governmental fiscal policy, see Scharpf(1987, 261–79 ); Knott 1981. Scherf gives overly critical accounts for the fiscal policies during the decade (Scherf 1986).   Back.

Note 43:  Schmidt(1988, 79–85 )   Back.

Note 44:  Cit. by Scharpf 1987, 168.   Back.

Note 45:  Alber 1989, 284–327.   Back.

Note 46:  Nakamura(1980, 228–32 ).   Back.

Note 47:  Horiuchi 1993.   Back.

Note 48:  On the reality of the alanced budget in the postwar period see (Hayashi 1975).   Back.

Note 49:  Campbell 1977, 241–71.   Back.

Note 50:  Remodeling of the Japanese Archipelago plan could remind of the contemporary highway extension plan in Germany during the social–liberal coalition government. Cf. Karl Dietrich Bracher/Wolfgang Jager/Werner Link(eds.), Republik im Wandel 1969–1974. Die Ara Brandt (Die Geschichte der Bundesrepublik Deutschland Vol.5/I), 142f.   Back.

Note 51:  There were debates over which of the two expenditures mainly caused structural rigidities to the national budget in the seventies, social security costs or public works expenditures. See (Noguchi 1987), (Mabuchi 1994: 292–98 ).   Back.

Note 52:  Mabuchi 1994.   Back.

Note 53:  Deutsche Bundesbank 1995, 59f.   Back.

Note 54:  Mabuchi 1994, 327–32.   Back.

Note 55:  Cit. by Bolling 1983, 121–41.   Back.

Note 56:  Bundesministerium der Finanzen(ed.), 1985, 14f. ; Sturm 1993, 46–51.   Back.

Note 57:  Sturm (1993, 48).   Back.

Note 58:  Webber 1992.   Back.

Note 59:  Tano 1992.   Back.

Note 60:  Struver 1996; Farber 1996.   Back.

Note 61:  Heritier 1997.   Back.

Note 62:  Ishi (1997, 130–3).   Back.

Note 63:  Funabashi 1988, 88–93.   Back.

Note 64:  Noguchi 1987; Miyajima 1989.   Back.

Note 65:  On the nature of the Japanese welfare state and its possible classification see Esping–Andersen 1997.   Back.

Note 66:  Mochida 1992; Shibata (1993, 167–78).   Back.

Note 67:  Shibata (1993, 131–40).   Back.

Note 68:  Rosenbluth 1989, 106–12.   Back.

Note 69:  Goodman/Pauly (1993, 64–70); Rosenbluth 1989.   Back.

Note 70:  Rosenbluth 1989, 51f., 63f., 79, 95; Funabashi 1988, 93–104.   Back.

Note 71:  Yoshida/Konishi 1996; Tomita 1997.   Back.

Note 72:  Hollingsworth/Boyer 1997.   Back.

Note 73:  Lehmbruch 1991.   Back.

Note 74:  Czada 1993; Seibel 1994.   Back.

Note 75:  Czada 1995.   Back.

Note 76:  Sally/Webber 1994.   Back.

Note 77:  After Unification, the federation once succeeded in dividing the states to secure the majority for revising the temporary scheme of financial aid for the good of the federation in 1992. However, the federation failed to carry out the same strategy by the conclusion of the olidarity Pact See Altemeier on the federation strategy as genda setter Altemeier 1997).   Back.

Note 78:  Bundesministerium der Finanzen(ed.), 1996.   Back.

Note 79:  On the various kinds of possible barriers that could constrain public borrowing in Germany see (Sturm 1993).   Back.

Note 80:  The financial deregulation has been one of the crucial causes of the asset inflated ubble economy since the late eighties. Cf. Miyazaki 1992.   Back.

Note 81:  Ishi (1996, 20–25).   Back.

Note 82:  Asahi Shinbun Feb. 8, 1999.   Back.

Note 83:  Mabuchi (1997, 77–83). While the Bundesbank is formally required to intervene in the foreign exchange market within the European Monetary System, the BOJ remains to trade foreign currencies on behalf of the MOF as before. The MOF makes the decision on the foreign exchange market and the BOJ follows to undertake currency trade, making use of the fund raised through purchasing of the government bonds by the BOJ itself.   Back.

Note 84:  Asahi Shinbun Oct.27, 1998.   Back.

Note 85:  Asahi Shinbun May 14, 1999.   Back.

Note 86:  Asahi Shinbun Mar. 8, 1999.   Back.

Note 87:  Financial Times Feb. 9, 1999.   Back.

Note 88:  Recently, a section, which had been in charge of formulating overall principles for economic policy, was transferred from the Ministry of Economics to the Ministry of Finance at the direction of the newly appointed Minister of Finance Oskar Lafontaine. It was argued that, along with the similar transposition of another section for financial regulations in the early nineteen–seventies, the Ministry of Economics was significantly weakened in relation to the Ministry of Finance. Cf. Wilfried Herz, toppt Oskar jetzt! in:Die ZEIT, Nr.43, October 15, 1998, p.48.   Back.