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No.5 ,Economy  Feb 04, 2011

TPP MAY SPARK JAPANESE POLITICAL RESTRUCTURING

In the wake of the collapse of Lehman Brothers in September 2008 and the financial crisis that ensued, the traditional forms of macroeconomic policy lost their effectiveness as tools for managing the US economy. This has compelled the United States to change the direction of its economic policy. The Obama administration, recognizing that its fiscal and monetary policy mix was not expanding effective demand, has launched an effort to create jobs, using exports as the bridgehead. This policy is aimed at doubling exports within five years, based on the idea that the employment situation is unlikely to improve without an export-driven expansion of the economy.

Doubling exports within five years will require an average annual increase of 15%. The participation of the United States in the Trans-Pacific Strategic Economic Partnership (TPP) emerged in this context.

Originally, the TPP was conceived as a system of full free trade between four smaller nations in the Asia-Pacific region: Brunei, Chile, New Zealand, and Singapore. In order to achieve economic growth and improve the lives of its citizens, every country must make good use of its economic resources through selection and concentration, but none of these countries is large enough to accomplish this effectively on its own. The TPP was devised as a way for them to overcome their restricted scale by maximizing the use of policies aimed at economic liberalization. The underlying concept, in other words, is that given their small size the four countries need to hasten their efforts to design a system that allows them to benefit from the global economy.

Economic textbooks deal with the topic of trade by dividing countries into the categories of “large” and “small.” According to this formulation, small countries are only able to adjust to the given price levels. Even if they adopt special policies, the impact on the internationally established price system is nil. However, the four Asia-Pacific countries that conceived the TPP are acting to intensify their creation of added value. These smaller countries, after attracting the participation of larger countries, are playing a leading role now in the effort to create a new system. The United States, for its part, hopes to use this initiative begun by smaller countries to its own advantage as a way of surmounting the current impasse in its macroeconomic policies.

Given the fact that the situation has reached this point, Japan should likewise position participation in the TPP as a strategic task. In the past Japan was strongly inclined to view the multilateral framework of the World Trade Organization as sufficient for the purpose of economic liberalization. However, reconciling the interests of all the WTO member states has proved to be a very time-consuming process. Seeking to break through this impasse, countries have moved to create bilateral free-trade agreements in increasing numbers. But Japan has had a hard time opening up its agricultural sector and other domestic industries, and as a result it has lagged behind other major exporting nations in concluding such FTAs.

Within the frameworks of FTAs reached worldwide up to now, countries have sought to achieve total liberalization of trade on the vast majority of product categories, but they have agreed to allow some exemptions for particular “items of interest.” Even if they scrap tariffs on, say, 90% of the list of products traded, they have let each other exclude around 10% of the items on the list. In other words, FTAs do not require totally free trade but provide a loophole for some protectionism. Countries have been able to select prospective partners on this basis, and this is how FTAs have expanded among countries other than Japan.

Under the TPP, by contrast, the aim is to achieve free trade for 100% of the items traded; this is because the agreement’s framework was created by smaller countries with a clear focus on what they were seeking to achieve. Moreover, rather than being limited to trade, the TPP also seeks to introduce global economic standards in such areas as investment, intellectual property rights, government procurement, and product standardization. Naturally, another of its aims is to construct a unified global framework for finance and labor mobility.

For this reason, the TPP has become a mechanism of economic integration that surpasses FTA frameworks. Participating in the TPP would mean Japan’s complete economic integration with the United States, given the two countries’ economic scale and fields of competition and the importance to each of the other’s market. The TPP will encompass telecommunications, information technology, finance, intellectual property rights, and product standardization. As a supplementary feature, it will also be part of a strategy to counter China.

China, since becoming a WTO member, has been involved in many cases of alleged violation of WTO rules. The United States, despite its stature, has lacked adequate power to counter China’s singular policies, particularly in the areas of intellectual property rights and government procurement. Some corporations facing problems in such areas have voiced dissatisfaction about being unable to state their cases strongly because of the pressure that the Chinese government exerts from its advantageous position. Even the US government has been at a loss when it comes to dealing with China. Japan also lacks the wherewithal to counter China, particularly when it comes to product standardization, in the face of the buying power generated by the growth of the huge Chinese market. However, if Japan and the United States were to build up the TPP framework, they would be in a position to counter China in terms of scale and other conditions.

These benefits of the TPP would be favorable to Japanese manufacturing, needless to say, but the agreement’s significance is not limited to that alone. Japan needs to make its decision on whether to join from a long-term perspective.

The population of Japan is aging. In this graying society, the Japanese economy will need to have a mechanism in place to further increase added value as a way of countering the contraction of the working-age population and the fall in domestic surplus funds for investment (such as household savings). Despite this need, Japan has been holding on to the social customs and economic mechanisms of the past and has not seriously undertaken moves to improve productivity substantially. The result of this inaction has been a long period of economic stagnation.

With the emergence of the TPP issue, however, Japan now finds itself confronting the question of how it can apply regulatory reform and bring its domestic economy into line with global standards–a question that relates to the creation of added value. Prime Minister Kan Naoto has taken a proactive stance toward the TPP. He seems to view this framework, which suddenly appeared from the outside, as a golden opportunity, and to be positioning it as a tool for selecting a strategic course for Japan.

An Unfinished Process

In the years following the Meiji Restoration of 1868, Japan undertook to modernize itself and strove to catch up to the more developed countries of the West. The international consensus is that this catch-up process was successful overall. However, because Japan was playing catch-up, it only needed to follow the examples of countries that had preceded it on the path to development. Perhaps for this reason, after Japan managed to catch up to other countries, it unfortunately failed to squarely address the task of putting in place the economic framework needed for the further creation of added value.

Why was this the case? Examples from world history show that once a country has industrialized to a certain point, stagnation occurs as a result of emerging contradictions related to income distribution. The country thus faces a situation where it cannot reach the next developmental stage unless it manages to channel additional resources to sectors with higher productivity. Effecting a change in income redistribution is very much a political task and involves a sort of transfer of political power.

Here we can look to the historical example of the anti-Corn Law movement during the first half of the nineteenth century in Britain, where the clash between the ideologies of free trade and mercantilism resulted in political and social change.

At the beginning of the nineteenth century, the British industrial bourgeoisie, which centered on cotton manufacturing in Manchester, gathered force. A thorn in the side of this bourgeoisie was the Corn Laws, enacted in 1815. These laws were designed to protect the interests of the large landowners, many of them aristocrats, by placing high tariffs on imported grain, thus driving up grain prices. The removal of this trade barrier to allow for free trade would have the effect of dramatically lowering grain prices, improving the de facto level of workers’ wages, and improving the return on capital for the industrial bourgeoisie. Viewed from a different perspective, removing the trade barrier would mean depriving the landlords of the “rent” they had extracted by limiting supply.

The bourgeoisie centered in Manchester formed the Anti-Corn Law League, with Richard Cobden, and John Bright acting as its ideologues. This campaign launched to defeat the power of the landowners developed into a broad movement, and in 1846 succeeded in abolishing the Corn Laws.

The movement’s success signified more than simply removing an economic restriction: It marked a shift of the mainstream in British politics–the moment when the advocates of an open economy gained ascendancy over the defenders of mercantilism, which had been the dominant economic policy in Europe since the age of exploration. This led directly to a change of direction in Britain’s foreign policy. The mercantilist-based policies of the British Empire had involved scrambling to obtain colonies and employing military force overseas. The drive to win bigger markets through an open economy signified the rejection of this earlier policy as being too costly; in its place the industrial bourgeoisie in Britain successfully pushed for the adoption of a set of policies that would promote their own interests through an open economic system.

Did anything similar to what happened in Britain occur in Japan as it strove to catch up to the more advanced countries after the Meiji Restoration? Were there ideologues comparable to Cobden or Bright? Did anything like Britain’s industrial bourgeoisie emerge as a force within Japanese politics? The answer is no, Japan’s historical record reveals no developments like those exemplified by the emergence of “Manchester” and the success of the anti-Corn Law movement in Britain.

Even though the changes initiated by the Meiji Restoration did proceed as far as the adoption of a constitution and the establishment of a parliament within the context of a government headed by the emperor, political leadership was exercised by the hanbatsu, the oligarchs who emerged from the domains (han, the fiefdoms into which Japan was divided under the Tokugawa shogunate, 1603-1867) that played a leading role in the Meiji Restoration. The hanbatsu tinge of the government later faded, but the bureaucratic apparatus that sustained the monarchical setup kept parliamentary forces at arm’s length, resulting in the formation of the “transcendentalism” (chōzenshugi) whereby the government was administered independent of political parties. Through the end of the Meiji era (1868-1912), the makeup of the cabinet continued to be determined by the genrō (also called genkun), the elder statesmen who had led the country in the years after the restoration.

The first cabinet composed of political party members was formed in the Taishō era (1912-1926) under the Rikken Seiyūkai (Friends of Constitutional Government), a party led by Hara Takashi. Hara aimed to establish a Japanese version of party-centered politics based on a compromise with the genrō. Expressed schematically, the aim was to counter the power of the genrō and bureaucrats by bundling the interests of the landowning class together with those of business world and maintaining a conservative stance to counter the proletariat, which had begun to emerge as a social force around this time. The Liberal Democratic Party formed after World War II can trace its roots back to the Seiyūkai.

The history of Japan shows that its industrial bourgeoisie did not succeed in assuming power in a way that would make it possible to eliminate the sort of “rent” that the British swept away by repealing the Corn Laws. Japan thus failed to open up the path leading to the full completion of its effort to catch up to the world’s leading countries through capital accumulation.

It is true, of course, that Japan’s progress was impeded by the worldwide economic depression from at the end of 1920s, which led to the creation of economic blocs. However, no seeds of what might be called a “bourgeois revolution”–comparable to the anti-Corn Law League movement–were planted earlier in that decade, when Japan should have been expanding its options. Moreover, no such revolution has been seen over the years since then through the present.

“Rent” that Distorts the Japanese Economy

The conventional historical explanation of the post-World War II period is that agrarian reforms were carried out after Japan’s defeat and that democracy made huge strides forward. The reality of the agrarian reforms, however, was that they created clusters of small-scale landowners. Moreover, we should note that these landowners subsequently formed an enormous new political force that consistently supported the effort to hold on to the same sort of rent that existed in Britain during the era of the Corn Laws.

After World War II, the tempo of Japanese industrial development rose through the open global markets to which Japan had not had access before or during the war. Yet the chance to open up markets in the agricultural sector actually receded. And in the years that followed, ownership of farmland itself became a vested interest.

Agricultural cooperatives have acted as a powerful political lobby focused on maintaining high rice prices, but at a certain point in time the target of their political activities shifted to the fixed asset tax. As a result of their efforts, the rate of this property tax on agricultural property was cut substantially, and the cost of owning farmland was thus reduced almost to zero. And landowners even in urban areas were able to take advantage of this favorable tax treatment simply by having fruit trees growing on their plots.

Generally speaking, land prices rise along with economic growth, but it depends on political decisions whether the beneficiaries of that price increase will be landowners or not. A tax can be levied on the bulk of gains from the sale of undeveloped land that has risen in value. A combination of property taxes and taxes on profits from land sales can lead directly to the more effective use of land.

Of course, immediately after the war, there was little possibility of selling agricultural land in rural areas for high prices. With economic growth, however, more and more agricultural land was appropriated as public-use land for such purposes as building roads and railway lines or constructing industrial complexes and public facilities. At times, for whatever specific reason, plots of land owned by the postwar small-scale landowners throughout Japan could be sold for high prices.

Development carried out by either the private or public sector can contribute to the creation of value by generating opportunities for economic activities. In contrast, no added value whatsoever arises from just selling land. The tax system in Japan has not distinguished between developmental activities and simple land ownership, and this has been a decisive obstacle to true agricultural innovation.

Unfortunately, in postwar Japan no structure was created for maximizing the creation of added value. The politics of protecting rent continued, without ever knocking down the wall of agricultural protectionism. Here we need to consider the meaning of the term “rent” in even broader terms. From a far-reaching perspective, rent also emerges in economic systems where political significance is attached to government expenditures or their regulation. This can even lead inevitably to the formation of rent-seeking political forces.

The politics of the LDP were dubbed gozoku kyōwa, or “five zoku [tribes] in harmony–an ironic allusion to the founding principle of the Republic of China, wuzu gonghe, written with the same Chinese characters but ordinarily translated “Five Races Under One Union–because the party was made up of five main zoku, or “tribes,” each closely linked to a particular section of the bureaucracy, namely: nōsui-zoku (agriculture and fishery tribe), dōro-zoku (road tribe), yūsei-zoku (postal tribe), bunkyō-zoku (education tribe), and kōsei-zoku (health and welfare tribe). At times the political bosses of these power bases overlapped, but all five coexisted. For example, if the ceiling on postal savings account was raised, so that the agencies in charge of operating the fiscal investment and loan programs were flush with funds, some of the funds could be channeled for use in national highway construction. Furthermore, as exemplified in the fact that most of land purchased for road construction was farmland, there were organic links between the tribes.

The point worth noting here is that this set of rent-seeking arrangements does not include any elements that create value. Because Japan’s economy was expanding smoothly in the postwar years, no discussion emerged to grapple directly with the issue of value creation. Since the collapse of Japan’s economic bubble, the Japanese people have confronted 20 “lost years.” We must reflect on our failure to come up with an adequate mechanism for controlling rent-seeking activities, which do not contribute to value creation.

Why Japan Is Losing Out to South Korea

The manufacturing sector, which is core of the Japanese economy, obviously derives its profits from competitive markets. Competition in these markets revolves around the effort to increase sales and keep down total costs. These are places where added value is created through the introduction of innovative management techniques intended to minimize costs and to open up new markets and obtain new customers by means of developing new products and technologies. The crux of LDP politics concerned how the profits obtained through manufacturing should be redistributed throughout the country. It is evident that rural impoverishment in prewar Japan led to social instability, forming the backdrop to the rise of militarism. It was thus correct, in the period after World War II, to achieve political stability through redistribution to those areas where little surplus value was created. It is also fair to say that this stability helped provide a firm foundation for Japan’s postwar growth.

However, when a number of countries other than Japan in the surrounding region joined the catch-up game starting in the late twentieth century, the prospects for Japan’s postwar approach dimmed. Japan should have squarely confronted the issue of added-value creation back in the 1990s. Instead, the Japanese government failed to take adequate note of the problem and subsequently did not come up with a satisfactory response. This was because Japanese politics consisted of a framework for consuming surpluses through rent-seeking mechanisms rather than one that involved the creation of value.

Japan’s manufacturing sector began to focus on the TPP initiative after witnessing South Korea, its emerging export rival, achieve major breakthroughs in negotiating free trade agreements. South Korea has already entered into FTAs with the European Union and with the United States. It has become clear to any observer that eventually South Korean automobiles and electronic goods sold in EU countries and the United States will be better positioned with regard to tariffs than comparable goods from Japan.

The agricultural sector makes up 3% of South Korea’s gross domestic product, as compared to 1% of Japan’s. From this perspective, it was to be expected that resistance within South Korea’s agricultural sector to FTAs with the EU and United States would be even fiercer than in Japan. Indeed, at the time the FTA with the United States was being discussed, when President Kim Young-sam was in office, farmers crowded into the streets of Seoul to protest against the agreement. I happened to be there and witnessed a demonstration where protesting farmers piled up mounds of green peppers in the district where government ministries are located.

People in South Korea realized, however, that the country could not rely on protectionism, given the limited size of the domestic market. Even more than Japan, South Korea required foreign markets to sustain its economic growth. Moreover, from a historical perspective, South Korea was in a geopolitical position where it was bound to experience conflict between those advocating the “continental” approach of prioritizing relations with China, and those arguing for what might be called the “maritime” approach of seeking to share the values and systems of the US-centered West. The decision that emerged out of this rivalry was to adopt the mechanisms befitting a “maritime” nation in order to raise its added value, rather than taking the “continental” approach. South Korea’s FTAs symbolize the overall approach it chose to adopt.

In recent years it has become increasingly clear that the offensive launched by South Korea’s manufacturers–spurred by the weakness of its currency after the 1998 economic crisis–has stirred the Japanese industrial world from its complacency. Japanese business has at long last felt obliged to focus specifically on the mechanism for creating added value.

South Korea has been creating mechanisms for actually eliminating rent in the broad sense discussed here. The key point, however, is that eliminating rent is not in any way synonymous with eliminating agricultural production. The process of actually getting rid of rent does not signify the end of agricultural production in rural areas. On the contrary, these efforts will facilitate long-term leasing of farmland and act as an impetus to agricultural production. The example of South Korea demonstrates that dealing with rent involves aiming for a socioeconomic system under which income is not redistributed to sectors that create no added value–and that this contributes to the creation of added value through agriculture.

Japan, which is in danger of losing out to South Korea, has finally become aware, through its engagement with the TPP process, of the need to greatly curtail rent and organize a process for eliminating it. Conversely speaking, Japan up to now has not paid adequate attention to how important the creation of added value is to its economy.

Restructuring Politics Through the TPP

The fact that Japanese political parties have not squarely confronted the key tasks facing the country has already been pointed out on numerous occasions. People have questioned whether either of the two main political parties has formulated policies capable of opening the way to a new era. Granted, the nature of a two-party system tends to make each party become a “catch-all” organization, but in Japan neither of the two parties has managed to sort out its own internal policy disputes.

For example, when Prime Minister Kan pledged in his policy speech to the Diet last fall to promote participation in the TPP, a group of legislators within his own Democratic Party of Japan gathered to express their opposition to the TPP.

Meanwhile, at a meeting that the opposition LDP convened to consider its position on the TPP, two incompatible views were expressed. On one side were those representing the traditional rent-seeker interests, who argued that the response to the TPP issue is a serious matter requiring the establishment of a commission within the LDP to study the many problems associated with the TPP. On the other side of the fence were those LDP members who thought the response to the TPP had been too tepid, and that an assembly of pro-TPP Diet members should be formed. Clearly, a new debate has emerged in today’s Japan, with its graying population, over the importance of creating added value and the policy structure needed to do so.

Various efforts are being made to overcome the instability of party politics. But rather than allying with or opposing particular politicians or regrouping forces just to gain Diet seats, it would be more helpful to focus action on policies that will have an impact on the prospects for Japan in the twenty-first century. In this connection, it would be much better for us if the political forces would realign themselves on opposite sides of the debate over TPP participation.

Another point to note is that the TPP will put the bilateral relations between Japan and the United States on a clearer footing. The backdrop of the TPP negotiations will also have great significance with regard to Japan’s effort to establish mechanisms for creating added value as it seeks to tap the expanding Chinese market. In addition, it will be an important way to promote modernization and democracy within China itself and encourage it to conform to the international economic system.

In these ways, the TPP will allow Japan to make its political, economic, and social systems sustainable, and it will give our country the chance to play a positive role in the restructuring of the global economy.

Translated from “TPP to iu nōgyō jiyūka ga okosu nihon no seiji kakumei,” Chūō Kōron, February 2011, pp. 102-9. (Courtesy of Chūō Kōron Shinsha) [February 2011]

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