Japan: Strategic zones to revitalise the Japanese economy?

Prime Minister Shinzo Abe’s landslide victory in Japan’s upper home election provides one of the strongest political mandates a Japanese leader has received in recent times. But the victory does not necessarily help in Abe’s pursuit of market-based economic reform for sustainable increase.

The sad reality is that the additional the Liberal Democratic Party (LDP) wins, the additional representatives of various pressure groups occupy Diet seats and cry for the protection of vested interest groups. The major obstacles against Abe’s reform policies come not from opposition parties but the ancient LDP members within, whose major goal is to redistribute the fruits of economic increase to their favoured pressure groups. Such politics have contributed to long economic stagnation and, with it, declining tax revenues, resulting in Japan’s substantial fiscal deficit (amounting to over 200 % of GDP).

Abe’s ‘third arrow’ of economic increase strategy is to stimulate private sector investment through regulatory reform, following the expansionary monetary and fiscal policies of the initial and second arrows. At the core of Abe’s economic increase strategy is the creation of appropriate strategic zones in Tokyo and other major cities that can provide international business environments on par with London and New York. For example, regulations on floor-area ratios will be eased to allow for additional high-rise residential buildings in these zones to stimulate housing investment without relying on public funds. They are expected to attract additional foreign and Japanese business workers in the central metropolitan areas which remain under-utilised. Regulations will as well be eased to make it easier to set up international schools and allow foreign doctors to practice, which are significant amenities for attracting foreign firms and personnel to Japan. As well, there will be relief from Japan’s higher-by-international-standards corporate tax rates and inflexible labour market regulations in appropriate strategic zones.

The initial reaction by market players has been disappointment. A lot of wonder why appropriate zones are again being touted at the same time as it is nationwide regulatory reform that is most needed. Appropriate zones for structural reform were tried under the Koizumi government in 2001–06, and while they worked well in the beginning, the zones fell into disuse.

But appropriate zones are the only real luck for reform given the difficulty Abe faces in persuading core parts of the LDP in accepting nationwide reform. Moreover, these appropriate strategic zones will be different in at least three significant ways from those that were tried before.

Initial, they are contrary to the LDP’s traditional policy of rural improvment(‘equal development across all regions’). The old policy tried to prevent the migration of people from rural to urban areas by allocating additional public investment to rural areas to attract private investment and employment increase there. Most of these initiatives did not work because there were insufficient ‘agglomeration effects’. Meanwhile the cities have suffered urban congestion because of lack of infrastructural investment that has choked off life in the metropolitan heartlands. While the LDP’s previous attempts to develop Japan’s regional economy may have had some merit in times of high economic increase with abundant tax revenues, these days are long gone. Establishing appropriate strategic zones represents a initial step in policy change toward stimulating private investment through regulatory reform in the major metropolitan areas, where the rate of return on this capital is expected to be higher.

Second, unlike the former appropriate zones initiated by the local authorities nationwide, the new zones are a national project in collaboration with major city mayors. Given this support, the reforms are additional ambitious. Metropolitan mayors are additional positive toward market-friendly policies compared with others in local areas who simply seek financial transfers from the central government.

Third, it is argued that the economic effects of regulatory reform will naturally be additional limited in appropriate zones than if reform was nationwide. But because the positive impact of reform will be additional visible in large cities like Tokyo, to both foreign and domestic investors, it will be easier to spread to other cities as well.

The idea of appropriate strategic zones is similar to that in China, where the government selected major developed cities and opened them to foreign investment while preserving the regulated socialist system in other areas. This was a key to China’s economic development over the last three decades, and the concept is as well applicable to Japan, given its dual economic structure today. Japan’s manufacturing industry is market-based and highly competitive in the world market; but on the other hand, the agricultural and service sectors are highly regulated and afflicted by low productivity.

Japan’s planned appropriate strategic zones have the potential to stimulate the market-based service sectors inclunding housing, urban development, finance and labour markets. They could be crucial to the revitalisation of the Japanese economy in coming years.

Naohiro Yashiro is Visiting Professor at International Christian University and was formerly on Japan’s Council on Economic and Fiscal Policy under the previous Abe government.