Why Tokyo Is Yanking On The Economic Reins

It's holding off speedy recovery to put its fiscal house in order

To an American trade hawk, it may seem Japan's Ministry of Finance was up to its old tricks. Responding to warnings from U.S. Trade Representative Charlene Barshefsky, Finance Minister Hiroshi Mitsuzuka in early June said that Japan's surging trade surplus is "a passing phenomenon." Just days later, Tokyo revealed that Japan's current-account surplus for April nearly doubled, to $9.8 billion, from the year before. Most economists expect the surplus to keep ballooning for the rest of 1997. Meanwhile, Tokyo is suppressing demand for imports by hiking taxes and cutting spending, slowing the economy just as it is gathering momentum.

What are Tokyo's fiscal mandarins thinking? Some skeptics fear the Ministry of Finance policies will throw the economy back into recession and renew trade friction with the U.S. as well.

BUYING TIME. But the MOF is gambling it can win at a longer-term game. Before letting the economy gallop forward and embracing the "Big Bang" deregulation of its financial markets, the MOF would like another year of slow growth of 2% or even less. The extra time, and revenue from the tax hikes, would enable the MOF to start repairing the budget, which was ravaged by $531 billion in road work, rural irrigation projects, and other wasteful measures devised to keep the economy afloat.

The austerity policies also would relieve pressure on the Bank of Japan to raise its record-low interest rates. That's important, because a sharp increase could devastate the balance sheets of Japan's banks at a time when they need to write off some $200 billion in bad debts. "The government's attitude is that a year of dull growth is a price worth paying," says Richard Jerram, economist at ING Barings Ltd. in Tokyo.

As usual, the cost of all this will be borne chiefly by Japanese consumers and foreign exporters. In April, Japan's consumption tax jumped from 3% to 5%. The government also announced rollbacks in annual income-tax rebates and higher fees for the socialized medical system. These moves will raise $80 billion this year. "The nation at large is in a retrenchment mood," says Kazuo Nukazawa, senior managing director of Keidanren, the corporate trade group.

Sluggish domestic spending will translate into weaker demand for imports, which were already hit by the weaker yen. Despite the currency's 13% jump since May 1, to 111 to the dollar, it's still 30% off its level of two years ago. Among the hardest hit will be Asian nations such as Thailand and Indonesia, which depend heavily on exports to Japan.

EXPORT POWERHOUSES. Fresh strains in Japan-U.S. trade relations are another likely result. Soon after the trade figures were released, U.S. Treasury Secretary Lawrence H. Summers pleaded for Tokyo to boost domestic demand. Yet while U.S. companies exporting to Japan, such as Compaq Computer Corp. and Ford Motor Co., find the going tougher, the resurgent export powerhouses of Japan are on a tear in the U.S. Japanese auto exports to the U.S. should jump at least 20% this year. It's a similar story in electronics.

After nearly a decade-long decline, during which production shifted to Southeast Asia, exports of Japanese-made televisions have risen for the past seven months, surging by 33%, to 358,000 units, in April alone.

Despite the disturbing signs, Japan's bureaucrats are betting they can stave off a backlash long enough to pursue their agenda. The question is whether Japanese companies can resist the temptation to export as much as possible. Some 40% of Toyota Motor Corp.'s $6.1 billion in recurring profits last year came from currency gains. "I hope (companies such as) Toyota and Honda keep things in moderation," says Minoru Makihara, president of Mitsubishi Corp.

The Ministry of Finance hopes that chances of trade strife will be reduced by the more aggressive stance of American manufacturers, who have increased their competitiveness and offshore presence since the first Japanese onslaught of the 1980s. And so far, Washington's protests have been restrained, partly out of fear that Japan's recovery remains fragile. If the Clinton Administration brings heavy pressure now to strengthen the yen, Japan's economy could well slip back into recession. But Tokyo is betting that if it curbs the budget gap and sets the stage for serious deregulation, foreign trade partners and Japanese citizens will agree that the extra year of pain was worth it.

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