How did a postal savings system with a balance of Japanese yen 15,000 in 1875 grow into a Japanese yen 440 trillion (US$3.43 trillion) octopus of public-sector agencies and companies so large that there is virtually nobody who can see the whole thing? How does Japan now plan to dismember this ungainly beast? Fascinating questions both. To answer them is to understand a lot more about Japan's apparent paralysis in the past decade and what it's going to look like -- as a society, an economy, and a market -- when its current reform process is completed.
A thumbnail history begins with the postal savings system now 127 years old. The original model was Britain's, in which citizens could open savings accounts at post offices. The system added postal life insurance in 1916, an embellishment of the British system, and an enforced pension plan in 1941 as part of the war effort. This is the origin of what is now the world's largest single pool of pension assets.
In 1951 came the crucial event: The strapped postwar government began raiding the system's funds to finance other public sector agencies and corporations. Japan has been saddled with a so-called second budget -- huge, amorphous, poorly measured and managed -- ever since.
Highway corporations, a scholarship foundation, rural development, small-business and municipal enterprise corporations, a "green resources" company, a mining agency, airport authorities -- these are among the vast array of entities now funded under the Fiscal Investment & Loan Program at the Ministry of Finance. While they are free to raise their own money and credits, they are financed largely through the FILP fund by the postal savings and insurance system and the national pension plan.
The FILP system is unique -- you won't find anything like it anywhere else -- and to a certain extent logical. But helter-skelter growth and lack of supervision almost inevitably led to problems.
"Crucially, there was a systemic failure of governance: no clear locus of accountability and no agreed schema of transparency," writes Stephen Church, whose "Public Sector Reform in Japan" was just published by Analytica Japan, a financial research consultancy.
And here we are. Japan's public sector is a sprawl of vested interests controlled by zoku, or tribes, in the national Diet.
It's home to thousands of former ministry bureaucrats who "descended from heaven" by way of the so-called amakudari system. It's also home to what Church reckons to be a risk exposure of Japanese yen 545 trillion, of which at least Japanese yen 129 trillion is irrecoverable.
It's a mess, all right -- a huge mud puddle that remains hard to see even though it remains right in front of us.
Now for the way out of the mess. In a policy being carried out in steps from 2001 to 2008, FILP's traditional sources of funds will be replaced by two types of bonds. Stronger public entities will issue their own as an interim step toward privatization. Others will rely on new bonds issued directly by the Ministry of Finance -- in effect, Japanese government bonds.
Begun last year, FILP reform has already made a measurable dent in the agency's budget. The target for 2008 is to cut FILP's balance sheet by at least 20 percent. That will require Japanese yen 250 trillion's worth issued by the Ministry of Finance itself, roughly Japanese yen 20 trillion's worth of bonds issued by FILP agencies, and the beginning of what will be a lengthy loss-amortization period.
The score so far: FILP agencies issued a modest Japanese yen 1.1 trillion's worth of bonds last year and have a target of Japanese yen 2.7 trillion this year. These bonds are implicitly guaranteed by the government, and the first issues had a yield 20 basis points higher than benchmark Japanese government bonds.
FILP reform is considered by many to be a fine piece of bureaucratic craftsmanship. Commercially viable agencies are being pushed into the bond market -- often unwillingly -- and out on their own. At the same time, the government will retain responsibility for agencies providing necessary public goods while refinancing them -- also through the market.
Among the things I like about all this are the political implications. By restructuring sources of funds and forcing market criteria on loan capital, Koizumi or his successors stand to deal a critical blow to the zoku in the Diet and the amakudari system by which bureaucrats take up public sector positions toward the end of their careers.
Greater transparency, prudent management, a fairer financial market as public sector banks go private -- these are all on Analytica's "good news" list. But we can't forget the bad news.
It's staring us in the face.
Inertia and resistance have already started a fight that will leave a lot of political blood on the floor, possibly beginning with Koizumi's. There's also evidence that many agencies are entering the bond market with all the willingness of a spoiled teenager told to leave home.
The markets are going to be flooded with new bond issues, and they are already showing signs of indigestion. The spread of 20 basis points above government bonds on those first issues has already gone to 40 to 50 points, and the near-term schedule for FILP agency bonds is unlikely to be met.
In the end, FILP reform will raise Japan's public debt from its already alarming 130 percent of gross domestic product to more than 200 percent -- uncharted territory for a major economy. In the meantime, risk exposure is rising even as the FILP budget is getting squeezed, a parallel to the bad-loan problem faced by private-sector banks.
As several readers have already pointed out, the sluggish pace of Japan's reform is costing it dearly, even if it can't be avoided. The world's not waiting for Japan, to put it mildly, and many are those who have already written it off.
I come out an optimist nonetheless. Reform this big never comes without problems. And there is a sense of inevitability, Church has found in his explorations into the bowels of the system, even among those recalcitrant tribesmen in the Diet.
"Everyone other than the most obtuse knows the game is up," he tells me.
What a game it was for a good long while. But late-night reruns take you only so far. I'm more interested now to watch as a reinvented Japan comes gradually onto the screen.
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