The Royal Institute of International Affairs, established in 1920, is one of Britain's top think tanks on international affairs. The building it occupies was once the residence of the Earl of Chatham, prime minister in the eighteenth century, so the organization is commonly known as Chatham House.

Good morning, ladies and gentlemen. Last year was the 100th year since the birth of Ernest Hemingway. Hemingway once wrote The Sun Also Rises, which Mr. Bill Emmott followed in 1989 with The Sun Also Sets: The Limits of Japan�fs Economic Power. As this book antici-pated, the sun did truly set on Japan. However, now that 11 years have passed, I am happy to stand before you, as we once again see the dawn�fs first light, and report on the current situa-tion and future outlook for Japan�fs economy.
Although I won�ft be making direct reference to the materials distributed to you, you may want to refer to them at a later time.

1. Policy Responses since the Collapse of the Asset Bubble (to Autumn 1998)

   The Japanese economy is finally beginning to revive from the longest economic downturn since World War II, a downturn brought on by the collapse of an asset bubble starting in 1991. The economy is now on the mend after bottoming around the end of 1998. Why has the economy stagnated for so long? Three elements are especially noteworthy. First, the size of the bubble meant that its collapse had enormous repercussions, and considerable time was needed to deal with the aftermath. Second, both the public and private sectors clung to their belief in an expanding economy, and they repeatedly put off the need to deal with problems to the future. Third, the Japanese economy, by its very maturity, embodied various forms of systemic fatigue. These are the circumstances that led to the institution of misguided policy measures, the principal reason for Japan�fs prolonged economic downturn.
   Monetary policy offers a perfect example of a misguided response. The Bank of Japan began to tighten its monetary grip in 1989, a change of policy caused by an overheated economy and the rapid appreciation of land and share prices. The BOJ, however, did not refrain from making two large rate hikes after share prices began to plunge in 1990.
   The government�fs land policies were scarcely any better. Even after it became evident that land prices were falling, the government persisted in policies to curtail land prices until about 1996. These policies included restrictions on the aggregate amount of real estate loans and higher taxes on land holdings.
   What made the government adopt these sorts of policies risking a hard landing? It was excessive worries over asset inflation, which made it imperative in the government�fs mind to subdue asset prices without delay.
   Then, just after the economy turned upward in 1995 and 1996, the government increased the taxpayer burden by 9 trillion yen, or 51 billion pounds, in 1997. Despite the bad debt still encumbering financial institutions, the government raised the consumption tax in April 1997 and increased patient copayments for medical expenses in October of the same year. The government also proclaimed a structural reform package, including the reform of public finances. Thus, they made a 180 degree switch from an expansionary budget to an aus-tere one. It is hardly surprising that these measures became an enormous drag for the recovery.
   Since the 1980s, the United States, the United Kingdom, and northern European nations have seen bad debt problems lead to bankruptcies in the financial sector. Although the cir-cumstances for these bankruptcies are similar to Japan, what is different is the process and the speed with which these problems were addressed. In nations other than Japan, public funds were made available or other measures were taken at a relatively early stage, and the resolu-tion of financial problems was followed before long by economic recoveries. In Japan�fs case, however, the response of regulatory authorities to financial system problems, particularly the need to drastically reduce bad debt, was too little, too late. No wonder a financial crisis erupted. Thus the real growth of the economy fell to around 1.5 percent in the 1990s from between 3.5 percent and 3.9 percent in the 1980s. Clearly, bad policies were behind this downturn lasting for ten years.

   
   

2. Precursors to the Recovery (from August 1998)

   The government�fs policy stance shifted dramatically once the Obuchi administration was installed in 1998. The new administration made economic recovery its top priority. It endeavored to increase demand through large supplementary budgets centered on public works spending. It also put off structural reform for the time being, the rationale being that reform efforts do not yield immediate results and come with high initial social costs.
   These changes set the stage for the economy�fs recovery. The first and direct precursor to the rebound that began in 1999 were the financial system measures the government instituted. In 1998, the Obuchi administration pushed through a financial reconstruction law to ease sys-temic instabilities arising from the bankruptcies of large financial institutions in 1997 and 1998. The legislation set aside public funds totaling 60 trillion yen, or 340 billion pounds, for the recapitalization of large financial firms. Of this amount, more than 14 trillion yen, or 79 billion pounds, has already been tapped to replenish the capital of banks. The administration also estab-lished a special credit guarantee allocation in its budget and assigned it a large amount of funds. This was followed by the supply of enormous quantities of credit to small and medium-sized firms, which freed many of them from an extreme shortage of liquidity. The financial system measures the government carried out have brought about a marked improvement in the sentiment of firms and households and have returned a degree of stability to the financial system.
   A second precursor laying the groundwork for the recovery is the zero-interest-rate policy the Bank of Japan initiated in February 1999. To achieve this target, the Bank of Japan flooded financial markets with liquidity. As a result, interest rates fell sharply in the domestic money market and the government bond market, and the Japan premium vanished in foreign financial markets.

   The government�fs financial system measures and the BOJ�fs zero-interest-rate policy have enabled share prices to trend upward since the spring of 1999, and the confidence of firms and households have improved by no small measure.. It is true, however, that employment and income conditions remained bleak in 1999. This is attested by the unemployment rate approaching 5 percent, in large part a reflection of corporate restructurings. Still, the economy is thought to have expanded by about 1 percent in 1999, the result of the support given to demand by public works spending and tax cuts, the bottoming of consumer confidence, and the growth of exports allowed by the rapid recovery of Asian economies.

   
   

3. Outlook for 2000 and Beyond

   What can be expected of Japan�fs economy in the year 2000? Taken as a whole, it will be a better year than 1999. Although public works spending will slow, exports will help drive the economy forward in the first half, and production will continue to recover without a break. Starting about autumn, the engine of growth will switch from public works spending and exports to capital expenditures. As a self-sustaining recovery takes hold, the economy will grow at a pace considerably faster than its recent trend rate of 2 percent. Also, the deflationary trend that has persisted for so long will come to an end.
   As for capital expenditures, large firms are working to increase the performance of capital deployed. As such, they can be expected to maintain their current stance of restraining capital investments. This will mean that the recovery of capex will be weak. Capital spending, how-ever, is showing signs of bottoming for small and medium-sized firms owing to the improvement of their cash positions. Accordingly, the pace of recovery will quicken for capex in the year 2000, most notably for investments in information technology. In addition, as total demand grows, sentiment that capacity is excessive will ease.
   

   The appreciation of the yen under way, by damping the advance of corporate profits, will have an adverse effect on the economy that has just begun to improve. However, if the yen does not strengthen too far past 100 yen to the dollar, the expansion of the U.S. and E.U. economies and the powerful rebound of Asian economies should rule out a drop-off of exports.
   Despite the adverse effect of a stronger yen, corporate profits will benefit from the decrease of labor�fs share of income and from the revival of total demand. Conse-quently, corporate profits are expected to grow by double digits in year 2000.
   Although companies will continue to trim personnel costs, employment and income con-ditions will brighten when compared with the second half of 1999. However a clear decrease in the unemployment rate will likely await 2001 or later.
   Starting around autumn, the need to put public finances in order is likely to come up for discussion. However, there is only a remote possibility that a program to restore fiscal balance will be launched in either 2001 or 2002.
   Although I began my talk by criticizing certain government policies, there is one policy the government has pursued consistently and is commendable. This is Japan�fs Official Development Assistance. Through the 1990s, Japan�fs ODA has exceeded 10 billion dollars each year, accounting for more than 20 percent of all the ODA of donor nations. In eight straight years since 1991, no other nation dispensed more ODA than Japan. About 50 percent of Japan�fs ODA is distributed in Southeast Asia and other Asian nations. This development assistance has paved the way for the rapid recovery recently made by Asian economies.

   
   

4. Medium- to Long-Term Outlook

   In conclusion, I will mention two major changes taking place over the medium to long term. The first is a revolution in information technology, and the second, of special concern to Japan, is the demographic transition to a diminishing population.
   Now an IT revolu-tion is beginning to sweep across the world, which can be called the start of a new industrial revolution. The observation is frequently made that Japan is falling behind in the spread of personal computers, in Internet usage, and in the market size of e-commerce. On the other hand, the use of portable phones and other mobile communications equipment is growing at a stunning pace in Japan. At the end of 1999, the cumulative total for mobile phones and Personal Handy-phone Systems in use reached 54 million, equal to nearly one out of two Japanese. The ownership of such communications devices will soon surpass the ownership of fixed-line phones. As the function of portable communications devices moves from voice to data transmission, the rapid spread of these devices will become an important foundation for the establishment of an information-technology society.
   Many commentators proclaim that an age of digital household appliances is just around the corner. These are electrical appliances that will connect homes with a networked society. The supply of low-cost, convenient, and high-value-added goods that meet user needs�|the application stage�|is without doubt Japan�fs forte.
   A new economy based on information technology will be supported by a new array of businesses. The promotion and development of these businesses will require an expanded supply of new risk money. Several promising developments can be mentioned. Since last year, in the context of the BOJ�fs zero-interest-rate policy, funds have begun shifting rapidly into investment trusts and other so-called market-based indirect financing.

   In November 1999, the Tokyo Stock Exchange founded Mothers, a new stock market for start-ups and other new business ventures. And in June 2000, Nasdaq Japan will be established at the Osaka Securities Exchange. The year 2000 promises heightened competition between Exchanges over the list-ing of new business ventures, and an IPO boom can be envisioned. Through this animation of the stock market, there is every reason for believing that the supply of risk money will increase.
   Another major change unfolding over the medium to long term is the demographic transi-tion to a diminishing population. Japan�fs population is forecast to shrink after peaking in 2007. Japan will no longer be able to avoid the decrease of its population, only to slow the pace of this decrease.
   As Japan�fs population diminishes, there will be a need to increase the labor participation rate and increase productivity to support economic growth. One effective response will be to expand employment opportunities for women. Many Japanese housewives are highly edu-cated. Such highly qualified women entering the labor force will have a pronounced and positive effect. The labor participation rate for women forms an M-shaped curve in Japan, dipping in the middle for women between the ages of 25 and 40. Reversing this situation will expand the labor force by more than 10 per-cent according to one estimate. However, if women workers are sought, it will be essential to create an environment where women can comfortably balance the demands of work and fam-ily. Preparing such an environment can involve the outsourcing of house work, the development of cities where work and residential areas are in proximity, and the improvement of child care facilities.
   I began my talk by stating that government policies are the main culprit for the longest economic downturn that Japan experienced since World War II. More recently, the govern-ment has implemented a series of effective policies in short order, policies that sparked the current recovery.

   This spotlights the importance of politics, and the coalition government formed by the Liberal Democratic Party, the Liberal Party, and the New Komei Party has clearly brought new strength to the political arena. As Japan�fs population dwindles, the promotion of economic growth based on an information-technology revolution will require even greater political leadership to achieve such goals as the improvement of productivity and an increase in the labor participation of women.