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banking scandals surfaced.6Japanese banks had adjusted poorly to interest rate deregulationbetween 1985 and 1991. Under US pressure, the Ministry of Finance (MOF) deregulated bankdeposit rates to benefit individual consumers. This changed competition in Japanese banking,which relied on customer relationships.7Success was now determined more by a banks abilityto raise the cheapest capital, and effectively manage its costs and risks, than by whom it knew.Banks were reluctant to pass on higher costs of funds to long-standing customers who belonged

to the same keiretsu,or informal business group, as the banks. Banks owned stock in keiretsucompanies and their officers sat on their boards. Keiretsu companies also owned each othersstock and this cross-shareholding created a strong vested interest in serving the interests ofkeiretsu members. (In the early 90s, about 45% of companies shares were accounted for bycross-holding.8) Instead of covering their higher borrowing costs by raising the rates theycharged customers, banks focused on asset growth to increase market share.

As the stock market collapsed, it eliminated much of the value of collateral held bybanks, typically property. The stock market collapse also squeezed banks capital, a significantportion of which was accounted for by shares in keiretsu companies. The MOF attempted to easethe trauma by directing Government pension funds into the market in 1992, but the decline

continued. In the mid-90s, regulators forced closure of several housing loan companies,jusen,which were central to Japans banking crisis, as well as some banks, such as Kobes HyogoBank. Lack of transparency in Japanese business made it difficult to estimate the true extent ofbad debts.9In 1995, MOF estimated Japanese banks bad debts at $470 billion. Private analystsput the number at $824 billion. In 1998 those estimates rose to $1 trillion. Reflecting on thebubble and its handling, theEconomists Christopher Wood observed:

The Bubble Economy represents the most dramatic failure of post-1945 Japaneseeconomic management . It was the twentieth centurys best example of the dictum ofCharles Mackay, the celebrated nineteenth-century historian of speculative manias, whoobserved that men think in herds, go mad in herds, but only recover their senses one by

one. As a group culture that discourages individualistic thinking, the Japanese are evenmore vulnerable than most to this decidedly human trait.10

Corporate Challenges

The bubble economy had induced companies to invest and hire workers aggressively in the lateeighties, leaving them vulnerable with high fixed costs when the economy deflated. Ascompanies cut costs, consumer spending fell and the economy slowed.

Rising yenWhile rising productivity in the eighties helped some Japanese companiescompete internationally, that advantage was eroded by higher wages and a rising yen, whichforced companies to check prices in foreign markets to fight cheaper competition (see exhibit 1

for currency trends). It became more attractive to move manufacturing to countries like Chinaand Malaysia. After touching a high of 79.85/$ in April 1995, the yen retreated. With Japanesetransplants meeting foreign appetite for Japanese goods from outside the countrys shores there

6Christopher Wood, The Bubble Economy, New York: The Atlantic Monthly Press, 1992.7By 1991 all deposits exceeding 500,000 earned money market rates.8OECD,Economic Survey: Japan, 2006.9Wall Street Journal,Japans banking mess, July 7, 1995;New York Times, Japan catches up in bank failures,

September 10, 1995.10Wood, 1992.

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Land hoarding was encouraged by low inheritance taxes and property taxes on agricultural lots.

GovernmentJapan experienced remarkable political stability after the departure of the Occupation Forces inthe early fifties. The Liberal Democratic Party (LDP) controlled the government from 1955 to1993, when it briefly lost power to the opposition, as citizens grew frustrated with corruption.

Japan turned over seven Prime Ministers during the nineties, often over corruption charges,16prompting TheEconomistto call it a karaoke democracy in which everybody can have a turnat being Prime Minister.17

BureaucracyJapanese bureaucrats were relatively untainted by corruption till the midnineties. Powerful ministries, such as the MOF and METI (Ministry of Economy, Trade andIndustry, known as MITI, or Ministry of International Trade and Industry, till 2001), drewtalented graduates from leading universities. These (mostly-male) bureaucrats spent their wholecareer in government, working long hours, drafting laws and administering the country by fiat, orthrough advice. The bureaucracy provided continuity in the midst of political turmoil.However, critics claimed that bureaucrats avoided risk. In 1995, when a massive earthquake

struck Kobe, killing 6,000, the government was severely criticized for its slow response.18Theyakuzasyndicate, Yamaguchi-gumi, was praised for quickly mobilizing to assist victims. By thelate 90s, bureaucrats were increasingly implicated in corruption.

Diplomacy Since WWII, Japans neighbors had demanded official acknowledgment ofits war atrocities. The Governments response was seen as inadequate. It was not until 1994, forexample, that the Government admitted that nearly 40,000 Chinese citizens were forciblybrought to Japan between 1943 and 1945 to work in mines and factories.19

SecurityIn 1997, Japan and the US strengthened their security agreement. Japan agreedto support the US in Asian security crises. The inclusion of Taiwan in the agreement upset

China.20There was concern in Japan that the US might cozy up to China and gradually becomemore attentive to its concerns.

RECESSION OF 1998

In 1998, the Japanese economy was officially in recession for the first time since the1974 oil crisis. (An economy was defined as being in recession when GDP fell for twoconsecutive quarters.) Unemployment hit a post-war record of 4.1%.21From 1998 to 2005 theeconomy suffered price deflation averaging 1.5% per year.

Economic options22

The Government desperately tried to reignite economic growth with

stimulus packages (tax cuts and public spending) worth 75 trillion ($700 billion) between 1992and 1995. These stimuli softened problems but failed to produce sustainable growth. In spring

16New York Times, June 26 and 30, 1994.17

Economist, July 2, 1994, pp. 33-34.18The Japan Times Weekly International Ed., Kobe is back on track after six months of toil, July 24-30, 1995.19

Boston Globe, June 23, 1994.20Peter Montagnon, Reluctant, cautious diplomacy,Financial Times, July 14, 1998.21Gillian Tett, Predictions of immediate crisis appear excessive,Financial Times, July 14, 1998.22Tett, 1998.

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1997, as economy recovered, Prime Minister Hashimoto tried to check the large budget deficit.He cut government spending, raised the national consumption tax from 2% to 5%, increasedsocial security taxes and withdrew tax concessions. His actions were ill-timed. The largegovernment spending had buoyed consumer demand temporarily without generating longer-termgrowth. Demand dropped and the economy slowed.23The Government was forced to provide anew stimulus package worth 17 trillion ($130 billion).

In the immediate post-bubble years, the Government attempted to prime the economy bycutting interest rates. However, that provided no room for stimulus after February 1999 when thediscount rate was down to 0.1%. In 2001, the BOJ adopted a policy of quantitative easing(QE), which directly targeted the money supply by adjusting banks current accounts with theBOJ.24The Japanese Government was in a bind. If it aggressively deregulated the economy toenhance long-term flexibility it risked deepening the recession by causing more bankruptcies. Ifit dragged its feet on structural reform it risked prolonging the economic malaise.

Banking problemThe banking crisis continued to simmer. In July 1998, theGovernment announced that it would set up bridge banks to take over sick banks and help them

restructure. Skeptics feared that the outcome would be unlike Americas handling of its Savingsand Loan bank crisis in which bridge banks were used to restructure institutions by swiftlyreplacing old managers, disposing assets and bad debt, and selling institutions to new buyers in ashort space of three to four years. They felt Japan would simply transfer ownership of weakinstitutions to government, with few managers sacked, and public money squandered with freshloans to weak borrowers instead of forcing restructuring.

25

Japanese financial system worked like a convoy. Banks supported each other and were inturn supported by the MOF, which was determined to prevent bankruptcies. It briefly appearedthat the convoy system was dying when the Government allowed the twentieth largest bank,Hokkaido Taku-shoku, and the fourth largest securities company, Yamaichi, to fold. However, it

was uncertain if dissolution of other major financial institutions would be allowed.26

TRANSFORMATION UNDER KOIZUMI:2001-200627

In 2001, riding a wave of public disenchantment with corruption, the LDPs JunichiroKoizumi became Prime Minister after defeating a candidate supported by his partys mostpowerful faction. Koizumi was an unusual Japanese politician. He wore long wavy hair and wasa fan of Elvis. Adopting the slogan change the LDP to change Japan, Koizumi drew his powerdirectly from the people, using the Lion Heart e-mail magazine to communicate with them.Lion Heart referred to the Prime Minister's lion-like hairstyle and his unbendingdetermination to advance structural reform.28Koizumi loosened factional hold within the LDP

and softened the grip of ministries. When his plans to privatize Japan Post were obstructed by theleft-leaning opposition party, DPJ, and by vested interests within the LDP in 2005, he expelled37 of the LDPs Parliament members and scored a decisive victory in snap elections.

23Economist, Hurtling towards paralysis, March 21, 1998.24EIU,Japan, Country Finance, April 2006.25Economist, Japanese banks: bad analogies, July 4, 1998.26Economist, Bag, pop or splutter? May 9, 1998.27This section draws from The Sun also Rises,Economist, 10/6/05, and OECD,Economic Survey: Japan, 2006.28http://www.kantei.go.jp/foreign/m-magazine/backnumber/koizumi/2006/0921.html. Downloaded 10-30-06.

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Remarkably, Koizumi governed Japan for the full five-year term allowed by the LDP.

Economic Recovery

Led by exports to China, the Japanese economy picked up in 2002. By 2005, recovery hadblossomed into an expansion fueled by domestic demand. The Nikkei almost doubled since 2003and land prices stopped falling. In the first quarter of 2006, when the consumer price index

turned positive, the BOJ ended quantitative easing. In July 2006, it raised the short-term interestrate by 0.25%. There was concern that if interest hikes came too quickly the economy mightstall. It was expected to slow down anyway with the 2007 problem, when post-war babyboomers (theDankaigeneration) began retiring. The shrinking workforce would reduce outputand increase the burden of supporting retirees. To make matters worse, Japans population begandeclining in 2005 because of its falling fertility rate.29

Corporate & banking sectorNon-performing loans held by banks declined significantlyby 2005 and the ratio of corporate cross holding reduced from 45% in 1994 to 27% in 2002.Companies gradually created a more flexible labor force, reducing dependence on lifetimeemployees as attrition reduced the payroll. Companies filled openings with part-time workers

who earned 60% less than full-time workers. This group comprised women or young unskilledmen. Their ratio in companies workforce rose from 19% in 1990 to 30% in 2005.

Globalization

Japan remained less globally integrated than many OECD countries. It had the lowest level ofimports and inward foreign direct investment (FDI) as a proportion of GDP, and the smallestratio of foreigners in its labor force. The OECD estimated that Japans per capita GDP would be4.4% higher if it reduced external and internal barriers to the level of the least restrictive OECDmember. In addition, higher inflow of foreign resources could stimulate innovation.

FDIBetween 1998 and 2002 the stock of inward FDI in Japan tripled as some FDI

restrictions were eased. In 2002, labor productivity in foreign affiliates was 60% higher than theaverage for Japanese manufacturing companies and 80% higher in services. Corresponding gapswere smaller in many OECD countries. FDI inflow was discouraged by Japans M&A rules,product-market regulations, cross-shareholding and labor laws that discouraged restructuring.

TradeJapan had much greater trade with Asia than with other regions (see exhibit 2),and Chinas importance as a trade partner had increased over the years (exhibit 3). Japan becameChinas second-largest export market as Japanese companies invested in China to export lower-cost goods back home, taking advantage of Chinese wages, which were 5% of those in Japan.The overall low penetration of imports into Japan was accounted for partly by Japans highertrade protection (14.3% versus 12.6% for the EU and 8.2% for the US).30Restrictions included

non-tariff barriers like price and quantity controls, technical regulations and competition policies.

Foreign exchange reservesJapan had been concerned about ensuring that the yen stayedlow enough to encourage exports, and purchased dollars in foreign exchange markets to keep theyen low. In 2004, as the economy picked up, the Government stopped foreign exchange

29EIU, Asia and Australasia: Regional Review, 2006.30Kee et al., 2006, Estimating trade restrictiveness indices, Centre for Economic Policy Research Discussion

Paper No. 5576, London.

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intervention, which had led to burgeoning foreign exchange reserves.31By 2006 Japans foreignexchange reserves were $829 billion, followed by China at $819 billion. In 2013, Japansreserves were close to $1.3 trillion and Chinas were $3.4 trillion.

THE TASK AHEAD FOR PRIME MINISTER ABE32

On June 27, 2014, the Japanese government announced that unemployment had fallen to3.5%, the lowest since 1997.33However, Japans long-term economic prosperity remained anarea of major concern. Other challenges included addressing economic inequality, managingJapans contentious relations with important neighbors and defining its role in global affairs.

The Economy

By 2010, Japan had emerged from the global economic crisis of 2008 with 4.5% GDP growth. InMarch 2011, North East Japan was devastated by a deadly earthquake and tsunami that killedover 20,000 people and left 100,000 homeless. The tsunami crippled the Fukushima nuclearpower plant, releasing radiation and forcing people to flee. Destruction from the earthquake andtsunami caused economic loss worth $300 billion.34Production halted in the region and slowed

elsewhere as supply chains were disrupted. As funds flowed into Japan for reconstruction the yenrose, hurting exports. GDP fell by 0.6% in 2011, but growth bounced back to 1.4% in 2012

Shinzo Abe had started out strong, quickly reviving the economy in 2013 with the firsttwo of three arrows (fiscal and monetary stimulus) that were part of a program dubbedAbenomics. Within two months of assuming office, Abe got Parliament to approve aneconomic stimulus package and appointed Haruhiko Kuroda, a proponent of aggressivelycombating deflation, as governor of the BOJ. He set an inflation target of 2% and began aquantitative easing program in April 2013.35The Nikkei 225 stock index soared 50% to 15,000in five months36and urban property prices began rising. Since Abe assumed office the yen haddepreciated about 20%, boosting exports. However, by the third quarter (ending September

2013) the economy was slowing. Japans Asian markets were sluggish causing exports to decline0.6%. Imports grew 2.2% as energy costs grew and the iPhone 5S flooded Japan.37Japan closed2013 with GDP growth of 1.5% (see exhibit 4 for growth rates of selected countries).

GDP rose sharply in the first quarter of 2014 as consumers rushed to make purchasesbefore the Government raised consumption tax from 5% to 8% on April 1. This was followed bya sharp drop in consumer spending in April and May. Dai-ichi Life Research Institutes chiefeconomist, Yoshiki Shinke, noted, A contraction in the second quarter is a certainty, but the jobmarket improvements are positive for the economy. The Economist Intelligence Unit raised itsforecast for Japans 2014 GDP growth from 1.5% to 1.8%. The Nikkei experienced difficultymoving up in 2014. (It closed at 15,095 on June 27, 2014.)

31EIU, Asia and Australasia: Regional Review, 2006.32This section draws from the authors previous paper: Vachani, S. 2011. Introduction to the Colloquium - Japans

Tragedy and Aftermath: Lessons for Crisis Management. Vikalpa, 36.2, 81-84.33Reuters, Japans Jobless Rate Falls to 16-year low,New York Times , June 27, 2014.34Tabuchi, H., Earthquake and aftermath push Japan into recession,New York Times, May 19, 2011, p.2.35Economist Intelligence Unit, Japan Country Report, November 17, 2013.36http://www.bloomberg.com/quote/NKY:IND/chart downloaded November 19, 2013.37H. Tabuchi, Slowdown in Japan Raises the Pressure on Abe,New York Times, November 14, 2013.

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Structural reform?The excitement of Abes initial months gradually dissipated aspeople wondered if the promised third arrow, structural reform, would be effective. Forsustainable growth Japan needed to remove impediments that held back the economy, keepingproductivity low and discouraging investment. Japan had to boost labor productivity.Companies productivity and margins were compromised by barriers to laying off redundantworkers, some of whom earned high wages because of seniority. Lack of mobility across

companies and sectors prevented optimal deployment of skills. There was low representation ofwomen on the workforce and it was difficult to hire foreigners to fill jobs requiring special skills.

Lacking the ability to fire workers, companies resorted to age-old tactics to drive themaway by humiliating them; for example, by assigning them to oidashibeyaor chase-out roomsto perform trivial tasks or simply stare out of windows, in the hope that they would leavevoluntarily.

38Fewer layoffs meant fewer fresh college graduates were hired. In 2013, Sony hired

160 fresh college graduates compared to 1000 in 1990. Labor reform was politically sensitiveand Abe shelved it before the July 2013 elections.

Abe was thinking of reviving a 2003 initiative to create special deregulation zones, or

tokku, where employment and zoning regulations were eased to promote business. Previously,such deregulation had not gone far enough to be significant. Abe planned to provide tax breaksto experiment with making such zones more attractive in three of Japans largest cities, Tokyo,Osaka and Nagoya. In June 2013, the government announced that the third arrow wouldinclude liberalization of the electricity sector, removal of the ban on sale of over-the-counterdrugs over the Internet and relaxation of regulations to allow quicker market introduction of newdrugs and medical technologies.39By late 2013, people were increasingly skeptical of Abesresolve with regard to reform. There was disappointment, for example, when he backed off fromeasing restrictions on sale of drugs on the Internet.

Fiscal predicament Japans continual efforts to stimulate its economy in the post-bubble

era were financed with deficits that increased debt. In 2012 deficits touched 9.9% of GDP,improving somewhat to 8.2% in 2013, while gross public debt rose to 219% of GDP in 2012 and226% in 2013. While this was the largest among developed economies, it did not pose as muchrisk to Japan as high debt presented to countries like Greece, where it was held by foreigners.(Ninety percent of Japans debt was held domestically and incurred low interest.)40

Higher taxes were needed to cover rising social security costs and reduce the burgeoningdebt, which would become more costly to service with rise in inflation and interest rates. Theincrease in consumption tax in April 2014 was meant to reduce the deficit. This, and a furtherincrease to 10% in 2015, had been legislated by the previous administration, making thatgovernment unpopular. In order to prevent higher tax from stalling economic recovery Abes

government provided a new stimulus package worth 5 trillion yen ($51 billion) in October 2013.

Corporate problems Japanese companies continued to face governance challenges. InOctober 2011, the Japanese camera company, Olympus, fired its President, Michael Woodford, aBritish citizen, after he had served just six months. Woodford had questioned the board about

38H. Tabuchi, Layoffs Taboo, Japan Workers Are Sent to the Boredom Room,New York Times, August 17, 2013.39EIU, Japan Commerce Report, 2013.40EIU, Japan: Country Report, November 2013.

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and discriminated against the poor. Fewer children used computers in Japan than in otherindustrialized nations. Japanese education was regarded as rigid and hampering creativity, whichwas needed for technological innovation and entrepreneurship.

46

Peoples Mood

Japanese youngsters had experienced nothing but a depressed economy. Many could not find

jobs and were reluctant to spend. This added to the general Japanese propensity to save. The2011 natural disasters increased reluctance to spend, hurting the economy. It appeared insensitiveto shop while others suffered.Jishuku, self-restraint, was more fitting.47. Abenomics first twoarrows lifted the mood, which also rose when Tokyo was selected to host the 2020 Olympics.

Shift in global power

As East Asia became more integrated through trade, countries in the region worked to strengtheninstitutions that governed relations among them. Japans regional influence was diminished bythe rise of China, whose GDP overtook Japans in 2011. China was expected to surpass the USby 2027.48Its GDP adjusted for purchasing power parity (PPP), to eliminate the effect of cross-country price differentials, would match Americas by 2018 and Indias had crept past Japans in

2012 (see exhibit 6). Some forecasters estimated that Chinas GDP at PPP would exceed that ofthe US before 2015. (Exhibit 7 provides comparative indicators for Japan and other countries.)

Tensions with neighborsChina and South Korea remained hostile toward Japan for itsunwillingness to accept responsibility for aggression in the first half of the 20thcentury. A recentJapanese Prime Minister, Naoto Kan, tried to pacify them by asking his cabinet to forgo visitingTokyos Yasukuni shrine on the anniversary of Japans WWII surrender.49Previous leaders hadinsisted on the visit to honor Japans war heroes, but China and South Korea protested becauseYasukuni held the remains of 14 Class A WWII criminals. Abe angered China and Korea byvisiting Yasukuni in December 2013, but skipped visiting it in April 2014.

Tensions between Japan and China were also high because of territorial disputes over gasreserves in the East China Sea.50In 2010, when Japan detained a Chinese fishing boat in disputedwaters close to islands known as Senkaku in Japan and Diaoyu in China, it had to back downafter China halted export of rare earths critical for Japans electronics and auto industries.51(Vietnam and Philippines also had territorial disputes with China.) In fall 2012, tensions rose asChinese ships entered disputed waters more regularly. Chinas ambassador to Britain, LiuXiaoming, asserted that abundant historical records show that the Diaoyu islands had been anintegral part of Chinas territory for centuries, till they were seized by Japan during the firstSino-Japanese war in 1895.52China was determined to protect its sovereignty and territorial

46

See chapter on Education Reform in Japan in OECD,Economic Survey: Japan, April 2011.47Belson, K. and Onishi, N., In deference to crisis, a new obsession sweeps Japan: Self restraint,New York Times,

March 28, 2011.48 http://www.bloomberg.com/news/2010-08-16/china-economy-passes-japan-s-in-second-quarter-capping-three-

decade-rise.html downloaded November 5, 2012.49Blair, G., Japan PM Kan sends signal to Asian neighbors by shunning Yasukuni Shrine,The Christian ScienceMonitor, August 16, 2010.50Pilling, David, A Japan that can,Financial Times, May 10, 2006.51Fackler, M., Japan yields to Chinese over arrested boat captain, The International Herald Tribune, September

25, 2010, p. 7.52Liu Xiaoming, China responds to Japans provocative behavior,Financial Times, November 2, 2012, p.9.

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integrity. Japan asserted that when it had annexed the islands in 1895, they had been previouslyunclaimed by China, which only claimed them after their value as energy sources wasestablished in the 1960s.

53Standing beside Prime Minister Abe in Tokyo in April 2014, US

President Obama stated that the US-Japan security treaty covers all territories under Japansadministration, including the Senkaku islands, though the US did not take a position onconflicting claims of sovereignty by Japan and China.54

Economic falloutJapans territorial dispute with China led to consumer boycotts ofsome of its products in China. Honda reduced its 2012 profit forecast by 20% partly on accountof lower sales in China. Toyota, however, raised its profit forecast by 2.6% as it recovered froma bad year in the US. Toyota had lower exposure to China, which accounted for 12.6% of itsglobal unit sales versus 19.4% for Honda and 26.7% for Nissan.55

Trans Pacific Partnership (TPP)Abe had backed Japans inclusion in the proposedtrade agreement among twelve Pacific Rim countries: Australia, Brunei, Canada, Chile, Japan,Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam and U.S. He hoped the TPP wouldprovide leverage in pushing structural reform within Japan, as well as securing important trade

markets, though some economists did not see much economic benefit associated with the deal.

Relations with IndiaJapans trade with India was a mere 1% of its total trade. In fall2011, Japan and India signed an agreement to stimulate trade and investment. They also agreedto explore cooperation on civilian nuclear power, development of rare earth minerals, andensuring safety of sea lanes in the Indian Ocean.

56Leaders of all five permanent members of the

UN Security Council (China, France, Russia, UK and US) visited India in 2010. All exceptChina favored Indias entry to that exclusive club. Chinese Prime Minister Wen Jiabao assuredIndia of Chinas friendship and negotiated business deals. However, tensions existed betweenthem over territorial disputes.57

India remained neutral in the posturing between the US and Japan on one hand and Chinaon the other. However, during Prime Minister Abes visit to New Delhi in January 2014, Indiainvited Japan to join the Indo-US naval war games in the Pacific. Later in 2014, Indias newlyelected Prime Minister Modi signaled interest in forging stronger ties with Japan, which heplanned to visit in July. Modi was one of three people that Abe followed on Twitter.58

Rising militarism

The increased posturing over Japans territorial disputes with China and Korea was accompaniedby rise in nationalism in each country. In May 2013, during anti-Korean protests in the Shin-Okubo area of Tokyo, which had many Korean stores and restaurants, demonstrators calledKoreans cockroaches that deserved extermination.59

53AFP, Japan claim Chinas behaviour over disputed islands jeopardising peacetime, Telegraph.co.uk, October29, 2013.54Parsons, C. and Makinen, J., Obama reaffirms alliance with Japan,Los Angeles Times, April 24, 2014.55Tabuchi, H., Toyota Raises Forecast Despite Lag in China,New York Times, November 6, 2012, pp. B1-2.56BBC, Japan, India agree to continue talks on signing nuclear accord, October 29, 2011.57Yardley. J., Asia's Giants Face Off: India Digs In Its Heels as China Flexes Its Muscles,Financial Times,

December 30, 2010, p.8.58Rajat Pandit, India gears for combat exercises with US, to include Japan, Times of India, June 23, 2014.59T. Osaki, Nationalism rearing ugly head with greater frequency, The Japan Times, May 23, 2013.

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Under Koizumi, Japan had strengthened defense, investing in spy satellites and advancedwarships. Its security still depended on the US, which maintained 85,000 troops and seven of itseleven aircraft carriers in the region.60In late 2010, the strategic missile arm of the ChinesePeoples Liberation Army (PLA) deployed land-based missiles that could eventually threaten USaircraft carriers in the Pacific. China was believed capable of launching small satellites that could

stealthily approach enemy satellites. However, some observers felt it would take China severalyears before it could question US military dominance.61

Abe favored changing Japans constitution, which was written during AmericanOccupation of Japan after its defeat in World War II. Article 9 of the constitution stated:

the Japanese people forever renounce war as a sovereign right of the nationand the threat or use of force as means of settling international disputes. In orderto accomplish the aim of the preceding paragraph, land, sea, and air forces, aswell as other war potential, will never be maintained. The right of belligerency ofthe state will not be recognized.62

Over time, Japan had stretched its interpretation of Article 9 by creating a self-defenseforce of 240,000 personnel, which would not be used to commit war but would defend the nationfrom aggressors. In July 2013, Japans Defense Minister, Itsunori Onodera, proposed an overhaulof Japanese defense strategy so that the country could stand up to China and North Korea.63Abefavored modifying the constitution to allow Japan to develop full-fledged offensive militarycapability, including deployment of cruise missiles, for example. However, the majority of theJapanese people did not support that view.

In November 2013, China decided to test US and Japanese resolve by declaring a newair defense identification zone (ADIZ), requiring airplanes entering the zone to identifythemselves.64The zone overlapped space claimed by Japan including the disputed islands. The

Chinese air force flew its fighter jets to enforce the rules. Japan had similarly deployed itswarplanes to monitor its air space when Chinese jets came close to the islands. The US expresseddispleasure over Chinese actions, but advised civilian planes to conform to Chinese instructions.In a symbolic gesture the US flew two B52 bombers in the zone claimed by China withoutseeking Chinas permission. China did not engage the US warplanes.65On June 12, 2014, Japanprotested after Chinese fighter planes flew menacingly close to Japanese surveillance aircraft inan area where the two countries ADIZs overlapped.66

60Bumiller, E. & Wines, M. U.S. Pivots Eastward To Address Uneasy Allies,New York Times, Oct. 25, 2011, p.4,61Hille, K. Belligerent language masks limited capability,Financial Times, Special Report: China, Oct. 26, 2011,p. 3.62Source: http://www.kantei.go.jp/foreign/constitution_and_government_of_japan/constitution_e.html, accesses

December 15, 2013.63M. Fackler, Japanese Minister Proposes More Active Military Presence in Region, New York Times, July 26,

2013.64Buckley, C. China Claims Air Rights Over Disputed Islands. New York Times, November 24, 2013, p. A12.65 http://sinosphere.blogs.nytimes.com/2013/11/26/u-s-b-52-flight-prompts-indignant-reaction-in-china/66Japan Times, Chinese fighter planes fly close to Japanese planes again, officials say, June 12, 2014.

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Exhibit 1Value of US Dollar in Yen (Average for year)

Exhibit 2Major Regions Share in Japans Exports and Imports

(as a percentage of its total exports and total imports)

50

100

150

200

250

/$

Year

Source:IMF (Averages calculated from daily rates).

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$!"

%!"

&!"

'!"

!!"

(!"

%))* %))+ %)$) %)$$ %)$%

,-./01 1/ 2345

67./01 80/7 2345

,-./01 1/ 9/01:

27;04

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Exhibit 3

Japans Major Trade Partners

Share of exports to thecountry (%)

Share of imports fromthe country (%)

Country/region 2000 2005 2012 Country/region 2000 2005 2012China (including HK) 12.0 19.5 23.2 China (including HK) 14.9 21.3 21.5

China (without HK) 6.3 13.5 18.1 China (without HK) 14.5 21.0 21.3

Hong Kong (HK) 5.7 6.0 5.1 Hong Kong (HK) 0.4 0.3 0.2

US 29.7 22.5 17.6 US 19.0 12.4 8.6

South Korea 6.4 7.8 7.7 Australia 3.9 4.8 6.4

Taiwan 7.5 7.3 5.8 Saudi Arabia 3.7 5.6 6.2

Thailand 2.8 3.8 5.5 UAE 3.9 4.9 5.0

Singapore 4.3 3.1 2.9 South Korea 5.4 4.7 4.6

Germany 4.2 3.1 2.6 Qatar 1.5 2.1 4.1

Indonesia 1.6 1.5 2.5 Malaysia 3.8 2.8 3.7

Australia 1.8 2.1 2.3 Indonesia 4.3 4.0 3.6

Malaysia 2.9 2.1 2.2 Germany 3.4 3.5 2.8Source: Based on data from http://www.customs.go.jp downloaded on 10-23-2006, 11-5-11 and 11-29-13.

Exhibit 4

GDP Growth Rate of Selected Countries (%)

-10

-5

0

5

10

15

%))( %))> %))* %))+ %)$) %)$$ %)$% %)$& %)$' %)$! %)$( %)$> %)$*

GDP

GROWTH

%

YEAR

Source: IMF World Economic Outlook Database, April 2014.

Numbers for 2013 and beyond are estimates.

?:4@5

6@A45

B05C4D

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Exhibit 5

Income Inequality: Gini coefficients

Gini coefficient based on

household market income

Gini coefficient based on

household disposable income

1995 2007 2010 1995 2007 2010

Czech Rep. .442 .452 .449 .257 .255 .256

Sweden .438 .426 .441 .211 .259 .269

Germany .459 .494 .492 .266 .287 .286

Average NA .459 .473 NA .306 .306

Japan .403 .462 .488 .323 .329 .336

US .477 .486 .499 .361 .378 .380Source: OECD data, accessed on December 12, 2013 from http://www.oecd.org/social/inequality.htm

The Gini coefficient is defined as the area between the Lorenz curve (which plots cumulative shares of the

population, from poorest to richest, against the cumulative share of income that they receive) and the 45-degree

line, taken as a ratio of the whole triangle. The values range from 0 in the case of perfect equality and 1 in

the case of perfect inequality. Jones, R. S. (2007), Income Inequality, Poverty and Social Spending in Japan,OECD Economics Department Working Papers, No. 556, OECD Publishing.

http://dx.doi.org/10.1787/177754708811

Exhibit 6

GDP (at PPP*) for Major Countries ($ Trillion)

* PPP stands for purchasing power parity. GDPs adjusted for PPP eliminate the difference in GDPs on account

of difference in prices in the countries being compared.Source: IMF, World Economic Outlook Database, April 2014.

Numbers for 2013 and beyond are estimates.

!

#

$!

$#

%!

%#

%!!& %!!' %!$! %!$$ %!$% %!$( %!$) %!$# %!$* %!$+ %!$&

GDP

$

Tr

PPP

YEAR

GH

?:4@5

6@A45

I5.5@

E;075@F

B05C4D

8/10/2019 Japan 2014, June 29, 2014

16/16

16

Exhibit 7Comparative indicators Japan and other countries

Popu-

lation,

2012

Popu-

lation,

annualgrowth

rate,

2000-

10

Popu-

lation,

ages0-14,

2012

Immi-

grants

as %of

popu-

lation,

2010

Male

life

expec-tancy

at

birth

2011

Female

life

expec-tancy at

birth

2011

Percen

-tage

ofpopu-

lation

living

on lessthan

$1.25

per

day*

Womens

partici-

pation inwork

force as

% of

workingage

women,

2012

Internet

users

per 100people

2012

Mobile

cellular

sub-scrip-

tions

per 100

people2012

m % % % years years % % Nos. Nos.

Brazil 199 1.1 25 0.4 70 77 3.8 63.5 50 125

China 1351 0.6 18 0.1 74 76 15.9 63.7 42 81

Germany 82 -0.1 13 13.2 78 83 .. 70.8 84 131

India 1237 1.4 29 0.4 64 68 41.6 30.1 13 69Japan 128 0 13 1.7 79 86 .. 63.2 79 109

US 314 0.9 20 13.8 76 81 .. 68.4 81 98

* Surveyed in following years: Brazil, 2009; China, 2005; India, 2005.Sources: World Development Indicators database, accessed December 17, 2013. World Development Report, 2012

and 2013.