FROM THE OFFICE OF PUBLIC AFFAIRS

Good afternoon.  It’s a pleasure for me to address the U.S.-Japan Business Council this afternoon. 

The Administration’s international economic strategy aims to raise economic growth throughout the world.  Japan and the United States, as the world’s two largest economies, play a critical role in creating opportunities for the entire world.  And you in this room are in the front line of making that happen – as employers, producers of goods and services, and also as shapers of economic policy in both of our countries.

 Your role is even more important because of the changing tenor of our economic relations with Japan and our discussions with the Japanese government.  Until just a few years ago, these discussions were focused on market access. They were often contentious.  In addition, many in the United States viewed growth in Japan as a threat to the U.S., as if world output were a zero-sum game.

 We now recognize that growth abroad adds to opportunities for American workers and producers, and enhances prosperity in the United States.  We welcome the contribution that Japanese firms have made to U.S. employment by investing here.  And American firms – your members – now play a critical role in financial services, automobile production, retailing, pharmaceuticals, and a host of other industries in Japan.

 At the same time, the nature of the issues has shifted away from market access, and towards market development, regulation, and corporate governance.  These are issues that affect domestic firms as well as foreign firms in Japan.   And these issues are often detailed and technical.  Current financial services issues, such as the development of defined contribution pensions and regulatory transparency, are industry issues, not foreign firm issues.

 I welcome your advice on the key policy issues that we face in the United States.  And I am delighted by the role that many of you have played in advising the Japanese Government and the Diet on policy issues.

We also rely on your ideas and analysis in shaping our own view about the Japanese and American economies, and in shaping our discussions with the Japanese government.  This is why we have made private sector participation a central part of the U.S.-Japan Economic Partnership for Growth.  I strongly encourage you to continue to develop joint policy recommendations for our two governments, as you have done in the Joint Private Sector/Government Commission.

Of course, there will continue to be a role for government-to-government discussions to facilitate a more hospitable environment for trade and investment between the United States and Japan.  A recent and important result of these discussions is our agreement in principle with Japan on the text of a new U.S.-Japan Bilateral Income Tax Treaty -- a treaty I was very pleased to announce earlier this year.  The proposed treaty reflects the deepening economic ties between the United States and Japan, and the globalization of the two economies.  The proposed treaty reduces existing tax barriers to trade and investment between the United States and Japan, most significantly by substantially reducing withholding taxes imposed on cross-border dividends, interest, royalties and other income.  This includes the complete elimination of source-country withholding taxes on royalties, certain interest, and certain inter-company dividends.  I had an opportunity to discuss the tax treaty with Japan’s Finance Minister and Prime Minister Koizumi in Japan last month.  Both welcomed the agreement in principle and shared my view of the importance of a new treaty.  I look forward to signing this treaty as soon as possible.

 This tax treaty is only one small example of our feeling that the U.S.-Japan alliance is as strong as it has ever been. Our alliance forms a keystone of our security relations in East Asia and our economic policy agenda world-wide.  Japan has been a vital ally in the war against terrorism.  Japan’s contribution to the war in Iraq was greatly appreciated in the United States.  Its generous contribution of $1.5 billion in grant assistance to the reconstruction of Iraq will help that nation advance as a free people.

Our cooperative efforts with Japan are particularly important for raising economic growth around the world.  At the recent IMF/World Bank meetings in Dubai, the United States, Japan, and the other nations of the G7 agreed on a new “G-7 Agenda for Growth.”  Under this milestone agreement, G-7 countries have committed to concrete supply-side actions to increase productivity, spur growth, and create jobs

Each country will identify its own policy plan under the Agenda.  The United States will work to lower health care costs, reduce frivolous lawsuits and streamline regulations and needless paperwork through President Bush’s Six Point Plan.  Japan reiterated its commitment to address the obstacles to sustained, vibrant growth – in the banking sector, in ending deflation, and in carrying out structural reforms and deregulation to raise growth.

The central part of an effective policy to enhance growth is promoting economic flexibility – the ability to respond to market incentives and move resources to new, growing, and high productivity sectors.

Economic flexibility involves being able to respond to price signals, including signals from international markets.  The goals of raising growth can best be accomplished in an international financial system that relies on the principles of free trade, free capital flows, and market-based exchange rates among the major economies. This principle was embraced by the United States, Japan, and the other members of the G-7 in their statement in Dubai in September.

In the United States we had our own period of hardening of the arteries in the 1970’s.  But significant policy changes, including lowering marginal tax rates and encouraging restructuring and adjustment, led to renewed American growth in the last two decades.

Japan’s postwar experience gave birth to the term “miracle economy.”   However, as the Japanese economy has matured, its growth rate has fallen, and the Japanese economy has struggled through the past decade.  I believe that current estimates of Japan’s potential growth rate – 1 to 1½ percent per year – undervalue Japan’s capabilities.

Statistics do show a loss of flexibility in the Japanese economy over time.  One striking phenomenon is the decline in the rate of new firm formation in Japan – new firms created each year fell from about 8 percent of total firms in the mid-1970s to less than 4 percent in the past few years.   There is also less exiting of old firms.  A much smaller fraction of firms go bankrupt in Japan now than in the 1970s or earlier.  But firms that do go bankrupt are much larger and older than before.

This suggests less bubbling up of new activity and new firms in Japan than in more rapidly growing countries, or in the Japan of 30 years ago.  And it may also indicate that problems are allowed to linger, without being addressed, until firms eventually collapse at great cost.

The continuing problems in the banking sector are surely part of the reason.  Unresolved bank and “distressed borrower” problems freeze productive assets in place.  Deflation and very low interest rates also delay the burden of servicing debts, postponing hard decisions for banks and borrowers.

Fortunately, I believe that things are changing in Japan, in a way that will produce more flexibility and stronger growth.  Prime Minister Koizumi has clearly stated that “no growth is possible without structural reform.”  The efforts of the Japanese government to deregulate and institute structural reform in areas such as health care, information technologies, and distribution and logistics should open up opportunities for investment and growth.

Banks are making progress in resolving troubled borrowers and removing bad loan claims from their books.  A market has developed in distressed assets.  And the Japanese government has taken steps to encourage restructuring and revitalization of troubled borrowers.
 It’s important that this process begin at an early enough stage to salvage real value from companies.  Banks need incentives to deal with risky loans, including provisioning requirements.

 Many Japanese firms are now restructuring for increased productivity and efficiency.  The sharp rise in corporate profits this year is in large part due to these efforts, as is the recovery in the stock market.  One of the indicators of increased restructuring is the rise in mergers and acquisitions (M&A) activity.  Here foreign direct investment can make a particularly valuable contribution, as it has in the U.S.  I applaud the Prime Minister’s goal of doubling the volume of foreign direct investment, as well as the emphasis that this Council has put on increasing foreign direct investment.

 President Bush and Prime Minister Koizumi will continue to pursue policies to achieve stronger growth in both countries, and in the global economy.  But for those efforts to succeed, we will need continued guidance and input from the leadership of our two countries' business communities – such as from the membership of the U.S. – Japan Business Council. 

Thank you for your contributions now, and in the future.