FROM THE OFFICE OF PUBLIC AFFAIRS

It is a pleasure to be here today. As many of you may know, I was in Japan when the tragic events of September 11^th occurred and forced me to postpone my meetings with Japanese government officials and members of the private sector. I am gratified that I now have the opportunity to pick up on that agenda and to renew some of the relationships I established with Japanese officials and private individuals when I was a corporate executive. From my private sector experience, I have developed the highest respect for the ability of Japanese industry to rise to the challenge of world competition, and to challenge all of us to rise to our best.

On this occasion, I came to Japan to attend the Conference on Afghan Reconstruction. The conference demonstrated that Japanese and U.S. cooperation could be a tremendous force for global progress - in this case, giving Afghanistan a real opportunity to rebuild its economy and foster democratic institutions. What is true in political and strategic affairs holds with even greater force in economics. As the two largest economies in the world, along with Europe, we have a shared responsibility for global economic outcomes. The pace of our economies is of great importance to the prospects and potential of the economies of the rest of the world.

Since mid-year 2000, the U.S. economy has slowed, with negative effects on the world at large. We in the United States know that the world needs a vibrant U.S. economy. We also know that the world needs vibrant economies in Japan and Europe. We are working hard to improve U.S. competitiveness and we are using our macro policy tools to restore strong U.S. growth. The Federal reserve has cut interest rates to the lowest levels since the early 1960s. The President's tax cuts, and fiscal measures enacted immediately after the attacks will support U.S. recovery, and I am confident that the U.S. economy will deliver accelerating growth as we move through the year.

Japan has performed far below its potential over the past decade. The resulting cost has been high - for the Japanese people and for the world economy. When the world's second-largest economy struggles, we all are affected. Some commentators have given up hope that Japan can again be an engine for world growth and prosperity. In fact, I am struck by the change in tone and prescription from the outside commentators. They have gone from offering a bewildering - and often contradictory - spectrum of policy advice to counseling other nations to protect themselves from a continuation of Japan's economic malaise, or worse.

But I believe that the critics who are now ready to write the Japanese economy off are wrong. Japan has tremendous resources in the diligence of its workforce and the competitiveness of the best of its firms. Imagine what Japan would look like if its whole economy performed like Toyota or Sony, or any number of other Japanese companies. The path-breaking manufacturing techniques and systems ideas developed by top-flight Japanese companies have also benefited U.S. consumers through cheaper, higher-quality products, and made U.S. industry more productive and efficient. Japan's economic leadership inspired people around the world to rise to new challenges, innovate and improve.

Every country, no matter how competitive, goes through periods where decisive economic adjustments and changes in policy are required.

• In the United States, I remember the painful period at the end of the 1970s and early in the 1980s, when many critics were willing to write us off. Our public and private institutions responded to the challenges and created an historic economic boom.
• In the United Kingdom, Margaret Thatcher led a fundamental reshaping of the British economy during her tenure as Prime Minister. Her labor market reforms, deregulation, privatization, and overhaul of the tax system improved incentives and injected a healthy dose of fresh competition into the U.K. economy.

Decisive policy actions reinvigorated these nations and made them examples to people around the world who were shrugging off the yoke of communism. By invoking a vision, leaders change expectations about the future and create public confidence to see their nations through the pain of the initial adjustments.

Japan has its own historical examples of decisive action. In the 1970s when the world was confronted with a series of energy shocks, Japan acted quickly to adjust. In the industry I know the best - aluminum - Japan took concerted action to stop producing primary aluminum as it recognized its competitive disadvantage in this energy-intensive business. To be sure, this action caused dislocations for the Japanese employees and companies, but it demonstrated that when Japan decides to act it can do so quickly and effectively.
Such quick and effective action is needed now.

This is why President Bush has expressed strong support for Prime Minister Koizumi and his reform program. Prime Minister Koizumi has a vision of Japan - prosperous people providing leadership for a vibrant Asian economy that sets a model for the world.

The Prime Minister has embraced a strong reform agenda that can return Japan to its place of global prominence and recognition. Let me say that nowhere have I seen any indication from the Prime Minister's remarks that he believes that tampering with foreign exchange rates is a realistic element of a reform agenda. I agree with him. During this trip, and on many other occasions over the past year, I have been asked about the U.S.-Japanese exchange rate. Implicit in the questions is the suggestion that exchange rate manipulation can return Japan to sustained economic growth. The straight fact is this: exchange rates cannot improve productivity or fix non-performing loans. The weight of historical evidence shows that those who have tried to fix underlying economic problems with protectionist measures - artificially depreciating the currency is one of those - actually weaken their own economy.

From the rest of the world's point of view, the objective and the measure of success is a Japan growing its gross domestic product again. It is clear that the policy prescriptions of the past - export led growth and endless public works projects - cannot work. But I am convinced, if the Japanese people resolve that they will grow again, they will devise the means to do it. If you establish a goal you will achieve it.

In order to accomplish the goal it will be necessary to formulate specific policies and to assign to each policy its expected contribution to the goal - along with the expected timetable to fully achieve the policy. It is clear in both public and private activities that goals without policies and timetables are destined to be not goals but unfulfilled yearnings.

Let me turn briefly to three areas that I believe may help to unlock the full potential of Japan's economy. The first is the banking sector. I applaud the central role the Prime Minister Koizumi's reforms have given to addressing the banking sector problems. The President in two U.S.-Japan summits - as well as my G7 finance ministry and central bank colleagues - have welcomed Japan's particular emphasis on this issue, and for good reason. A financial sector that is healthy and efficiently allocates capital to its most productive uses is critical for an economy to reach its full potential. A healthy banking system is also willing to take on risk, but does so consciously, and continually appraises its loan portfolio at its true market value.

We in the U.S. know from our own experience that a banking system that is struggling to rid itself of bad and risky loans can expect a tremendous drag on the real economy. If one can learn as much from mistakes as from successes, there are many lessons to be drawn from our own savings and loan crisis - which grew significantly over time before it was effectively addressed.

There were two things that I think were critical in turning the corner. The first was a decision to deal with the problem in its full extent, rather than through a series of partial measures designed in each case to minimize the immediate cost of dealing with the problem. The second was the decision to speed the return of distressed assets to private hands through sales of loan claims and their underlying collateral in the market.

What we learned, in the S&L crisis and in the banking problems we had in the 1990s, was the importance of addressing the problems of the borrowers. In some cases liquidation and sale of assets was the only available option.

But in many cases there was a core business that was viable within a company that was heavily indebted. Extracting that viable business was not simply a matter of reducing debt; restructuring of operations and management was almost always necessary. But if a company could be successfully restructured, its value was much higher than in liquidation, the loss of employment considerably lessened, and the chances of creating a secure future much higher.

A supportive macroeconomic environment is especially important in the context of banking reform, as firms and their employees adjust to changes in the financial system. The first element of such an environment is price stability. We have all learned the corrosive effect that inflation has on economies, but deflation is at least as bad. Deflation multiplies the burdens faced by debtors, as well as discouraging both consumption and business investment. Like inflation, persistent deflation is a monetary phenomenon, and will respond to monetary policy. But as long as deflation persists other reforms remain much more difficult to achieve.

The other leg of macroeconomic policy is fiscal policy. As the Koizumi Administration has emphasized, nonproductive public investment does not produce sustained growth.

I would also like to discuss the introduction of true price competition throughout Japanese industry. While Japan's best firms face price competition on a daily basis - both at home and abroad - in significant parts of the Japanese economy there are firms that owe their survival less to the creation of real economic value than to barriers and regulation. Increased price competition through deregulation and structural reform can lead to adjustments and some dislocation. However, it also creates economic opportunities and activity that will lead to a new entry by both domestic and foreign firms, increased employment, renewed growth, and a secure future.

Actions by individual companies indicate what is possible for the Japanese economy as a whole. Nissan is a company that appeared on the verge of closing two years ago. New investors and a determined effort at restructuring, in which both management and workers participated, returned this company to profitability well before most thought possible. Nissan rewarded its workers by meeting the union's last wage and bonus demands in full

The telecommunications industry is a clear example of the benefits that opening up new markets to competition can bring. Freeing up entry and price competition in mobile telephone services led to a rush of investment in base station and antenna facilities, and to a skyrocketing number of cellular telephone subscribers. And, as a result of the opportunities created and the new competition introduced, NTT DoCoMo is now a world leader in mobile communications innovation.

Big Bang financial services deregulation has led to a burst of new competition on products and pricing, just as it did in the United States and the United Kingdom. Japanese companies that once had to go to New York or London to obtain the financial service products they needed can now find many of them domestically. After deregulation in the United States, the financial services industry grew at a far faster rate than the economy as a whole, and I expect the same to occur in Japan.

The introduction of price competition throughout the Japanese economy entails thousands of smaller, detailed yet highly important decisions in trade, regulatory, and fiscal policies. It is not my place or the place of the U.S. government to lecture the Japanese government on how to proceed - these are decisions for the Japanese people. I do want to offer my support to Prime Minister Koizumi as he has clearly stated that structural reform "with no sacred cows" is necessary for economic recovery and strong, sustained growth. The Prime Minister has already outlined steps to cut back inefficient public works expenditures and to abolish or privatize Japan's public corporations. I wish him full success as he takes these initiatives forward.

Much is riding on these efforts - for Japan and for the world. In the U.S.-Japan Partnership for Economic Growth our two countries have recognized the decisive influence that our two economies have on global economic growth and wellbeing. We have a shared responsibility to do all that we can do to assure that we reach our full economic potential.

I am a strong optimist on the United States. I am also a strong optimist on Japan, and view this period as a time of great opportunity for policy to bring about a change for the better. Decisive actions are necessary to solve difficult problems, and the United States supports Prime Minister Koizumi's commitment to take decisive actions. Markets are clearly waiting for implementation of such actions and will respond strongly and positively to policies that will help Japan to achieve its full potential. Building confidence will reduce the short-term pain of the adjustments and speed the return of Japan to a path of strong growth. But I firmly believe that the Japanese miracle is not finished, is not in the past. Returning Japan to robust and durable growth is of the utmost importance to Japan, to the United States, and to the world.