February 29, 2008; Volume 04, Number 07

of the

Japan Considered Podcast

[Listen to the audio file by clicking here]

Clink Links Below for Today's Topics

Reported Snags in Tainted Gyoza Investigation Bilateral Cooperation
Atago Collision Incident Investigation Mired in Domestic Politics
Japan Considers Creation of a Sovereign Wealth Fund
Comments by Dr. Edward Lincoln on Sovereign Wealth Funds
Concluding Comments

Good Morning. From Beautiful Spring Valley. In the Midlands of South Carolina. Today is Friday, February 29th, 2008. And you are listening to Volume 04, Number 07, of the Japan Considered Podcast.


Welcome, and Happy Leap Year Day to all of you, on this February 29th. A sure reminder that we’re going to have a presidential election toward the end of the year. If we needed any reminding, that is. The airwaves and print media have been chuck full of what passes these days for “news” about the political primaries.

Every issue, domestic or international, that comes up seems to be tinted by the effect it is likely to have on that November electoral contest. Until it’s over, it’ll continue to be difficult to find commentators for this program who remain unaffected by the game. I sometimes feel as though I’m trying to write an academic history of football while sitting in a noisy sports bar during the run-up to the Super Bowl!

It should be encouraging for anyone concerned about the state of civil society in the United States to see such energetic interest in electoral politics. But, judging from the tone and quality of most of the commentary, I can’t help thinking that presidential politics in the U.S. has become just another spectator sport. Maybe it’ll replace football. The way football replaced baseball some years ago. Sports bars may soon tune their large television screens permanently to the political “news/entertainment” channels. So patrons can keep track of “their teams,” and enjoy boozily cheering at the screen. With the occasional minimalist fist-fight. Hmmm.

Japan still has a way to go before things reach that stage. But, in Nagatacho, at least, there’s lots of excitement even there these days. Anticipating the possibility of a change of government. As in presidential primary-afflicted Washington, every issue that comes to Tokyo’s attention is measured, reported, and handled with a keen eye toward its potential for encouraging or discouraging that change of government. Most exciting, of course, replacement of the LDP as the dominant party. But even a change of cabinet would do. Or, as we’ll consider in a moment, even forcing the resignation of a single cabinet member.

In other words, surprise, surprise, it’s all about political power. Who gets to sit in the big chairs. Now, that’s not earth-shaking news for most everyone. But it’s surprising just how many observers attempt to analyze these happenings on the basis of “the merits,” or “the issues” involved. We just can’t afford that here. Also, once it becomes too blatant – too obvious – the participants themselves lose credibility with the attentive public. They appear to be more interested in their own careers and power, than in the interests of the public. That goes for both the politicians and the news media. Not good.

Reported Snags in Tainted Gyoza Investigation Bilateral Cooperation

Last week I may have been a bit too optimistic about the potential for cooperation between Japan and China over the issue of tainted gyoza imports. Earlier this week China’s police authorities were reported by Japan’s press to be taking a less cooperative tone. To the point their Japanese counterparts appeared to be caught off guard. Genuinely surprised by the change in attitude.

Yesterday, Thursday the 28th, Chinese police officials involved in the investigation were quoted as saying the Chinese side considers it very unlikely the gyoza were contaminated while they were in China. Their detailed investigations of the factory that produced the gyoza, as well as their transportation facilities, have turned up no possibility of tampering with the product on their end.

Chinese police authorities yesterday also cast doubt on the notion that the pesticide contaminating the gyoza was not available in Japan. As the Japanese side has insisted. Suggesting it could have been smuggled into Japan illegally. Though they did stop short yesterday of flatly accusing the Japanese side of the contamination.

All of this is discouraging. Good relations between Japan and China are essential for a peaceful, prosperous Asia. Indeed, for the whole world. Cooperation on the contaminated gyoza investigation might well have provided an opportunity for Japan and China to develop greater confidence in their negotiating counterparts. Further, expansion of the bilateral issue mix might have provided greater opportunities for diplomatic “horse-trading” behind the scenes. With mutual give-and-take, that could provide both sides face-saving opportunities once the inevitable compromise decisions were announced publicly. Perhaps even extending to the ticklish issue of the East China Sea EEZ demarcation. And exploitation of natural resources there.

I was hopeful last week. Developments yesterday in Beijing, and Tokyo’s immediate response to those developments, however, have tossed at least tepid, if not cold, water on those hopes. I have little insight into the workings of Beijing’s Forbidden City. But it would appear that Chinese officials willing to cooperate with Japan on the contaminated gyoza issue have lost ground to those who oppose such cooperation. Maybe it’s concern over the upcoming Olympics. Maybe it’s simply reluctance to appear too cooperative with Japan on even this sort of issue. Maybe it’s nothing more than miscalculation of Japan’s reaction to China’s tougher line. Anything’s possible. We’ll have to keep an eye on this. Recognizing that we’re working with only limited information.

Atago Collision Incident Investigation Mired in Domestic Politics

Last week we also considered Tokyo’s response to an unfortunate collision between an MSDF Aegis-equipped destroyer, the Atago, and a fishing trawler. The incident occurred early in the morning of February 19th, off the coast of Chiba Prefecture. Well, that investigation continues, with media attention directed largely on its potential to influence Japan’s current delicate parliamentary balance. As I noted just a moment ago.

Can Defense Minister Shigeru Ishiba be forced to resign? If so, how would his resignation affect the precarious position of the Fukuda Cabinet? Is this the issue that will drive the Fukuda Cabinet’s public approval ratings into negative numbers? Have Defense Ministry bureaucrats withheld information from the press? Or, even from their own minister? And so on.

With no evidence at all that the Fukuda Cabinet has reconsidered its defensive game plan. The distant observer could almost conclude Defense Minister Ishiba had been hung out to dry by his prime minister and cabinet colleagues! Twisting slowly in the wind, to borrow an over-worked phrase from Washington’s Watergate era. But, of course, that’s unlikely….

We’ll just have to keep an eye on this issue as well. Not the substance. But the politics. Watching for signs of change. Together with a number of other issues that have become entangled in Japan’s current political situation. 

Japan Considers Creation of a Sovereign Wealth Fund

Anyone who follows Japanese economic news even casually must have heard the phrase “sovereign wealth fund” at least once during the past few months. This is hardly a new idea. But interest in the concept seems to be growing in Japan. At least within some circles. While others have quietly expressed caution, or downright opposition to the idea. The idea, that is, of Japan developing its own large-scale sovereign wealth fund scheme.

Friday before last, February 18th, the Liberal Democratic Party even got into the act. Establishing what they described as a “project team” – I think we used to call them “committees” – to look into the sovereign wealth fund concept. To see if Japan should have one of their own or not. That committee – sorry, “project team,” – is headed by LDP Member, Yuji Yamamoto, from Kochi. Yamamoto is respected within the LDP as an expert on economic policy. He was an early and important supporter of Shinzo Abe’s candidacy for the LDP presidency and premiership. And served as Abe’s minister in charge of financial policy.

Yamamoto has been expressing interest in the sovereign wealth fund idea since at least late last year. In early December he and a group of like-minded LDP members announced formation of a group – not “project team,” now – to look into creation of a fund that would more effectively invest Japan’s enormous foreign exchange reserves. And possibly public pension funds as well.

Although no formal announcement was made, the Finance Ministry, of course, quietly opposed the idea. Since any such move would cut seriously into their control over Japan’s national economy. In a variety of ways. Yoshimi Watanabe, another well-known reform-minded LDP member, and Yamamoto’s successor as financial services minister, has been quoted positively on the subject of sovereign wealth funds as well. Though he has yet openly to endorse creation of one for Japan.

Wire services reported yesterday that Yamamoto and his LDP “project team” hope to pass enabling legislation as early as later this year. With an eye toward increasing the return Japan earns on its enormous foreign exchange reserves.

Soooo, from a variety of perspectives, this is an interesting issue for us to consider. First, the obvious tension between elected political leaders and appointed bureaucratic leaders this issue entails. Will the Ministry of Finance be able to defend its turf from challenges launched by ambitious reform politicians? Creation of such a fund also would have economic significance.

With all this in mind, I asked Dr. Ed Lincoln, director of the Center for Japan-U.S. Business and Economic Studies at New York University, to help us sort through the substance of the issue. We talked via SkypePhone early Wednesday evening. Here’s what Ed Lincoln had to say.


RCA: Good afternoon, Ed. Thanks for joining us today on Japan Considered Podcast.

EL: Great to be with you again, Bob.

RCA: I wonder if we could talk a little today about a subject that’s getting some attention recently in Japan. Sovereign wealth funds. Just what is a sovereign wealth fund, anyway?

EL: Well, a sovereign wealth fund is an investment fund that uses money owned by the government. Probably the best known example of one is in Norway. The Norwegian government earns huge revenues from the sale of North Sea oil. A number of years ago, the Norwegian government said to itself, “This isn’t going to last forever.” Plus, of course, the price of oil goes up and down. So the Norwegian government says we really ought to do something to insulate our economy from the fluctuations in the price of oil.

And, in the long run, from the fact that this oil is going to run out, and we’re not going to have this revenue. So, rather than using the money that they earned from oil to spend on roads, schools, and hospitals, they took a substantial part of it and put it into an investment fund. This investment fund is free to invest around the world in whatever they want. Prudently. But they can put it in to equities, and other things.

This is a long-term investment. So it doesn’t need to be put into, say, very safe, short-term government bonds, or something like that. The idea was that this way they could earn a higher return. So the fund would grow over time. And when they needed the money to build roads, because tax revenues were down, the economy wasn’t growing fast enough, they would have it. This has become a more popular idea in other countries around the world over the last few years. Some of the Middle Eastern countries now, for example, that also have oil and gas, have been setting up such funds. And that’s what the Japanese are now thinking about.

RCA: As a non-economist, some of this is a little confusing to me. And probably to some of our non-economist listeners. It sounds, however, listening to what you just had to say, that this is a method of taking government money and investing it at higher risk than it would otherwise be invested. Is that the objective? Or is that a misunderstanding.

EL: Well, that is correct. Normally, oh, let’s say with the U.S. Social Security system, or the Japanese national pension fund, those kinds of monies normally are required by law to be invested in the bonds of the government. So, U.S. Social Security funds are invested in U.S. government bonds. That, of course, is very safe. The return is relatively low. And so, yes, this opens up the fund to a bit more risk. Though, as I say, the managers, I think, are under a mandate – at least, in the good systems – to invest relatively prudently. But they can invest in equities and corporate bonds.

RCA: Well, why is it that some people, at least, in Japan now, are considering creation of a Japan Sovereign Wealth Fund?

EL: Well, the current interest rate on Japanese government bonds is around 1.4 percent. Not very high. So, if you had a concern about trying to earn a higher rate of return, to the benefit of whoever is going to be receiving those funds in the future, why not? It makes some sense to consider investing in something other than very low interest rate domestic government bonds.

RCA: Have other countries that have created sovereign wealth funds had the success that Norway appears to have had?

EL: I don’t know. I haven’t looked at the issue close enough to know that. I have heard that there are grumblings and worries about some other funds. Either because they’ve behaved in too risky a way. Or perhaps their investment portfolio has been influenced by politics as much as hard-nosed economic calculations.

RCA: That’s interesting.

EL: That’s one reason why governments didn’t do this in the past. They don’t want to create a fund …. They don’t think it’s prudent to have a fund in which the managers might be swayed by political considerations rather than pure analysis of what might offer the best return.

RCA: And that brings us directly to the question of the Ministry of Finance. I don’t think the issue has reached the point in Japan where MOF has stated an official position. But how do you think they will react to the proposal, should it gain legs?

EL: By and large, I would assume that they would not be particularly in favor of this. For a couple of reasons. One, it is likely that a Japanese sovereign investment fund would be run by some organization other than the Ministry of Finance. So it wouldn’t be something that they could control. It might be the national pension system. That’s actually probably the most logical organization to do it. Or, if they chose to create a fund out of Japan’s foreign exchange holdings, that would be something that might come under the jurisdiction …. Well, it could end up in the Ministry of Finance. Technically they’re held by the Central Bank. But I would be inclined to think that some new institution would be established to manage the money itself. So it wouldn’t be under their control. That would be one concern for the Ministry.

The second concern is that for the national pension money, as in the U.S. Social Security system, that is all now automatically – or has been automatically – invested in Japanese government bonds. Now, they’ve already tried to free it up. So this may be a moot point. But the Ministry of Finance probably would not favor a sovereign wealth fund that would be diverting investment away from government bonds to something else. Because they’ve very concerned about being able to float their bonds. And to keep those interest rates quite low.

RCA: And they’ve traditionally been highly suspicious of the economic responsibility of other government agencies, let alone the political sector, haven’t they.

EL: Correct. But, as I say, some of this has already happened. Starting, oh, five or six years ago, even longer than that, the pension system has had more flexibility. They do not have to turn their money over to the Ministry of Finance to be placed in government bonds. Or the old Fiscal Investment Loan Program. So, there already has been some diversion of money. Although I’m not quite sure what the current status is of how that money is invested.

RCA: If this were actually come into being, what kind of effect would it have on Japan’s economy, or Japan’s international economic relationships? Any at all?

EL: Well, the economic reason for doing this is that Japan’s population is aging very rapidly. And with the very low rate of return on investments in Japan over the past ten years, it gets more and more difficult to finance the retirement of a larger and larger proportion of the population, that’s coming at them very quickly right now. So one solution is getting a higher rate of return on the money that’s in the social security system, the pension system. That makes the sustainability of that system a little easier on down the road. The same thing is true for Japanese individuals. Most households in Japan have their money invested in bank accounts. They’re earning one percent, or less than one percent, these days. So you’d think that households looking at a retirement getting closer and closer would think they need a higher rate of return in order to have enough money to retire on. And that you’d think would have driven them toward investments in mutual funds. There’s been a little bit of that shift in Japan. But not a whole lot.

RCA: But for the opportunity for gain, there’s also the opportunity for loss, isn’t there? If there was a major ….

EL: Oh, absolutely. Sure.

RCA: What would the effect of that be?

EL: Risk is a funny thing. Economists will tell you … yes, higher rate of return, higher risk. Over long periods of time, say ten or twenty years, you assume that on average you will have a higher rate of return. That the risk is mostly in the short run. You may have a year or two in which there are actual losses. As, for example, Americans are experiencing over this past six months or so in the stock market. But, you presume that over a longer period of time – five years or ten years – that markets go back up again. And that on average over those longer periods of time, you can earn more money than if you stuck it in government bonds or in a bank account. And that’s been largely true. Not necessarily true in Japan. Where the stock market today is still trading at a level back where it was over twenty years ago. And real estate prices are back where they were twenty-five years ago. But in general, economists expect that you can get higher returns.

RCA: Do you think it’s likely that those in Japan now supporting this sovereign wealth fund will be successful? Do you think Japan will do it, in other words?

EL: I would be a little surprised if they did. Partly …. The big examples we have in the world are governments that are investing revenues they get basically from running a business. Oil and gas. They own the oil and gas, and they get the revenue from selling it. And they know it’s going to run out. And so they’re going to invest it for a long period of time. Japan’s not quite in that situation. So in Japan we’re talking about investing … creating a sovereign wealth fund out of something else. Whether it’s out of the national pension system money. Or taking, say, a chunk of their large foreign exchange reserve holdings. That’s a little different from, let’s say, what Norway’s doing. So I’m not entirely sure Japan will go down that road. And as I say, with the national pension fund, even without calling it a sovereign wealth fund, they have freed up the system to engage in investment in things that may be a little riskier, but offer a higher return.

RCA: Thank you very much, Ed, for clarifying the terms of this discussion. We’ll probably hear more about this in the next few month.

EL: Well, if nothing else, they’ll continue talking about it. Probably for a long time.

RCA: I appreciate it, and thanks for your time today.

EL: Sure, Bob. Always a pleasure.

Concluding Comments

That was Dr. Ed Lincoln. One of the very few professional economists one can turn to for commentary who understands both the economics AND the politics of sensitive political issues. Click on over to the excellent website he’s created for his Japan Center. I’ll put a link in the transcript for you. Thanks again, Ed.

Well, we’re over time again. Not by much. But we’re trying to show some discipline here. So, no bluegrass clip today. Perhaps I’ll find something inspiring for the next program. So in the meantime, Goodbye all. Until next week.