The 11 March 2011 Great East Japan Earthquake was the strongest ever recorded in Japan and triggered the country’s worst disaster of the post-war era. We express our deep sorrow at the enormous loss of life and offer our condolences to those affected by this tragedy. The OECD will be working closely with the Japanese authorities in the coming months and is ready to assist them in any way we can at this difficult time.

Great East Japan Earthquake on 11 March 2011, the strongest ever recorded in Japan, led to a tsunami and an enormous loss of human life, as well as massive economic damage. The impact has been exacerbated by the damage to thermal and nuclear power plants, which significantly reduced electricity generation. While it is still too early to assess the overall impact, it is likely to exceed the damage to the physical capital stock caused by the 1995 Hanshin-Awaji (Kobe) earthquake, which is estimated at 2% of annual GDP. A key priority has been to address the serious humanitarian needs resulting from the disaster.

Japan’s recovery from the severe 2008-09 recession was led by exports and fiscal stimulus. After stalling in late 2010, the expansion appeared back on track in early 2011, thanks to renewed export growth and improving labour market conditions, when Japan was hit by the Great East Japan Earthquake, the worst disaster in its post-war history. The earthquake and the accompanying tsunami led to an enormous loss of human life, as well as extensive damage to the physical capital stock that amounts to between 3.3% and 5.2% of GDP according to the government’s preliminary estimate. The negative short-term impact of the disaster on economic activity is likely to be reversed later as reconstruction efforts boost private and public investment. The Bank of Japan should maintain an accommodative monetary policy stance until deflation is overcome. In addition, the monetary policy framework could be improved by raising the inflation range that is considered consistent with price stability. While monetary policy has a major role to play in sustaining the economic expansion during the period of fiscal consolidation ahead, output growth depends mainly on structural reforms to boost labour productivity and inputs.

With gross government debt surpassing 200% of GDP, Japan’s fiscal situation is in uncharted territory. Correcting years of rising debt will require a large and sustained effort. A detailed and credible multi-year fiscal consolidation plan that includes both spending cuts and revenue increases will be a top priority to maintain confidence and prevent a run-up in interest rates. Given the size of the adjustment in the fiscal balance needed just to stabilise the debt ratio in 2020 – around 10% of GDP – it is important to start fiscal consolidation as soon as possible, while taking into account the need to reconstruct areas devastated by the Great East Japan Earthquake. The consumption tax should be the main source of additional revenue, given that it is low and its impact on economic activity is less negative than other taxes. Tax measures should be accompanied by social security reform that limits spending increases, including in health care, and addresses problems in pensions. Given the large deterioration in Japan’s fiscal situation since the collapse of the asset bubble in 1990 and the unprecedented size of its fiscal problem, a strong fiscal policy framework is important to reinforce the credibility of a medium-term fiscal plan. The framework may be improved through such steps as a multi-year budgeting plan, a stronger legal basis for the fiscal targets and an objective body at arm’s-length from the policymaking process.

The New Growth Strategy aims to create demand and jobs through regulatory reform and fiscal measures. The Strategy focuses on key challenges, notably climate change and population ageing, which can be turned into sources of growth. Given Japan’s precarious fiscal position, it is essential to co-ordinate spending related to the Strategy with the medium-term fiscal plan, in part by increasing the emphasis on regulatory reform. Such measures should cover the entire economy, rather than being limited to the seven areas identified in the Strategy. Among those areas, effectively promoting green innovation will require market-based instruments to place a price on carbon, preferably through a mandatory and comprehensive emissions trading system, to promote private investment, accompanied by a range of other policies. Achieving deeper economic integration with Asia depends on reducing support for agriculture to facilitate more bilateral and regional trade agreements, while bringing down barriers to foreign direct investment and foreign workers. Policies to expand venture capital would help launch innovative firms.

While Japan has achieved outstanding scores on the PISA exams, further improving educational outcomes is important to sustain growth in the face of rapid population ageing. The government should step up investment in early childhood education and care and integrate childcare and kindergarten to improve its quality, while allowing some diversity in the type of institutions. Upgrading tertiary education, in part through stronger competition and internationalisation, is also important to increase human capital and boost the role of universities in innovation. Given the serious fiscal situation, reforms to further raise the efficiency of educational spending per student, which is above the OECD average for public and private outlays combined, are needed. The large share of private education spending, which accounts for onethird of the total, places heavy burdens on families, thereby discouraging fertility, and creates inequality in educational opportunities and outcomes. Reducing dependence on private after-school educational institutions known as juku would help reduce the burden and enhance fairness.

Traditional Japanese labour market practices, which benefited both workers and firms during the high-growth era, are no longer appropriate in the context of slow economic growth and rapid population ageing. Reforms are needed in light of the upward trend in non-regular employment to break down labour market dualism and to encourage greater labour force participation by women, the elderly and youth. A comprehensive approach that includes improving the social insurance coverage of non-regular workers and upgrading training programmes for them, preventing discrimination against non-regular workers and reducing effective employment protection for regular workers would increase labour market flexibility and human capital. Moreover, such reforms would increase equity across different segments of the labour force. Drawing more women into the labour force requires removing financial disincentives to work, creating more family-friendly workplaces and increasing the availability of childcare. The labour force participation of the elderly should be raised by promoting continuous employment and abolishing mandatory retirement. More effective vocational training is needed for younger workers.