TREASURY SECRETARY PAULSON'S MARCH 5-6 VISIT TO

C O N F I D E N T I A L SECTION 01 OF 05 TOKYO 001029 SIPDIS SIPDIS TREASURY FOR IA/DOHNER, HAARSAGER AND POGGI E.O. 12958: DECL: 03/09/2017 TAGS: ECON EFIN OVIP JA SUBJECT: TREASURY SECRETARY PAULSON'S MARCH 5-6 VISIT TO TOKYO Classified By: Ambasssador Schieffer for Reasons: 1.4(B) and (D) ¶1. (C) Summary. Treasury Secretary Henry Paulson,s discussions with Japanese government officials centered on the need for ongoing economic reforms in Japan, confirmed the importance of the U.S.-Japan bilateral relationship and touched on developments in the Chinese, U.S. and Japanese economies. During his two-day visit to Tokyo on March 5 and 6, Secretary Paulson met with Prime Minister Abe, Chief Cabinet Secretary Shiozaki, Finance Minister Omi, Minister for Economic and Fiscal Policy Ota and Bank of Japan Governor Fukui, and attended a roundtable with Japanese and foreign financial leaders hosted by Tokyo Stock Exchange Chairman Taizo Nishimuro. End Summary. Prime Minister Abe ¶2. (C) Prime Minister Abe and Secretary Paulson began their meeting by discussing the strength of the U.S.-Japan bilateral relationship. Secretary Paulson went on to welcome the Japanese economy,s good performance over the past few years, saying that he had watched the reforms under former Prime Minister Koizumi work, and asked about the future course of policy. Prime Minister Abe stated that his Cabinet believes reforms should continue, however the opposition Democratic Party of Japan has focused on income disparities in criticizing his administration. However, he noted that the employment picture has been improving and it is now easier for university graduates to find jobs. He added that the GOJ needs to do more work on fiscal consolidation and regulatory reform. Japan needs innovation and to adopt an open attitude toward investment. Paulson responded that income disparities are a global phenomenon and the key to dealing with them is an ambitious reform program. ¶3. (C) Abe and Paulson briefly agreed on the need to maintain close contact on North Korea issues. Abe welcomed the good outcome of the Six Party Talks and stressed the need for verification. Further, he noted that Japan had barred entry for North Korean vessels at its ports, and as a result the price of stimulant drugs in Japan has risen, suggesting that North Korean vessels were key players in drug smuggling. ¶4. (C) Turning to China, Abe asked for Paulson,s thoughts on the recent turbulence in global financial markets. Paulson explained that global economic fundamentals are strong and the reaction to the drop in Chinese markets was psychological. He noted that the Chinese economy is relatively strong now, however, he is not convinced that will continue indefinitely and there are some risks there. He stressed that economic growth in Japan is more important to the global economy. Paulson also welcomed Abe,s visit to China last fall and the improvement in Japan-China relations. Finance Minister Omi ¶5. (C) Finance Minister Omi began the meeting by welcoming the outcome of the G7 Finance Ministers in Essen, Germany a few weeks prior. He noted that since then, the Bank of Japan had raised interest rates, however Japan,s recovery is sustainable and that he was unworried by the recent days, financial market volatility. Paulson agreed, noting that the key to recent Japanese growth was the reforms of the Koizumi era and stressed the need for those reforms to be accelerated. He stated that the yen trades in a competitive market and that non-intervention by the Japanese authorities has been very important. ¶6. (C) Omi inquired about the status of the U.S. financial sanctions against Banco Delta Asia (BDA). Paulson explained that talks were ongoing between Treasury and DPRK officials that would help resolve the BDA issues, and that he hoped an appropriate resolution would happen in the next few weeks. He noted the importance of Japan,s work on its anti-money laundering law with respect to Iran, as well as North Korea. With regard to North Korea, Omi described Japanese concerns about the abduction issue, noting that it affects human rights and national sovereignty. He added that until the abduction issue is resolved, it will be difficult for Japan to do energy-related assistance for North Korea. ¶7. (C) Over dinner following the meeting, discussions turned to China. Omi explained that Japanese Diet members believe TOKYO 00001029 002 OF 005 that U.S. politicians only care about U.S.-China issues. Paulson indicated that most U.S. politicians view relations with Japan positively, while there is a lot of tension with regard to China that he is trying to manage. ¶8. (C) Paulson then asked about the types of reforms the Japanese government is pursuing. Omi explained that corporate earnings are up and wages have been relatively flat, exacerbating public concerns about income disparities. To promote vitality in the economy, he said, the Abe administration is pursuing openness and innovation, with more attention to science and technology to improve productivity. Omi noted Japan,s severe fiscal problems and upcoming elections in July as part of the environment in which the government is trying to pursue reforms. Paulson asked about the Japan Post privatization, stressing the importance of a level playing field. Omi described the 10 year transition period beginning in October 2007 for the privatization and acknowledged that many private companies are concerned about competition from Japan Post. ¶9. (C) Omi and Paulson then exchanged views on North Korea, agreeing that North Korea is a serious problem that warrants continued cooperation. Omi stated that North Korea must not be allowed to possess nuclear weapons. Chief Cabinet Secretary Shiozaki ¶10. (C) The meeting with Chief Cabinet Secretary Shiozaki focuses on Japan,s reform agenda. Shiozaki reiterated the Prime Minister,s promotion of innovation and openness, including promotion of inward foreign direct investment. He said that Japan needed more deregulation. Paulson stated that when he was the head of Goldman Sachs he experienced the uncertainty of Japan,s financial market regulation, and stressed the need to strike the right balance between market integrity and entrepreneurship. He explained that U.S. regulators are reviewing our regulatory structure as well. He stated that Japan has a major financial market, but must keep working to stay competitive and compete with other markets, such as London. Shiozaki pointed out that Japan is also competing with Hong Kong, and Paulson noted that Hong Kong has the balance more right than Japan right now. Shiozaki added that the GOJ is also looking at corporate governance and accounting standards and does not want to be left out of international convergence of standards. Discussing raising Japan,s productivity, Paulson asked what steps the Japanese are planning. Shiozaki explained that Minister Ota and the Council on Economic and Fiscal Policy were working on a reform plan, including promoting information technology, and infrastructure. Paulson reiterated that continuation of reforms and promotion of competition is key to Japan,s continued growth, even though politically difficult. Minister Ota and Council on Economic and Fiscal Policy Members ¶11. (C) On March 6, Paulson met with Minister for Economic and Fiscal Policy Ota and three of the four private sector members of the Council on Economic and Fiscal Policy (CEFP), University of Tokyo Professor Takatoshi Ito, International Christian University Professor Naohiro Yashiro and Canon Chairman Fujio Mitarai, also Chairman of Keidanren. Minister Ota explained that the CEFP is working on the fiscal 2007 reform plan, due to be released in June. The focus is enhancing Japan,s growth potential through increasing productivity. Productivity in services is low, and labor market reforms are critical. CEFP wants to set a goal of increasing labor productivity by 50 percent over three years from 1.6 percent to 2.4 percent. Three strategies the CEFP are pursuing are increasing investment in human resources, innovation in the service sector and promoting economic partnership agreements (EPAs). Japan hopes to increase its EPAs from four to 12 in three years, and is looking at the feasibility of a U.S.-Japan EPA as a future task. Other areas where reform is needed include agriculture and the financial sector. Japan wants to boost domestic demand to contribute to global growth and help correct global imbalances. ¶12. (C) Paulson responded that he was pleased to hear about the GOJ,s pro-growth and pro-reform policy. He agreed that labor reforms to increase productivity is important and noted TOKYO 00001029 003 OF 005 that the USG was looking at our own financial market policies as well. Financial markets around the world are changing rapidly and reforms are necessary to stay competitive. Professor Ito described the CEFP working group on promoting Tokyo as a global financial center to compete with New York and London. He added that the regulatory and supervisory framework needs to be friendly for investors and foreign financial institutions, with no discrimination and effective regulation. After talking to US experts, Ito said he is not looking at the U.S. system as a model. Paulson agreed, saying that the United States has a complex regulatory structure with many regulators, and pointed to London as a good example of a single regulator system. Paulson said that in his own experience the regulatory regime in Japan was harsh and less predictable than other markets, noting that Hong Kong is more predictable. Paulson and Ito agreed on the need for balance in regulation. Paulson stressed that there is a huge upside to productive, efficient financial markets, with multiplier effects for the whole economy. ¶13. (C) Mr. Mitarai described Japan,s corporate governance system. Paulson stressed that to increase growth, there should be rules to make it easier for investors to force corporate restructuring. Ito noted that new rules for mergers and acquisitions and takeover bids will put good pressure on corporate management to improve performance, though this could cause some political backlash if foreigners invested for the short-term and realized large profits. Paulson acknowledged that this type of backlash occurs in many places. ¶14. (C) A discussion of income disparities and the role of labor market reforms in increasing productivity followed. Paulson described a global phenomenon of income disparities arising from the benefits of technology accruing to skilled workers. Professor Yashiro elaborated on changes in the Japanese labor market, where in the past employees, skills were formed inside the company. This is no longer the case, and Japan has to develop university and vocational programs to develop employees, skills outside of the company. Yashiro opined that Japan,s labor market needs to change completely to eliminate regulation that segments the labor market into regular and non-regular workers and introduce the same rules for all workers. Mitarai explained that Japan,s seniority-based lifetime employment system has led to high costs, necessitating a shift to a merit-based system with portable health and pension benefits that are not tied to seniority. Paulson explained that the impact of worker mobility on pension and health care benefits is also a concern in the United States. ¶15. (C) Turning to China, Paulson said that we need to urge the Chinese to keep moving ahead with reforms, especially implementing the rule of law and market opening. Though China is successful, people overestimate the success and underestimate the seriousness of China,s problems. China needs to move more quickly toward market mechanisms. This will have benefits for China, Japan, the United States and all global trading partners. Paulson noted that US-Japan relations are very strong, and that he is pleased to see Japan-China relations strengthening. Mitarai noted that the strengthening in Japan-China relations was due to demand on both sides, for cheap labor and the market from Japan, and for environmental and energy conservation assistance from China. It was agreed that the U.S. and Japan should join together to urge China to adhere to the WTO regime, particularly for IPR and investment. ¶16. (SBU) Mitarai closed the meeting by informing Paulson of Keidanren,s meeting with the U.S.-Japan Business Roundtable where it was agreed to study a U.S.-Japan EPA. Keidanren places vital importance on a U.S.-Japan EPA and asked Paulson to support these efforts. Tokyo Stock Exchange Meeting with Financial Leaders ¶17. (SBU) Tokyo Stock Exchange Chairman Taizo Nishimuro hosted a lunch roundtable for Paulson with a group of Japanese and U.S. financial firms. Financial firm attendees were Norimichi Kanari, Deputy President of Bank of Tokyo Mitsubishi UFJ; Junichi Ujie, Chairman of Nomura Holdings; Yoshinari Hara, Chairman of Daiwa Securities Group; Masanori Mochida, President of Goldman Sachs Japan; Jonathan Kindred, TOKYO 00001029 004 OF 005 President of Morgan Stanley Japan; Terunobu Maeda, President and CEO of Mizuho Financial Group; Teisuke Kitayama, President of Sumitomo Mitsui Financial Group; and Douglas Peterson, CEO of Citibank NA, Tokyo Branch. There was some initial discussion of the financial market turbulence of the preceding few days, with participants noting that global economic fundamentals are strong and the markets seemed to be rebounding somewhat. ¶18. (C) Turning to Japanese financial markets, participants noted the trend in the retail sector moving from deposits to investments. On the corporate side, Japanese industrial ties to the rest of Asia are important influences on investment and business activity. With respect to mergers and acquisitions, the market is still difficult for foreigners to enter and tax issues related to cross border stock swaps still need to be resolved for it to be a useful vehicle. Japan,s financial markets are still centered on traditional commercial banks with thin credit spreads, and need to develop further. Asked his thoughts about Tokyo as a global financial center, Paulson said the U.S. authorities were also struggling with competitiveness issues. He opined that Japan,s regulatory burden is heavier than it needs to be, and that unpredictability of regulation and adversarial inspections need to be addressed. He stressed the need to strike a balance between market integrity and entrepreneurial spirit. He emphasized that there is no reason Tokyo should take a back seat to any other markets, given its talented human resources. Japan,s regulatory reform trend is positive, but other markets are moving more quickly. ¶19. (SBU) Participants also discussed the critical role of continued reforms in sustaining Japan,s growth. They noted that the fiscal and demographic situation necessitates a shrinking of the public sector and redeploying of assets to the private sector. The importance of shifting away from placing a primacy on manufacturing to emphasizing services was discussed. Paulson added that he is trying to publicize the importance of financial markets around the world, and the multiplier effect that an efficient and vital financial services sector can have on the whole economy. He advised the participants to be very active in telling the public and politicians what the financial services industry can do for the nation as a whole. ¶20. (SBU) Looking at global trends, Paulson was asked about the impact of high degree of liquidity and of hedge funds on markets. Paulson described the work of the President,s Working Group on Financial Markets (PWG) in looking at hedge funds and private pools of capital, noting that the group concluded that these vehicles are mostly good for financial markets, though the next global financial shock will stress test them for the first time. While he is not pessimistic, Paulson stressed the need to be prepared. Regulators should focus on regulated entities and ensure transparency and that market infrastructure works efficiently. He noted that the press reports on the PWG report interpreted the conclusion as recommending no oversight of private funds, but that the report really emphasizes vigilance of regulators and transparency to protect the public. Bank of Japan Governor Fukui ¶21. (C) Bank of Japan Governor Fukui began the meeting by saying that recent turbulence in global markets was a second round of global risk reduction, but that he remained confident about a soft landing for the U.S. economy. Paulson agreed, noting that the U.S. economy has slowed, but has enough strength to continue the expansion at a slower pace. Fukui added that he is watching whether the high level of inventories in the U.S. housing market triggers further price declines and gauging the impact of the difficulties in the subprime mortgage market on other credit markets. Paulson stated that while inventories are big, he believes the major part of the housing correction is behind us, though the adjustment will last a bit longer. He added that he thinks spillover from the delinquencies in the subprime market will likely be limited. Paulson opined that the U.S. economy is very diverse, and that despite the housing difficulties and a dip in manufacturing, consumer spending and exports are strong. ¶22. (C) Paulson expressed concern that the pace of reforms in TOKYO 00001029 005 OF 005 Japan was slowing, rather than accelerating, and the lack of detail in GOJ official,s descriptions of their reform plans. Fukui explained that Prime Minister Abe has made up his mind to continue reforms, but is faces with a backlash against reforms and the view that inequality and income disparities were exacerbated by the five years of reforms under the Koizumi administration. Paulson acknowledged those concerns, and noted the backlash in the United States toward protectionism. He opined that technology and differences in worker skill levels were key factors in income disparities globally. He noted that Japan was the best information technology producer, but that Japanese companies do not utilize that technology efficiently due to distortions in the labor market. He added the need for further financial deregulation, and described U.S. efforts to promote financial markets competitiveness. ¶23. (C) Paulson then congratulated Fukui on his good work as Bank of Japan governor. Fukui said it has been a very difficult course on monetary policy. The consumer price index (CPI) is now down to zero percent. Bank of Japan should raise rates carefully and gradually, even if CPI is near zero or slightly negative. Paulson said that he knew the BOJ,s latest rate increase has been politically unpopular. He expressed that it is very important that the yen has been market determined and there has been no intervention. He ended by saying that noting the importance of Japanese growth for the global economy. ¶24. (U) This cable was cleared by the Secretary's delegation. SCHIEFFER