Japan's crunch time

23 November 2001

Oya yubi sedai - 'the thumb generation' - is the Japanese name for those who spend so much of their time typing text messages on their mobile phones that they have taken to using their thumbs for pointing and ringing doorbells. Twice this year already - in the race for the leadership of Japan's main political party, the ruling Liberal Democratic party (LDP), and in July's national election - the thumbs have been firmly raised in favour of Junichiro Koizumi.

Prime Minister Koizumi has threatened to breathe life into Japanese politics. Handsome, cool, seemingly iconoclastic, he has charismatic qualities rarely seen in Tokyo. And his mantra has been 'reform, reform, reform'. The extent of his popularity defies domestic comparison. His predecessor, Yoshiro Mori, stood out as the least popular Japanese leader since the Second World War; Koizumi has had unparalleled approval ratings.

However, eight months have passed since the formation of his administration and the critics are beginning to creep out of the woodwork. The complaint is that while all the talk of reform has been impressive, it has remained just talk. Koizumi has been accused of failing to deliver what he promised and, with most macroeconomic indicators moving in the wrong direction, there is a growing sense of urgency.

The long-haired premier has put the restructuring of Japan's mighty public sector institutions at the centre of his programme. The stated aim has been simple: to render public institutions more efficient; to privatise where possible; to stimulate the economy through focused government expenditure programmes rather than broad-based public spending; and to encourage the purging of the private sector, particularly the banking community. The rhetoric has gone down well with the electorate at large but has been taken as a challenge rather than an agenda by the old guard entrenched within the bureaucracy and Koizumi's own party. In fact, with the LDP having been in power almost continuously since 1955, there is no longer a sharp distinction between politicians and bureaucrats. And it is this blurred territory that is fighting back.

For example, the flagship initiative of the privatisation programme - the restructuring of the Postal Services Agency (PSA), and its sale - has been dogged by fierce internal resistance and apparent backsliding from the government. Originally, the PSA was to be put up for sale, but the plan has been so diluted as a result of opposition, that it will merely be converted into a public corporation in 2003.

The reason for the lost momentum is symptomatic of the wider malaise. The PSA has long been a reliable and dependable deliverer of votes to the LDP and as a result of the party has moved to defend the institution from the prime minister. On the macro level the issue is straightforward: the links between the LDP, the institutions of government and big business have become so close that mutual self-interest and the preservation of the status quo is often a more powerful driver than the need for reform.

The debate revolves around two questions. Are the intricate ties between the LDP and the bureaucracy - the relationship that steered Japan through its extraordinary period of economic growth - now driving the country ever deeper into recession? And should the remedy for Japan's stagnation be based on a radical reformation of the political economy, or can it be found more easily in merely the implementation of new policy?

Koizumi's barnstorming rise to power seemed to suggest that the surgeon's knife was to be used for more than just cosmetic work. The very fact that everything about him was different - from his close, informal relationship with the media to his blunt critique of the existing system - suggested that a new chapter was about to be written.

Koizumi's immense popular support has neither neutered nor dulled the resistance, but it will give him a strong hand if and when a pitched battle is sought. He has threatened that if any elements within his party move to flout his reforms he will dissolve the lower house of parliament. The implication is that he might try to use his personal support to split the LDP through an alliance with the main opposition party, the Democratic Party of Japan, and stay in power. Alternatively, he might find himself in a position to generate enough critical mass to force his enemies out of the LDP. For the opposition within the party, which has crystallised around the Hashimoto faction, this would spell disaster.

Such concerns have not prevented skirmishes, and they have been steadily growing in intensity. In mid-November, 53 LDP members of parliament - about 10 per cent of the party's representation in the lower house - announced the formation of a bloc dedicated to challenging Koizumi's policies. 'We are only trying to realise true reforms that all the people in the nation can agree on through open discussions,' Toshikatsu Matsuoka, one of the bloc's leaders, was reported as saying. 'The true path we should take is to achieve an economic recovery while also rooting out deflation.'

So far, Koizumi has been adept at sidestepping responsibility for the perceived stalling of his reformist programme. He has increasingly thrown down the gauntlet to his own party. 'I became the LDP president saying I will change the content, the LDP itself,' he said in a speech in mid-November. 'But now there are calls to change Koizumi. I hope they understand that we are not facing a situation in which the LDP can remain its old self. I want to inform my critics that their language is outdated.'

At stake is the medium-term health of the world's second largest economy. In Koizumi's favour is the fact that few would argue against the need for something new. The 'lost decade' - as the 1990s came to be known - has finished, but things have gone from bad to worse since. Gross domestic product (GDP) growth has not exceeded 2 per cent since 1996, and there was an economic contraction in 2000. The main challenge for the Koizumi government is to get real growth back, but debate rages over how this should be done.

Previous governments have unleashed ever greater economic stimulation packages in the hope that massive state investment would improve consumer confidence, induce increased consumer spending and trigger an economic upswing. Put simply, they failed. Too much of the public sector spend has been on inefficient rural infrastructure projects, and on the indirect protection of weak or unviable businesses.

Not only has the programme failed to reinvigorate the economy, it has also created a whole new problem: the price of failure. The stimulation packages have been financed through a sharp ramping up of the public sector borrowing requirement. Government debt rose to 130 per cent of GDP in late 2001 from about 60 per cent in 1991, and the cost of financing this massive debt pile could yet prove to be the most significant impediment to future economic health.

More immediate concerns centre on the impending danger of a deflationary spiral, with economists issuing warnings based on the threat of slow, no or negative growth combining with price deflation. Some are forecasting that the real economy will contract again this year - by up to 1 per cent - and that there will be price deflation of about 1.2 per cent.

There are still politicians - among them the breakaway bloc of 53 from the LDP - who argue that more of the old medicine is needed. They insist that government needs to spend its way out of trouble, and that any fiscal tightening will only have the effect of pushing the economy deeper into recession.

The alternative school of thought calls for a tsunami of 'creative destruction': the economic dead wood needs to be cleared before the path of growth can once again be found. Its students add that the new austerity must start with reduced but well-focused public sector spending.

'The programme focuses on three areas: resolution of banks' non-performing loans [NPLs]; revitalisation of the private sector; and medium-term consolidation of public finances,' wrote Masahiro Kawai, Japan's deputy vice-minister of finance in the London daily Financial Times on 19 November. 'Japan must undertake painful adjustment now - and accept low growth in the short run - to ensure higher productivity, improved competitiveness and sustained growth in the future. Aggressive reform will eliminate inefficiencies in the way domestic resources are allocated and will help restore confidence.'

So far, Koizumi has planted some crucial markers but he has also sent out mixed messages. He has pledged that he will cap bond issuance at Y 30,000 billion for both the current and the next financial year. Yet in November two supplementary budgets were unveiled which will add Y 5,500 billion to government expenditure, albeit mainly on the promotion of structural reform and on the creation of a safety net for the unemployed.

More unequivocal moves have been made. The prime minister has confirmed that there is a five-year timeframe for the abolition of the Housing Loan Corporation, which provides state-backed, low-interest mortgages, and he has slashed the Y 300,000 million highway budget allocation from the national budget, with effect from the next financial year. Some major infrastructure projects are to be cancelled and four government-owned highway construction companies are to be integrated and privatised.

One of the most important issues demanding redress is the health and structure of Japan's financial community. Bursting asset bubbles, tanking equity markets and ballooning non-performing loans (NPLs) have, for more than a decade, eroded much of what was strong in Japan's banks. The statistics are disturbing: Y 70,000 billion of provisioning has been made since the 1980s, but NPLs still total more than Y 32,500 billion, according to government figures. The reason is cultural: the system is not fully capitalistic, and over-leveraged or non-performing borrowers are not pushed into collapse. The result is a fundamental skewing of the method of asset allocation in Japan: too great a proportion of available funds is swallowed by unproductive elements.

If Koizumi succeeds in restoring vitality to the banking sector, and changes the thinking to such an extent that the banks function as purely economic animals, he will have been through traumatic times. As in most areas of reform, the challenge facing the government is huge, and many of the barriers will be intransigent.

'The international community has been down on Japan for a long time now,' said Kawai in his article. 'For much of that period it may have been right. But it must now recognise that structural change is finally under way. It is time to be optimistic about Japan.'

For the moment, the Elvis-loving prime minister is getting the benefit of the doubt both domestically and internationally. But the end of his honeymoon cannot be far away. Already approval ratings that were once over 90 per cent have fallen to the low 70s. Unless Koizumi is seen to be making serious reforms count, it may not be too long before more of oya yubi sedai, who have been giving him the thumbs-up, start to point the other way.

Exchange rate: $1=Y 123.1

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