On the Cusp of 2006

Economic Outlook

The positive growth cycle of the Japanese economy is forecasted to improve even more this year, with increased exports leading to expanded investment, the improvement of the employment situation, increasing income, and the beginning of growth in consumption levels. Though last year saw a general slowdown in Japan's economic recovery due to uncertainties in the Chinese and American economies, rising energy prices, and other factors, experts predict that those problems will be overcome to a large extent this year and economic recovery will leap forward. The root of this recovery will be strong, corporate R&D-driven efforts in innovation and improvements in the competitive market conditions to support it, promoted by comprehensive government policies for structural reform. In positive response to these conditions, the stock market will continue to be upbeat; with stock prices serving as the leading indicator of the economy, the favorable stock market indicates that Japan's economic recovery will proceed to make brisk progress in 2006.

Capping off "Koizumi's Revolution"

The Koizumi administration's reforms have entered into their final lap, with the pace of reform picking up considerably since the September 11 elections last year. In 2001 the Koizumi administration launched their reforms under the slogan “There can be no growth without economic reform,” and during the past four years have subsequently battled the aftereffects of the burst bubble, overcome the financial crisis, and tackled a vast array of daunting reforms vital for Japan's future.
Three years into the reforms, however, the Koizumi administration faced mounting opposition from both outside and inside the LDP, waylaying reform efforts on multiple sides. The symbol of this was the privatization of postal services. From the start of his administration, Prime Minister Koizumi made a pledge to the nation to tackle postal reform as the most important issue facing his term. Despite making this pledge and earning his party's trust as president of the LDP, his privatization proposal was shot down in the Upper House last summer.
Turning this rejection on its head, Prime Minister Koizumi seized the opportunity to ask the true will of the people directly, achieving a landmark victory in the September Lower House election. Not only did the election discredit the opposition within the LDP, but rival candidates were also fielded in the opposition's districts, causing many to lose reelection, and even going so far as to expel some major members from the party. On top of this, urban areas saw the debut of over 80 new representatives-known collectively as “Koizumi's children.” Triggering this seismic shake-up himself, Prime Minister Koizumi led the LDP to win 296 seats, while the combined LDP-Komeito coalition gained two-thirds of the House with over 327 seats in total. This overwhelming victory solidified the Koizumi administration's control over the House, and the government began to flex its leadership almost autocratically.
Following the election, the government moved to resolve outstanding issues stretching three years back, accomplishing a dizzying array of reforms in rapid succession, including postal reform, public finance reform, trinity reforms as a part of decentralization, civil-service reform and healthcare reform. It was a reform dash that realized three-years' worth of issues in three months. A score of additional reforms will likely cap off the Koizumi era as he approaches the end of his term in September of this year.
Looking closely into the substance of these reforms, however, there are a number that have not sufficiently met their initial purpose. Thus, the economic effects of these reforms are limited in most fields, and additional strengthening of reforms will be necessary to realize their original intent.
In contrast to the limited results of Prime Minister Koizumi's economic reforms, however, the greatest effects are to be found in the political sphere. The Koizumi reforms have marked the utter end of the old postwar political system of former Prime Minister Tanaka and his supporters, and have inaugurated a new Prime Minister-led policymaking function. This will likely be the clearest legacy of the Koizumi reforms.

The Next Cabinet

Which administration will take the reigns of state in the post-Koizumi era will, to a large extent, determine the future of Japan. Anticipating the post-Koizumi cabinet, it is thought that Mr. Koizumi filled his inner cabinet with promising candidates following the reshuffling in October of last year. Among these, Shinzo Abe, Sadakazu Tanigaki, and Taro Aso are thought to be the primary candidates to succeed Mr. Koizumi as prime minister. Outside of the cabinet, Yasuo Fukuda is considered to be an unheralded contender, while Heizou Takenaka-who has risen from within the cabinet to take on the Koizumi Cabinet's most important post as minister of internal affairs-is also thought to be a dark horse. Who will become the next prime minister will be decided from here on out, but whomever it is they will have to tackle even greater reform issues. This is because Japan has finally entered a phase marked by population decline, a megatrend that will decide the future path of Japan's economic society as a whole.
As a result of the twin trends of a declining population and an aging society, budget overruns are expanding in fields such as social security costs, the labor force is shrinking, the savings rate is declining, and there are regions that are becoming impoverished due to declining populations. These are grave issues that a new cabinet must tackle with bold and powerful policies. Reforms targeting the major sources of social security costs-pension plans and healthcare-are still insufficient, and measures to curb the declining labor force are still unformed. To stem the declining savings rate, it may be possible to radically alter the flow-of-funds structure that has supported Japan's development since the postwar; the strategy for how to cope with this, however, has also been neglected.
There are also major issues for Japan's international strategy as well. The Koizumi Cabinet has strengthened solidarity between Japan and the U.S., and relations between the two countries are the most favorable they've ever been. Meanwhile, Japan-China relations have been hung up on problems such as the Yasukuni Shrine issue, political exchange between Japan and Korea has fallen into dysfunction, and Japan was unable to take advantage of the valuable opportunity presented by U.N. reform. The striking rise of countries like China, India, Russia, and Brazil herald the multipolarization of the world and mark the evolution of a fluid international environment. To navigate within this changing world, the next cabinet must fully grasp the importance of Japan-U.S. relations, while at the same time embark on a new course that can earn the trust and meet the expectations of the international community.

Even if this year sees only the outlining of these elements, 2006 is set to be a fascinating and noteworthy year for Japan.