Triumph and Challenges for Japan’s Democrats
Martin Schulz
Research Fellow, Economic Research Center
September 01, 2009 (Tuesday)
Japan embraces change
Japan’s public finally seems to have had enough. It is the third time in a row that Japanese citizens have tried to oust old-style Japan politics of relying on bureaucracy, lobbyism, and heavy public investment. In 2005, they handed LDP reformer Junichiro Koizumi a mandate to reform the party and push productivity-oriented reforms. After his successors turned back the clock and turned against reforms, they banished the LDP in the 2007 upper house election. And now they have handed the opposition a landslide victory to finally implement changes that reach far beyond the economy.
Why did the LDP lose?
Under former Prime Minister Koizumi, the LDP had an excellent chance to overcome internal policy deadlocks and turn towards future-oriented solutions to Japan’s structural problems. A whole set of supply-side policies were actually implemented, and they improved Japan’s competitiveness and productivity. But the LDP was not prepared to follow through. Instead of supplementing supply-side labor market and regional reforms with demand-side policies of income support and further education during times of testing structural changes, they worked against their own key policies. Fortunately, the result has not been a return to old-fashioned LDP policies that favor public works and centralized planning. The clock has not been turned back in Japan; it just has stopped ticking for the LDP until it is willing to reform.
Democrat Party Promises
The Democrats promise more support for families and domestic demand, but less public investment and bureaucracy. Though many questions remain unanswered, the timing actually couldn’t be better. The economy is already bottoming out while earlier LDP spending is now kicking in and starting to lift domestic demand. Of course, similar to the LDP, the Democrats will initially rely heavily on public spending for economic growth. But the current economic environment of low interest rates and persistent deflation will also not punish such a policy stance immediately. With a strong focus on education and families, as opposed to construction and business lobbies, the DP has a decent chance to produce positive growth in 2010. At the same time, the legacy of outlandish accumulation of public debt by the LDP provides enough headroom for generous public spending without looking irresponsible, at least at first.
Policy Reality
But in the end, the Democrats will be measured by their ability to shape their structural policy agenda to deal with Japan’s long-term problems. Three important reform polices are key. Public pension reform should be a focus from the start, and fortunately the system looks messier than it actually is. Providing additional transparency and a better social safety net for low-income earners are two targets that are reachable and would go a long way towards reestablishing a sense of social security and sustainability. Regional policy is about to shift from centralized public projects to untied transfers to local governments. This hopefully supports local growth, which has long been Japan’s achilles heel. And last but not least, a shift of agricultural policy from price fixing, tariffs and protectionism to income support of farmers might open the doors for a more open economy and closer integration with East Asia.
Policy Risks
The Democrats won’t bring an immediate change to Japanese politics. The party is as much an assembly of splinter groups as the LDP was a bag of competing factions. Closed-door power broking will therefore remain a key element of Japanese politics. The party’s center of power, founder, and former president Mr. Ozawa is a poster child of Japan’s old fashioned power politics. He will likely continue to pull the strings behind the scene as a shadow shogun who cares more about balancing powers than putting effective policies in place. Here lies the greatest risk for the DP: if it looks like the LDP in style at first and later (most likely) in substance, it will be digging its own grave from the start. But there is good reason to be optimistic. The new cabinet will put age-old LDP ties and relations on the block, and a huge number of young lawmakers will try to push for a new set of consumer-friendly policies that have the potential to be well-received. Given the current state of the economy with its falling private demand and persistent deflation, the biggest risk is not the immediate economic backlash, but another fallback into policy deadlocks.
Investment, Growth and International Impact
Even big business in Japan is fed up with the LDP’s inability to implement coherent policy or necessary structural reforms. Major corporations are therefore not adverse to a Democratic government. But unlike Koizumi’s supply-side reforms seven years ago, nobody expects a sustainable invigoration of the business environment. Companies won’t come out and increase domestic investment, at least initially. They will continue to invest overseas, and therefore need stronger ties especially with China and Asia. If the DP sticks to their promise to be more open-minded in international relations, they could contribute tremendously to Japan’s business opportunities and long-term outlook.
Judgment Day
Despite all the hype, the DP has failed to produce a coherent policy framework that anybody could believe in. The incoming prime minister himself calls its plans a “utopia” that now faces a rough reality. It seems unlikely that the inexperienced government will find a clear reform line or the money to pay for it on the first try. But the positive impact of (LDP) public spending is just kicking in, and the public is willing to accept a hopefully enlightening chaos that the new leadership might produce for a while. Market reaction on possible inflationary and budgetary threats will likely be muted as well. So we should have about a year to see which new policy setup might emerge in Japan.