Mission accomplished

01.01.06 Publication:

Junichiro Koizumi will leave Japan´s economy on the mend and its politics invigorated


A Japanese spring

The land of the rising sun has been swathed in so much cloud during the past decade that even the optimists are nervous of speaking out. That is despite the fact that 2005 was a good year for Japan´s economy, a fine one for its stockmarket and excellent for its politics, and 2006 promises to be even better. Soon the Japan bulls will regain their voice. For at long last Japan is poised to surprise on the upside, not the downside.

As the year begins the economy will be pulling clear of the deflation that has bedevilled it. Falling prices might seem a boon in what was long considered a high-cost economy, but instead the result has been that consumers have deferred spending, wages have fallen and companies have held back on investment. All that is now changing. Since early 2005 wages have been rising again and since mid-2005 so has the sort of regular, full-time employment that is so important to consumer confidence. The growth of part-time and temporary contract work, which at 30% of the labour force has been vital in boosting profits but debilitating for demand, has come to an end. Gently but steadily, Japan´s excess labour has been absorbed and household incomes are growing again. Encouraged by that, corporate investment will rise and even productivity could start to jump. There is a lot of catching-up to do, after all.

That brings with it a worry, that the Bank of Japan might respond to inflation´s return by abandoning its zero interest rates and massive monetary expansion, and might thus choke the recovery. But as long as the Bank waits until mid-year, to be sure that economic growth really is being sustained and deflation really is over, then that fear is unlikely to be borne out. Rather, a modest return to positive interest rates will begin an important new phase of Japan´s recovery: the restoration of the price mechanism for allocating capital.

The prime minister, Junichiro Koizumi, was in September 2005 returned to power with a landslide election victory, so you might expect him to be carrying out a vigorous programme of reforms to stimulate the economy. If so, you would be wrong. Mr Koizumi´s main task in 2006 will be to stay out of the way of the economic recovery, resisting pressure from the Ministry of Finance or some colleagues in the Liberal Democratic Party to raise taxes or cut public spending, in order to reduce the budget deficit, now 6.4% of GDP. That will be necessary, as the gross public debt has reached 170% of GDP and even the net debt (ie, taking account of the public pension scheme´s holdings of government bonds) is over 80% of GDP, the fourth-highest in the OECD. But it will be best not to rush it as that too could risk choking consumer spending.

Rather, the reforms presented to the Diet (parliament) by Mr Koizumi and his economics minister, Heizo Takenaka, will be directed at the much longer term. Like the postal-savings privatisation that he used as his election-winning issue, the reforms of 2006 will be aimed at establishing a long-term squeeze on the state´s role in the economy. The postal privatisation will not take full effect until 2017. With the two-thirds majority in the lower house of the Diet that he enjoys with the LDP´s small coalition partner, New Komeito, Mr Koizumi will be able to implement other reforms a bit faster than that, but caution will remain the watchword. Next in line for the Takenaka treatment are eight state lending institutions.

The biggest challenge, though, lies in finding ways to cut the costs of the state health-care and pension schemes. Mr Koizumi´s election manifesto promised reforms, but was short on details. High principles governed his campaign for postal privatisation; hard graft will be needed for health and pensions, and he is not noted for that. This task will be left to his successor.

That succession could come remarkably quickly—remarkably, at least, given the election landslide. The LDP´s rules say that he must stand down as leader in September 2006. There will be plenty of pressure for the rules to be waived, to give him a further one or two years, both because of his 2005 success and because an upper-house election looms in 2007. Mr Koizumi is such a loner that no one can feel sure whether or not he will want to retire, as he claims. Human nature says he will stay on. But retirement currently looks like the better bet. He has achieved his long-held ambition of postal privatisation, has changed his party, as he said he would, and is not known to have any further agenda.

Human nature says he will stay on. But retirement currently looks like the better bet

If Mr Koizumi does decide to retire, the two likeliest successors are Shinzo Abe, a young, right-wing former LDP secretary-general, cut from the Koizumi mould, or Yasuo Fukuda, a less populist and very steady former cabinet secretary. Mr Koizumi´s cabinet reshuffle in October 2005 gave Mr Abe´s chances a boost by returning him to the public eye as cabinet secretary and government spokesman. In that case reformists will be pleased, but China will be unhappy. Mr Abe insists he will continue Mr Koizumi´s habit of visiting the controversial Yasukuni shrine for the war-dead that so irks the Chinese.