With so many eyes poised on China’s unbelievable rise, analysts are preoccupied with drawing doomsday scenarios about its inevitable democratization in the next few decades and the large-scale political instability – internal, regional and global – that such a process could entail. With a robust economic recovery under way (the country just reported for the first half of 2006 growth rates staggering for an OECD member), Asia’s incumbent economic leader, Japan, looks evermore like the good kid on the block, which by definition merits little consideration. Nevertheless, the oncoming Liberal Democratic Party (LDP) presidential elections on 20 September are about to set the stage for a series of decisions that are likely to shape the country’s – and the world’s – future for decades to come. 

   The recent spike in GDP growth is expected to mark the end of Japan’s lost decade – or, rather, more than fifteen years – of persistent deflation, rising unemployment and almost no growth, dotted by sporadic banking and housing crises. As the Bank of Japan (BoJ) moved earlier this year to discontinue its policy of monetary easing and in July even increased interest rates by a quarter of a percentage point, government officials have been quick to warn against a precipitous tightening of the money supply that might render the recovery stillborn. The BoJ did kill an insipient recovery in 2001 by an ill-timed interest-rate hike, which, according to estimates by the Economist Intelligence Unit, increased the total loss in economic growth since 1990 to about 25% of current GDP. Then as now, however, Japan had more than a few rotten apples in its basket of economic fundamentals, which could hardly ever be mended by monetary measures. As deflation firmly set in during the 1990s, the BoJ promptly decreased interest rates to zero and launched its printing presses for what became an unprecedented in economic history peacetime expansion of the money supply. This exhausted the measures that the BoJ could have possibly taken, but kept GDP slowly creeping up during Japan’s lost decade. Meanwhile, a succession of LDP governments and a short-lived opposition administration sat by and did little in the way of the broad-scale political and economic reforms that the country still so desperately needs.
            It was precisely his determination to push through with the long-overdue overhaul of the public sector that allowed Prime Minister Junichiro Koizumi to crush not only the official, but also the internal LDP opposition in an electoral landslide last September. Koizumi’s partial reforms deserve some credit toward the current economic recovery and the surprisingly favourable consumer attitudes. What Japan is now experiencing is, however, more of a temporary remission rather than the final cure of its many chronic illnesses. The country’s financial sector remains largely unreformed and poorly regulated – as has been highlighted by the livedoor scandal and embarrassing events at the Tokyo Stock Exchange earlier this year. Like their European counterparts, Japanese industrial giants still depend largely on loans instead of more liquid financial instruments such as bonds, which would make risk easier to diversify among more lenders. Combined with a still shaky and apprehensive banking system, this retrograde structure of corporate debt makes borrowing particularly difficult as the BoJ has pulled the plug on its printing presses. It is the government’s and not the central bank’s responsibility to improve bankruptcy law and the regulation of financial markets, which would make bonds more attractive. As bonds become more secure, their risk premium will diminish and corporations will be more likely to prefer issuing commercial paper over direct loans. The liquidity and overall health of the banking system will thus increase, making small lending cheaper and easier.
            Stuck with illiquid corporate loans, banks are less willing to risk lending to smaller businesses, which are the typical users of direct loans in a developed economy. For an OECD country, Japan depends to a high degree on industrial production and about half of manufacturing output comes from small, typically family-owned enterprises. These have been the source of business innovations even when industrial giants, whose stale hierarchies make change and adaptation more difficult, have floundered. The weakness of small-scale lending, which was particularly difficult during the lost decade and bore much blame for the stagnation, is likely to turn into a nightmare for entrepreneurs as monetary easing ends, with dire implications for economic growth. Nevertheless, only a nutcase central banker would not raise interest rates since the recently registered growth rates make it imperative that the BoJ rein in big-business investment. Japan still retains an investment rate of over 20% – a level unnaturally high for a developed country – and over-investment has been largely to blame for the banking and stock-market crises of the 1990s. The deflation of the lost decade forced upon corporations some of the tough steps they were unwilling to take on their own – divesting from domestic capacity, expanding overseas and directing a bigger proportion of investment towards research and development. Even so investment remained ineffective compared to other OECD countries. Now, improving domestic demand and the flamboyant export growth could easily push corporate Japan back into the seductive, yet sinful road of overinvestment, which could be the seed of yet another financial crisis.
            Managing the inefficient financial system seems like child’s play, however, if one looks at the Gordian knot of Japan’s labour market. One of the underlying causes of the slowdown in the 1990s was growing structural unemployment – a mismatch between supply and demand in the labour market, as firms were looking for better educated and experienced employees than were available. Unqualified workers still cannot find work because of largely unrepealed job-protection labour laws, which make firms loath to hire unqualified new workers. On the other hand, qualification is hard to come by when rigid corporate structures keep promising young employees bogged down in low-level positions instead of allowing them to grow faster up the hierarchy. Since pay is still usually tied to tenure (only rarely also to performance), employees have a huge disincentive to switch jobs, so it is virtually impossible to hire from outside qualified and trustworthy people for an opening in the higher or even middle-level ranks. On top of all this, Japanese universities have not been the best example of flexibility and innovation in the past few decades, producing quite a few graduates that are either unwanted in the labour market or poorly qualified, while making it difficult for more people to get a higher education and meet the growing demand for educated workers. In the medium term, the situation is bound to get much worse, as Japan’s baby boomers begin to exit the labour force under the pressure of corporate bylaws dictating compulsory retirement, and will weigh over the country’s already dangerously strained health and pension systems. Again, it is the government’s, not the BoJ’s, responsibility to reform labour law (by abolishing unsavoury corporate practices and most job protections) and make the educational system nimbler so as to reduce or postpone the oncoming cohorts of boomer retirees and smooth out the labour market.
            Labour reform is ever so pressing because the ranks of the structurally unemployed may increase significantly over the next decade or so. Despite being a member of the WTO, Japan has managed to remain an incredibly protectionist country, retaining high import duties on many agricultural and low-level manufacturing goods. However, the pressure is mounting from the US and other WTO members that Japan abolishes the customs barriers for these imports during the ongoing Doha round of trade negotiations. This abolition will be very beneficial for the Japanese economy because it will potentially unlock domestic demand for manufactures by dumping the prices of food and other essentials, while allowing the government to wrestle out better terms for Japanese exports abroad. However, many small farmers and manufacturers will go out of business, thus unleashing an outpour of unemployed and uneducated workers. Although the farming lobby is still strong, Japan could not keep up for much longer against both its own interests and foreign pressure. Structural unemployment is also likely to rise if Koizumi’s programme of improving the efficiency of public works is continued and deepened by his successor. Japan still builds hundreds of kilometres of unnecessary roads every year as constructors line the pockets of LDP fat cats, which are anyway eager to push through another pork-barrel project for their constituencies. The issue was partly addressed by introducing proportional representation for some of the seats in the Diet, but further improvements are needed to crack down on corruption and public spending, which on top of it all crowds the private sector out of the lending market. The inevitable fiscal contraction, ensuing from the reduction in public works, will also add to the ranks of the structurally unemployed, but will free up funds to patch up the social safety net and help contain the already inflated government debt.
            Evidently, Japan’s financial system is still too weak to support sustainable, healthy growth in the long run and its labour market is too rigid to meet the needs of employers for qualified personnel. The unreformed public sector is deficient in crucial spots such as healthcare, while maintaining a fiscal expansion driven by distributing pork. If the problems underlying these phenomena remain unresolved, in less than a decade Japan may find itself deep down a stagflation spiral propelled by growing wages and exploding government deficits combined with rising structural unemployment and weak domestic demand. The governments over the last fifteen years have failed to address these issues despite their obviousness; even Premier Koizumi has taken only a few initial steps along the road to revivifying Japan. The reasons for this lack of reform are embedded deeply into the country’s political system, which may soon become the source of even worse problems.
            In the continuation of this article we will look at Japanese politics in the next decade or so of potentially worsening economic conditions. Further ahead we will also scrutinize the oncoming militarization of Japan and how the power struggle in the LDP this September will shape all these developments

Be first to comment this article

Only registered users can write comments.
Please login or register.

Powered by AkoComment Tweaked Special Edition v.1.4.6
AkoComment © Copyright 2004 by Arthur Konze - www.mamboportal.com
All right reserved

---