Recent weakness in Japanese economic indicators is a worrying sign that the country’s longest economic expansion in the modern era may be stalling. But the growing political uncertainty after Prime Minister Shinzo Abe’s abrupt decision to step down is even more alarming from a longer-term perspective.
Abe stunned the nation on September 12 when he announced his resignation only a year into office. Given the dwindling public approval of his government and daunting legislative challenges after a humiliating election loss in July, he was definitely in an unenviable position. But the timing of the announcement was incomprehensible to voters and financial markets alike as it came just a few days after his policy speech to commence a four-month parliament session and only a few weeks after reshuffling his cabinet.
Political Vacuum to Slow Reforms
Abe is now convalescing in hospital, diagnosed with a stress-related stomach illness. Meanwhile, the leaderless nation has been left waiting for the ruling Liberal Democratic Party (LDP) to select their new premier on September 23 through an oldfashioned faction fight.
The political vacuum should not be taken lightly. It will push back the schedule for important economic reforms, including measures to enhance labour productivity, overhaul the public pension system and restore tattered public finances. These are all urgent issues because Japan’s rapidly ageing population is already starting to shrink, leaving little time for any political wrangling. In particular, it is imperative for the government to ease public anxiety over the 50 million sets of pension contribution records that have been lost due to sloppy management at the state pension agency. The issue has fanned taxpayers’ concerns about their future, paralyzed political debate over a consumption tax increase and emboldened critics of the small-government policy that Abe and his predecessor, Junichiro Koizumi, had adopted.
Pendulum Swings to Populist Policies
The youngest post-war prime minister, Abe enjoyed remarkably high approval ratings of around 70% when he took office a year ago. But since then, a long list of money scandals and politically incorrect remarks by members of his cabinet, in addition to the pension record issue affecting millions of people, have sharply eroded his support ratings.
In a bid to appease critics of the Koizumi/Abe policies, the LDP is now showing signs of favouring a return to what is euphemistically called a “consensus-oriented” leader who is more attuned to the needs of people who suffered from economic restructuring of recent years. This is a major concern because the turnaround may make it difficult to push forward dramatic reform policies. Furthermore, the LDP’s junior partner in the ruling coalition, the Komeito, is also now calling for an abandonment of the government’s target of balancing the budget by the early 2010s.
The two candidates in the LDP leadership race—effectively the race to become prime minister—are Yasuo Fukuda, 71, and Taro Aso, 66. Although Fukuda served as chief cabinet secretary in the Koizumi administration, he is widely thought to favour stability and consensus, whereas Koizumi thrived on controversy. Aso, currently the LDP’s secretary general, is a more brash personality, but he has made no secret that he is not a fan of the Koizumi/Abe economic policies. Of the two, Fukuda is the clear front runner, having secured support from a majority of intra-party factions and locked up votes of 70-80% of the LDP’s members of parliament and regional assemblymen.
Political Uncertainty to Persist
Any new prime minister will remain under intense pressure and will face a daunting task to push legislation past the upper house, now dominated by the opposition Democratic Party of Japan (DPJ).
Prolonged political stagnation may force the new prime minister to dissolve the lower house and call a snap election. If an election were to be called now, there is a good chance that the LDP would lose again and surrender power to the DPJ. The DPJ, whose members come from a wide spectrum of political backgrounds ranging from the former Socialist Party to the more right-of-center parties, is yet untested as a ruling party and political uncertainty would likely persist for some time. We want to emphasize that political development will still be crucial to Japan’s economic future.
Certainly, the economy has significantly recovered from the post-“bubble economy” shambles. But it is important to note that all the reform steps that have been implemented over the last five years or so are just the first steps toward bringing the economy back to a normal, sustainable growth path. Many areas require further reform, such as public finances. Indeed, the government is estimating its long-term debt will reach 773 trillion yen by the end of fiscal 2007, a new historical high and equivalent to 148% of nominal GDP. The OECD estimates are painting an even gloomier picture, forecasting Japan’s overall debt-to-GDP ratio to reach 177% by the end of this year, by far the worst among developed economies.
Fiscal reform is undoubtedly a weak spot for Japan as the clock is ticking for the ageing and shrinking population. Change also requires strong political will. If Koizumi and Abe couldn’t quite cut it, anyone with less determination will be doomed to failure. Strong political leadership is absolutely necessary for the Japanese economy to enjoy a brighter future.
For an illustrated discussion with charts and graphs, please download the pdf at the top of the page.
There is no guarantee that any forecasts or opinions in this material will be realized.
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