Japan’s moment of truth?

Aug 10th 2005
From The Economist Global Agenda

After losing a crucial upper-house vote on privatising Japan’s postal monopoly, the prime minister, Junichiro Koizumi, has called a snap election, triggering a civil war in his own party and taking the country into uncharted waters

THE party that has ruled Japan for most of the past half-century tore itself apart on Monday August 8th over an issue that has come to symbolise the battle between Japan’s market-friendly reformists and its conservative old guard: the privatisation of Japan Post. In one of the most keenly watched votes in memory, the conservative wing of the ruling Liberal Democratic Party (LDP) mustered enough support in parliament’s upper house to defeat the privatisation bills convincingly, by 125 to 108, with help from Japan’s opposition parties. Junichiro Koizumi, the LDP leader and prime minister, responded by doing exactly as he had threatened to do, calling a snap election for the lower house (the prime minister has no power to dissolve the upper chamber).

The lower-house poll will be held on September 11th, and should be one of the most closely fought general elections in Japan since the second world war. The LDP could easily lose its nearly unbroken 50-year grip on power, with consequences for the country that are hard to forecast. The party’s split is thus an extraordinary outcome by the standards of Japan’s cautious, consensus-driven politics. It was not required to hold new elections for another two years, after all. That Mr Koizumi has risked everything by bringing the poll forward shows just how divided the LDP has become.

During his four years as prime minister, Mr Koizumi and his LDP rivals have taken the heat out of most of their disagreements by compromising over both the details and pace of change. The Japan Post privatisation bills had likewise been watered down before they went to parliament, and Mr Koizumi had hinted that he would make further concessions in the implementation. So why did his LDP rivals risk so much over an institution as seemingly innocuous as the post office?

Because Japan Post does far more than just sell stamps and deliver letters. Its sprawling network of 25,000 branches reaches into every remote corner of the Japanese islands, and has benefited the LDP’s old guard in two ways. First, it offers subsidised savings deposits and life insurance policies to Japanese households. It is now sitting on ¥331 trillion ($3 trillion) of such assets: were it a private financial institution, it would be the world’s biggest by far. These assets help to finance Japan’s unique system of corporate welfare, which props up small firms, farmers, construction lobbies and rural interests in general. Mr Koizumi’s plan was to put that huge pool of capital gradually to better use, by separating the bank and insurance arms from the post-office network and encouraging them to invest in line with market forces.

That shift alone would be a threat to LDP conservatives. But privatisation would also injure them by weakening the influence of Japan’s local postmasters, who help drum up precious votes in rural constituencies. The most diehard members of the anti-privatisation crowd drew on every fearsome spectre they could imagine to defeat the bills. Yet a large group of upper-house lawmakers could not make up their minds until the last moment. Ultimately, they had to choose whether to privatise Japan Post (leading to more economic competition nationwide and, thanks to the withdrawal of postmasters’ support, more political competition in their own districts) or defy Mr Koizumi (leading to a snap election and more competition for the LDP as a party). Many of them decided to protect their own upper-house seats by voting against the prime minister, and to take their chances on the fate of the LDP.

An open contest

What all of this means for Japan, and for its gradual slog back towards economic health, is hard to predict. That is not just because the election will be close. Even if one could predict the final seat count on September 11th, there would still be two big sources of uncertainty hanging over the next cabinet: one political, one economic.

The political question arises because Japan has little experience of this kind of battle. The LDP has lost power only once—for ten months in 1993-94—and back then Japan’s political system was more fragmented than it is today, and political skirmishing led to the formation of even more splinter parties in the mid-1990s. Since the Democratic Party of Japan (DPJ) was formed in 1998, that trend has reversed, and it has gradually emerged as the clear opposition party. One effect of that consolidation, however, is that the DPJ is now home to a range of political views and interests, from young reformists and former LDP members to former Socialists who oppose market reforms.

Under Katsuya Okada, who took over last year, the DPJ made great strides in upper-house polls last summer, and did much better than expected in elections for the Tokyo assembly last month. Given the LDP’s troubles, Mr Okada might just be able to unseat it in September. But forging a coherent economic policy would be a much taller order.

Mr Koizumi, likewise, could find himself in an awkward position even if his party wins. In the election, the LDP will withhold support from the 37 lower-house party members who rejected the Japan Post bills when that chamber voted on them last month. The LDP coalition would lose its lower-house majority if the party and its partner, New Komeito, lost 43 seats or more. So even though he will field some new candidates against the LDP rebels in their own districts, Mr Koizumi is in for a close fight. He will be encouraged that public support for him has risen since he called the election, from 41% last month to 46%, according to a poll by Asahi Shimbun, a daily; and from 37% to 46% in a poll for Mainichi Shimbun.

If it can win, the LDP might be more of a “pure” party, having purged some of the anti-reformists. But if that results in a slimmer majority, it may not make reform any easier. And since the next upper-house election is not until 2007, Mr Koizumi’s hopes of getting the Japan Post bills approved now seem dead.

There is no guarantee, moreover, that Mr Koizumi will remain as prime minister, even if his party retains its grip on power. He could follow in the footsteps of Takeo Miki, who served as prime minister in the mid-1970s. Like Mr Koizumi, Mr Miki broke the LDP mould: he came from a small faction and pushed for political reforms. But although the LDP won the election that followed, in 1976, it lost some seats—and Mr Miki was forced to resign.

Economic arguments

If the politics of reform are unclear, so are the economics. While some economists remain downbeat about Japan’s economy, there is also an important division between two schools of recent optimists. The first bunch—which has included Robert Feldman of Morgan Stanley—reckons that the economy has recovered over the past few years largely because Mr Koizumi has done such a good job reforming it: he has pushed to privatise roads, fix the banks, cut public-works spending and free up market forces, according to this view, and Japan has been reaping the rewards. So now that reform appears stalled, this group is now more pessimistic. Mr Koizumi's resounding defeat in the upper house, says Mr Feldman, “implies a long period of policy gridlock” which will be “bad for bonds, stocks and the yen”.

Another group of optimists, however, places much more emphasis on the business cycle and good fortune. Economists such as Richard Jerram of Macquarie Securities reckon that buoyant China-driven exports and investment over the past few years have lifted company profits and given the economy a boost, while making it easier for the banks to begin writing off their bad loans. Mr Koizumi’s government may deserve some credit, they argue, but most of his reforms have been gradual and do not yet add up to much. Japan’s economic prospects, in their view, depend on whether healthier exports and profits continue to translate into more hiring, and eventually lead to rising wages, more consumer confidence and an end of deflation.

Whatever the outcome for reform and the economy, the split within the LDP is clearly a big event in the history of the ruling party. Mr Koizumi took office in 2001 promising to “change the LDP, change Japan”. Depending on the outcome of next month’s election, he may finally succeed in fulfilling the first half of that pledge.

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