Koizumi Is Blowing It: Japan's New Prime Minister Squanders a Chance to Repair His Country's Economy
Katz, Richard, The International Economy
The ascension of Junichiro Koizumi as prime minister has given Japan its best chance for genuine reform in years. This makes it doubly tragic that he is in great danger of flubbing the opportunity.
The problem is not Koizumi's sincerity. Like Mikhail Gorbachev, Koizumi is a product of the old regime, yet he genuinely understands how much Japan needs to change. But, like his Soviet counterpart, Koizumi faces two very large obstacles: his own political party and a tragically self-defeating economic strategy.
Like the Soviet Communist Party, Japan's ruling Liberal-Democratic Party (LDP) is incapable of being the vehicle of reform no matter who stands at its head. The LDP's social base is badly divided between those who would benefit from reform and those who would be hurt by it. Indeed, Koizumi came to power via a revolt by the LDP's grassroots urban machine against the more rural-oriented party leadership.
Ultimately, the process that put Koizumi in power may end up proving more important than anything he does. No longer can anyone claim that the Japanese voter is satisfied with muddling through. But the party barons have no intention of letting Koizumi succeed. Given his immense popularity, their daggers remain sheathed as they wait for recession to erode his support. For reform to succeed, the LDP will have to split again (see "LDP R.I.P" in the May/ June 2000 issue of The International Economy). The fight between Koizumi and the party bureaucrats could be the trigger for this split.
The LDP's civil war helps explain why Koizumi has chosen such a counterproductive economic strategy. Like Gorbachev before him, Koizumi is committing the tragic error of doing the right things in the wrong order. Koizumi is prioritizing budget cuts instead of eliminating the bad bank debt.
With Japan falling back into recession, this is the worst time for fiscal austerity. Yet, the small (2-3 trillion yen) supplementary budget now being considered is not enough to keep total government spending from falling from last fiscal year by an amount equal to at least 0.5 percent of GDP. Additional cuts of another 0.8 percent of GDP are planned for next year. This fiscal tourniquet would repeat 1997's horrendous blunder, when Tokyo raised taxes and sent the economy plunging. Once again, it associates reform with recession.
Why is Koizumi reprising known errors? Some of the motivation is economic: the sincere belief that a bloated state sector is Japan's chief economic defect. Moreover, Koizumi correctly recognizes that his predecessors abused government spending as a substitute for reform and that this failed because fiscal stimulus alone cannot cure what ails Japan.
However, much of the motivation is political. The Koizumi camp believes few reforms can be implemented without first decimating the political power of reform's opponents, who are centered around the LDP's largest faction, the one led by former Prime Minister Ryutaro Hashimoto. Reducing public works, farm subsidies, and quasi-state enterprises all serve to cut the funding of vested interests and their LDP protectors. Much of what passes for fiscal reform is, in fact, an attack on the power structure of the old regime. While Koizumi's strategy is understandable, it is neither good economics nor good politics. If public works are a problem, switch to tax cuts. But why deepen the recession and give the LDP reactionaries more ammunition?
To make matters worse, Koizumi's actions on banking fall short of the bold campaign rhetoric that originally led to his election. He is sticking with his predecessor's plan for a limited write-off of bad debt: only 12,700 billion yen (US$100 billion) over the next two or three years. This is a small fraction of a problem now grown to 95,000 billion yen (US$766 billion)--almost 20 percent of GDP.
The dilemma for Koizumi is that he cannot cut the budget and solve the bad loan problem at the same time. …