Popular dissatisfaction with the Ryutaro Hashimoto Government's handling of the economy has led to a change of government in Japan, but to see the vote as an implicit vote for financial restructuring will be a mistake.
ACROSS the world, the attention of economic analysts and policy-makers is focussed on Japan. Once again the country is set to get a new Prime Minister from the Liberal Democratic Party (LDP). The change in leadership was dictated this time by the LDP's disastrous performance in elections to the Upper House of the Diet.
Early estimates had expected the party to pick up an additional eight seats, relative to the 61 it occupied out of the 126 seats for which elections were being held. Japan's voters, it was argued, would possibly strengthen the hands of Prime Minister Ryutaro Hashimoto and back his effort to reform Japan's ailing economy by giving the LDP a majority in the Upper House. But Hashimoto's inability to turn the economy around, partly because of his failure in early 1997 to join hands with other countries in the region to create a regional fund to stabilise currencies and stall a crisis, changed the course of events. In an election with an unexpectedly large voter turnout (59 per cent as compared with the 44 per cent recorded in 1995), voters chose to slash the LDP's strength by 17 seats, giving it 44 out of the 126 contested. The reason appears clear to all: dissatisfaction with the Government's handling of the economy. Thus, unlike earlier, when issues like corruption forced a change of guard, this time the LDP is getting a new leader and Japan a new Prime Minister because of economic policy ineptitude.
The inadequacy of economic policy does not concern only Japan's citizens. Japan's negative Gross Domestic Product (GDP) growth of 3.7 per cent over the year ending the first quarter of 1998, an industrial recession as a result of which industrial production fell by an annualised 21 per cent over the last three months and political uncertainty, is threatening to stall world economic growth. Japan's poor performance worsens the year-old crisis in East Asia, resulting in a decline in output of a magnitude far greater than earlier projected. It also threatens to weaken the yen further, which could "necessitate" competitive depreciations in China and, therefore, a collapse in the already debilitatingly poor export performance of the Asian industrialisers.
The problem, however, is not merely one of a "second crisis" in Asia. As slow growth in the region begins to tell on the bottom lines of American and European transnationals and the currency depreciations in the region transform their trade deficits with the rest of the world into surpluses, the paradox of robust growth in the West and deep recession in the East looks unsustainable. This is generating a change in perception in the West.
Till recently, Western governments had sought to present the crisis as a peculiarly Asian problem, at the centre of which was the accumulation of large non-performing assets by an unusually opaque financial sector. But the United States' intervention in currency markets to stabilise the yen and occasional signs of nervousness in U.S. stock markets in response to new evidence of a deepening recession in Japan indicate that the fear of an easterly economic wind that could prove damaging to the West is real. The difficulty, however, is the helplessness of the U.S., other Western governments and even of the Japanese rulers when it comes to halting the decline.
The first opportunity came just when the currency crisis struck East Asia and governments in the region, including those of Japan, Taiwan, Korea, Singapore, Indonesia and Malaysia began discussing the possibility of pooling their foreign exchange reserves to create an Asian regional fund that could be used to defend the region's currencies and provide individual countries time to restructure their real and financial sectors. That effort was, however stalled when Japan withdrew from the proposed arrangement in deference to U.S. perceptions that the task of dealing with the crisis should be left to the International Monetary Fund (IMF).
It is now clear that Japan's refusal to contribute to a regional adjustment effort not only forced an unduly deflationary 'adjustment' programme on countries like Thailand, South Korea and Indonesia, but that the consequent recession in the region has made Japan's effort to reflate its own economy near-futile.
Japan's slow growth is not a new problem. Since 1992, GDP growth has averaged just 1.3 per cent a year. During those years, developed country governments adopted a schizophrenic attitude with respect to global economic policy: while they wanted most countries to opt for reduced government spending or a deflationary fiscal stance, they wanted Japan to play a greater role as a locomotive of world growth by pump-priming its own economy. According to an OECD (Organisation of Economic Cooperation and Development) estimate, between 1992 and 1995, at least yen 64,000 billion had been outlayed on packages aimed at stimulating the Japanese economy, which included income tax cuts that reduced government revenues by yen 17,000 billion, new public investment totalling about yen 38,000 billion, and government land purchases and public loans to the tune of yen 20,000 billion. Partly as result of that spending and partly because of stronger export growth fuelled by the depreciation of the yen, Japan experienced a recovery in 1996, when output expanded at 3.5 per cent.
While this trend of acceleration was maintained during the first quarter of 1997, a sharp deceleration set in during the second quarter of that year and has worsened since. The causes are obvious. The first cause is the onset of recession in the East Asian region to which Japan is closely tied. That is, Japan is paying the price for its refusal to contribute to a regional solution to the currency crisis triggered by financial liberalisation. The second cause is a disastrous decision, fuelled by conservative finance, to impose a consumption tax to prevent the budget deficit from rising too much.
Since the first signs of slowdown in the summer of 1997, the Japanese Government has announced five packages aimed at reviving the economy. The most recent was the yen 16,000 billion ($124 billion) package announced on April 24 once again to spur domestic consumption and investment demand.
According to the Government, there is an equivalent of yen 12,000 billion in extra spending in that package which should raise growth by 2 percentage points over 12 months. It is now clear that the package is having little impact on the Japanese economy, since its effects are being neutralised by the adverse impact of the regional downturn on exports and the profits of Japanese conglomerates. Japan's failure to offer an alternative to and its acquiescence in the face of IMF-style deflation in East Asia is what explains its own crisis. It is to conceal this fact that Western governments and the Western media are making it appear that the problems being faced by Japanese banks, whose non-performing assets have burgeoned in the course of the crisis, represent the "structural" cause of the crisis.
UNDER G-7 pressure, the LDP had begun a process of financial restructuring in which healthy financial firms like the Sumitomo Trust Bank were to take over or merge with unhealthy ones like the Long Term Credit Bank. The problem with this strategy related to the handling of the large portfolio of bad loans accumulated by the weak banks. The LDP's strategy was to get the Government to purchase these loans either through existing institutions like the Resolution and Collection Bank or new institutions in the nature of "bridge banks", paving the way for a relatively painless restructuring of the banking system. The thrust of policy prescriptions pushed by the G-7 was to further this process by even allowing a few banks to close if resources were not available. Western governments and the media conveniently interpreted the economically motivated vote of the Japanese people as an implicit vote for financial restructuring that closes banks and drives corporations to bankruptcy.
This is far from the truth. One of the major beneficiaries of the loss in confidence in the LDP has, for example, been the Japanese Communist Party, which is no symbol of the forces backing a strategy of financial restructuring and liberalisation of the conservative kind. The JCP, which occupied six seats out of the 126 up for election, more than doubled its strength to 15, and together with another eight it holds among seats not contested, accounts for 23 seats in the House of Councillors; this is the highest number it has ever held. What is more, in terms of vote strength the party garnered 14.6 per cent of the votes cast in the national proportional representation constituency.
Interestingly, the focus of the JCP's campaign was not larger outlays for banking reform but larger outlays for growth of a kind which relies on higher consumption from people at large. In the campaign, the JCP called for a cut in the consumption tax rate to 3 per cent as a first step towards overcoming the present deep economic depression and to safeguard the people's living conditions. As the Asahi Shimbun of July 13, 1998 commented, "When the JCP raised the question 'whether to use 30 trillion yen for supporting the banks or to cut the consumption tax rate to 3 per cent to help the working people,' these diametrically opposed views became part of the whole election campaign."
There are others like U.S. economist Paul Krugman who argue that tax cuts alone are not enough. What is required in their view is a dose of inflation, which deals with the difficulty of cutting Japan's rock bottom nominal interest rates by making real interest rates negative by raising the rate of inflation. This would ostensibly encourage businesses and consumers to borrow and spend on investment and consumption, triggering in the process a recovery.
The difficulty with views of this kind is that while they challenge the obsession with financial restructuring which can intensify the recession by worsening the credit situation and driving not just banks but also firms to bankruptcy, they also treat the current problem as purely internal to Japan. The fact that the beginnings of a recovery in Japan were aborted by the crisis in East Asia suggests that Japan should look outward towards the region and realise that its recovery is linked to a recovery in the rest of Asia. If that be the perspective, then the challenge is to correct the error in which by refusing to participate in a regional financial arrangement to stave off currency crises, Japan brought the current recession upon itself. This would require finding means by which instead of letting capital migrate to the U.S. in search of higher interest rates it migrates to the rest of Asia, and uses the benefit of depreciated exchange rates, deflated asset prices and low costs in those countries to trigger another growth episode which then impacts on Japan as well.
This of course calls for a complete rethink of strategy which the politically devastated LDP is hardly in a position to undertake. Perhaps what Japan needs is not just another Prime Minister from the same party, but a whole new election to the House of Representatives where the LDP currently commands a majority, so that a new set of forces can come to power with a Prime Minister who has the mandate to change the way Japan thinks of itself vis-a-vis the U.S. and the rest of the region and the world.
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