After expanding by 2.3 per cent in 2007, GDP contracted by 1.2 per cent in 2008, and then by more than 5 per cent in 2009.
Japan’s financial markets have now stabilised from the after-shocks of the Lehman Brothers collapse of September 2008, after the Japanese economy bottomed out sometime around March 2009, but economic recovery is still very slow and the level of economic activity, as shown in various indices, is still below pre-crisis levels.
Moreover, Japan has slipped into sustained deflation which now presents a difficult challenge to the Bank of Japan’s monetary policy. Deflation puts pressure on business and government through higher debt burden and reduced sales and tax revenue. If business responds to deflation by cutting wages and government by increasing taxes or cutting expenditures, a vicious deflation cycle could occur, leading to further contraction of GDP. Indeed, nominal GDP shrank 6 consecutive quarters until the 3rd quarter of 2009 and the nominal GDP level of that quarter was still only back to the level of 1991.
The so-called ‘GDP gap’ – a gap between actual economic activity level and potential level, is now negative 6.7 per cent of GDP, the largest negative number ever in the post-1945 period. Whether the government and the Bank of Japan will be able to lift the economy out of this situation will be one of the most important economic policy challenges of 2010.
In the political realm, 2009’s ‘power shift’ was historical.
The new coalition government, led by the Democratic Party of Japan (DPJ) with Yukio Hatoyama as Prime Minister, is the first government not led by the LDP in the 16 years. This has meant a departure from the ‘iron triangle’ politics of the LDP, business and bureaucrats, which created deep-rooted and vested interests amongst those wielding power.
The DPJ is trying to fracture this pork-barrel ‘triangle’, by shifting resources, as they describe it, ‘from concrete to people’s lives’. In actuality, the LDP government lasted for 46 years from 1955, except for only 11 months from 1993 to 1994 in which Morihiro Hosokawa was Prime Minster. In the 38 years from 1955 to 1993, the LDP monopolised rule of Japan’s government, and from 1994 to 2009, the government was led by the LDP in coalition with other parties.
There are several apparent and latent problems facing the DPJ-led coalition government. In particular, security policy, including the U.S. military presence in Okinawa, requires an urgent solution, given the serious tension and friction that has been created between the Obama administration and the Hatoyama government. This year is the 50th anniversary year of the US-Japan Security Treaty, but the U.S, is currently in no mood of celebrating this anniversary.
It is difficult to reconcile differences over various policy choices amongst parties in a coalition. The DPJ’s two coalition partners are very small with less than 5 per cent seats of 3 coalition party’s total. But in the 242-seat upper-house, with 2 seats vacant, the DPJ, with 108 seats, still needs the Social Democratic Party’s 5 votes and the People’s New Party’s 5 votes to command a majority. Because of this situation, a victory for the DPJ in the July upper-house election is extremely important. For now, the DPJ cannot afford to exclude these marginal parties in the coalition, no matter what they demand. The confusion and indecision over the Okinawa issue, which has been increasingly irritating the Obama administration, has to be viewed in light of this political backdrop.
Other important policy issues facing the DPJ government this year include: construction of a new economic growth model, fiscal reconstruction, pension system reform, policy formation over Japan policy towards East Asian Community.
All in all, 2010 will be a crucially important year of big decisions, for the DPJ government and for Japan’s economy and society as a whole.
This is part of the special feature: 2009 in review and the year ahead.
Akira Kojima is Senior Fellow at the Japan Center for Economic Research (JCER) and Visiting Professor of National Graduate Institute For Policy Studies (GRIPS) and was formerly Editor-in-Chief of the Nihon Keizai Shimbun.