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Japan’s challenges all begin with ‘D’

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In Brief

Japan has faced a number of ‘D’ challenges throughout 2010 that will be increasingly difficult to handle in 2011 unless they are addressed properly and quickly. Time is not by any means a friend in this.

The ‘D’ challenges that Japan currently faces include Deflation, De-population or Demographic changes, public Deficit and Debt, Dilution of the stock market, De-leveraging, Dollar Depreciation, Defense and DPJ (Democratic Party of Japan) governance.

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Ten years long of persistent deflation has forced the Bank of Japan (BOJ) to pursue the unconventional monetary operations that Japan was the first OECD country to launch, well before the USA FRB’s QE2 ( quantitative easing) policy was released on November 2010. Zero interest policy was first introduced by the BOJ as early as 1999. Deflation actually started in 1998 and still continues. Recent rounds of QE policy discussion have considered the establishment of the framework for an asset purchase program, including the purchasing of risk assets such as real-estate investment trusts (REITs), in the hope of supplying liquidity more directly to the real economy. As deflation may continue well into 2011 and even into 2012, the BOJ has no choice but to continue its QE policy with zero interest rates for the time being.

Japan’s fiscal position has deteriorated further because of the additional expenditure measures implemented to boost an economy depressed by the global great recession after the Lehman stock crash and also because of decreased tax revenue. Less than half of total government expenditure in Japan is financed by tax revenue and this tends to create more public debt. The gross public debt is around 150 per cent of GDP, and is forecast to rise to 200 per cent by the end of 2015.

Though 94 per cent of Japanese government bonds (JGBs) are purchased by Japanese residents, household saving rates are now as low as 2-3 per cent after many years of wage deflation and the consequent sustained trend of a decline in household income. The government should move to limit such deficit financing by domestic saving, as this fiscal position is completely unsustainable. In the summer of 2010, the IMF recommended Japan try to begin a gradual increase of consumption tax rate over time (it is currently 5 per cent). Prime Minister Naoto Kan, soon after taking office, hinted at his intention of increasing the consumption tax, but gave up the idea after losing a majority in the upper house in the July 2010 election. After loss of the majority of the upper house seats in the Diet, Kan’s government has been wracked by intra-party power fights.

For many reasons, approval ratings of Kan’s cabinet had slumped to low a 20 per cent by the end of 2010, down from almost 70 per cent when he took office. Among the reasons for the slump in popularity was a series of unhappy incidents in international affairs. One of the most prominent was the military tensions and conflicts over resources with China. Japan-China relations were at their worst in 2005 when anti-Japan street protests occurred in Shanghai, Beijing and other big Chinese cities. Since then, there has been a gradual improvement in bilateral relations, leading to regular meetings between the top leaders of both countries. But the situation changed suddenly in September 2010 when Japanese officials arrested a Chinese boat captain near the Senkaku Islands. This was followed by a Chinese ban on exports of rare-earth minerals to Japan, creating a large shockwave through Japan’s high tech industries.

In 2010, China overtook Japan as the second largest in the world in terms of total GDP, a position that Japan has held since 1968. How to come to terms with a rising and more demanding China will be an issue of increasing importance in Japan in 2011. Tension on the Korean peninsula is another of Japan’s worries, which, together with the China issue, is forcing Japan to reconsider the nature of its alliance with the United States.

Debate over Japan’s possible participation in the Trans Pacific Partnership (TPP) accession negotiation is about more than an international commercial policy issue alone. Through the TPP, a higher quality, more comprehensive trading agreement may be attained than through regional or bilateral FTAs. Japan may be able to use the TPP to compete with China for regional leadership in an area where China has so far been surging ahead of Japan by virtue of an aggressive FTA strategy. This is by no means a policy of containment. Japan is trying to find her place in the process of Asian economic integration. At the same time, Japan faces very difficult Domestic political challenges such as how to deal with an agricultural industry that is seriously limiting Japan’s free hand in trade negotiations.

All these difficult D challenges need to be addressed though doing that is constrained by the most difficult challenge of political governance and leadership. Prime Minister Kan’s leadership is weighed down by low public support and a minority position in the upper house. The next election for the House of Representatives is not due until August 2013. But politicians have already begun to speculate about an early general election. Japanese politics in 2011 are likely to be fluid and volatile as none of the D difficulties will go away soon.

 

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.

This is part of a special feature: 2010 in review and the year ahead.

One response to “Japan’s challenges all begin with ‘D’”

  1. D for Depressing! But I am reminded of Shiro Armstrong’s posting mid-2010:

    http://www.eastasiaforum.org/2010/08/16/what-japan-can-do-about-its-malaise-weekly-editorial/

    He emphasised promising shifts in some Japanese corporate activity and ‘culture’, in investing abroad etc, so I wonder what your own perceptions are in that respect.

    My book (and other works) found a significant albeit “gradual transformation” in Japanese corporate governance more generally:

    http://web.me.com/lukenottage/japaneselawlinks/Corporate_Governance.html

    Inbound FDI has also risen over the last decade (but off a low base, concentrated in a few sectors, and tracking a broader boom in FDI worldwide – until the GFC) while outbound FDI is supported by an increasingly elaborate network of investment treaties:

    Hamamoto, Shotaro and Nottage, Luke R., Foreign Investment In and Out of Japan: Economic Backdrop, Domestic Law, and International Treaty-Based Investor-State Dispute Resolution (December 26, 2010). Sydney Law School Research Paper No. 10/145. Available at SSRN: http://ssrn.com/abstract=1724999

    Luke Nottage

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