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Japan on the brink of change: What does it mean for Southeast Asia?

Updated On: Aug 22, 2009

On Aug 30, Japanese voters are likely to take the momentous step of ousting the Liberal Democratic Party (LDP), which has ruled Japan for most of the past 54 years, and replace it with the Democratic Party of Japan (DPJ). How much real change will this mean for Japan and what implications will it have for us in Southeast Asia?
Will LDP really lose?
The opinion polls show the DPJ so far ahead of the LDP that it is difficult to imagine the LDP catching up in the few remaining days. The most recent polls suggest that the DPJ is set to win about double the share of votes that the LDP can. The polls also show a large number of undecided voters, however, so it is always possible that the consensus on a DPJ victory turns out to be wrong. However, our call is for the DPJ to form the next government. Even if the DPJ does not do as well as the opinion polls say, it will almost certainly emerge as the largest party and win sufficient defections from other parties to form a majority in parliament.
Japan needs change
There are high expectations that the new DPJ government will usher in fundamental policy changes that will put Japan on a more hopeful course. Japan certainly needs to find a way out of the predicament it is in:
  • Not only is its population ageing, but the total population and workforce is declining. That will depress the growth potential of the economy to just 1% unless something is done to unleash radical productivity improvements. Given the unexploited potential for productivity gains in the still-unreformed services sector, policy reforms by a new government could make a huge difference;
  • A massive public debt that has kept Japan’s sovereign rating at the same level as the better- managed poorer countries such as Botswana: Its public debt-to- GDP ratio is about 180% and set to rise to almost 200% in coming years unless painful decisions are made;
  • A persistent tendency to deflation: Japanese consumer and producer prices are falling again, as are land prices, putting the recovery at risk;
  • Weak consumer spending, which leaves Japan overly dependent on exports: Consumers have lost confidence in a financially secure retirement, following scandals about the pension system and studies showing that pension liabilities are substantially unfunded. This forces them to save since they cannot be sure about their pensions; and
  • Japan has yet to forge new strategies in response to a world that is changing uncomfortably rapidly, with a rising China poised to take Japan’s position as Asia’s leader.
Of course, Japan also has considerable strengths: It is a world leader in technology and possesses some of the world’s most impressive and competitive companies. Moreover, Japan possesses a massive hoard of private savings despite its weak public finances. Most importantly, the Japanese people have in the past shown themselves capable of rising to challenges.
But change will not come easily However, there are several reasons investors should moderate their expectations of how quickly Japan can be transformed:
  • Change cannot come easily to a country like Japan, which is large, mature and highly developed, one where institutions and practices have deep roots. Interest groups such as the bureaucracy, large business groups and the agricultural and construction lobbies wield considerable power behind the scenes and can often be much more powerful than mere politicians; and
  • The DPJ is a coalition of such divergent groups (including former socialists, trade unionists and defectors from the LDP) that it is hard to discern its unifying philosophy. The party is also untested — it is unclear how it will manage the challenges of high office and what skills it has in mobilising support for the changes Japan needs. 
The DPJ has made many proposals in the course of its election campaign. Much of this involves additional spending — a very generous allowance for each child from birth until the child completes middle school, higher medical spending and guarantees for pensions. The idea is to boost the birth rate while giving consumers the confidence to spend, thus reducing Japan’s dependence on external demand. The DPJ has been coy about how all this will be funded, given Japan’s already weak fiscal position. It has ruled out any rise in the consumption tax for four years at least. In addition, reflecting the trade union base it depends on, the DPJ has indicated its opposition to privatisation and its desire to extend greater protections to temporary workers.
In the end, we think the DPJ will have little choice but to form an alliance with the powerful bureaucrats without whose support the DPJ will find governing difficult. Working with existing bureaucrats may well dilute the reforms that the DPJ will bring to Japan. But we also should not underestimate the bureaucracy’s own realisation that Japan does need to change direction. The net result will be some important changes in fiscal priorities — from “concrete to people”, as the DPJ has said — spending on infrastructure will be cut to release resources for its proposed family allowances, etc. The DPJ is also likely to make a start to cleaning up the pensions sector, which has been seriously damaged by scandals and mismanagement. Confronted with the hard reality of its budgetary position, the DPJ will agree to an eventual rise in the consumption tax as well. However, we do not see the DPJ having the appetite for pushing through more far-reaching reforms such as opening up the services sector to external competitors or removing distortions in the agricultural sector. 
What does it mean for the region? 
What should we in the region look out for in these elections?
First, change will unfold slowly in Japan, with its effect focused principally on the household sector. If child allowances, pension guarantees and other support schemes do encourage consumer spending, we are likely to see slightly faster growth in Japan and in Japanese demand for exports. That would be positive for us.
Second, a DPJ victory would help break the logjam in Japanese politics and policy, which has slowed Japan’s responses to its challenges. It will set in train other changes, which over time will energise Japanese politics and policymaking. That would also be positive for us.
But, finally, we do not see sufficient supply- side reforms in the near term to materially raise the growth potential in Japan. Neither is it likely that the new Japanese government will change its approach to engaging Southeast Asia economically and diplomatically. 
Consequently, the net effect may well be some positives for the region but the risk is of a further diminution in Japan’s economic and political standing in Southeast Asia relative to China and India over the longer term.


Manu Bhaskaran
About the author: 

Manu Bhaskaran is a council member of the SIIA. He is a partner and head of economic research at Centennial Group Inc, an economics consultancy.

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