Koizumi Brings Japan to the Brink—But of What?


National Journal, May 4, 2001

Suddenly, unexpectedly, and not a moment too soon, Japan is the most politically interesting of the world's top industrial economies. "I think this can be called a peaceful revolution," Junichiro Koizumi, the new Japanese prime minister, told the press last week, when it became clear that he had captured the leadership of the ruling Liberal Democratic Party by storming the grassroots and routing the party bosses. That Japan needs a peaceful revolution—and that America needs Japan to have one—is not in much doubt. For all the sparks that sometimes fly between Washington and Tokyo over trade, Japan easily remains America's staunchest and strongest Asian ally. For a while, in the 1980s and early 1990s, many Americans lost sight of the fact that Japan is fundamentally a friendly power, that China is fundamentally an unfriendly one, and that it is better, on the whole, for our friends to be strong and our adversaries weak. Recently, with Japan nursing its economic wounds and China ransoming American fliers for undeserved apologies, Americans have had a wake-up call.

Whether Japan manages to turn itself around, therefore, matters. It matters most to the Japanese. For them, the 1990s were a lost economic decade, and they may face the prospect of another lost decade (or two) if their government does not get its act together. Japan's strength also matters, however, to Americans and to Asians, because Japan is the only power in the region that is remotely capable of balancing China. Other things being equal, a weaker Japan means a stronger China.

Koizumi appears at what may be a decisive moment, because the next six months or so may be crucial to Japan. At issue is whether the government will at last bite the bullet and resolve the country's seemingly endless debt crisis.

During the booming 1980s, Japan's banks backed their portfolios with soaring stocks and real estate, and lent to anyone and everyone. Then the bubble burst, the loans went sour, the collateral's value dived, and so did the banks' capitalization. "In absolute terms," says Adam Posen, an economist with the Institute for International Economics, "this is the worst financial crisis anyone has ever seen." Apart from a serious scare in 1997 and 1998, however, the banks' losses have caused economic anemia rather than heart attack, because Japan's enormous economy—the world's second-largest—could tolerate so much abuse. That allowed the government to do what governments (including America's government under President Reagan, during the savings and loan crisis of the 1980s) always prefer to do about banking crises: temporize. The government took a series of significant but nonetheless insufficient steps, and hoped that the sun would come out tomorrow.

The sun hasn't come out. One former Clinton Administration senior official estimates that Japan has so far resolved only between 30 percent and 40 percent of its banking problems. Edward J. Lincoln, an economist at the Brookings Institution, points to figures suggesting that $1.2 trillion (that's trillion, with a "T") in bad or dubious loans still sit like a lead blanket on the banks' books. Posen prefers a more conservative figure, about $700 billion, but that is still a big, big number: about 16 percent of the country's gross domestic product, and five times as much bad debt as in America's S&L crisis. Purely on the economic merits, Posen figures, half the banks in Japan should be closed or merged.

Until recently, Japan's murky accounting standards have let banks finesse their problems. In September, however, the banks will be required to issue their first reports under new "mark-to-market" standards that value banks' assets at actual market prices. A lot of banks may suddenly turn up insolvent.

Cleaning up the financial mess requires setting off what Posen calls a "controlled implosion" of the banking system: liquidating and merging many banks, recapitalizing others at taxpayers' expense, and foreclosing on billions and billions of dollars of underperforming golf courses, construction companies, and office buildings. The consequence, Posen figures, would be a big political headache and a recession lasting from four to six quarters.

The alternative, however, is worse. If an ambitious cleanup effort is not begun by the time the banks' financial reports arrive in late September, Posen believes, Japan may finally face the explosive financial crisis that it so far has skirted. The hitherto-stagnant economy could collapse, and then shrink as confidence evaporates and capital flees. "You're talking about a transformation of Japanese society," he says. "It'll be like Ireland. Young people will go abroad because there'll be no opportunities for them." Posen's forecast is on the dire side, certainly. Optimists would say that failure to bite the bullet would ensure more years of stagnation: relative rather than absolute economic decline. Take your pick.

Into this sunny scene strolls Koizumi, breezily. In a nation where all politicians wear the same dark blue suit, he prefers silver suits and blinding ties. He wears his hair long and likes rock music. He campaigned as an outspoken reformer, promising to change both the ruling party and the country. He touted economic and financial restructuring, while warning, almost gleefully, that both would be painful. He favored privatizing the country's post offices, which are really a political machine for the entrenched bosses of his own party. "I can't think of another politician in the LDP who's as committed" to real financial and fiscal reform, says Mike Mochizuki, a political scientist and Japan specialist at George Washington University.

On the other hand, Koizumi is no outsider. He was groomed by old-time LDP politicians and has served the party loyally during his 29 years in the Diet (the Japanese parliament), where his father and grandfather also served. "You don't do that by being a maverick," Lincoln says. Like America's Sen. John McCain, Koizumi is an insurgent insider, which may be just as well. To succeed, he will need to work with the same partisan establishment that he loves to bad-mouth.

In Japan, as in the United States and everywhere, people want reform but not pain. The political success of Koizumi's reformist rhetoric is encouraging, but many observers believe that what appealed to the partisans was not his program but his persona, plus the very realistic fear that a conventional candidate would be disastrous for the party in the elections for the Diet's upper house in July. Last week, The Economist quoted a person it identified only as a "party hack" as saying: "We picked the best man to lead us into the election battle. It's as simple as that." Somehow, Koizumi needs to sell an explosive financial reform to the LDP and its equally timid coalition partners. He is likely to need an assist from the reform-minded Democratic Party—which, however, is in opposition and is the LDP's main rival. Talk about a balancing act.

The betting is that events could break in either of two sharply different directions. In one scenario, conventional politics would snuff out reform, as it has almost always done in the past. Having been humiliated by Koizumi, the party elders would let him carry them through the July elections and then either dump him or emasculate him. Without the party machine's help, Koizumi would get nowhere with the Diet or the bureaucracy. But, to win the party's support, he would need to water down his reforms. So he would choose doing little over doing nothing, muddling through with the usual sorts of half-measures until the party bosses decided it was time to trundle him offstage. This seems to be what many Japanese, having seen it time and again, expect. "Even though they've put someone new at the top of the LDP, Japanese politics won't change," one restaurateur told The New York Times.

There is, however, an altogether different scenario. As the country's problems fester, the LDP is growing more unpopular by the day, and the party is adept at surviving if nothing else. Its brighter members know that the debt problem is a bomb in the basement. But what kind of idiot would be fool enough to go down there and defuse it? Hold on—this Koizumi fellow has just volunteered for the job. For the opportunistic LDP bosses, Koizumi may be a godsend. Send him in to clean up the banks, and pretend to grumble while he ropes the opposition Democrats into going along. If the reforms are popular or successful, then Koizumi is a hero and the LDP looks golden for the crucial Lower House elections in 2004. If the reforms are unpopular or unsuccessful, why, Koizumi is the perfect fall guy. Dump him and move on.

For Japan, the remainder of this year appears to be one of those rare times when conventional politics may produce unconventional policies. Japan is at an inflection point. If the current opportunity to restore Japan's economic health is lost or bungled, the next one may not come around for quite a while—possibly too late. Watch Koizumi. And cross your fingers.