Japan wasting opportunities afforded by crisis

May 31, 2011

By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

TOKYO — Machiavelli warned never to waste the opportunities afforded by a crisis. Japan today is struggling with an epic catastrophe: an anemic economy struck by a once-in-a-millennium disaster that may have killed 24,000 people, left hundreds of thousands homeless and destroyed nuclear reactors that spewed poisonous radiation over an estimated 600 square kilometers. Summoning their traditional spirit of “gaman” — enduring the unendurable — the Japanese have united to persevere and rebuild.

Yet even as Tokyoites trudge into their dimly lit offices to endure a sweltering summer without air-conditioning, elevators or escalators to prevent power shortages, the risk is that they cope without changing, rebuild without renovating. Japan has for the past two decades been in the grip of an economic paralysis inflicted by a sclerotic political and financial system. Beset by deflation, it has not seen GDP growth above 4 percent in a generation. In a country that prides itself on full employment and income equality, it has developed a chronic 5 percent jobless rate.

True, Japan still enjoys a trade surplus with almost every nation, boasts some of the world’s largest companies and has unrivalled engineering prowess. Japan has some of the world’s most prosperous citizens, the longest life expectancies and one of the lowest crime rates. It is a nation of cordiality, where dazzling technology and efficiency meet breathtaking aesthetics and precision.

These achievements disguise Japan’s real dilemma. Its population is shrinking, forcing a diminishing workforce to shoulder the growing burden of financing retirement for baby boomers born after World War Two. This youthful underclass labors in a pseudo-socialist system of developmental capitalism that has outlived its usefulness, valuing harmony and continuity at the expense of profitability and dynamism, and leaving the economy in the control of a nomenklatura of bureaucrats, politicians and giant corporations. This isn’t news to Japanese: it was rejection of this system that prompted them in 2009 to oust the Liberal Democratic Party, or LDP, that ruled for almost 54 years.

Yet the opposition has proved little better: teetering before the disaster, the government of Prime Minister Naoto Kan may not last the month. The LDP, now in opposition, plans to launch a no-confidence vote as early as this week. Kan also faces rivalry within his own party from erstwhile reformers. With any luck, Kan will be forced out and his Democratic Party can then forge a grand coalition with the LDP and a third party.

That could allow the DPJ to revive plans for a vital, second emergency spending package for reconstruction as well as reforms necessary to sustain recovery. It might also eliminate the LDP’s opposition to legislation needed to issue bonds for financing the deficit, a predicament reminiscent of attempts by the Republican Party in the United States to suffocate its own government. The risk is the same: not default, but drastic spending cuts that could delay recovery and force the government to pay off long-term liabilities with shorter-term borrowing.

That would intensify one of Japan’s most pressing issues: trimming a government debt twice the size of the economy. Japan has promised the G20 to whittle that down. The first step is to rein in spending, in particular pension costs. Japan’s pension system worked when the population was growing, but not now that only 3 out of 4 Japanese can still work. Pension outlays consume 30 percent of the government budget.

In late June, the government is due to present a plan for fiscal reform, including an overhaul of the pension system. The plan should restore caps on benefits and co-payments by the elderly on medical bills. It should raise individual contributions above 16 percent of their income and remove exemptions for housewives that favor wealthy single-income households. Most painfully, it should admit to retirees that it cannot afford to pay them as much as promised. Benefits will inevitably have to fall.

The June plan will also include tax reform. Japan has already delayed plans to cut its corporate tax rate, among the highest in the world. Proposals for increasing government revenue include raising taxes on incomes and property, even levying a tax on bank deposits. Most debate centers on how much Japan should raise its consumption tax, now at 5 percent. Proposed targets range from the government’s 10 percent, to incremental annual increases that would push the tax rate to 25 percent — on par with Scandinavia.

Critics of raising the consumption tax consider it regressive and warn that it would hurt consumer spending, as did a hike in 1997. But that increase coincided with a region-wide financial crisis that pushed many Japanese banks and companies into insolvency. Voters have in the past punished any government that raised it; polls now show they are convinced of the need to help pay for reconstruction. If announced with enough prior warning — and linked to the Tohoku earthquake crisis — a consumption tax increase could even stimulate the economy by prompting consumers to accelerate purchases.

But Japan needs to do more than revamp spending and taxation. Again, the crisis could provide the impetus for enacting sweeping reform of the political system, corporate behavior, the labor market and immigration policy. Among the changes Japanese leaders now have an unprecedented opportunity to tackle:

  • Japan’s legislature. The Diet is absurdly large, with 722 members for 128 million citizens. Aging rural areas are over-represented relative to younger urbanites. Seats need to be reapportioned to address this imbalance and constituencies consolidated to reduce the Diet’s size.
  • Corporate governance: Companies are focused on protecting jobs rather than profits, an attitude that would be commendable if it wasn’t slowly destroying Japan’s wealth. The broadest index of Japanese stock prices has sunk 49 percent in the past five years. Regulators, including the Financial Services Authority and stock exchange, need to push companies to elect more independent, non-executive boards, which in turn need to restore the animal spirits of executives by giving them a stake in reviving profitability.
  • Labor: The hiring market needs to be made more flexible and, essentially, female, allowing greater use of part-time and contract labor. This would benefit not only employers, but provide greater choice to would-be entrepreneurs and would-be parents. Politicians are bickering over how to incentivize childbearing. One answer might be to discourage the unproductively long hours workers typically spend in Japanese offices.
  • Immigration: Japan needs to have a frank discussion about importing labor to care for its aging population. The nation’s homogeneity has undoubtedly contributed to its vaunted harmony, but a strong, modern society must be able to withstand newcomers and absorb their skills and energy. One that cannot risks becoming a museum to quaint manners and interesting customs — but ultimately endangered and irrelevant.
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