Global Economics

Japan: New Leader, Little Change


With a recession looming, will Fukuda's surprise resignation set the stage for economic reform, or will it be more of the same?

Yasuo Fukuda's surprise resignation was perhaps the most interesting thing about his 11-month stint as Japan's Prime Minister. A lot like the tenure of his predecessor, Shinzo Abe, who quit suddenly after barely a year in charge last September citing ill health, Fukuda's short-lived reign was characterized by a weakening economy, stumbling stock prices, and political deadlock. And Fukuda's response to reporters' questions following his resignation announcement highlighted the extent to which he, like Abe before him, lacked the common touch (BusinessWeek.com, 9/1/08).

At a time when Japan is edging toward its first recession in six years, will a new face make much of a difference? While the painful days of the "lost decade"—the period after the collapse of the Japanese bubble economy in 1989—are long gone, Japan could do with a jolt. Workers' confidence in the economy, which shrank 0.6% in the last quarter, is at an eight-year low according to government figures, and Japan came in last out of 23 countries in a recent international survey of employee ambition by British firm FDS International. Inflation, at 2.4%, is touching 10-year highs and wages are failing to keep pace.

The short-term prognosis is for more of the same. The hot favorite to succeed Fukuda is ruling Liberal Democratic Party Secretary-General Taro Aso. An internal LDP election will take place later this month. "I would not deny that I am fit for [the post]," Aso told reporters after Fukuda quit. At 67, four years younger than Fukuda, Aso isn't exactly a fresh face. Like Fukuda, he is a very experienced LDP campaigner whose previous roles include Minister of Foreign Affairs and a host of other cabinet posts.

Less Fiscally Conservative

Certainly Aso is more colorful than Fukuda. A Roman Catholic known for his love of manga animation, Aso represented Japan in clay pigeon shooting in the 1976 Summer Olympics in Montreal. He's also an LDP scion: Just as Abe's grandfather and Fukuda's father were former prime ministers, Aso's grandfather Shigeru Yoshida had two stints after the second World War. His wife's father was also prime minister, while his sister is married to the first cousin of the emperor.

A hawk on foreign policy matters, Aso is seen being more pro-growth and less fiscally conservative than Fukuda; that is leading to speculation he will favor tax cuts and increases in pork barrel spending. But Tokyo watchers say it's unlikely Aso would veer too much from plans already laid out by Abe and Fukuda. One reason, as Fukuda found to his cost, is that the opposition Democratic Party of Japan controls the Upper House and can block contentious legislation. Another is that the competing factions within the LDP will make it difficult for Aso to take bold steps without first gaining broad approval. "The policy impact of the new prime minister will be relatively limited," noted Richard Jerram, chief economist at Macquarie Securities, in a note to clients.

That also means foreign investors, who have by and large shunned Japanese stocks since former Prime Minister Junichiro Koizumi stepped down in 2006, are unlikely to take too much comfort from an Aso premiership. "Aso is not Koizumi's heir in terms of economic policy," says Jesper Koll, chief executive officer of Tantallon Research Japan. "He is not openly advocating more deregulation or small government—his affinity to Koizumi comes from, well, patriotism."

Poor Communicators

That could prove problematic for Japan's ties with China, a relationship that had improved (BusinessWeek.com, 5/5/08) under Fukuda. Aso has often made hawkish statements and makes regular visits to the controversial Yasukuni Shrine. The Shinto shrine in Tokyo contains bodies of Japanese war dead, including 14 Class-A war criminals from World War II. For China's leaders, Koizumi's visits to Yasukuni were a major obstacle to improving Sino-Japanese relations.

Perhaps a bigger challenge, though, is how to make the Japanese political scene more relevant. Analysts point out that even popular politicians hold far less sway over the economy than they once did. "The market once reacted to Koizumi's reform drive but since then it has been decoupled from politics," says Seiichi Suzuki, market analyst at Tokai Tokyo Securities. These days, Japanese companies make more money overseas than they do in Japan and as a result are more heavily affected by overseas events. It also doesn't help that Abe and Fukuda were poor communicators, both quitting with approval ratings under 30%.

Investors initially reacted positively to Fukuda's quitting with the Nikkei 225 Index edging up in morning trading despite the increased political uncertainty. But by the 3 p.m. market close it had fallen 1.8%, to a five-month low.

The Best Outcome

Masaaki Kanno, chief economist at JP Morgan (JPM) in Tokyo, says Fukuda's decision to step down is unlikely to have a lasting impact, although there could be some benefit from having a new leader at the helm. "Fukuda failed to send any message about reform or economic policies," Kanno says. If that changes with the next prime minister, even with similar policies, "It could be a positive from an economic policy viewpoint."

Kanno adds that it would take a general election, which many pundits expect to take place in early 2009, to usher in a significant change. One scenario is that an election victory by the opposition Democratic Party of Japan, which has many former LDP members, would spur a huge realignment of Japanese politics with the DPJ and LDP replaced by two parties, one pro-reform and one anti-reform. Then, Japanese people would have the opportunity to choose which direction the country should go. "Ideally, both the LDP and DPJ will break up. That's the best outcome I can think of," he says.


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