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Abe’s Moment of Truth

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Published in the Financial Times 14/7/2014

Prime Minister Shinzo Abe’s project to revitalize Japan is entering a dangerous phase. Three key elements – his reflationary economic policy, his security strategy and his personal popularity – are coming under scrutiny at the same time.

The stakes are high. If Mr. Abe gets his priorities wrong, his term in office may come to be viewed as a brief interlude in the long saga of Japanese decline. But if he plays his cards well, he could be remembered as a Margaret Thatcher-style transformational leader. His track record would include not just the conquest of deflation, but the emergence of a confident and outward-looking Japan actively engaged in the region.

Mr. Abe’s immediate problem is the plunge in the high levels of public support which had bullet-proofed him against critics and rivals. The gap between his approval and disapproval ratings has shrunk from 30% at the start of the year to just 8%. If the trend continues, he can expect emboldened opposition on all fronts, from the deflationists associated with the Bank of Japan’s ancien régime to farmers hostile to the Trans Pacific Partnership free trade agreement.

The trigger was the public’s unease with the Abe administration’s recourse to the familiar, but shabby device of “re-interpreting” Japan’s pacifist constitution in order to green-light some types of overseas military commitment. China’s burst of territorial aggrandizement has created a clear and present need for a counter-balancing force in the region. The optimum solution is reform of the constitution, but that would take time. Not wanting to dilly-dally, Team Abe took a short-cut and is paying the political price.

Mr. Abe has recovered from blips in the polls before, but this time the economic background is less favourable. Officials sweet-talked him into raising the sales tax this April and the predictable result has been a loss of momentum in the consumer economy. Worse, he has been cornered into making an early decision on a second hike, to take place next spring, which would increase the squeeze on household purchasing power.

Meanwhile, the rise in inflationary expectations, a notable achievement of Mr. Abe’s first year in office, is not as secure as it looks. US-style “core” inflation for the Tokyo area was effectively zero in June. Tokyo University’s daily price index, based on real time data from the cash registers of the nation’s supermarkets, suggests there has been little progress since last autumn.

Mr. Abe’s overriding priority should be to boost the reflationary impetus. His political capital depends on it and his ability to transform Japan’s security arrangements depends on his political capital.

To that end he should delay further VAT hikes until nominal GDP growth has reached 3% for two years in a row. Corporate tax breaks should be aimed not at promoting capital spending, but at releasing companies’ vast cash holdings to shareholders and employees. Likewise there should be no backsliding from the BoJ’s target of 2% inflation in two years from April 2013 and no balking at a second round of quantitative easing, this time focussed on risk assets.

Reconfiguring Japan’s security and diplomatic profile is sensible, indeed essential. Amidst the geopolitical jockeying for advantage that is likely to be a feature of the East Asian region for decades to come, Japan’s constitution with its famous war-renouncing Article 9 and barriers to alliance-building is not fit for twenty first century purpose.

Ultimately, though, such fundamental matters have to be subject to public assent. In 2007, Mr. Abe’s first administration laid out a process for constitutional revision, comprising referendum and parliamentary approval. Pledging to set the ball rolling within five years would defuse the issue and, as with UK Prime Minister David Cameron’s promise of a referendum on EU membership, likely prove appealing to the public.

It would also be a signal of the robust health of Japanese democracy. Japan’s first constitution was put together in 1889 by a cabal of oligarchs who had taken power in what amounted to a coup d’état. The second was imposed by the US on a defeated nation. If Mr. Abe were to offer citizens a decisive say in their own system of governance, it would be for the first time since Emperor Jimmu, the legendary founder of Japan, came ashore in the 7th century B. C.

But Mr. Abe has to get the sequencing right. When economic recovery is in the bag, stocks well into a multi-year bull run and the streets a-buzz with the feel good factor, then and only then will the auguries be favourable for the epoch-defining work of constitutional reform.