Published in Financial Times 5/12/2012
No sooner has a new leader been appointed in China, than Japan faces change at the top too. When it comes to the transition of power – as in so much else – the gulf between the two Asian behemoths is as wide as the East China Sea.
In recent weeks the world has been transfixed by the carefully choreographed ascension of Xi Jinping, the new president of China. If all goes according to plan, Mr. Xi will remain at the helm until 2022.
In Japan Prime Minister Yoshihiko Noda has just called a general election that the ruling Democratic Party of Japan is almost certain to lose. Mr. Noda will have been in power for fourteen months – lengthy by the standards of recent Japanese prime ministers, of whom there have been seven since Hu Jintao took office in 2003.
The impression of Japanese political disarray is reinforced by the fact Mr. Noda’s successor will likely be Shinzo Abe, the leader of the Liberal Democratic Party. Mr. Abe already had a brief stint in the job five years ago. Japan’s political scene has been compared to a karaoke session in which everyone gets a turn at the mike. Even so, it is rare for anyone to be called back for an encore.
At first sight Mr. Xi seems in the more enviable position. He does not have to worry about elections and he heads up an authoritarian government that has overseen decades of turbo-charged growth. Mr. Abe , by contrast, will be confronted by a fractured political landscape and a stagnant economy in which once great names like Sharp and Panasonic are haemorrhaging red ink and jobs.
In reality, though, the balance of opportunity is probably the other way round. Mr. Xi is faced by a new set of problems – a much lower growth trajectory and massive structural corruption – that may well be beyond his power to solve.
In contrast Mr. Abe could drive significant changes relatively quickly. He has started well, positioning himself as the candidate of growth and reflation. Already he has called for an inflation target of 2-3%, and “unlimited easing” a la Bernanke. Some such dramatic change in policy settings is absolutely required if Japan is to break out of the self-reinforcing cycle of deflationary expectations.
He has also proposed an increase in infrastructure and military spending, both sensible suggestions. Twenty percent of Japan’s bridges are over fifty years old, and the country’s vulnerability to natural disaster mandates an upgrading. Likewise an enhanced military capability is the natural response to China’s increasingly aggressive posture.
Mr. Abe has given a qualified assent to the Trans Pacific Partnership, a US-inspired free trade compact that includes many Asian and Pacific countries, but not China. Given the LDP’s traditional links with the farm lobby, this is a bold move. It is unlikely to work, politically or economically, unless Japan exits deflation and returns to growth.
The Abe package looks coherent and attractive. But can he bring it to fruition? Many other Japanese leaders – including Mr. Abe himself first time round – have talked a good game, but failed to make headway against the opposition of Japan’s highly conservative bureaucracy.
The financial mandarins managed to convince the hapless Mr. Noda to raise the consumption tax in a deflating economy on the grounds that “Japan might become the next Greece.” The reality is that Japan has net overseas assets equivalent to fifty percent of GDP and has long been rated by the bond market – as opposed to the rating agencies – as the best credit on the planet.
Likewise, the Bank of Japan remains locked in self-justificatory inertia. As long ago as 1998, Milton Friedman blamed Japan’s economic problems on “a decade of inept monetary policy” and warned against the fallacy of “identifying easy money with low interest rates.”
The tightness of Japanese monetary policy is demonstrated by the ever-rising yen, which has reinforced deflation and exacerbated the competitiveness problems of Japan’s manufacturers. Mr. Abe is moving in the right direction. Shaking up the BoJ is crucial to shaking Japan out of what Friedman presciently termed “an eerie if less dramatic replay” of the US in the 1930s.
Already Mr. Abe’s words have knocked back the yen a welcome few percent. If he manages to walk the talk this time, there could be much more to come – including an end to Japan’s long bear market in equities and even longer bull market in government bonds.
Japan’s political choices should also be read in the context of a shifting and complex Asian geopolitical framework. The DPJ took power in 2009 eager to distinguish itself from the outgoing LDP, which during its fifty year near-monopoly of government had made the US relationship the centrepiece of both economic and foreign policy.
The DPJ’s two founders were cut from a different cloth from your standard Japanese politician. Naoto Kan came from a background of social activism. Yukio Hatoyama, an erratic centrist known as “the extra-terrestrial” , talked grandly of an Asian version of the EU with no American presence.
Together, they made the strengthening of ties with booming China a key element in DPJ foreign policy. In the aftermath of the global financial crisis, their approach struck a chord in the boardrooms of growth-starved corporate Japan too.
That was then. This is now. The spat between Japan and China over the Senkaku/Diaoyu islands is a symbol of increasing tension and rivalry between the two regional powers. Neither Japan’s public nor its policy-makers are likely to forget China’s threats to Japanese sovereignty over Okinawa, the Red Guard-style slogans calling for extermination of the Japanese enemy, or China’s recourse to economic blackmail in embargoing the export of rare earths.
The new dynamics in China are driven by long-term factors that are unlikely to be reversed. Generational change in the communist party and the military has spawned a strident assertion of national might in place of the Deng-inspired emphasis on China’s “peaceful rise.” Meanwhile, a slowing economy means more risk of social instability and a greater need for diversionary jingoism.
More fundamentally, China’s interests have changed as its industry has become increasingly reliant on resources imported from distant parts of the world. It is unlikely to draw back from the goal of creating a powerful blue water navy, and its neighbours are equally unlikely to view that prospect with equanimity.
From Japan’s point of view, the economic game has changed too. China remains an important trading partner, but its attractions as a near-limitless source of cheap labour have faded. Even if Beijing defies the odds and manages a seamless transition to a consumer-driven economy, profit margins are likely to be squeezed as the labour share of national income rises. China’s sweet spot has gone for good.
The US’s well-flagged “pivot to Asia” is an attempt to contain what could otherwise be a vortex of turbulence. By 2020, the US navy will have 60% of its resources deployed on the West Coast and in the Asia-Pacific area. Australia has agreed to host a US marine base in Darwin and long-distance drone flights may be launched from Australian soil. Meanwhile Myanmar, one of China’s only two allies (the other being North Korea), appears to be moving rapidly to the Western camp.
Amidst all this activity, the position of Japan is absolutely, well, pivotal. From the US point of view a wealthy, confident and committed ally is a vital asset in what it is likely to be a long drawn out strategic game. Encouraging Japanese reflation should be an American strategic goal.
Tough-minded former prime minister Yasuhiro Nakasone – whose mutually beneficial relationship with Ronald Reagan was known as the “Ron’n Yasu show” – had little time for the DPJ’s founding duo. “They are like soft ice-cream which melts away in the summer heat,” he proclaimed. With the geopolitical mercury on the rise, it comes as no surprise that the Japanese public prefers something crunchier. Washington probably feels the same way.
Mr. Abe is definitely up for it. In a recent interview with the Wall Street Journal, he stated “I think it is extremely important to show to the people in Japan, in Asia and the world that Japan and the US have fully regained our trusting relationship.”
If Mr. Abe manages to handle these challenges – seeing off the deflationists at the Bank of Japan, shifting away from self-defeating fiscal austerity and engaging with the US in a manner that secures Japan’s long-term strategic interests – he will deservedly earn a long spell at the microphone.