Helping Koizumi Out of the Box
Edward J. Lincoln, Senior Fellow, Foreign Policy Studies
Clyde Prestowitz, President, Economic Strategy Institute
5 April 2002
The Asian Wall Street Journal
While the eyes of the world's press and political leaders are firmly
fixed on the war on terror and the explosive situation in the Middle
East, an economic time bomb of potentially nuclear proportions is now
set for detonation in Japan unless bold preventive action is taken
soon. During his recent Asian tour, U.S. President George W. Bush
praised Japanese Prime Minister Junichiro Koizumi as the leader whose
new policies would prevent the explosion. But Mr. Koizumi, already
under fire for lack of accomplishment, promptly undermined his (and the
U.S. president's) credibility even further by unveiling a hopelessly
inadequate economic reform plan that fails to alter the steady march of
Japan's economy toward a meltdown that could take much of the global
economy with it. Even if Mr. Koizumi really wants to pursue the
necessary reforms, it is clear that the old guard of Japan's ruling
Liberal Democratic Party will not allow him to do so.
It is time for the U.S. to start thinking outside the box on Japan
policy. For starters, the Bush administration ought publicly to make
clear its loss of confidence in the LDP leadership while suggesting to
Mr. Koizumi that he might best lead by resigning and precipitating a
Such a stance would mean changing the traditional U.S. policy of
subordinating economic concerns to a priority on cooperation with the
long dominant LDP to assure Japan's support for U.S. security policies.
This approach is now badly outdated because economic and security
interests have merged. Accounting for nearly 70% of total Asian GDP,
Japan is by far the biggest buyer and investor in the region, and a
meltdown of its economy would greatly complicate the task of dealing
with North Korea and the terrorist threat in the Philippines, and might
stimulate the disintegration of Indonesia and other parts of Southeast
Asia. Beyond that, the meltdown would disrupt global financial markets
and potentially damage the U.S. economy in ways that could undermine
the conduct of the war on terrorism. But a meltdown is precisely the
situation which Japan and the world are moving towards at an
A decade of stagnation and deflation has left Japan's financial sector
saddled with $1 trillion to $2.4 trillion of bad debts that are growing
more rapidly than they can be written off. A bailout requiring enormous
public funding is inevitable at some point. At the same time, massive
deficit spending that is meant to provide a stimulus to the economy
(and pork for the LDP) has sent the national debt soaring to a
developed country high of nearly 140% of GDP without having the
intended effect of stimulating economic growth. With deflation, the
debt to GDP ratio rises automatically. Thus, if current conditions
continue, the debt ratio could double in less than a decade. Long
before then, however, it will become unsustainable.
So far, the deficits have been financed through the sale of Japanese
government bonds yielding only about 1.5%. If, like Argentina, Japan
had to sell its bonds abroad, the economy would have collapsed long ago
because foreign investors would demand much higher returns for such
risky assets. But because of its high savings rate and trade surplus,
Japan has been able to finance all the debt internally.
However, there is a limit even to what Japanese savers can provide.
Total annual Japanese savings are currently about $1.1 trillion, of
which about $800 billion are used to cover corporate and household
investment needs, leaving a maximum of $300 billion available to
finance government bond issues. With annual new JGB issues running at
about $230 billion, the Japanese government is approaching the point at
which it will not be able to sell all its bonds in Japan and will be
forced either to cut spending dramatically or to print massive amounts
of new yen. In either case, the economy will go into a severe crisis.
Of course, these calculations are subject to many variables, and no one
can predict the exact timing, but there is probably a window of one to
three years before extreme scenarios become inevitable. Exactly what
would happen is also unpredictable, but if Japan attempted to deal with
a crisis by cutting expenditure, the result could be a 1930s-style
depression that would have severe ripple effects globally.
Alternatively, running the printing presses and printing money could
easily lead to a surge of inflation that would wipe out Japanese savers
and cause a devaluation of the yen that would destabilize the rest of
Asia while cutting off the critical flow of capital that helps finance
America's huge trade deficit. Without this capital, U.S. interest rates
would soar, taking the economy back into recession.
All this can be avoided if bold action is taken in the next few years
to truly reform the system. But such action will not be taken as long
as the LDP old guard is in control because reform means destroying the
vested interests that constitute the core of the party's support.
In this situation the Bush administration's options are quite limited.
But the U.S. does play a peculiar and subtly powerful role in Japanese
politics: One lingering effect of the post-World War II military
occupation and the long years of Japanese security and economic
dependence on the U.S. is that the LDP's power rests to a significant
extent upon the perception that the party has a special relationship
Thus, by cutting the old ties and letting its doubts about the course
the old guard has set be known, the administration could help create a
new political reality that is the necessary prerequisite to economic
reform. This, of course, implies abandoning the current
administration's stance of not publicly criticizing Japanese policy,
but such a step could only enhance U.S. credibility and influence with
the Japanese man in the street who knows the LDP plans are phony and
has been wondering why the U.S. doesn't catch on.
As for Mr. Koizumi, since it is now clear that he cannot carry out
reform from within the LDP, if he truly wants reform the only
alternative is to seek a political realignment by resigning from the
party, dissolving the Japanese parliament and precipitating new
elections that would focus on the need for political as well as
economic restructuring. Because such a move dovetails neatly with
Washington's needs, the Bush administration should encourage Mr.
Koizumi to consider it seriously. But regardless of what Mr. Koizumi
does, it is essential that the U.S. government not delay reform by
acting as if he and the LDP are the only realistic choices. They are
Of course, success is not guaranteed. But the risk of a new U.S. policy on Japan is less than the risk of doing nothing.
© Copyright 2002, The Brookings Institution