Will Japan’s New Prime Minister Start a Debt Crisis?

History tells us that Abe's archaic slate of policies won’t solve what ails Japan

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It’s back to the future for Japanese politics. The Liberal Democratic Party (LDP) crushed its rivals with an ally to gain a supermajority in the lower house of the Diet, the national parliament, which means the party’s president, Shinzo Abe, will become the nation’s next Prime Minister. This would be a repeat performance for Abe, who had a less-than-stellar stint in the Prime Minister’s job from 2006 to ’07. His term was distinguished by his miserable approval ratings and scandals among members of his Cabinet, leading to his sudden resignation in September 2007. But in the weird and wacky world of Japanese politics, such issues as competency don’t seem to matter much. Abe will get a chance to redeem himself.

Can he? Looking at his policy statements, the odds don’t look good. If Abe is a blast from the past, so are his economic policies. The agenda he has forwarded during the campaign promises a return to the days of frivolous government spending and easy money — policies that have already proved unable to extricate Japan from 20 years of economic malaise. And this time around, the damage could be severe. Abe, if he follows through on his promises, could seriously weaken Japan’s already fragile financial position.

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In simple terms, Abe’s plan is to flood the economy with cash, either from government coffers or the Bank of Japan (BOJ), to boost growth. The LDP advocates a plan to lavish a staggering $2.4 trillion on public-works programs over the next decade — a gargantuan stimulus equivalent to 40% of the country’s GDP. And where will Abe find the money to pay for all of that construction? The government itself, already posting huge deficits, doesn’t have the resources. So Abe figures he can extract the cash from the supposedly independent Bank of Japan. Here’s Abe’s position from a campaign speech (reported in the Wall Street Journal):

To protect people’s lives and keep our children safe, we must implement public-works spending and do so proudly. If possible, I’d like to see the Bank of Japan purchase all of the construction bonds that we need to issue to cover the cost. That would also forcefully circulate money in the market. That would be positive for the economy, too.

Abe later moderated his stance, saying the central bank would buy these construction-financing bonds on the open market, not directly from the government. But either way, Abe has loudly called for greater action from the BOJ to stimulate the economy. He has said he favors “unlimited” easing by the BOJ to fight deflation. The LDP party platform calls for closer cooperation between the BOJ and the government on economic policy. All of this spending and easing will also achieve another policy priority of Abe’s — weakening the yen to give a helping hand to Japanese exporters.

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Will any of these ideas work? Perhaps Abe can give the economy a short-term jolt. But history tells us that this archaic slate of policies won’t solve what ails Japan. The LDP has tried again and again to repair the economy through construction spending, while the BOJ has repeatedly engaged in easy money strategies. None of this has worked. Japan has entered yet another recession this year. And there is no reason to believe Abe’s strategy will succeed this time around. Japan is a textbook case of the limits of monetary policy to repair economies. Despite repeated bond-buying programs and periods of zero-interest rates by the BOJ, the economy is no closer to an end to its lost decades. Nor can fiscal policy achieve much more. Japan is already the official home of the bridge to nowhere and the empty airport — more construction spending will simply be wasteful.

It could also be lethal. More debt-financed state largesse will only further weaken Japan’s shaky finances. Japan’s debt burden is already the heaviest in the industrialized world. The IMF expects Japan’s government debt to reach a dizzying 237% of GDP this year, on its way to 250% by 2017. (Compare that with 171% for Greece, 91% for Spain and 107% for the U.S.) The pressure Abe has put on the BOJ has raised fears that he plans to use it as an ATM for government programs, which would undermine the central bank’s credibility.

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By now there is widespread agreement that the only route Japan can take out of its economic mess is structural reform. That would include reducing bureaucratic meddling in the economy, deregulating domestic markets to boost efficiency and bring down costs, encouraging entrepreneurship, and integrating more with a rapidly growing Asia. Will the LDP pursue any of these more fundamental reforms? The early signs are not good. Though Abe has made some positive noise about joining the negotiations to form the Trans-Pacific Partnership, a U.S.-backed free-trade agreement, the LDP platform rejects the idea. Even more, his cash-pumping strategy would likely reduce the pressure, at least in the short term, to push through politically difficult market-opening measures. An editorial in the Japan Times called out Abe’s policies for what they really are: a dodge:

Mr. Abe appears to be obsessed with the idea that monetary policy will solve most of the major problems the Japanese economy is facing. But that will not be the case. He should realize the simple fact that appropriate government action combined with proper monetary policy by the central bank is needed to solve the economic problems Japan is facing…Concentrating on applying pressure on the BOJ as Mr. Abe is doing is nothing but an abdication of political responsibility.

Where will Abe lead Japan? In almost any other country, I’d say a debt crisis. Yet Japan is fortunate enough to have such a giant pool of savings that its government doesn’t have to rely on foreign money to finance its deficits (like Greece does). Most Japanese government bonds are in the hands of locals. As long as the Japanese are willing to employ their hard-earned savings to support their bloated government, then Japan may avoid the dire consequences of Abe’s actions.

But that doesn’t mean Japan will be indefinitely immune to the forces of economic gravity. By threatening both the independence of the central bank and the nation’s already fragile financial position, Abe could whittle away what shreds of confidence remain in the Japanese economy, both at home and abroad. Since Japan is still the world’s third largest economy (behind the U.S. and China), what Abe does can have global consequences. We can only hope his next term turns out better than his last.

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