For Japan’s Shinzo Abe, the Tough Work Is Just Starting

In wake of election victory, prime minister aims to tackle structural issues that have bedeviled his predecessors.

Japan Prime Minister Shinzo Abe News Conference

Shinzo Abe, Japan’s prime minister and president of the Liberal Democratic Party (LDP), attends a news conference following a victory in the upper house elections at the LDP headquarters in Tokyo, Japan, on Monday, July 22, 2013. Abe’s ruling coalition faces the challenge of maintaining unity and public support after cementing control of both houses of parliament on a platform of economic revival. Photographer: Koichi Kamoshida/Bloomberg *** Local Caption *** Shinzo Abe

Koichi Kamoshida/Bloomberg

In his first seven months in power, Shinzo Abe has done more to change Japan and shake it out of its long deflationary slump than any prime minister has in years. But the hardest steps are still to come after Abe’s governing coalition won control of the upper house of parliament in late July.

Since taking office in December following a sweeping victory in lower house elections, Abe has invigorated the economy more than anyone was expecting with a 13.7 trillion yen ($140 billion) dose of fiscal stimulus and a massive round of monetary stimulus, the latter orchestrated by his hand-picked Bank of Japan chief, Haruhiko Kuroda. These two policy “arrows,” as Abe calls them (using archery symbolism that is deeply embedded in Japanese tradition) have sent the yen into an export-boosting dive, given a lift to corporate profits, ignited a surge in the Tokyo stock market and stimulated household consumption and confidence.

Now, Abe is embarking on the third, and most difficult, arrow of his strategy: structural reform. It is an issue that has bedeviled his predecessors over more than two decades of economic stagnation. Can this once-sickly scion of a pedigreed Japanese political family succeed where others have failed and reestablish Japan as a leading power in Asia, restoring its economic and diplomatic status vis-a-vis China? Or will he implode and fall back on narrow nationalism, as some fear?

“So far, Abenomics has been about spending money that you don’t have and creating more money than the economy can absorb, which result in an aggressive devaluation of the yen to export deflation,” says Kenneth Courtis, an economist and longtime Japan-watcher who formerly was a vice president at Goldman Sachs (Asia). “But the markets have now pretty much cottoned on to that story,” he tells Institutional Investor . “So Abe must now deliver on substantial structural reforms to release long-term domestic demand and to engage in serious fiscal reform. Otherwise the credibility which has been gained in the last few months will quickly dissipate.”

Abe finds himself in the position of someone playing Snakes and Ladders, whose first few throws of the dice have propelled him close to winning the game. From here on, however, he must climb the ladders one strenuous rung at a time while avoiding the snakes that are waiting to send him sliding back down again.

That Abe has gotten this far is no small surprise. He first became prime minister in 2007 but lasted less than a year in office, with no notable achievements to speak of, before succumbing to a stress-induced illness and resigning.

This time, Japan’s comeback kid has had better luck. The then-governing Democratic Party of Japan was self-destructing last December because of internal dissension over a proposed consumption tax hike when Abe led his Liberal Democratic Party to a landslide victory in lower-house elections.

Abe has also made his own luck. He surrounded himself with a brain trust including special economic adviser Koichi Hamada, a former Yale University professor, and Heizo Takenaka, a former banking reform czar and postal-privatization architect, that hammered out the government’s three-pronged growth strategy.

Abenomics, as the strategy is known, was marketed not so much as a set of economic principles as a kind of magical antidote to all of Japan’s economic ills. The first two doses, of massive fiscal and monetary stimulus, have invigorated the economy, which grew at an annual rate of 3.5 percent in the first quarter. The stock market soared, and although it has retracted some gains over the past two months, it remains up 60 percent since Abe first announced his economic strategy. Small wonder then that Abe’s LDP and its coalition partner, New Komeito, won a majority in the upper house of parliament in the July 21 election, giving Abe more control over the levers of power than any prime minister has had in decades.

Yet the much-heralded “third arrow” of Abenomics has not streaked across the firmament with anything like the impact of the first two. When the prime minister outlined his plans for structural reform in June, many analysts expressed disappointment with its vagueness and questioned its ambition; it seemed all too similar to countless other growth plans that previous governments had announced over the past two decades, all of which have faded with little trace. The plan lacked the specificity of the government’s earlier moves, which included setting a real annual growth target of 2 to 3 percent and having the Bank of Japan set a 2 percent inflation target.

The New Growth Strategy, as Abe calls it, has multiple objectives: liberalizing domestic markets by easing competition rules; restructuring industry by fostering consolidation and letting zombie companies go bust; freeing up the labor market by ending Japan’s system of lifetime employment and making it easier for companies to hire and fire; and restructuring the agricultural sector to emphasize food processing and exports.

Many of these ideas have been floated before as part of previous revitalization plans. What is different now is the government’s clout, with control of both houses of parliament and Abe’s deep personal involvement at the center of debate and action.

Nowhere is this more apparent than with the Trans-Pacific Partnership, or TPP, a trade and investment pact currently under negotiation among a dozen Asia-Pacific nations including Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the U.S. and Vietnam. Abe has taken a reluctant, if not exactly kicking and screaming, Japan into the negotiations.

By opening up the country’s agricultural markets and reforming medical services to admit foreign participation, TPP membership will “Americanize” Japan, says Ichiro Ozawa, a veteran politician whose defection from the Democratic Party of Japan helped seal its demise last year. Ozawa’s new party, Kokumin no Seikatsu ga Daiichi or “People’s Livelihoods First,” opposes the trade negotiations. Still, an early result of the new trade openness is expected to come soon when Japan’s state-owned postal conglomerate begins marketing cancer-insurance products from the U.S. insurer Aflac.

The TPP provides cover for Abe. In the past, reforms and liberalization initiatives have often been easier to achieve when presented as being in response to outside pressure or “gaiatsu,” similar to the way that Japan opened up to U.S. Navy commodore Matthew Perry in the mid-19th century. Once the foot is in the door, it is easier to open it wider.

Success is not likely to come easily to Abe. His extended honeymoon with the Japanese electorate shows signs of fading. A Kyodo poll published at the end of July showed a surprise drop in the popularity of the Cabinet. One possible reason is the government’s plan to go ahead with the scheduled hike in Japan’s consumption tax, or sales tax; it is due to go from the current 5 percent to 8 percent next April, and then to 10 percent in October 2015. But as political analysts point out, Abe has three years before the next national election is due. That is truly a long time in politics.

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