Koizumi’s Challenges: Deflation, Crime, Debt and Bureaucracy

It is a new era in Japanese politics. Junichiro Koizumi was elected president of Japan’s Liberal Democratic Party, or LDP, and with that victory, he became the new prime minister. He ran a courageous campaign that broke ranks with the party bosses who have dominated Parliament for nearly 50 years through a system of privilege and patronage.

In Koizumi’s first address to Parliament, he reaffirmed his promise of change by calling for reform “without being afraid of pain, being daunted by those who have vested interests and being hampered by previous experiences”--the kind of straight talk that is needed but not usually found among rank-and-file politicians in Japan.

Now more than ever, Japan needs a leader with Koizumi’s vision and new policies. The yakuza , Japan’s gangster contingent, is the third rail of the country’s politics, using bribery, manipulation and physical intimidation to get its way. The country is plagued by political corruption, an impotent economy and a banking system that is estimated to have more than $1 trillion in bad or dubious debt on its books. And the government, which is controlled by Koizumi’s own party, has managed to incur debt equal to 120% of gross domestic product--the highest ratio ever in the industrialized world.

These are no small concerns and will require all of Koizumi’s political ability and charisma. What follows is a list of economic and structural reforms that are dramatic but necessary medicine and will go a long way toward restoring Japan’s stature and credibility on the world scene.

* Halt deflation. The Bank of Japan must be persuaded to end its devastating deflationary policies, which have decreased the value of real estate and financial assets. It can do this by dramatically easing its monetary policy and injecting a significant amount of money into the economy. The central bank’s adherence to its old deflationary program only throttles economic activity, damages profits and stifles entrepreneurial instincts.

Defeating deflation won’t be easy. Koizumi’s predecessors tried to implement these same tactics with not a minor amount of resistance from the central bank. The bank has recently signaled that it will only entertain easing monetary policy if Koizumi also puts forth the effort to clean up the dilapidated banking sector and government corruption. These are important tasks that should be accomplished for their own sake as much as for the purpose of appeasing the central bank.

* Clean up corruption and government regulation. Political corruption and unsavory power brokers are endemic. The gangsters harass elected officials, manipulate the media and funnel dirty money into political campaigns. The legal authorities and even the judges are hardly a deterrent as they are often either in the pocket of the Japanese mob or fall victim to its coercion.

There are no easy answers, but Koizumi has already made a difference. In his ascendancy to prime minister, he challenged the status quo and refused to succumb to the entrenched power brokers. Now he must hew to his principles and begin cleaning out the government from top to bottom.

Eliminating anti-competitive regulations that subsidize politically connected industries and prosecuting the corruption in government will aid Japan’s efficient multinational companies and weaken the power of the gangsters. The Japanese bureaucrats who control many of the large industries in the country--including telecommunications, energy and rural construction--are no match for the skill and acumen of the market in predicting trends or employing innovative solutions. The rules in place now make it almost impossible for multinational companies to forge deals with foreign entities. Also, the government maintains tight control over prices and retail distribution, and government-supported industries are propped up by market-distorting, protective regulations.

Ultimately, legitimate and productive economic interests need to replace the societal parasites of corruption and regulation that hinder progress and economic prosperity.

* Write down bad loans. When the Japanese stock market collapsed in 1990, the banks were left with more than $516 billion in bad loans. Today, it is estimated that the troubled loans held by banks and credit unions amount to $1.25 trillion. As a result, the banks have been unable to act as financial intermediaries, and businesses do not have the investment dollars to expand production, hire workers, invest in innovation and grow the economy. To confront this burgeoning crisis, Koizumi should implement policies whereby the banks realistically and, with all deliberate speed, write down bad loans.

The Financial Services Agency, which is charged with overseeing this process, must be given the power and support necessary to do the job right. In addition, Koizumi should force recalcitrant bank bosses from their jobs. They are too close to the companies that own the bad debt, and they are the ones who got Japan into this mess to begin with.

Let’s be clear. Writing down bad loans over a couple of years will mean that a flood of bankruptcies and job losses will follow, particularly among the LDP’s core constituencies in the construction and retail industries. However, as painful as this process will be, it is certainly better than the alternative of refinancing these lemon loans, which allow inefficient businesses to continue to drag down the economy.

* Cut taxes. Along with the assistance from the central bank, Koizumi can help guide the country through the quagmire of its growing debt and sluggish economic performance by enacting fiscal policy that will sustain higher growth. Two years ago, Parliament did enact a Reaganesque tax cut of $79.6 billion, including a 20% reduction in income tax and significant cuts in the residential tax and effective corporate tax rate. It was a good start, but it did not go far enough and was derailed by deflation.

Koizumi will need to rein in his predecessors’ wasteful government works programs and lower taxes on capital formation. Doing so will help restructure the anachronistic domestic economy, fuel productivity, diversify investment and spur entrepreneurship. Once the multinational corporations and globally competitive industries in Japan rise above the inefficient and corrupt construction and agricultural industries, the Japanese people will be raised up with them.

Unfortunately, many of these solutions are politically unappealing, making them difficult to enact or see through to completion. A July election in the upper house of Parliament will give Koizumi’s opponents every incentive to frustrate his efforts and create gridlock for their own gain.

However, great leaders emerge in the face of adversity and seemingly insurmountable odds. Today, Koizumi has the opportunity to become one of Japan’s truly great leaders.