A Collapse That Could Have an Economic Domino Effect : Japan: The shattering of the Miyazawa government reverberates worldwide, just a month before the G-7 summit.

After four decades of steady and stable government, Japan today is adrift. The once powerful Liberal Democratic Party is shattered. The collapse of the Miyazawa government opens a period of instability that creates the risk of pervasive paralysis at the very moment that Japan faces three important policy issues.

First, the economy. The just-released results for the first quarter indicate that the economy scraped bottom and turned upward smartly. The rebound had gross domestic product ahead at an annual rate of 2.8%. Over the first three months of the year, growth came from a strong rebound in consumer spending, particularly for big-ticket items like cars, and continuing robust public-sector investment. In contrast, corporate-sector spending continued to lag.

For the reversal to be sustained, consumer and corporate confidence must be strengthened. Over the past three months, however, the surging yen has drained growth from the economy, which raises new questions for the course ahead.

Thus the collapse of the government in Tokyo could not have come at a worse time, for it will work to weaken confidence when what is required is strong policy leadership to confirm the recovery. In particular, any new measures to support the economy must wait at least until after the formation of a new government in the autumn.

Second, next month’s G-7 summit in Tokyo. A condition for a successful summit is a successful conclusion to the difficult economic negotiations between the United States and Japan. Adroit and forceful political leadership on both sides will be required to do a deal, but negotiators have made little progress to date and only two more meetings are scheduled before the summit. With the collapse of Japan’s government and the Clinton Administration very much on the run, the required political leadership is simply not there. As much of Europe slides deeper into deflation and the North American economy continues to experience great difficulty, Japan’s G-7 partners have been looking to Tokyo for direction. Now, that will not be forthcoming, and as pressures build, risk will increase in markets everywhere.

Third, the conclusion of the GATT Uruguay round. Negotiations have begun to accelerate in all areas where agreement is still outstanding. The most important of these are agriculture, market access, intellectual property and financial services. Decisions from Tokyo are critical in all four areas. Japan’s proposal to slash tariffs and an accord on financial services that emerged from recent U.S.-Japan meetings in Washington are important steps. The key issue on which Japan has made no movement is agriculture.

Although the main conflict on agriculture pits the United States against France and the Common Market, Japan’s inability to move will allow others to hold back. There cannot be a successful conclusion to the Uruguay round without an accord on agriculture, the critical area in which the rich countries must make concessions to win agreement from the Third World on the other three issues.

The dynamics of this situation can only accelerate the move to regionalism. Thus the collapse of Japan’s government will lead to increased economic difficulties, not just for Japan, but also for the world.