What if Toyko Never Changes?

Psychologists are fond of joking that some people never change, they just become more like themselves. What if the same holds true for some societies?

That is the inescapable question following last Tuesday’s meeting in New York City between President Bill Clinton and Japanese Prime Minister Keizo Obuchi. The United States, once again, pressed for restructuring of Japan’s nongrowing economy and crippled financial system. Japan said it would do what it could. Then Clinton seemed to let the Japanese off the hook when he said that Japan can only do what is “politically possible.”

True enough, but that simply won’t do. Mired in recession, after years of stagnant growth, with the yen and the Nikkei index periodically teetering on the edge of free fall, Japan has repeatedly demonstrated that it will not alter its course no matter how loud the demands that it do so or ominous the consequences of inaction. It is time the Clinton administration acknowledge this painful reality and move to protect the United States from Japan’s economic and political dithering.

Tokyo’s track record in the last few years demonstrates its unwillingness to do what is necessary to get the Japanese economy growing again. Huge, headline-making economic-stimulus packages have masked the fact that the government eventually delivered only about one-third of what it had promised. Moreover, Japan’s economic medicine is weak in comparison with that administered by other major industrial nations facing similar downturns. In each of seven attempts to jump-start its economy in the 1990s, Tokyo has spent, on average, an amount equal to less than 1% of the country’s gross domestic product. Over the last 30 years, stimulus packages in Europe and the United States have averaged nearly 2% of GDP.

Additionally, Japanese banks may be carrying up to a trillion dollars in bad debts on their books. Various bailout schemes have not worked, largely because they were designed to protect existing bank management and owners, who enjoy close ties to the ruling Liberal Democratic Party. As long as the Obuchi government resists nationalizing the failing banks, traditional banking practices such as cross shareholding and loans to sister companies lacking sufficient collateral will continue, with disastrous results.

In short, Japan has remained the world’s most closed industrial economy despite unremitting pressure from the United States to liberalize. Manufactured imports account for only 4% of the Japanese economy, half of what the United States imports. Direct foreign investment in the Japanese economy is equal to less than one-half of 1%, of the economy, compared with more than 7% in the United States and 13% in Europe.

The failure to embrace change is not limited to the economic realm. Despite the LDP’s weakness in the recent upper-house elections, the long-predicted emergence of a two-party system has yet to materialize. Much-touted electoral reform failed to deliver one-man, one-vote, which enables rural interests to continue to dominate policy debates. The old guard of the LDP clings to power. Elected officials have failed to step into the decision-making vacuum created by recent scandals involving the vaunted bureaucracy.

As a result, factional fighting within the LDP has repeatedly delayed and watered down fiscal-stimulus efforts. Plans to restructure the banking system are held hostage to opposition-party hopes for a lower-house election. A cut in the consumption tax, the best way to jump-start consumer spending, is blocked by LDP disputes.

Until Tokyo justifies a more hopeful conclusion, Washington must alter its policy toward Japan in ways that protect Americans from a potential global financial meltdown precipitated by Japanese inaction. Admittedly, such a course will be dangerous (attempts to economically isolate Japan in the 1930s sparked Japanese nationalism), difficult (there is no sure way to isolate the world’s second-largest economy) and costly (the United States benefits from trade with Japan). Which is all the more reason to keep the pressure on Japan. The difference now, because so much is at stake, is that Washington must not shy away from applying unprecedented pressure. These efforts should be expressly designed to safeguard U.S. interests if Japan remains intransigent.

For example, the Asian financial crisis has stimulated widespread talk of controlling international capital flows. More and more economists believe that the absence of such controls exacerbated the ills of the emerging economies. Washington should make it clear to Tokyo that Japan will be the first target of such action. The Federal Reserve already has asked Japanese banks to report on their activities in the United States more frequently. Fed chairman Alan Greenspan should use the information to limit U.S. banks’ exposure to the weakest Japanese financial institutions. In so doing, he would merely be following the Europeans’ lead. The European Bank for Reconstruction and Development recently announced it may cut lines of credit to some Japanese commercial banks.

At the same time, Clinton should call for a U.S.-Japan-China meeting in November, when he will be traveling in Asia. This would let Japan know that Washington and Beijing plan to work together to contain the Asian crisis, with or without Japan. These and other similarly tough initiatives might convince Tokyo that its head-in-the-sand behavior is unacceptable in a global economy and that stasis is not an option.

True, exerting such pressure may trigger the very market collapse the world is trying to avoid. Leveraging Tokyo will take a surgeon’s skill and a poker player’s nerve. But any debate over tactics should not lose sight of Japan’s record of inaction, which is already impeding recovery efforts. The Clinton administration must recognize that the greater risk is to become a passive victim of Japan’s failure to change.*