Obuchi’s Legacy Must Not Languish

The end of the Obuchi administration in Japan marks the first phase in the country’s torturously slow recovery from the recessionary 1990s. The Japanese economy is again showing signs of life. The Nikkei index has rebounded. The yen is strengthening. Wall Street sharks are bottomfeeding in the Japanese asset market. A new generation of entrepreneurs and venture capitalists has emerged in Tokyo.

But the roots of the new economy in Japan are shallow. The restructuring and deregulation of the old economy are far from complete. Massive corporate and governmental debt still threatens to swamp the recovery. Political resistance to further reform is growing.

The government of former Prime Minister Keizo Obuchi staunched the economic bleeding. His successor, Yoshiro Mori, or whoever takes the reins of power after the impending Diet elections, must step up the pace of economic change. Failure to do so will increase the likelihood that the Japanese economy will continue to muddle through.

The world can ill afford to have its second-largest economy content with anemic growth: importing less than any other major industrial nation, curtailing its investment and lending to East Asia, forcing the United States to be the global engine of growth. It’s a prescription for global economic turbulence.

The unassuming Obuchi surprised nearly everyone when he first came to power in 1998. Discounted as a caretaker prime minister, he thrived in the job. He pushed through a long-delayed bank bail out. Overcoming the opposition of the Finance Ministry, he pumped a record amount of public money into the economy and was rewarded with a boomlet.

But Obuchi’s honeymoon was short-lived. His nascent reforms threatened entrenched interests, eroding support for his ruling Liberal Democratic Party (LDP). By late last year, facing the approaching Diet election, Obuchi began to drag his feet, postponing crucial banking and accounting reforms.

Nevertheless, Obuchi leaves the next prime minister a promising foundation to build on. Strong economic growth is expected to be reported for the first three months of this year. Dynamic start-up companies, like Softbank, have fueled the stock-market recovery. Tokyo’s “big bang” has led to previously unimaginable consolidation among banks and insurance companies and major foreign investment in the securities houses. Cross shareholding and keiretsu business relationships that typified the old, closed nature of the Japanese economy are eroding. Renault has acquired Nissan, and DaimlerChrysler has bought a controlling interest in Mitsubishi Motors. Deregulation has become a government mantra. And a new business mentality, marked by unprecedented risk taking, promises of new labor-market flexibility and surprising attention to share-holder value, have begun to emerge.

But much remains to be done. Japan’s economy has performed worse for longer than any other major industrial nation’s in the last half century. The only substantial economic expansion in the last decade has come after massive doses of public spending, with recovery petering out every time the tap was turned off. Such fiscal profligacy cannot continue. Government debt is now 130% of GDP, a peacetime level previously associated with only Italy among major nations. Servicing that debt will soon become a drag on growth. Much of the bank debt Obuchi eliminated from the private sector’s books has simply been transferred to the government’s ledgers. Insurance companies and pension funds have even larger unfunded liabilities.

Meaningful economic restructuring has barely begun. Excess capacity still plagues steel, autos and other basic industries. The current 4.9% unemployment rate is only half that experienced by other major industrial countries that have gone through significant recessions. This failure to shed workers seems a humane alternative to heartless U.S. layoff practices. But it traps many younger employees in dead-end jobs in dying industries.

Japan’s economic transformation, while significant compared with its past, is dwarfed by the changes going on in other parts of the world. Japanese mergers and acquisitions are rising, but they are still a fraction of those that occur each year in Britain or the United States. Foreign direct investment in Japan exceeded $12 billion in 1999, an impressive tripling of foreign interest in Japan in a single year. But Mexico, with an economy one-tenth Japan’s size, received more than $10 billion in foreign investment during the same period.

One should have no illusions about Japan’s motivations in finally allowing foreigners to buy into its economy. Tokyo is engaged in a forced sale of depressed assets. The true test of Japan’s embrace of deeper integration with the global economy will be whether foreign investors are able to grow these crippled companies back to health and, in doing so, expand market share and diversify their holdings.

None of these problems are going to be tackled until after the Diet election, which could be as early as June 4. Economic policy in Tokyo will drift until the country’s leadership is sorted out.

Unfortunately, policy paralysis could get worse, not better, after the balloting. More than half the current LDP members of the Diet belongs to an anti-reform caucus and can be expected to oppose more restructuring and deregulation. Moreover, before Obuchi’s stroke, public opinion polls showed the party losing up to two-dozen seats from its Diet majority. Such an undermining of its power could make a new LDP government dependent on its coalition partner, New Komeito, a religious party that draws much of its support from small shopkeepers who feel threatened by further economic restructuring.

After years of indifference, the Clinton administration and the next president must refocus U.S. attention on Japan, supporting, prodding and even threatening the next Japanese government to not settle for an underperforming economy. The greatest tribute to Obuchi would be to ensure that his economic legacy is not squandered.