Tokyo’s Fiscal Dithering

Junichiro Koizumi, Japan’s prime minister, was a firebrand on the campaign trail, promising a radical overhaul of the creaky Japanese economic system. But lately he’s been backtracking. Koizumi is letting the yen plunge in value--at around 132 to the dollar it has lost more than at any other time since 1971--and is talking about using public funds to prop up the banking system. Both developments are bad for Japan, its neighbors and the United States.

Permitting the yen to depreciate has been Japan’s tried-and-true formula for avoiding reform. A lower yen means that Japanese exports become cheaper and imports more expensive. This allows Japan to sell more goods abroad while avoiding opening up its closed system to the U.S. and others. The result is that the banking and industrial cartels that run Japan are not challenged by market forces from abroad. But the economic situation has deteriorated so much that it’s unlikely that a fall in the yen would be enough to revive the economy. Instead, it could drag down China and South Korea. Their currencies will lose value and their economies will suffer as it becomes more difficult for them to export to Japan. China has already demanded that Tokyo “take responsibility” and move to stabilize Asian economies.

As difficult as it may be to imagine, the Japanese economy, which has been mired in recession, is getting even worse. The most recent industrial production figures showed a 13.1% drop, the biggest since 1975. Retail sales are down 2.7%, and orders for construction projects fell 6.9% over the past year.

Cleaning house is the first step to reviving the economy. Banks have to admit to the bad loans they made to industry, and obsolete and redundant businesses need to be shut down. Despite all the bad news, lethargy rules.

It would take great boldness and stamina to overcome the inertia and entrenched interests in the bureaucracy and the Liberal Democratic Party, which don’t want any change. Functionaries cling to a discredited system that allows them to control the economy and dole out patronage.

Koizumi looks increasingly ineffectual. Washington needs to at least reiterate that there is no substitute for real reform.