Will a Rudderless Japan Drift into Crisis?

Japan Needs a Captain

The upper house election in Japan last Sunday dealt a huge blow to the ruling Democratic Party of Japan (DPJ), leaving the country with a "twisted" parliament and no clear path forward. In contrast to the previous decades of nearly uninterrupted single-party rule, the new, messier political environment is a positive sign for Japanese democracy.

But this difficult transition to a new mode of governing comes at a time when strong leadership is needed to address a possible sovereign debt crisis that could hit within five years. Ironically, the DPJ's defeat last Sunday was partly the result of Prime Minister Naoto Kan's flip-flopping over a consumption tax that was meant to help stave off any problems emanating from its exceptionally large debt-to-GDP ratio (near 200 percent). Most voters support the tax but the prime minister buckled under criticism on the issue, fostering the impression that he is simply an opportunist. The party's loss may have made prospects for reform "an uphill battle."

I had the chance to talk with people from media, politics, government, business, and academia in Japan during the week leading up to election day. Consistent with the polls, many of the people I spoke with were undecided about which party to support, and the murky election result may delay financial reforms. Rating agencies Standard & Poor's and Fitch have warned of possible credit rating downgrades due to Japan's expected political gridlock, which may hinder the country's ability to reign in its sovereign debt.

Hatoyama's Parting Gift

Yet there is good news. While the lower house election last August was a rejection of the long-ruling Liberal Democratic Party (LDP), last week's upper house election was about real issues while also serving as a referendum on the DPJ's 10 months in power. A political monopoly has been replaced by a period of what Japan expert Gerald Curtis calls political "creative destruction." One DPJ staffer told me that the current, more pluralistic public debate over policy issues was the legacy of former Prime Minister Yukio Hatoyama.

Whether or not by design, the two administrations of Kan and Hatoyama have put on the table thorny issues, including the logistical details and strategic importance of the U.S.-Japan alliance and the previously unpopular idea of a consumption tax, which led to the downfall of the Ryutaro Hashimoto administration more than ten years ago. I was told the DPJ expression for this expanded public square is "the new public."

Meanwhile, the new smaller parties actually stand for something other than an unbridled thirst for power. In particular, Your Party, analogous perhaps to American libertarians, seeks an inflation target and to shrink the government thus unleashing Japan's entrepreneurial spirit and creating jobs. Your Party did quite well, gaining ten seats. It appeals to a common frustration in Japan with government in general and is populated with stars from Tully's Coffee Japan, JP Morgan Chase, and the Ministry of Economy, Trade and Industry (METI).

The outcome is a real multi-party system. But contrary to hollow calls for a revolution last fall, this is the new reality: the slow democratic politics of compromise.

Drifting into Troubled Waters?

Nevertheless, the slowness of Japan's new politics could launch the country adrift into a debt crisis. Although 95 percent of Japanese government bonds are held by domestic investors, several factors could create risks. First, with Japan's low savings ratio and low economic growth, if its aging population starts to draw on its savings, the government may be forced to rely on foreign funders who will demand higher interest rates. Second, a deteriorating Japanese current account, due to a stronger yen or weaker global demand for Japanese products, would also reduce a source of debt funding. Reuters has quoted one analyst as predicting a current account deficit by 2016. Finally, it isn't clear whether a consumption tax would generate enough revenue or whether the tax would only dampen an already stagnant economy.

But whatever happens, five to ten years seems to be the critical time horizon. The next lower house election will take place in 2013 and by 2015 Japan is expected to shift toward external funding of its debt and will therefore face higher interest rates.

"Three to four years from now I expect a sovereign debt crisis to hit Japan and long-term interest rates to surge," former Bank of Japan board member Teizo Taya said in a May interview with Reuters. Taya also believes that the five percent foreign holdings of Japanese debt would be sufficient to trigger a crisis if there were a sell off.

One government official echoed these views when I visited Tokyo last week, saying the current account was the figure to watch. But interestingly he said that while some had hoped the election of the DPJ would have provided the "shock" to the Japanese system to bring about economic reform, the DPJ's failures over money scandals, mishandling the U.S. alliance, and the consumption tax have killed that hope. Instead, he and his colleagues are looking to a debt crisis to provide the necessary shock for economic reform. Changes could occur in Japan's tax structure (reducing corporate taxes and increasing consumption taxes over time) as well as in its industrial policy to spur growth. Can't change occur without the need for a crisis?

"The Deadlocked Japanese Economy"

Underneath the sovereign debt risk is an economy that is in irons. Just as its political system faces drift, so does Japan's economy, according to a METI report released last month.

METI minister Masayuki Naoshima puts it this way last month when he unveiled his ministry's new industrial vision: "Some people say that the Japanese economy is recovering from the economic and financial crisis triggered by the Lehman Shock the year before last. However, in reality, many Japanese people probably find no improvement in the sense of stagnation they feel in their everyday lives. They even seem unable to see any new light for the future. I believe the reason for this lies in the uncertainty about 'what will drive Japan's revenue and employment in the future.'"

Naoshima goes on to underscore the economic conundrums Japan faces: People think that Japanese people save too much, thus dampening demand, but actually the household savings ratio is one of the lowest among major economies; on the flip side, domestic consumption is stagnant since wages haven't risen in the past decade; an export-led recovery may seem appealing but Japan's export ratio is low by international standards and stagnant wages in the past 20 years call into question the country's industrial structure; specializing in high tech products would also seem logical but Japan's global market share "has rapidly declined" and low levels of profitability suggest that the business model for Japanese industries that has "caused them to lag behind the world."

In response to these challenges, government officials told me last week that the broad strategy is to globalize Japan, making its social systems, ports, and infrastructure attractive to businesses that create value and jobs. Naoshima puts it like this: "If Japan wants to save itself from decline, Japan has no other choice but to aggressively push forward with globalization. However, if Japan pursues only globalization without taking action to stop the decline in its international competitiveness as a business location, Japan will lose both domestic jobs and added value."

A major element of this strategy will be to "globalize human resources." This means the country's education system must be modified in order to create a more worldly mentality among the next generation of leaders, thus slowing the inward-looking direction or "Galapagos syndrome" as I have called it. One of the most creative proposals I heard last week is to encourage university students to study abroad by offering a ten-year income tax break to those who take advantage of the program. As these more cosmopolitan leaders enter the job market, they must find companies with a more globalized governance structure, diverse board of directors, and global business strategy, one official told me.

Japan Needs More Mavericks

It's nearly a cliché to say that in Japan, the nail that sticks out gets hammered down. Harmony and conformity are prized in big organizations. But these qualities can also lead to stagnation. Entrepreneurship requires a bit of rebelliousness.

During my trip last week, I traveled to Numazu for a day to visit one of the most innovative breweries in Japan. Baird Brewing Company is a joint partnership company that was founded in 2000, and in recent years has received much acclaim for its high quality, creative beers. I had the great fortune to meet the company's founders Bryan and Sayuri Baird, a husband and wife team. Bryan graduated from Johns Hopkins SAIS in the early 1990s and came to Tokyo to enter the corporate world but had another calling. "I didn't know much about brewing at the time but I knew how to study," he said. Using passion and determination, he founded the company with some friends. For the first few years, his beers were dismissed as too challenging. His customers were initially afraid to try something new. For the same reasons, Bryan's competitors in Japan were brewing up pale, uninspired, safe lagers. Bryan stuck to his principles and kept making a great product that emphasized Japan's proud tradition of craftsmanship (monozukuri) until his customer base caught up with him.

"The Japanese people need to overcome their fears and be the nails that stick out," Bryan told me. Bryan is an entrepreneur who embodies what Japan needs—globalized human capital creating a business that adds value and jobs. Another notable maverick who has been globalizing Japan includes Rakuten CEO Hiroshi Mikitani who is making English the official language at Japan's biggest online retailer. Fast Retailing, Nissan Motor, and Toyota Motor also are moving in the direction of adopting English at the workplace.

In politics, LDP star Taro Kono recently published a book on how he is going to revive his party. The main message is: As a nail that has stuck out in the LDP, he knows how the party can revive the economy. Japanese culture is famous for its perseverance and the country's history proves it. The country needs some major changes in order to prosper. For it to create real change, Japan needs more mavericks. And to pilot away from the rough waters, it will need a bold leader; it needs a captain.

Photo by quatro.sinko

Hatoyama's Hard Road for 2010

Thoughts from my recent trip to Japan (as well as China and Singapore) last month, re-posted from Huffington Post:

Just about four months in office, Japanese Prime Minister Yukio Hatoyama has paved an unnecessarily difficult path for himself and his Democratic Party of Japan (DPJ) for 2010 as a crucial upper house election approaches this July. As one Diet aide told me during my recent trip to Japan, Hatoyama has chosen a hard road (ibara no michi) and the most vexing policy issues seemingly as a show of personal development rather than political astuteness. A reoccurring theme I heard in Japan was that Hatoyama is not demonstrating leadership skills. As a result, support for his cabinet has dropped below 50 percent.

One example of this leadership problem has been Hatoyama's decision to try to hastily fulfill his campaign promises and his party "manifesto" rather than attempting to compromise with his country's various constituencies or stand up to coalition partners. He has thus painted himself into a corner . Ironically, as one think tank executive told me, the party's platform contained some ideas that were irrelevant to most Japanese people and some that were untested with the leaders of industry and government. This executive complained about Hatoyama's government budget public vetting process, which he likened to a Maoist charade, and the administration's soft approach toward China, which he felt embarrassed Japan's hardliners. Hatoyama's ambitious but laudable targets on carbon emissions and recent plan for economic growth were met with skepticism by the business community. Hatoyama's personal leadership skills are not matching with his high ideals .

My trip coincided with a controversial visit by the presumptive next president of China Xi Jinping with Emperor Akihito. The visit caused a stir with conservatives and the imperial family because it ignored scheduling protocol. On my way to a meeting with business executives in downtown Tokyo, I witnessed something I have never seen: Right-wing sound trucks were protesting Xi Jinping's visit by blasting messages in Mandarin rather than Japanese.

Although right-wing protests should not be considered a barometer of Japanese public sentiment, it should be noted that Japan is aging and in this way becoming more conservative. This episode also does illustrate another problematic theme of the Hatoyama administration so far: While the new government has righteously focused on helping the vulnerable in Japanese society, especially given Japan's relatively high poverty rate, it also has consistently managed to alienate powerful people in the bureaucracy, business, associations, media, and the U.S. alliance--creating what Ian Bremmer and Nouriel Roubini call a "no-party system" in which new faces in the coalition have few connections with the business elite.

Meanwhile, Hatoyama has become beholden to his coalition partners who are not after his best interests. As one executive told me, Mizuho Fukushima of the socialist party only cares about the bottom of Japanese society, while Shizuka Kamei of the People's New Party only cares about himself. Ultimately, many Japanese see Hatoyama's prime minister-ship as doomed because he is under the thumb of the DPJ's iconoclastic chief Ichiro Ozawa and is therefore unable to take real leadership.

Several people lamented Ozawa's recent direction of backroom bullying, away from his more principled past when he urged Japanese people to rely less on government and more on themselves. When he recently visited China with a Diet delegation, Ozawa bizarrely declared he was the commander of the People's Liberation Army. "The tail is wagging the dog," as Doshisha professor Noriko Hama put it in the New York Times and if Hatoyama fails to get control, the economy will backslide. The economy has already slid to its lowest level since 1991.

The DPJ's uncomfortable coalition has resulted in disagreements over the government budget and tension with the U.S. alliance. Despite campaign promises to cut waste, Kamei has urged Hatoyama to expand a government budget that is set to reach a record $1 trillion, sparking fears over Japan's debt-to-GDP ratio, which at 181 percent, is already the highest among industrialized nations. I happened to catch Kamei's mid-December press conference at the Foreign Correspondents' Club of Japan where he taunted Hatoyama and warned "so long as the CIA does not assassinate me, things will not go back to the way things were before, when Japan simply followed America's lead."

Gaffes from Japanese politicians are not unheard of but it is rare to come from cabinet members. Kamei's strategy appears to make the coalition so awkward for Hatoyama that he has to meet Kamei's demands on expanding social welfare. With a declining population and economic doldrums, the Japanese have long wondered if they were becoming a marginal player in the region or a "sick man of Asia," but with rhetoric like this cabinet's, the international image is more akin to Asia's dictatorships in Cambodia and North Korea, one executive said.

Several twists loom in the summer upper house election for Hatoyama. Most of all, electoral success will prove essential to the DPJ in regaining control of the agenda since poor results would only prolong the party's reliance on its coalition partners, making it more likely that it will continue to suffer from the perceived leadership problem. But until the election, Hatoyama must continue to accommodate his coalition partners on issues like the budget and the U.S. alliance but, in a catch-22, this accommodation is leading some voters to conclude that he is simply dithering on important issues.

Fortunately for the DPJ, its popularity remains higher than the opposition's and Hatoyama has been loosening up on his promises. But the party may calculate that its best path would be to replace Hatoyama. Speculation has already emerged over possible candidates: Deputy Prime Minster Naoto Kan is said to be a savvier politician, while younger transport minister Seiji Maehara has gained notoriety in his management of the restructuring of ailing Japan Airlines. The snag in this strategy would be that voters may conclude that the DPJ is no different from the previously-ruling Liberal Democratic Party and little change has taken place since last summer's elections after all. But if the DPJ fails, an already gloomy Japan will get gloomier. If the DPJ can't take off within four years, one of Japan's top public intellectuals Masaru Tamamoto told me, "Japan will be in a first class seat down the drain."

Photo by chez_sugi.

Expect Minor Quake (No Tsunami) From Japan's Elections

Next week's lower house national elections in Japan will likely give the inexperienced Democrats (DJP) a majority, putting an opposition party in power for only the second time since 1955. Will the expected DPJ victory really spell a "tsunami" for the U.S.-Japan relationship as some have suggested? My view is that this concern is probably overblown.

Earthquakes are a fact of life in Japan. Some generate tsunami, some don't. During my recent trip there, I experienced three significant quakes, one of which was quite dangerous. Despite a lot of anxiety about what the expected Democratic Party of Japan's victory in the lower house elections on Aug. 30 will mean for U.S.-Japan relations, I expect only a minor quake in Japan's foreign relations. The tastelessness of using the cliche "tsunami" to describe the upcoming elections aside, I would argue that there are too many factors weighing against a Japanese foreign policy moving away from the U.S. alliance in any meaningful sense.

First, political opposition in Japan, just like in most places, likes to create rhetoric in all spheres that distinguish it from the ruling party. That doesn't mean a party will follow through on its campaign or opposition rhetoric. In the United States, one only needs to recall George W. Bush's 2000 campaign promise to carry out a "humble" foreign policy if elected. Once in power, parties have to come to grips with the realities of governing--or as my colleague David Speedie calls it the limitations on options and thinking strategically.

In other words, national interest will trump political rhetoric and most Japanese see close ties with the United States as a critical national interest. The DPJ's Secretary-General Katsuya Okada recently said in an interview that U.S.-Japan relations are "extremely important for Japan's national interests. We should consider how we can make US-Japan relations, the US-Japan alliance, more fruitful."

In fact, as it looks more probable that the Democrats will win in Japan, the DPJ has moderated its critiques of the U.S.-Japan relationship. As Dan Okimoto recently said in an interview, "What I've noticed over the past several weeks is that the DPJ statements have stepped back from commitments to make immediate and far-reaching changes. They've been backtracking from the positions of ending the refueling mission in the Indian Ocean and of moving quickly out of Futenma. What the DPJ leaders appear to be seeking is a smooth, seamless transition, where bilateral issues don't get entangled with domestic reform priorities."

Which brings me to another point: The DPJ (and Japan itself) already has a full plate. At the top of the DPJ's agenda is reviewing budget priorities and eliminating waste, as well as reducing the amount of nepotism in politics and increasing the power of local governments. The DPJ also wants to give more power to politicians in making policy at the expense of the elite bureaucracy. Then there are the long term policy issues, including the aging society and pension burdens on taxpayers. These priorities alone will keep the DPJ busy. It doesn't need another battle.

Some of what we are hearing from the DPJ is a matter of emphasis and being honest about Japan's capabilities. People have long advocated for tighter U.S.-Japan economic ties and collaboration in non-military areas such as energy and the environment. "Japan's relations with the U.S. have been heavily biased toward defense," DPJ head Yukio Hatoyama recently said. "Now it's time to shift our focus to economic ties. We will strengthen our economic ties and promote free trade while protecting our national interests." And above all, the Japanese, like most people, want to feel safe in a region that still looks like a dangerous neighborhood.

The refrain I kept hearing from everyday people in Japan was this: "The DPJ will become the LDP."

What does this mean? The most obvious interpretation is that it will be business as usual; the DPJ (which in fact has former LDP members in its ranks) will adopt the same policies as the LDP. Somewhat darkly, perhaps there is a success strategy in this thinking: For the DPJ to survive as the ruling party, it may be forced to adopt some of the policies and practices of the LDP. The expectations are so low for the DPJ, meanwhile, that if it can govern without being corrupt, it will have a shot at staying in power. Conversely, the phrase may mean that that LDP as the opposition will have to move closer to the DPJ's anti-corruption and pro-social safety net rhetoric.

But if the DPJ seems to be failing, I doubt the Japanese population will have much patience. The Japanese voters love Schadenfreude, and if the party gives them something to complain about, they will. The DPJ must therefore remember that their support from the population comes as a rejection of the LDP, not an explicit endorsement of the DPJ. The DPJ would be unwise to over-interpret their mandate.

But when it comes to the foreign policy differences between the LDP and DPJ, what are we really talking about? A stronger emphasis on the non-military elements of the U.S.-Japan relationship; better relations with Japan's Asian neighbors; more active involvement with multilateral initiatives through international organizations, like the United Nations. These are precisely the types of foreign policies the Obama administration would welcome. The concern among Japanese about U.S. foreign policy stemmed from Bush's unilateral action in Iraq, trashing of international treaties, and contempt for international organizations--the very things that concerned the Obama team, too. When you look at it, the Democrats in Japan and the Democratic Party in the United States are quite aligned.

Instead of sounding the tsunami alarm, Americans should be welcoming political change in Japan as a manifestation of a real, healthy democracy. Japan, which has been held up as the shining example of democracy in Asia can now walk the walk. Small quakes are a fact of life in Japan; a political tsunami in U.S.-Japan relations would be out of character and would probably require a much more dramatic shock to spark it.

Photo by Toe Stubber

Mieko Nakabayashi: Japan Must Stop Wasting Money

(Posted Aug. 18, 2009; photos by Devin Stewart)

I just saw my old friend and former colleague Mieko Nakabayashi. She is now a bright star in the Democratic Party of Japan (DPJ) who is running to represent Kanagawa's first district in Japan's lower house in the Aug. 30 national election. In many ways, she epitomizes Japan's opposition the DPJ: She is hard-working, innovative, and conservative on budget issues.

Mieko was doing "yuudachi" (evening campaigning at subway stations, targeting people coming home from work). This aspect of Japanese elections is the core of democracy here; the candidate and her staff burst on to the public squares near commuter railway stations to make the case for their candidacy. A DPJ politician who introduced Mieko harshly criticized former prime minister Junichiro Koizumi's deceptive administration, which he said only focused on postal reform. Today is the first official day of Mieko's campaign and she is working from 6am to 9pm each day to get her message out:

True to her unique background working on budget issues at the U.S. Senate years ago, she is a blue dog (in fact, her campaign color is marine blue, a link to Yokohama's maritime culture), fiscal conservative. In line with the top pillar of the DPJ platform, her key message is, Japan must stop wasting money. It is already the most in debt rich country in the world. Like the GOP in the United States, Mieko compared Japan's budget to a household, asking passersby whether they would feel OK with running a household with such high levels of debt (to income).


Mieko said that in this election, the Japanese people will truly have a choice and that choice will allow for a thorough review of the budget. By reviewing budget priorities, Japan will be better able to afford social services like job training--a line that reminded me of the Obama campaign. While the DPJ has campaigned against graft and excess, it has been attacked by ruling party LDP for suggesting the need for new social service.

When Mieko and I worked at a Japanese think tank years ago, a common theme was the need for a competition of ideas and policies---a marketplace of ideas, in the parlance of Washington think tanks. Mieko used this kind of thinking to advocate for a real competition between political parties to bring about competitive policies for Japan. All in all, Mieko struck me as showing a lot of integrity, humility, and sincerity, resembling the colleague I knew years ago. And the people in the Yokohama suburban neighborhood seemed to embrace her as such with many people from all walks of life stopping to shake her hand and read her literature.

Given some of the alarm in Washington about the prospect of having a new party in power in Tokyo (the LDP has been in power almost consistently since 1955), I asked Mieko what her approach to the U.S. alliance would be. Not to worry (no surprise for me), for Japan, "the U.S. relationship is the most important in the world."

Campaign Secrets from Ichiro Ozawa

I am in Japan this week, and everyone is talking about the upcoming national election. What new policies will it bring? How will it alter the policy-making process? What will it mean for the U.S.-Japan alliance?

The opposition party, the Democratic Party of Japan (DPJ), is expected to win, upsetting the Liberal Democratic Party's (LDP) nearly consistent grip on power since 1955. The strategist behind a lot of the DPJ's success is Ichiro Ozawa, who was previously a member of the LDP.

The latest issue (Aug. 17, 2009) of the Asahi Shimbun Weekly (AERA) spells out Ozawa's campaign secrets. Here are his top eight pointers for winning an election:

1. Small speeches in the countryside are more effective than large ones in the city.
2. Give small speeches at least 50 times a day.
3. These small speeches should be done in 1 to 5 minute stretches around local vicinities.
4. Longer (10 to 15 minute) speeches should include two personal failure stories.
5. When you bow, you should do so properly by keeping your legs straight.
6. When you receive a business card, examine it carefully (don't simply stick it in your pocket).
7. When you visit houses, you should always go in pairs (to avoid becoming lazy) and target 200 households per day.
8. If support is strong in a town, you should campaign hard there. If the support is weak, you should campaign less hard (as it warrants).

Good luck with your campaign!

Democratic Wealth Funds?

This morning, I visited the Japan Society in NYC to listen to a talk on sovereign wealth funds with John Green of the Eurasia Group, Edwin Truman of IIE, Ann Wyman of Citigroup, and Japanese politician Kotaro Tamura (pictured left). A lot of interesting ethical issues surround sovereign wealth funds.

Some of the common questions people often ask include: how transparent are the investments made by the funds? Will the investments be made for the purpose of wealth generation or for political purposes? Is investment in strategic industries fair? If governments are undemocratic but have funds, are they investing on behalf of the people, and are those investments being made at the expense of projects that should take place in the home country? This point relates to some very interesting points that Tamura made.

Tamura is a member of the Japanese House of Councilors and of the ruling Liberal Democratic Party (LDP). He is also leading a group that is seeking to establish a sovereign wealth fund for Japan. When people think about governments investing in assets and potentially making decisions on boards, a gut reaction that it is not fair for governments to have this kind of power when they did not have a role in the entrepreneurial generation of wealth. Governments can print money, collect foreign reserves, tax its people, conduct currency interventions, and other activities. I might not think of these things as giving governments the authority to have stakes in a company. But Tamura put it a different way:

If a government is democratically elected and represents its people, it can act on behalf of its people, as Tamura put it. In Japan, an economy with some socialist characteristics (as Tamura admitted), the government could bring about positive corporate change through the investments it makes--at least in theory. Sure, Japanese society often thinks of government to provide the solution to problems and needs. But Tamura's remarks made me think about the relationship between companies and their stakeholders.

If stakeholders are broadly defined as the society in which a company operates, then in a way, the government might indeed have a role to play in pushing for positive change in corporations. It is sometimes said that if everyone owned a little part of the whole economy, then there would be more incentives for shareholders to push companies to act on behalf of society at large. Well, what if a representative government owned part of many companies? Is there a case for democratic wealth funds?