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Political Volatility Returns to Japan

November 16, 2017

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Among Prime Minister Shinzo Abe’s many accomplishments in the nearly five years since he returned to power in December 2012, perhaps none is as remarkable as his stabilization of Japan’s political system.

Abe’s return came after a period in which Japan was led by six prime ministers in six years (including Abe’s tumultuous first premiership in 2006-2007). His long-ruling Liberal Democratic Party (LDP) was decisively driven from power by the Democratic Party of Japan (DPJ) in 2009, leading to a three-year interregnum characterized by foreign and domestic crises that was capped off by the devastation of the Tohoku region by an earthquake and tsunami, and the subsequent Fukushima nuclear disaster. During this period, new parties rose and fell with bewildering regularity, growing out of internal fissures in the major parties. Political volatility took its toll on policymaking, and Japan looked increasingly adrift, especially in the aftermath of the global financial crisis.

While Abe came to power pledging to address specific crises – rising tensions with China, economic stagnation, and the slow progress of reconstruction in Tohoku – he was also determined to exercise stable leadership. He succeeded mightily, deploying the institutional powers of the prime minister’s office to their fullest extent to articulate policy and control the bureaucracy, taming the factional infighting that had long hindered LDP prime ministers, and taking advantage of unified control of the Diet and a supermajority in the House of Representatives to manage the legislative process. The LDP, meanwhile, was the center of what came to be called the “one large, many small” party system, facing an opposition DPJ that had shrunk in stature, and was unable to regain the support of voters. With firm control of the political system, Abe was able to advance Abenomics and pursue more assertive foreign and defense policies, even withstanding occasional public backlash to his policies.

At the start of 2017, it seemed as if this situation could continue indefinitely. Abe began the year with approval ratings near their peak, at roughly sixty percent. In recognition of his leadership, at its annual convention in March 2017, the LDP formally changed its rules to allow its leaders to serve for three, three-year terms, instead of two. This rule change would allow the prime minister to seek a third term as party leader when his term ends in September 2018. If successful, he would serve as prime minister through 2021, surpassing his great-uncle, Eisaku Sato, as Japan’s longest-serving postwar prime minister. Few doubted that, after leading the LDP to four straight national electoral victories, Abe would be easily confirmed for a third term.

What happened instead, was the return of the political volatility that Abe seemed to have banished. Even as the LDP opened the door for a third term, the prime minister was hit with allegations that he had used his office to benefit friends and associates, including a steeply discounted land sale to a school with links to the prime minister and First Lady, Akie Abe, and allegations that senior officials pressured bureaucrats to approve a veterinary school license for a private school operator headed by a longtime friend of the prime minister’s. While in neither case was there definitive proof that Abe was aware of the activities of his subordinates, the impression of influence-peddling eroded public trust in the prime minister.

As a result, Abe’s approval ratings –the self-reinforcing foundation for a government that prided itself on its stability – plummeted, his net approval swinging from nearly +30 percent to -15 percent. Tarnished by the prime minister’s scandals, the LDP suffered a catastrophic defeat in Tokyo’s metropolitan assembly elections on July 2, 2017, in which Tokyo Governor (and former LDP parliamentarian) Yuriko Koike cemented her status as a potential threat to LDP dominance with help from the local chapter of the centrist Komeito party, the LDP’s coalition partner in the national government. Prominent LDP members, including not only one-time Abe cabinet member-turned-leading Abe critic, Shigeru Ishiba, but also Abe’s longtime foreign minister, Fumio Kishida, critiqued the prime minister’s policies and talked openly about their ambitions to lead the LDP. Polls showed that majorities opposed Abe’s serving for a third term, and that nearly 70 percent of voters thought Abe’s government was “arrogant.”

But there was still worse to come. Buoyed by recovering approval ratings in August and September, thanks in part due to public anxieties regarding the intensifying North Korean crisis, and facing an increasingly rudderless Democratic Party (DP), Abe decided to dissolve the Diet’s House of Representatives and call a general election for 22 October. This maneuver backfired almost immediately: the same day that Abe formally announced that he would call an election, Koike, who had been flirting with creating a national party, announced that not only would she back a new party called the Party of Hope, but she would personally lead it, while continuing to serve as Tokyo’s governor. Days later, Seiji Maehara, who had struggled to assert control of the DP since his election as party leader on 1 September, announced that the DP would effectively dissolve itself to join the Party of Hope. Instead of going into a general election facing a disorganized opposition, it appeared that the LDP would face an increasingly unified opposition led by a popular, experienced politician, drawing from the populist playbook that earlier politicians had used to win major electoral victories.

As it happened, Abe’s gamble paid off: Koike’s Party of Hope fizzled and actually finished behind a second DP splinter party, the Constitutional Democratic party of Japan (CDPJ), leading to her resignation as Hope’s leader and seemingly ending her national ambitions. The LDP and Komeito retained their supermajority in the House of Representatives, even as Komeito lost several seats, strengthening the LDP’s hand within the coalition. Abe, meanwhile, has gone from facing the dysfunctional Democratic Party to facing three opposition parties – Hope, the CDPJ, and the rump DP – struggling to find their footing. Having led the LDP to a fifth straight national election victory and smashed the opposition, Abe will be able to silence the nascent anti-Abe movement in the LDP and will likely clear a path to a third term as LDP president.

Tough Decisions

But while the snap election was a personal victory for Abe, the prime minister still faces a year of full of difficult choices for Japan’s economy and foreign policy. While Abe may be stronger than before the general election, the scandals that eroded public trust in his leadership have continued to linger after the election; Japan’s Board of Audit, for example, found in November that there was no justification for the discounted land sale that led to the first allegations of influence peddling. Meanwhile, although the DP has splintered, the CDPJ, which surprisingly finished second in the October election, is more popular than the Democrats were at any point since losing power in 2012.

The upshot is that 2018 will therefore be a pivotal year for Abe, Abenomics, and Japan. Even if he secures his third term as LDP leader in September 2018 and stays on as prime minister until 2021, decisions made in 2018 will strongly shape Abe’s legacy.

Reviving Abenomics

When Abe announced on 25 September that he would dissolve the House of Representatives and call a general election, he touted the progress Japan’s economy had made since he returned to power in December 2012 due to Abenomics, his eponymous economic program. Japan’s GDP has grown for seven consecutive quarters, the first time it has done so in 16 years. Unemployment has fallen and has stayed just under 3 percent for months. The labor market is the tightest it has been in more than four decades, and new school graduates have ample employment opportunities. As a result, part-time workers have enjoyed considerable wage increases. Abe might also have added that the stock market is at its highest levels in more than twenty years; the yen has shed much of its strength and could weaken further depending on what the Federal Reserve does; Japan has seen record numbers of tourists; and Japan’s companies have continued to enjoy record profits.

And yet despite this positive record – which was of course an important part of Abe and the LDP’s pitch in the general election campaign – in calling the snap election, Abe cited two crises as underscoring the need for an election. One was North Korea’s burgeoning arsenal of nuclear weapons and ballistic missiles, for which Abe sought a mandate to “advance robust diplomacy upon gaining the public’s trust through this election.” The other, however, was Japan’s “rapidly progressing aging society and falling birthrate,” for which Abe would seek a mandate to deliver a “productivity revolution” and “human resources development revolution” that would mitigate the impact of the demographic challenges.

By citing the demographic crisis as the reason for calling a snap election, Abe signaled that despite a positive outlook for short-term growth, Abe and Abenomics have failed to achieve their cardinal objective, sustainable growth over the medium to long term. While some progress has been made advancing the three main solutions to Japan’s demographic issues – boosting productivity, bringing new workers into the labor force to offset the decline of the working age population, and spurring long-term population growth through pro-natalist policies and immigration – many of these policy victories have been incomplete. Much of what the Abe government will do between now and the end of Abe’s time in office will be to try to make headway on these fundamental, difficult challenges.

As noted previously, the Abe government’s main priorities going forward will be “two revolutions,” a productivity revolution and a human capital development revolution. The former refers to a new initiative to use tax incentives, fiscal spending, and regulatory reforms to encourage businesses – including small and medium-sized enterprises – to invest in labor-saving advanced technologies (robots, AI, the internet-of-things, Big Data) to boost productivity and wages. The latter refers to a new initiative that would provide universal early childhood education from 3 to 5, subsidize higher education for low-income households, and invest more in workers who provided nursing care for the elderly. Both of these initiatives, however, are still under consideration, so it is unclear what form they will ultimately take or whether they will succeed where earlier initiatives did not.

This new approach has provided more clarity regarding the overall trajectory of Abenomics, especially in fiscal policy. Whereas in the early years of his tenure, Abe sought to strike a balance between growth-friendly policies and fiscal consolidation – despite a mantra of “no fiscal consolidation without growth” – over time Abenomics has increasingly been less committed to fiscal consolidation, with little interest on the part of the prime minister to use his political capital to make significant spending cuts or tax increases. As was the case with the BOJ, this shift has, at least in part, been the result of a political struggle, as Abe has struggled against the finance ministry and fiscal hawks in the LDP to create space for more spending. The sharp recession that followed the first phase of that plan, the increase from 5 percent to 8 percent in April 2014, significantly undermined the progress that had been made in combating deflation, but it also gave Abe ammunition for delaying the second tax hike that was initially scheduled for October 2015 first in November 2014, and then again in June 2016, when he pushed the hike back to October 2019 and indicated that his government would introduce another infrastructure-heavy stimulus package reminiscent of the stimulus package introduced in early 2013. The general election, meanwhile, has ratified a plan to divert a portion of the projected revenues from the October 2019 tax hike from debt reduction to investment in education through free universal early childhood education and higher education aid for lower-income households. The upshot of this proposal is to eliminate once and for all the possibility of achieving the government’s goal of producing a primary fiscal surplus by FY2020, which will force the government to draft a new medium-term fiscal plan in 2018. As this proposal suggests, growth-friendly fiscal policy has won out over fiscal consolidation, notwithstanding reforms to drug pricing and other policies to seek greater efficiency in public spending. Abe’s attempts to modify the fiscal target – he has increasingly discussed stable reduction of the debt-GDP ratio as a fiscal target – suggests that his government will make little meaningful progress in reducing the numerator in that equation, the size of the debt itself, even if higher tax revenues and savings from lower interest rates on government bonds enable the government to avoid significant increases to the deficit.

At the same time, monetary policy and the fight against deflation appear to be lower priorities for the Abe government. From the birth of Abenomics, breaking free of deflation was central to the Abe government’s project for revitalizing the Japanese economy. The Abe government has systematically remade the Bank of Japan (BOJ) since 2013, starting with the appointment of Haruhiko Kuroda and Kikuo Iwata as governor and deputy governor in 2013, and continuing with the replacement of outgoing policy board members leftover from the pre-Abenomics BOJ, with new board members committed to reflationary policies. As of July 2017, the BOJ’s policy board has now been appointed entirely by Abe, theoretically giving Kuroda unanimous support.

But despite Kuroda’s – and Abe’s – control of the BOJ leadership, both men must increasingly reckon with a monetary policy dilemma. The fundamental problem is that despite the BOJ’s easing policies, it has repeatedly delayed the timeline for achieving its 2 percent inflation target. Inflation remains barely positive, and market-based inflation expectations suggest that prices could dip again. With robust growth despite low inflation, the bank has been forced to consider whether it is worth retaining its 2 percent target and the policies it has introduced in order to achieve it. The question of how long the BOJ should persist with its easing policies in the face of stubbornly low inflation or disinflation is even more pressing considering that the BOJ already holds more than 40 percent of outstanding Japanese government debt. Critics warn that the bank could run out of bonds to purchase as soon as the second half of 2018. The BOJ could have little choice but to adjust its purchases or its inflation target, with potentially harmful effects on interest rates and financial markets more broadly.

The impending end of Kuroda’s term in April 2018 has led to wider debate over what the BOJ has accomplished and whether it should begin considering its exit from monetary easing. Kuroda himself has acknowledged the “side effects” of his easing policies, feeding speculation about policy change. But while the debate over Kuroda’s legacy and whether he deserves a second term as BOJ governor will occupy considerable attention, the BOJ’s fight against deflation is no longer the priority for the Abe government that it once was. Abe may continue to support Kuroda’s leadership and his easing programs, but the government appears less fixated on 2 percent inflation than on its broader growth agenda.

Changing Japan’s Constitution

However, as important as Abe’s decisions about the economic policy agenda are, one issue could have outsized influence over whether the government’s economic policies advance: constitutional revision. In May 2017, Abe not only pledged that he would revise the constitution by 2020, but said he would push for a change to Article 9 – the constitution’s “peace clause” – that would clarify the constitutional status of Japan’s Self-Defense Forces (SDF). Revision has been Abe’s primary goal throughout his career, and achieving it would seal his legacy. This pledge, however, was seemingly abandoned when Abe’s approval ratings fell.

Another consequence of the LDP’s electoral victory has been to revive the revision process. While Abe has entrusted the work of drafting and submitting amendments to his party, it is still his decision whether to prioritize revision in 2018. Prioritizing revision means directing his attention to a tremendously complicated issue that requires securing two-thirds majorities in both houses of the Diet and winning the support of a majority in a national referendum. In seventy years, the constitution has never been revised and many Japanese feel a strong attachment to Article 9 in particular as a symbol of Japan’s pacifist identity. The prime minister has said that he wants the Diet to approve amendments by mid-2018, with a referendum following in late 2018 or early 2019.

If Abe forges ahead with constitutional revision, it could mean further delays to his economic agenda, could foster divisions within the LDP and between the LDP and Komeito, and could prompt a public backlash against Abe that could lead to a defeat in a referendum, a defeat that would be difficult for Abe to survive. Given the stakes, it is by no means guaranteed that Abe and the LDP will push revision forward on an accelerated timetable. But given Abe’s commitment to changing the constitution – and a political calendar beyond 2018 that could make it impossible for Abe to realize revision during his tenure – it is still likely that he will try. The uncertainty surrounding revision, and the potential for contentious battles inside the Diet and among the public at large, is the single greatest source of uncertainty in Japanese politics.

Foreign and Security Policy Leadership

Despite this uncertainty, however, it is unlikely to affect Japan’s embrace of a regional and global leadership role in advancing global economic integration over the long term. Faced with a U.S. president inclined towards protectionism, Abe has been an unabashed supporter of global free trade and his government’s pursuit of new agreements has had as much to do with upholding the liberal trading system as with improving market access for Japanese companies. Embracing this role is not without challenges for Tokyo, which has often been fiercely protective of its home market in trade negotiations, and now finds itself trying to convince reluctant trading partners to open their markets and embrace higher-quality rules for trade and investment. Nevertheless, Japan’s willingness to assume the mantle of leadership on free trade looks to be an enduring shift, one that will likely survive Abe’s tenure. The result has been Japan’s shepherding of the revision of the Trans-Pacific Partnership (TPP) to reflect the absence of the U.S., an effort that missed its target of completion by early November, but appears to be nearing its conclusion. It has also reflected Japan’s eagerness to finalize a bilateral agreement with the European Union, which was initially concluded in July 2017 but still faces some final hurdles.

The impact of domestic uncertainty on Japan’s management of the North Korea crisis could also be limited. For the foreseeable future, Abe and his cabinet ministers will be preoccupied with ensuring that the U.S. and Japan work closely together on security issues. The prospect of North Korea’s using the threat of an intercontinental ballistic missile attack on the continental U.S. to drive a wedge between the U.S. and Japan – reminiscent of cold war-era concerns about “decoupling” – will lead the Abe administration repeatedly to seek reassurance from Washington that the security relationship is sound and the U.S. nuclear “umbrella” intact. The same concerns will lead Japan to strengthen its missile defense capabilities, including through the purchase and deployment of the Aegis Ashore missile defense system. While Japan’s defense ministry could receive its record-high $5.25bn request for defense spending in 2018, defense spending would still be only roughly 1 percent of GDP, and would therefore not signal a significant quantitative increase in Japan’s capabilities. The government may be tempted to consider developing autonomous strike capabilities that would enable Japan to retaliate for attacks on its territory. Were Japan to pursue new strike capabilities, it would mark a significant step away from Japan’s longtime defensive security posture. But if the LDP moves ahead with constitutional revision, it is unlikely that the Abe government would also move to acquire these capabilities in the near term; with the public divided on their merits, a move to acquire strike capabilities could negatively impact the outlook for revision.

Would Be Successors

Given these challenges, we should expect to see a broader debate regarding what post-Abe Japan should look like. The aspirants to the LDP’s leadership – Ishiba, Kishida, newly-appointed Internal Affairs Minister Seiko Noda, and others – have already begun grappling with the legacies and unfinished work of Abenomics and articulating their own visions for Japan’s economy. Whoever succeeds Abe will have to reckon with the risks inherent in the BOJ’s stimulus program; have to decide whether deficit reduction through tax increases and spending cuts is achievable in the near term; and whether there are reforms that have not yet been tried that could raise Japan’s potential growth and offset the impact of its shrinking population. To the extent that these debates will all intensify in 2018, it will be the year that post-Abe Japan truly comes into focus. Even if Abe recovers and seeks a third term, it is likely that not only will he face a serious challenge in the party election, but he will increasingly have to defend his government’s policies from criticism from a reinvigorated opposition.

The views and opinions in these articles are solely of the authors and do not necessarily reflect those of Teneo. They are offered to stimulate thought and discussion and not as legal, financial, accounting, tax or other professional advice or counsel.

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