[paper] From Koizumi-Magic To Koizumi-Nomics

Jesper Koll: Chief Economist of Merrill Lynch Japan Securities

Graduated from Johns Hopkins University. Held positions in the J.P.Morgan and Tiger Management L.L.C. before taking up present position. Publications include Nihon Keizai korekara Ougonkihe.

Good News - A Long Period of Political Stability

Prime Minister Junichiro Koizumi is off to a good start. The strong Upper House election results raise the odds that Japan will now get something it has not had in a long time - a period of political stability. The fact that Japan had nine prime ministers in the past ten years is as good an indication of Japan's deep-rooted problems as, for example, the decline in the stock market or the increase in unemployment. Frequent leadership change is always an indication of national weakness and desperation. It breeds distrust in government and the rule of law. Above all, it breeds uncertainty amongst business leaders, entrepreneurs and consumers.

Now, the Liberal Democratic Party's victory is founded on the immense popularity of its leader. No doubt this may fade in coming months, just as the public embrace of a new, hot movie star or cartoon character may quickly turn from hot to cold. However, Mr. Koizumi is now in a strong position, strong enough to become the first PM since Yasuhiro Nakasone's rule in the mid-1980s to stay in power for more than just a couple of years. This raises the hope that public trust in the policy making process may start to increase.

The key challenge for Mr. Koizumi is not the possible threat to his leadership from within the LDP. No doubt the conservative and anti-reform wing will always exist. But in Japanese politics - like everywhere - nothing succeeds like success. Mr. Koizumi delivers what no other LDP president has delivered in a long-time: prospects of a steady grip on power and a new-found pride in being a member of the party.

There is not a single man or woman in the LDP who does not agree with Mr. Koizumi's central rallying point. The ruling elite has recognized that Japan is in danger of becoming a second- or third-rate power if it continues its old ways. Any rational analysis makes this risk appear very large. The fiscal debt dynamics, the demographic decline, and the challenge posed to Japan by the emergence of China in the world economy suggest as much. The most important dynamic in Japanese politics today, however, is that Mr. Koizumi is the man who has successfully turned this fear of national decline into a political force. His message is simple at the core - the LDP can either be the leader to respond to the national challenge to fend-off decline, or be thrown into the dustbin of history. And if there is one thing the LDP understands better than any other political party on earth, it is the Machiavellian will to stay in power. Indeed, perhaps the biggest worry is that Koizumi-Magic stays unchallenged from the opposition parties for too long. How long will it take before the opposition parties are united and can counter the mass-appeal and erotic attraction of Koizumi-Magic with a man or a woman of their own? Can opposition party leadership capture the imagination, the dreams of the Japanese people?

From Kozumi-Magic Toward Koizumi-Nomics

The real challenge for Mr. Koizumi is on the economic policy front. The leader of the second-largest economy on earth must now turn his political mandate into a forward-looking and transparent economic strategy. If this is then followed by consistent execution, he will quickly gain the trust of business leaders, entrepreneurs and bankers. Failure to show economic policy leadership could quickly push Japan back toward the brink of an economic crisis. It is now or never to turn Koizumi-magic into Koizumi-nomics.

The key to Koizumi-nomics is the purchasing power of the Japanese people. Just as his political power is based on the support of the people, not the smoky backrooms of LDP factions, Mr. Koizumi's strongest economic ally is the Japanese public. The success or failure of his economic policies will be determined by primarily one factor - whether he will be able to raise the purchasing power of the people. In history, he will be judged not by whether he succeeds in limiting next years JGB bond financing to Y30 trillion but by whether his policies bring democracy to Japan's economy just as he brings people power to the Japanese political process. Like Ronald Reagan or Margaret Thatcher before him, Koizumi's economic policies rise and fall with the success of supply-side economics.

Raising the Purchasing Power of the People - A More Aggressive Deregulation Drive Is Needed

The great supply-side leaders - Thatcher and Reagan - were fully aware of the immediate deflationary impact of their policies. Supply-side policies - less government intervention and more focus on private sector initiatives - are always deflationary in the first instance. This is because the weaker, inefficient companies will be forced out of business as competition increases. To counter the initial deflationary pull, traditional supply-siders implement large-scale tax cuts. This directly raises the purchasing power of the people. Here, Japan has limited options due to the record-high budget deficit. Personally, I think a cut in corporate taxes from the current 40% to 30% should be implemented to raise Japan's competitive position. However, Koizumi does have one other, potentially much more effective policy tool available.

To raise the purchasing power of the people Koizumi-nomics must break up the economic and business cartels that still directly and indirectly dominate Japan's economy and business culture. One of the first items on the agenda should be a deregulation drive focused on the large de facto public monopolies. On an economic level, this move would effectively offer quasi-tax cuts through deregulation, while cutting down the monopoly profits of these players. Japanese consumers spent about 2.5% of total annual consumption expenditures on telecommunications bills, for fixed lines, mobile phones and Internet access charges. A government mandate to cut access charges by 30% would free up about 0.7% of the consumption expenditures for the purchase of other services or goods from the free economy.

Another excellent candidate for indirect tax cuts - indirect because they come from cuts in government regulated prices, not tax rates - are the de facto utility monopolies. Consumers in the urban area spent about 5% of annual expenditures on paying utility bills for water, gas and electricity. A government-mandated price cut of 10% would boost free-market consumer demand by perhaps as much as 0.5%. While we don't know the exact economics of utility price cuts°› how much of the cost savings would actually be saved, how much will be used for more utility consumption are more use of telephones - this should not be a concern for a national leader. Moreover, the economists argument that this will not raise aggregate consumption is also irrelevant. The point is an executive decision to re-distribute national welfare away from de-facto government monopolies to the free-market economy.

The central question facing Japan's economy in the autumn of 2001 is "how to raise demand for free-market goods and services consumption." Raising the purchasing power of the people through more aggressive deregulation and price cuts of the de facto public monopolies of the telecommunications and utilities industries is the most direct and most efficient way to do so. Watch the autumn policy proposals for concrete steps to free purchasing power of the people by more aggressive government price cuts and deregulation policies.

New Profit Opportunities for Japanese Banks

On the banking and financial policy side, the much-publicized debate about non-performing loans and assets of the banks is distracting from the real focus. On banks, Koizumi-nomics is actually following a similar policy to the "purchasing power of the people " one. Since Mr. Koizumi assumed power three months ago, he has pushed hard for the privatization of the Housing and Loan Corporation. This mammoth organization is the mainstay of Japan's financial socialism machine, the postal savings, and fiscal investment and loans program.

Funded by postal savings deposits, the public Housing and Loan Corporation offers below-market rate mortgages. Its market share is about one-third of all mortgages. Deregulation here would immediately trigger "crowding in " - lucrative business and profit chances for Japanese banks. Because the mortgage markets offer very solid profit margins for banks, top banking analysts estimate Mr. Koizumi's deregulation policy may add as much as 15% to the operating profitability of Japanese banks.

As such, Mr. Koizumi's policy offers concrete new business and profit opportunities for banks. This is clearly more important than the never-ending debate about problem assets. If the PM's Housing and Loan Corporation privatization plans get turned into law this autumn, Japan's bankers may finally be dealing with a forward-looking policy.

No Large-scale Supplementary Budget

Another way of judging Koizumi-nomic is by focusing on what must not be done. In the past, any recession was quickly countered with a large-scale supplementary budget. Mr. Koizumi will not follow that route, as a supplementary budget would actually cut the purchasing power of the people. Already, Japan's past fondness of Keynesian remedies has pushed up the deficit to 130% of GDP. The cost of this is born by the Japanese people. Mr. Koizumi's stated policy is to cap next year's new government bond financing to \30trn ($244bn), equivalent to about \2,000 per Japanese household per day. The money buys you a set lunch for two people in Tokyo's expensive financial district, and about three lunches in the cheaper local areas where real people live and work.

There can be no question that eventually the repayment of next year's government debt will cut the purchasing power of the people. Moreover, unlike the price of the set lunch, the price of public debt is unlikely to come down in the future because interest rates are already super low. Mr. Koizumi's economic policy is focused on this, fully aware that added public deficits will do nothing but cut the purchasing power of the people. Of course, technically a small supplementary budget of about \2-3trn will become necessary this autumn. That much is needed to fund the cyclical tax revenue short-fall likely this year. But another large-scale spending program would be a very negative signal.

Mr. Koizumi's mentor, former PM Nakasone, once coined the phrase "In Japanese politics, three inches ahead there is nothing but darkness." There is no doubt that many challenges remain ahead for Mr. Koizumi, both politically and policy-wise. But overall, chances are good that his economic policies are starting off in the right direction. If Koizumi-nomics focuses on raising the purchasing power of the Japanese people through deregulation and privatization, then Japan's economy is poised for good things.