As expected, the LDP and its allies have won again in the Japanese general election. Also, as expected, the LDP lost some seats, but managed to keep an overall majority in its own right with a larger advantage when in continuing coalition.
With 261 LDP seats and 32 Komeito seats in a 465-seat parliament, the government should be able to get through its wishes. The government of the new prime minister Fumio Kishida will sit down to the same economic issues that have confronted Japanese governments since the spectacular crash of the late 1980s. Mr Kishida now has his own mandate and needs to show he has some better answers.
Japan has never properly recovered from its enormous boom and bust at the end of the 1980s. A large expansion of credit resulted in a massive overvaluation of properties and shares. The deflation unleashed to correct the bubble led to years of damaged banks, low credit demand and asset prices way below the highs they had reached at the peak of the bubble.
Japan was an early adopter of the idea of the central bank creating more money and injecting it directly into markets, buying up bonds and even exchange traded funds (ETFs) of shares in a desperate effort to keep interest rates very low, to boost asset values and to provide more cash to get the economy moving faster.
This process has continued for many years, allowing the Japanese state to spend and borrow on a large scale. Japanese state debt is now a huge 265% of GDP, far higher than any other advanced country. Borrowing at zero interest for 10-year money means the state can afford it. Inflation has remained obstinately low despite all of this extra cash. An ageing and declining population saves a lot – and is cautious about new spending.
The future of Abe’s ‘three arrows’
The last concerted attempt to tackle slow growth and no inflation came from Prime Minister Shinzo Abe. His famous “three arrows” still underlie much of Japanese policy. He went for an expanded state deficit and spending, for more monetary action with large programmes of bond buying, and for some supply side reforms to galvanise cartelised or monopolistic areas of economic activity.
The main opposition party, now called the CDP, had only a brief period in power following a great election victory in 2009. This was ended by a series of internal conflicts and not helped by the tsunami and nuclear incident in 2011.
The LDP changed its approach for the latest election. It included much more rhetoric about tackling inequalities and much less about more traditional small state liberal economics. Out is going Abe’s wish to see more dramatic reforms on the supply side and in is coming more emphasis on government programmes for poverty relief and community improvement.
The LDP is drifting leftwards to leave less space for the CDP offering. The new government will need to propose a budget soon after the election and is talking about a substantial new stimulus. Given the tolerance of the markets for high and rising levels of state debt, and the ability of the Bank of Japan to keep 10-year rates at zero and short-term rates negative, the government will be able to finance the stimulus in the time-honoured way. Japan is racking up ever bigger debts to itself but keeps a decent balance of payments position – so it is not unduly dependent on the goodwill of foreigners.
Japan is having to live with a more aggressive China as a neighbour. It is linking itself more tightly is to the US-led regional quad of the USA, India, Australia and Japan. A US carrier group is normally based in Japan, and Japan acts with the US over trying to limit Chinese expansion in the South China Sea.
Japan, which led much of the world’s consumer electronics and manufacturing revolution of the 1980s, has not been so prominent in the digital age, but it does have strengths in artificial intelligence, robotics and modern manufacturing. An island with few natural resources and little domestic prime energy, it relies on imports and is now seeking to add renewable power to its armoury after the unfortunate nuclear chapter.
Markets have risen in response to the government victory and will now look forward to a reflationary budget. Japan still has more leeway with inflation than Europe and the US but will still struggle to transform its longer-term slow growth rate. Markets need to balance the advantages of the extra spending against the absence of structural reforms.
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