Why hasn't Japan learnt?

Even before 2002 is out, we have seen a few high profile incidences of Japan's resistance to reform. First, Mr. Koizumi's postal reform was watered down in July this year to a mockery of his original idea of breaking up the postal saving bank by focusing on mail delivery. And even there, reforms were unreal.

Under the "reformed" system, competitors to the post office must set up a daunting minimum of 100,000 post boxes, while the legislation has barred any reduction in the number of state postal branches. Instead of making mail delivery more efficient, the reform bills have created a more costly and inefficient system!

Second, the deposit insurance reform, which is essential to attack moral hazard and complacency in the banking system, was shelved after strong opposition from vested interests. Then the Bank of Japan announced in September that it would buy stocks directly from the nation's banks to pop up their balance sheets. The move effectively socialises banks' risk by shifting it from the private sector to the central bank.

But on his part, Mr. Koizumi also made a mistake by appointing an LDP old guard Hakuo Yanagisawa, also in July when his postal reform bill was watered down, as the head of the Financial Services Agency (FSA). Though Japan has been using excuses to skirt structural reforms for many years, all these incidences stood out as hallmarks of reform resistance because they came at the time when hope was rising that Japan might finally put her acts together under the reform-minded prime minister.

Deja vu?

The first thing Mr. Yanagisawa did when he took office in July 2002 was to deny that there was a banking crisis. He also made no secret of his preference to prop up rotten banks by rigging the stock market to bolster bank capital, instead of weeding them out.

Thus, Mr. Koizumi's move to replace him by a more reform-minded Heizo Takenaka in the cabinet reshuffle on 1 October can be seen as a move to repair the damage that was done in July.

This has raised hope, again, that Japan might finally be trying to break the logjam on bad debts. The new FSA head, Mr. Takenaka, who also heads the Economic and Fiscal Advisory Council, is a known ardent supporter for banking reforms. As a non-politician, free of vested interest interests, he seems to be in a prime position to make the needed changes for Japan. Indeed, Mr. Takenaka is the Prime Minister's most trusted advisor and the most outspoken critic of the FSA's timid policies towards the banks.

The question is can Mr. Takenaka deliver? Remember a dashing Koizumi came to power on a wave of popularity, promising "structural reform without sanctuary", just eighteen months ago? It is obvious that Mr. Koizumi was fighting a losing battle within a reactionary bureaucratic system.

The situation is no different for Mr. Takenaka. He inherits senior FSA bureaucrats who were appointed by Mr. Yanagisawa. He is disliked among the bureaucracy for being a better economist and policy advisor who is closer to the Prime Minister than many other bureaucrats. Hence, high hopes on Mr. Takenaka could end up in disappointments, just like what happened to those who held high hopes on Mr. Koizumi.

The root of the fault

To see why it is so difficult for reformists like Koizumi and Takenaka to change the system, we need to trace the root cause of resistance. It comes from the very top government bureaucrats because they know they are the culprits for the nation's economic disaster today. A process to purge the system's faults would reveal their culpability.

It all started with their pursuit of a centralised political-economic system, from which they derive their power. Japan's official economic managers sided with these bureaucrats, preaching their claims that an economic visible hand with centralised guidance would produce sustainable growth and long-lasting stock market boom.

Japanese bankers thus lent freely, irrespective of credit risk, under the official direction. The official rhetoric, underpinned by a legal accounting framework that allows Japanese banks to count equities as their capital, also prompted local banks to load up equities in their balance sheets.

However, the economic malaise since the 1990s has refuted all these illusive claims and left the banks in a quagmire. Not only had the questionable loans turned bad, but the collapse in stock prices eroded banks' capital base just when they needed it the most to cover the bad debts. Thus, those who control Japan's system have made every effort to resist any fundamental reforms that would shed light on these causes and effects.

The reform resistance from the public, especially to using tax money to restructure the banking system, is related to the bureaucrats' mistakes. The common Japanese citizen has lost a lot of money in stocks and properties since Japan's asset bubble burst in 1989. These people inevitably resist using their tax money to bail out banks and pay for the sins of the top bureaucrats.

Conflict of interest

There is also a conflict of interest problem. Notably, the very obstacles to growth serve as pillars of Japan's political system. Collusion, regulations, artificial high prices and bank loans to insolvent companies all serve as mutant social safety nets in Japan. The electorate is divided between those who would benefit from reform and those who would be hurt by it.

Without growth, these unbridgeable conflicts of interests will continue to mount and sabotage the leadership's decision making and reform process. But without reform, growth will not revive. The whole country is stuck in a vicious cycle.

So deep-rooted are Japan's dysfunctions that even if she did everything right at once, it would take at least five years to get growth back on track. And Japan will not do everything right at once because the system is swamped by conflicting objectives of vested interests that obstruct changes.

Given all these constraints, it is hardly optimistic for the Koizumi-Takenaka team to make any breakthrough changes in just one cabinet shuffle. Nevertheless, Japan will eventually reform. And when she finally does, she will regain the world's admiration.

Her information technology (I.T.) revolution could unleash an even more powerful push for economic growth than in other major economies because, ironically, all the inefficiencies that would be eliminated by the IT revolution are greater in Japan than many other developed economies. However, the bad news is that it could take more than a decade's bumpy journey for Japan to reach this Promised Land. So, don't bet your shirt on a Takenaka miracle รป you will lose it!

Chi Lo, an independent economic strategist in Hong Kong

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