Japan 2010: Can’t Get Out of Their Rut

Japan 2010: Can’t Get Out of Their Rut
November 7, 2010

About a year ago, I took a look at Japan’s new government, the first non-LDP government in fifty-five years (excepting a very short-lived one in 1994). I concluded at the time that the Democratic Party of Japan won its landmark 2009 Lower House election because of its economic policy platform. The DPJ promised a reduction in government spending, especially the public-works-centric spending that has characterized Liberal Democratic Party rule since 1955, and, at the very least, no increase in the consumption tax until the next Lower House election, scheduled for 2013. This was a much better proposal than the LDP’s worn-out agenda of public works spending, exemplified by a whopping ¥15 trillion “supplemental budget” – a “stimulus package” in U.S. parlance – in 2009, and looming tax hikes including an increase in the consumption tax (national sales tax) as soon as 2010.

November 1, 2009: Japan’s New Government

Since then, the DPJ has flip-flopped on virtually all meaningful policies, seen its popularity collapse like a burned-out satellite, and suffered a major loss in the July 2010 Upper House election.

The way forward for Japan – and the clear preference of voters – is lower spending to fix the deficit and lower taxes to ramp up the economy. This is of course the Reagan/Thatcher strategy that worked so well in the 1980s. Whenever a political party makes vague hints that it is moving in that direction, its popularity increases. When a party moves the other way – higher spending to help the economy, and higher taxes to reduce the deficit – its popularity collapses. If this program is implemented, the result is a larger deficit and a slumping economy.

After the historic Lower House election victory in August 2009, the DPJ set about – with impressive energy – rolling back the LDP’s already-passed ¥15 trillion public works stimulus plan. Construction was immediately halted on dozens of projects. The DPJ promised, in the election, that it would reduce existing spending by a meaningful ¥9 trillion annually. In the end, about ¥1.7 trillion was identified for reduction, and by August, public works projects were restarted. Big disappointment.

¥9 trillion yen is, actually, quite a lot. It is exactly the kind of chainsaw approach to government spending that Japan desperately needs. It is, for example, equal to the revenue generated by the existing 5% consumption tax, of ¥9.6 trillion in 2009. You could argue that, if the DPJ delivered on its spending cut promises, there would be no need to raise the consumption tax to 10% as many have suggested, which would presumably generate another ¥9.6 trillion in revenue (probably less in real life). The central government spent ¥5.7 trillion on public works directly in 2009, but also had tax transfers to local governments of ¥17.4 trillion, which balance equivalent public works spending on the prefectural and local level. Thus, directly or indirectly, the central government finances about ¥23.1 trillion of public works spending, virtually all of it waste, from which it shouldn’t be too hard to chop ¥9 trillion. Theoretically, anyway.

However, the DPJ also promised an additional ¥16.8 trillion per year of new welfare-type spending, centered on a new giveaway where families would receive ¥312,000 per year for each child under the age of 14. Eh? There was no request from voters for any sort of giveaway of this type. It was later seen as a ploy to buy political support by handing out government cash, pushed upon the DPJ by one of its leaders, Iichiro Ozawa. Of course it is completely contrary to the goal of less government waste which, I argue, voters have consistently favored since the extraordinary election of Junichiro Koizumi (2001) and several years earlier as well.

In June, payments of the child-subsidy allowance began, at a rate of ¥13,000 per child per month instead of the promised ¥23,000. However, already by June, the DPJ backed off its plans to increase the amount to the full ¥23,000 in 2011. Also, the government said in June that it would allow municipalities more discretion over the use of the child-rearing support funds, in effect changing it from a definite check in the mail for families to an open-ended subsidy of local governments.

By July, a survey by the Yomiuri Shimbun showed that only 44% of people supported the child-support policy, and another survey showed support at only 30%. What? Thumbs down on free money from the government? After twenty years of recession and government spending plans, Japanese citizens know that the “free money from the government” road is a path to nowhere. Another poll showed what voters are actually concerned with, ranked in order of importance:

1)    Business stimulus and economic revitalization
2)    Fiscal reconstruction (i.e. big spending reductions, smaller deficit)
3)    Employment policy (more jobs)
4)    Pension reform (Social Security)
5)    Medical and care service policy

Also by June, the DPJ was warming up its own “supplementary budget” of a substantial ¥5 trillion. Whaaaat? In less than a year, the DPJ had gone from promising a ¥9 trillion reduction in public works/stimulus spending to advocating an additional ¥5 trillion of spending. This was passed in October.

As you can see, June was a big month of flip-flop failure for the DPJ. Not surprisingly, it was also the month in which Yukio Hatoyama, who led the party to its historic victory less than a year earlier, stepped down as prime minister, ostensibly because of a flap involving the Futenma air base. (Japanese politicians are always taken down by some trivial issue that is unrelated to the real causes of their unpopularity.) He lasted 266 days.

Hatoyama’s stumble is widely ascribed to the influence of Iichiro Ozawa, who pursued a strategy of building political support via government handouts. As the Nihon Keizai Shimbun related:

Prime Minister Naoto Kan must learn from the missteps of predecessor Yukio Hatoyama, who squandered overwhelming public support by letting Democratic Party of Japan power broker Ichiro Ozawa pull strings from behind the scenes.

Naoto Kan speaks after being elected prime minister on Friday.
After winning the lower house election in August, Hatoyama kept rolling out policies designed to please voters but which lacked the necessary financial backing. Ozawa’s influence as the party’s supreme campaign operative was evident. …

The money scandals that ensnared Hatoyama and Ozawa also played a part in driving up public discontent.

Eliminating Ozawa’s influence is crucial. Hatoyama, who was DPJ president, relegated all party management to Ozawa, his No. 2. Despite pledging that his cabinet’s policy decisions would be free of party influence, Hatoyama allowed Ozawa to interfere with its decision-making.

“For Kan, Reversing Hatoyama’s Errors is Job One.” Nihon Keizai Shimbun, June 5, 2010

As Hatoyama stepped down, Ozawa officially quit his No. 2 role in the party, leaving under a cloud of alleged campaign funding irregularities.

Naoto Kan became the DPJ’s new prime minister. Kan immediately geared up for Upper House elections in July. Practically his first act, on June 17, was to declare that the DPJ’s new policy was to promote an increase in the consumption tax to 10%!


Remember, Japanese voters want (in my view) lower taxes and lower spending – the Reagan/Thatcher strategy. For the last thirty years, since ousting prime minister Masayoshi Ohira in 1979, voters have consistently thrown out any politician who suggests raising the consumption tax — except for those cases when that politician is running against someone who suggests raising the consumption tax even higher, in which case the voters will hold their nose and vote for the lower-tax-hike option. I documented this extensively last year.

Remember, also, that the DPJ’s big election victory in August 2009 was based on a reduction in public spending by ¥9 trillion, combined with a promise not to raise the consumption tax until 2013 at the earliest – compared to an LDP promise to increase the consumption tax as early as 2010.

Where did Kan’s policy change come from?

The prime minister broached the idea of a consumption tax raise for the first time on June 17 when he unveiled the DPJ manifesto for the upcoming election at a news conference.

Shortly before he faced the press, Kan phoned DPJ policy chief Koichiro Gemba, a political source said, quoting Kan as telling him, “I’m going for the 10 percent tax rate. Forgive me.” He left Gemba with little to say on the issue, the source said.

“Kan’s Consumption Tax Stance Could Cost DPJ Votes in Election,” Kyodo News, July 7, 2010

Whaaaat? He called the DPJ policy chief seconds before a press conference? “Forgive me?” Since when does a ruling political party allow its leader to set its election platform in this way?

There is a precedent for this sort of last-minute switch toward a tax-hike policy: Morihiro Hosokawa, in 1994. Hosokawa was the first non-LDP prime minister in postwar history, and originally promoted a plan to cut taxes. In February 1994, Hosokawa called a sudden midnight press conference, without consulting his political allies, in which he declared that he was now in favor of a consumption tax hike to 7% (from 3% at the time). His coalition government – the precursors of the DPJ – were shocked and appalled. Hosokawa’s popularity imploded, and he resigned as prime minister two months later, in a scandal involving a trucking company. The LDP regained power until 2009.

Hosokawa is widely believed to have been pushed toward his tax-hike flip-flop by the Ministry of Finance, which has been pushing for a consumption tax hike since 1974. It is their white whale. Kan’s tax-hike plan probably stems from MOF influence also. Indeed, the DPJ’s policy faceplant in general stinks heavily of bureaucratic influence. MOF is generally in favor of tax hikes and a reduction in spending, while all the other ministries are in favor, naturally, of more spending.

Here we come upon a basic weakness of the Japanese government beginning from the Meiji Restoration in 1867. In the United States, the government began with a Constitution, which led to a Congress, which oversaw an Executive Branch, which formed a permanent bureaucracy. In Japanese history, the final Tokugawa shogunate was overthrown by high-level reformist bureaucrats. It is called the “Meiji Restoration” instead of the “Meiji Revolution” because it was focused on restoring the power of the emperor (a monarch supported by a bureaucracy), as opposed to the Shogun (the term means “premier general”), who was a warlord or military dictator. The new Meiji monarchy was built upon a traditional Japanese pattern whereby the emperor would perform high priestly duties, and the bureaucrats would rule in his name. The bureaucrats eventually drafted a constitution in 1890 – 23 years after the formation of the new government — which led to a parliament that was originally rather weak.

Thus, below the superstructure of Western-style democracy in Japan lies a foundation of Asian-style mandarinate government, of the type that has governed China for thousands of years, and governs China today. A mandarinate government is one in which bureaucrats are chosen and promoted according to internal politics, much like the management of a corporation, rather than by some external voting process.

After World War II, historians have argued that Japan has never really been sovereign in the manner of the Western European nations or the U.S., but acted as something of a vassal state to the U.S. Japan’s postwar constitution was drafted and handed down by the U.S. military occupation government, and mandates that Japan have no military. Thus, the postwar government consisted of a U.S. occupation government, in partnership with the existing bureaucratic class, who then drafted a constitution and created the parliament. In 2009, there were 35,688 U.S. soldiers in Japan, occupying 68 military bases.

In Japanese history, Shoguns, emperors, military governments, foreign occupation governments, constitutions and parliaments have come and gone, but the bureaucracy has remained throughout.

The problem with the mandarinate arrangement, of course, is that it is hard to replace the mandarins if they go rotten. In general, people in positions of public leadership do not change their mind. They have to be replaced. Imagine, if you will, the typical Japanese bureaucrat, such as those of the Ministry of Finance. They are all graduates of the Law department of Tokyo University, more convinced of their inherent superiority than the most insufferable Harvard MBA. They went straight from high school to Todai (Tokyo U.), from which they went directly to the Ministry of Finance for the entirety of their careers. They have never run a business, and in fact have never even been an employee in a profit-oriented organization. They have never experienced unemployment, or even a single missed government paycheck. Nobody from MOF is ever fired. Although there is internal competition, they all progress on the same career ladder, and reach their highest office at a certain age, roughly 57. Although some are shunted to the side, everyone stays in line. A younger, talented person never leapfrogs the more senior bureaucrats on the career track. They all retire at exactly age 60, after which they are taken care of in some ornamental and well-paid corporate position.

All democratic governments face the problem of a permanent bureaucratic class below a layer of elected officials and appointees who change often and must struggle in elections to maintain their position. If this is the case in the U.S. or France – as it most certainly is – imagine what the situation must be like in Japan, where, due to the nature of the parliamentary system, elected governments and ministers can change at a depressingly fast pace.

It appears then, that the recent dynamics regarding the DPJ’s actions are:

1)    Pressure from MOF to raise taxes, especially the consumption tax.
2)    Pressure from other ministries, and countless entrenched interests, not to cut back any existing spending.
3)    A political strategy, led by Ozawa, to attempt to “buy votes” with various sorts of handouts.

Ozawa is now on the ropes, after a high court decided to indict him on campaign finance irregularities.

Not too long ago, I was talking with a friend about the situation in Japan. I concluded that the mandarins (and politicians) of Japan’s government basically wanted to become like France. France, of course, is well known for its monster bureaucracy, sweeping ministerial powers, and high taxes. France is also known, like Japan, for its wonderful cultural tradition, and an economy that, while maintaining its developed-country status, is characterized by stagnation, chronic unemployment and a persistent underclass. It is not a very appealing picture for the country as a whole, but for a high-ranking bureaucrat, it is as close to heaven as you can get on this Earth.

Thus, I was most amused to find these sentiments recently expressed by none other than Eisuke Sakakibara, the former MOF honcho known as “Mr. Yen” in the 1990s.

Ultimately, the issue will be the size of government. The DPJ government seems inclined toward an expansion of European-style social welfare. The child care subsidy and other similar programs can be thought of as the first steps in that direction. But Europe is a land of big government. In Japan, the ratio of tax payments and social welfare contributions to national income comes to 39%, putting us in the category of small government with the U.S., which weighs in at 35%. By comparison, France’s public burden comes to 61%, Germany’s 52% and the U.K.’s 48%.

The DPJ government has yet to make clear whether it wants a big European-style government. On the one hand it is providing a child care subsidy and free high schools, but it also seems to be trying to keep government small by screening budget programs and so on. It is about time for Kan’s cabinet to start talking about what shape of country it wants Japan to be. Cutting waste is always necessary. But Kan needs to spell out whether he is aiming for a European-style welfare society or a small government, in other words an American-style competitive society.

I personally think Japan should take the road to a European-model big government. That would entail raising the consumption tax 10-15 percentage points to around 20%.

“Sakakibara: Tax Hike Can Wait, but National Vision Can’t,” Nihon Keizai Shimbun, August 10, 2010

Sakakibara makes very clear what his National Vision is: “gimme your money!”  However, as he notes, the Japanese people themselves might have a different view of the matter. For the past 150 years, Japan has been characterized by relatively low taxes, high growth, business and innovation, low unemployment and a broad middle class.

Today, we have the DPJ corralled by MOF into its 10% consumption tax hike plan. The LDP, now the opposition party, has – surprise surprise! – exactly the same plan, to raise the consumption tax to 10%. MOF is all in favor of a rise to 10%, as long as it keeps rising to 20% in the future. Among the policymaking elite there is perfect agreement, while the voting public – as it has done for the past thirty years – tries every method to throw these tax-hiking goons out.

I was intrigued to find numerous references to the political history of the consumption tax hike efforts, and the charred bodies of former politicians strewn to either side as their popularity collapses time and time again. Although I described this in detail last year and also in my book, this is the first time I have seen such an outline in the Japanese press. It is as if a polarization is forming, between the mandarins and the captured politicians, and the citizens and business class of Japan, who want a vibrant capitalist economy instead of a bureaucrat’s petting zoo.

Thus, we have both a tax-hike and tax-cut trends happening at the same time.  The consumption tax-hike talk has been paired with new discussion about raising personal income tax rates, which now top out at a 50% effective rate. Also, payroll taxes keep ticking higher year after year, as they rise from 13.6% in 2003 to 18.3% in 2017. Since the payroll tax is paid both by the employee and employer, this is actually a rise from 27.2% (not exactly low to begin with) to 36.6%.

Also, MOF has been trying for years to push the capital gains tax on equities to 20%. This originally took the form of a 20% capital gains tax implemented in 1989. However, this tax was paired with an optional tax of 1.05% of the sale price, so in effect the 20% tax was rarely paid. In 2003, the 1.05% option was eliminated, and the capital gains tax was “temporarily” reduced to 10%, with a plan to raise it to 20% in 2009. (Thus MOF was able to label the tax hike to 10% — from effectively zero – as a “reduction.”) Previously, capital gains on equities had been tax-free in Japan since the mid-1950s. The increase for 2009 was postponed, but talk continues about the end of the “temporary” reduced capital gains tax rate.

However, it appears that some are now arguing to eliminate the capital gains tax completely. This is a new development, and exactly the kind of dramatic pro-growth spirit that has infused Japan’s best eras. Also, there seems to be broad consensus that Japan’s corporate tax rate, at 40% effective the highest in the developed world, should be reduced by five percentage points. This could take place as soon as next year.

The problems in Japan’s political system are coming into sharper focus. The citizens and businesspeople will have to find a way to flush the toilet on their rotten bureaucrats and politicians. However, they won’t go quietly. A crisis seems to be coming.

I’ve decided to split this year’s Japan update into a “political” report, and a “financial” report. Lots of interesting items have been coming up, which deserve a separate piece to deal with.