Country Risk & Threat Advisory Briefing: Japan

Overview

Japan’s spectacular economic rise, which began after WWII and achieved first place in the world in terms of Gross National Product (GNP) by the end of the 1980s, was considered ‘the’ economic model for countries to follow until – just as spectacularly – it collapsed in 1991 and from which many analysts would argue, has never recovered.

At some point in almost everyone’s lives, they have used a product made by a Japanese manufacturer, whether it be cameras, watches, calculators, personal music devices, cars, motorbikes, or musical instruments, to name just a few. During the early 1980s, when interest rates ranged between 5 and 10%, no one would have believed the Japanese economy would ever be described in such terms as slow growth, huge government debt, deflation, inability to attract foreign investment and growing unemployment. And yet, that is exactly what the Japanese public themselves have been saying and louder with each passing year.

Political

The current ruling party in Japan, the Liberal Democratic Party (LDP), was formed from the merging of two right-wing parties – the Liberal Party and the Japan Democratic Party – and has been in power for the majority of the time since its creation in 1955[1]. It is pro-business (if only Japanese for the most part) and very pro-US via its foreign policy. So much so, that opposition parties regularly describe the country as being nothing more than a province of the US.

Despite the image a long reign may conjure up, the LDP’s fortunes and popularity have been decidedly rocky over the decades – often as a result of scandal and corruption. Nevertheless, it has only lost power twice, and both occasions were brief. In 1993, after 38 consecutive years in office (20 of which laden with corruption), the LDP lost power to a splinter group of the party (the Japan New Party – JNP) led by former member, Morihiro Hosokawa. He created the JNP in protest against the rampant corruption plaguing the LDP and, therefore, the government. Hosokawa actually managed to initiate some political reforms until he was forced to resign over, perhaps fabricated, revelations of receiving a Yen¥100 million loan from a trucking company with ties to organised crime. The only other period the LDP’s hands were not on the levers of power, was when the Democratic Party of Japan (DPJ) held government from 2009 -2012.

The LDP’s structure is made up of political cliques. It has been heavily criticised over the years due to in-fighting and the enormous amount of time and effort members of each faction spend engineering support for their member of choice to become party leader (read Prime Minister) rather than addressing the country’s problems. This ‘engineering’ involves a lot of infighting between the members because, if successful, it improves greatly their personal chances of becoming a minister in government, where they will generally last a lot longer than the leader does.

The negatives notwithstanding, the LDP continues to survive due, in part, to the enormous political capital it gained holding back the rise of the Japan Socialist Party and the Japan Communist Party during the country’s most difficult period in 1960. Then, the economy was growing rapidly (GDP was over 10%) and unemployment low, at around 1.3%, but the renewal of the US-Japan Mutual Security Treaty was seen as a further attack on the political left’s leaders, which had already been removed from civil service positions of power to quell a rise in radicalism back in 1947. It was seen as a decision driven by the US government.

As a result, 1960 saw the largest protest movement in Japan’s history and was driven, at least physically and publicly, by a leftist student movement, which was anti-government and, by extension, anti-American. It is for this reason the party continues to receive support from the ever-growing ‘older population’, which is decidedly conservative. It is also supported widely by religious groups, specifically Buddhist.

However, support for the party does not mean the LDP is popular. The change in government during the 1990s, mentioned above (also known as ‘the lost decade’), is an excellent example of the enormous corruption at the time being bad enough for the public to want to vote them out and also indicates the hurdles any prime minister of Japan faces trying to push through reforms to bring about economic recovery today. The splinter group, JNP government, was making waves and in very short order. In just 9 months (and the party had only been formed a year before), Hosokawa was able to limit campaign contributions and modify the electoral system. Difficult as these reforms were to get passed – but passed they were as the public had not complained – it was not until he began focussing on the introduction of GST tax when the problems began. The public was immediately up in arms about it and the outcry marked the beginning of descent within his coalition government. The revelations – noted earlier – emerged shortly thereafter.

In the end, GST or Consumption Tax as it is called in Japan, was not formerly introduced until 1989 (7 years later) and was set at just 3%. It then took a further 8 years to raise it to 5% and, given that there was a recession shortly after, the public held the tax increase responsible for it. GST currently stands at 10% for most items, though there are some exceptions such as food, drink and newspaper subscriptions (8%).

It is said the Japanese people actually fear change, and the LDP party use that fear to political advantage in the background. If any prime minister proposes ‘a’ reform that the people believe affects them negatively, they will quickly protest for their direct removal or vote for an alternative, no matter the benefit of that reform for the country. If a reform affects political vested interests, the political cliques will stop their infighting and find a way to quickly remove the problem by finding something the public will dislike about it and publicise the fact negatively. Rinse and repeat.

It is worthy of note that there are no official term limits for a prime minister in Japan. Yet the political landscape is replete with prime ministers removed for one reason or another before completing a single term in office. In 1989, for example, Prime Minister Uno Sōsuke lasted just 68 days and, from 2006 to 2011, the country saw 7 different prime ministers come and go.

Economic

Twenty-nine years after Hosokawa, the Japanese people still feel the same about change and the condition of the economy reflects this. Although the LDP has, as a result, developed a highly advanced skill in ‘kicking the can down the road’, problems are now mounting at ever-increasing speed and the government will no doubt soon find its hand forced to bring in hard policies that will almost certainly threaten the loss of the next election, either to another splinter group of the LDP or a left-wing coalition.

The steep decline and massive debt seen in the Japanese economy today was already massive, long before the earthquake and tsunami of March 11, 2011, that destroyed the Fukushima Daichi nuclear power plant in the town of Ōkuma. But the exorbitant cost of the government’s response to a massive public outcry that forced the then Prime Minister, Naoto Kan (DJP), to shut down all the remaining nuclear plants (a total of 54 at the time), exacerbated the problem much further than was necessary.

This measure alone ensured that before it was even possible to take stock of the damage and associated costs, the government had to immediately increase energy imports by 85%, making Japan the second largest net importer of fossil fuels after China. The clean-up costs alone were staggering for the economy. Those associated with the reactor are estimated to be around US$15 billion, coupled with the US$60 billion refugee compensation fund and an additional US$250 billion earthquake and tsunami damage bill, unrelated to the reactor. Following the well-worn path of so many of his predecessors, Prime Minister Naoto Kan did not stay in power long after.

The LDP returned to power and Prime Minister Shinzo Abe[2] announced his 3 arrows economic policy plan (dubbed Abenomics) in 2013. Touted as the answer to Japan’s ailing economy, the provision of fiscal stimulus in the hundreds of billions of dollars, implementation of negative interest rates and the engagement of structural reforms combined would, it was believed, help the country reach a growth target of 2%.

By the 3rd quarter of 2017, GDP finally passed the target reaching 2.5% (annualised) following seven consecutive quarterly gains. By every metric, Japan, it seemed, had finally found the road to recovery and without upsetting the public too much in the process. When industry leaders were asked what risks on the horizon might blunt Japan’s recovery, they saw them only as external in nature, a downturn in the Chinese and US economies, yen appreciation or military clashes. At that time, of course, most of the potential issues seemed unlikely.

However, nobody had banked on Covid and the crushing effect on the world economy it would bring. As a result, industry leader’s worst fears effectively all came at once, with the exception of the Yen appreciation. Rather, today, the yen has declined further to a twenty-year low. Yes, this has helped exports, which grew 12.5% from last year to US$63 billion. However, these gains have been more than eaten away by the 28% increase in the cost of energy as a result of the current US administration’s massive reduction in oil production and the Russian invasion of Ukraine.

Perhaps the only reason Japan appears to maintain a hybrid image of stability after two years of lockdown, from which it has still not fully opened at the time of writing, is due in one sense to a rather simple method of accounting. The Bank of Japan’s (BoJ) holdings are a part of the government’s consolidated balance-sheet, and it ‘agrees’ to buy US$740 billion of government debt every year (by necessity this amount was increased from US$720 billion in 2019). The government sells its sovereign debt to the bank and the bank returns the (0%) interest to the government. Therefore, the debt is effectively cancelled. It is why, from the political side-lines, Abe recently stated that, “the Bank of Japan is just a tool of the government.” It is without doubt being used that way, despite the protestations from the bank’s board claiming otherwise.

On its face, the policy would appear to be a ‘win/win’ scenario. Yet it does not take into consideration that such a mechanism appears to create a laissez-faire attitude toward debt within government. In 2019, government debt to GDP was 238% and in 2020, massive budget increases to handle Covid pushed that figure to 266%, the highest in the world. Today, Japan’s long-term government debt stands at US$8 trillion and with the current lack of stability in world affairs, that number is very likely to climb still further, especially as politicians discuss the need to strengthen defensive military capability to counter China and North Korea. As of 2021, Japan’s current account surplus had reduced to a 7-year low as overseas investment flows indicate no sign of improvement, and this is unlikely to change while the interest rate remains in negative territory.

The BoJ currently holds around 43.5% of the country’s debt in government bonds and has said it will be issuing more soon in its continuance of monetary easing policy. The bank is also holding an enormous quantity of (in some cases risky) Exchange Traded Funds (ETFs) valued at US$454 billion, from which it will need to unwind by selling them via third parties to the public. Experts, including the former central bank policy maker, Makoto Sakurai, sees 2024-5 as the earliest timeframe for a meaningful recovery to begin, so it is very unlikely there will be an end (or the beginning of cuts) to stimulus before then. Certainly, the government will not be able to draw in enough revenue to continue with this model for too much longer.

The long-standing issues directly caused by a rapidly aging population coupled with very low birth rates – around 30% less than the death rates for 2022, marking 11 straight years of decline – is one such thorn in the government’s side in relation to debt. Tax revenue is declining, and to increase tax would produce another public outcry. With the high cost of living often cited as the reason the average age of couples marrying has climbed to 50, it is not likely they will want or be able to have children.

Of course, some of these problems, deep routed though they are, could be addressed, or at the very least, stabilised. Increasing foreign worker quotas and adapting immigration rules to make it easier for those workers to enter and stay, is one such method. This would not only help with the worker shortages the Japanese corporates have to juggle with, but also increase tax revenue. As foreigners appear to marry Japanese partners younger and be more likely to have children, this reform would help with the birth rates too.

These policy options have been debated, yet the government chose against them, perhaps in fear the public would view them as ‘foreigner favouritism’ or become uneasy at a visible increase of foreigners within a homogenous country. As a result, immigration rules for foreign workers remain deliberately onerous. The alternative chosen was to push international tourism hard as a “key pillar to economic growth”. It would bring in much needed additional revenue and, although there would be some pushback at the increased number of foreigners, the government could at least truthfully point out that most of them would be going home at the end of their holiday.

While the band-aid tourism policy did help – the industry attracted 2.3 million tourists in 2019, ending a 10-year high, with a total 32.5 million – it, too, was hammered in the face of Covid. Moreover, even if Covid had not come along, the low-birth rate was not something tourism could address.

Prime Minister Fumio Kishida’s cabinet currently enjoys a 61.5% approval. Some Japanese observers suggest his popularity comes merely because he is not the divisive Yoshihide Suga, his predecessor, and there may be some truth to that. Nevertheless, it might well be as a result of him not rocking the boat… Yet. Although the public are, perhaps, in for a rude awakening, given that he floated the idea of capital gains tax formation last year and has just stated that the debate continues. Expect another public outcry soon.

Interestingly, 53.7% of the public believe the government should focus more on economic recovery than Covid. However, higher numbers still believe the BoJ should continue its massive monetary easing. Or at least they do, until further reforms (tax) will be needed to pay for it.

Corruption

As indicated at the beginning of this report, the one area of the country riddled with corruption is politics and, by extension, those sectors directly connected to it. Bid-rigging in public procurement, especially at prefectural level, is clearly an area where politicians and Japanese corporations work within very tight patronage networks.

Corruption within the legal system of Japan, however, is a very low risk, either for the general public or corporate company bosses. While bribes do occur for favourable outcomes, from a judicial standpoint, it is an extremely rare event and legal procedures/processes are generally carried out in a professional and trouble-free manner, although they will take longer to be concluded than in the West. Where there is an area of doubt is in the appointment of Supreme Court judges. The process of appointment lacks transparency, which, on its own, is irksome enough yet, when their rulings appear to regularly favour leniency where the government is involved, it is not surprising the appointment lacks clarity nor is it likely an issue that will be reformed any time soon.

While corruption is generally not a matter of concern, culture differences where cases of crime are brought to the courts, will be. Criminal law in Japan in the Meiji era (1868 – 1912) adopted the German inquisitorial system as the country began to modernise. Then, after WWII, it took on a version of the adversarial system from the US. Unfortunately, with each new adaptation, many elements of the Meiji-era’s legal system remained, especially where the dominance of the state is involved, forming a cake-like mix that is both inquisitorial and adversarial.

Described occasionally as a hybrid, the current criminal law system only bears a passing resemblance to that of the US system and has unintentionally created a way by which the government’s prosecutor can achieve a 99.9% success rate without any form of corruption or maleficence taking place. Partly, this is achieved because the police are allowed by the court to deny a prisoner access to a lawyer while being questioned and, perhaps to a larger extent, because the prosecutor has almost free reign in determining which cases to take. Given that they wish to maintain their enviable record, prosecutors tend to defer around 60% of cases, usually when there is doubt over winning.

Further, it is claimed that some judges have admitted fearing handing a ‘not guilty’ ruling as they know the prosecutor will immediately appeal the decision and get the ruling overturned in a higher court. There is another problem in terms of balance or fairness in the criminal courts. There are many older judges who truly believe they are able to determine the guilt or otherwise of an individual without the need to examine the evidence.

Foreign Relations

Despite clear, strong alignment with the US in relation to just about every issue over the years, Japan is perhaps, for the first time, struggling to meet the demands of its ally. The government has pledged a total of US$700 million to Ukraine, which it could ill-afford, it has publicly condemned Russia aggression, it has applied, albeit weak, sanctions on Russia but it is now exhibiting signs of reluctance. Japan has little in the way of natural resources with which to plug the gap left in energy requirements since the Fukushima disaster, especially as many of its nuclear power plants remain shut down. In fact, only 10 of the 36 still viable plants have been brought back into service (the other 18 are now unable to meet inspection safety standards) and the government’s current energy plan is for nuclear power to provide only 20-22% of the country’s needs to fiscal 2030.

In the beginning of May, Koichi Hagiuda, the energy, trade and industry minister highlighted the problem, making it as clear as possible for a Japanese minister that, “it is difficult for us to align ourselves with the EU”, which was proposing a complete ban of oil from Russia. Although officially, PM Kishida says Japan will continue to phase out oil imports from Russia, key emphasis from his and Hagiuda’s statements has been placed on terms such as “phase out”, “slowly”, “in principle” and “in light of reality”. No timeline has been given at any point, suggesting the government is hoping that if it drags its heels long enough, it might be able to avoid such a painful withdrawal.

And it would be painful. Although at this time, over 90% of Japan’s oil requirements come from Saudi Arabia, UAE, Qatar and Kuwait, it still relies on Russia for 4% of its oil needs, 9% of its natural gas needs and 11% for its coal. Further, Kishida made it clear that Japan would maintain its interests in the oil & gas projects it has in the Russian Far East (read Sakhalin Islands), a chess-move borne out of necessity to secure energy supplies but also to protect Japanese businesses and, more importantly, his own government’s stake holdings in Sakhalin 1 & 2. He has gone so far as to say that if Japan were to step away from these projects, China would jump in and take them. What he did not say, was what possible destruction such a move would have on Japan’s economy as a whole.

[1] Although it’s roots can be traced back to the late 1800s.

[2] Twice Prime Minister and the only one who has managed to survive two full terms, making him the longest serving PM in the country’s history.

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