Will the DPJ weather the global rebalancing?

David Brooks's latest column in the New York Times calls for a restoration of "economic values" in the United States, with the aim of making "the U.S. again a producer economy, not a consumer economy." Brooks sees a decline in traditional values of restraint behind the rise of consumer spending to ever greater portions of GDP and the growing indebtedness of consumers. Whether or not the emergence of the US as a consumer economy is a function of declining values, greater restraint by US consumers is the flip side of Japanese consumers spending more of hoarded savings. After all, the growth of the US consumer economy was accompanied by global imbalances, massive current account surpluses by countries like Japan.

The question now is how to execute the transition to a more balanced relationship among the world's economies, including and especially in the relationship between the US and Japan. How can the US become relatively more predisposed to production and Japan relatively more predisposed to consumption (especially of imports from the US and elsewhere)? The FT's Wolfgang Münchau praises the G20 for at least recognizing the problem of imbalances. For his part Münchau rejects the notion that adjustment can happen automatically simply by US households changing their behavior — or rather, that it can happen, but the transition will be painful everywhere, as Japanese exporters, deprived of American consumption, have discovered over the past year. Instead he argues that each country will have to adjust in its own way:

The answer is that policy will have to be tailor-made to suit the specific circumstances of each country. China will probably not be able to reduce its excessive current account surplus without a revaluation of the renminbi. In Germany, the best overall macro-policy instrument would be a big tax cut to boost domestic demand. In the UK, restoration of balance will have to include heavy cuts in public spending, while Spain will also have to raise taxes, even in addition to last week's announcement of a rise in value-added tax.

And what of Japan?

The DPJ fully acknowledged during the campaign that the challenge facing the government is managing the transition from the postwar producer economy — divided between efficient exporters and inefficient domestic producers and service providers — to a more consumer-centered economy.

But less clear is how the Hatoyama government plans to contribute to the global rebalancing. After all, the government has few policy tools at its disposal. Interest rates cannot go any lower. The government's debt burden limits its ability to use public funds to make up for weak private consumption. The yen's exchange rate is one tool available to the government, but as Finance Minister Fujii Hirohisa's conflicting remarks suggest, there are political limits to how far the government can permit an undervalued yen to rise. After stating following a summit with US Treasury Secretary Timothy Geithner on the sidelines of the G20 summit in Pittsburgh last week that the government would not intervene to keep the yen down, Fujii subsequently softened his position, alluding to intervention should the dollar-yen exchange rate rise too rapidly.

Richard Posner's note upon reading John Maynard Keynes's General Theory of Employment, Interest, and Money for the first time — "How I Became a Keynesian" — makes for interesting reading in light of Japan's dilemma. Posner highlights Keynes's focus on consumption as the engine of growth in an economy — and how uncertainty can trigger hoarding. "People do not save just to be able to make a specific future expenditure; they may also be hedging against uncertainty," writes Posner. "And the third claim, related to the second, is that uncertainty — in the sense of a risk that, unlike the risk of losing at roulette, cannot be calculated — is a pervasive feature of the economic environment, particularly with respect to projects intended to satisfy future consumption." This passage strikes me as a particularly succinct description of the problem faced by the Japanese government since the bubble burst: how can the government dispel the ubiquitous sense of uncertainty on the part of Japan's aging consumers? LDP governments engaged in policies that took the outward form of Keynesianism — large-scale construction projects — without appreciating the essence of Keynes, that the goal ultimately was (and is) getting consumers secure enough to spend their own money again. For all the dams and bridges built by the government, the money probably would have been better spent rebuilding the social safety net, which would have in turn made the economy better capable of weathering the transition from the producer-centered dual economy.

In short, the DPJ-led government will attempt what should have been done a decade ago, except that now its fiscal policy options are constrained and the global economy is recovering from a monumental crisis. It will have less recourse to foreign demand to ease the pain of transition than the LDP had up until the global financial crisis. Ultimately the DPJ may be able to do little more than make the transformation marginally less painful, but, as Noah Smith wrote at this blog earlier this year, it will be painful nevertheless. The DPJ may be able to extend its time in office if it is able to deliver adequate social spending in its budgets, but admittedly the prospects for success are grim. The government may simply not have the tools at its disposal to overcome the thriftiness of the Japanese people in an age of uncertainty — but it could pay the political price for "inaction" anyway.

The LDP's unlucky numbers

With two days until the general election, Asahi anticipates that turnout this year might be higher than 2005's 67.5% and might even top 70% for the first time since the 1990 general election. The weather should cooperate: there is some rain in the forecast for the Kanto area Sunday, but otherwise it looks clear across the country.

But it is not just the weather that favors the DPJ.

Evidence continues to mount that independents will abandon the LDP in extraordinary numbers, having tired of LDP rule. In its last poll before the election Mainichi found that the LDP should be able to get LDP supporters out to vote, but the problem is that LDP supporters have fallen to 20% of respondents. Nearly 40% of respondents who said they voted for the LDP in PR voting in 2005 said they will vote for the DPJ in PR voting this year. Mainichi also confirmed that as far as policy goes, this campaign has been contested on the DPJ's terms: the DPJ's policies are preferred on the areas of greatest concern to voters, pensions, health care, and child and education policy. The issues of greatest important to respondents are pensions and health and nursing care (33%), anti-recessionary policy (25%), education and child policy (16%), "regime change" (8%), and administrative reform (7%). It seems that for the second consecutive election the LDP has decided not to talk much about the issues of greatest concern to the Japanese public. Mainichi also found evidence that the DPJ's manifesto-centered campaign strategy — discussed here — has paid dividends. 70% of respondents said that they are referring to manifestos in casting their vote, and of those 70%, to DPJ is preferred 51% to 23% for SMDs and 50% to 21% in PR voting.

Of course, beyond the poll numbers, there is this figure: unemployment in July reached 5.7%, an historic high, as deflation worsened and households cut their spending. Much as Japanese households benefited relatively little from Japan's "longest postwar growth period" during the earlier part of this decade, they are not benefiting from Japan's supposed "recovery." The LDP may have been the victim of the global financial crisis ("originating from America"), but these figures are a testament to the LDP's failure to develop a new growth strategy since the bubble burst nearly two decades ago. It is a final remainder of how economic insecurity has grown during these two decades, arguably the insecurity that will drive the LDP from power on Sunday.

Asō makes a pun

Speaking before the Upper House Budget Committee on Monday, Prime Minister Asō Tarō reached a new low for an LDP leader attacking the opposition DPJ.

Asō was addressing the debate regarding the DPJ's plans to finance new spending by cutting wasteful spending and tapping the so-called "buried treasure" of Kasumigaseki, surpluses in the government's numerous special account budgets. Calling upon the DPJ to be more specific about the sources for the 20.5 trillion yen in spending proposals in its manifesto, Asō then said the following:

"The DPJ is flying the flag of regime change, but if there is regime change, there will probably be a recession."

民主党は政権交代を旗印にしているが、政権交代は必ず景気後退になるだろう。

It seems that Asō, known for stumbling over words (like this recent gaffe), was trying to make a pun, connecting 政権交代 (seiken kōtai) to 景気後退 (keiki kōtai). Nicely played, Mr. Asō.

Except that I can think of at least two things wrong with this critique. First, it seems that Asō has forgotten that Japan is already in a recession. Perhaps someone could show him the latest labor survey released by the Ministry of Internal Affairs and Communications, which found that the unemployment rate rose to 5.2% in May. Naturally Asō would wave off this complaint by repeating the refrain about the "once in a century economic crisis originating in America," but whatever the source, Asō is hardly in a position to be talking about recessions to come, not with Japan mired in a rather severe one under his own government.

Second, the causal logic in this statement is dubious. How exactly will the DPJ cause a recession by not offering a clear account for how it intends to pay for its programs? Is Asō is suggesting that LDP profligacy caused past recessions? How exactly will the DPJ's failure to outline in precise detail how it will pay for its programs trigger a recession? Or is Asō speaking in a general sense, that the DPJ is so clearly maladroit at governing that it will drag Japan done? If so, one need only ask about Asō's own party, or his own government, for that matter, which just loosened restraints on public spending. How is carefree spending under the LDP the mark of a "responsible party" but carefree spending under the DPJ the harbinger of recession?

In short, there is very little that the LDP can ask about the DPJ without having the DPJ turn around and ask the same question about the LDP.

Is the government running out of options — or out of options already?

The political system is gearing up for a debate over the government's 15 trillion yen stimulus package that could decide the timing and the outcome of the next general election.

Kan Naoto has indicated that if the government is open to revising the plan, the DPJ will cooperate to smooth its passage. What choice does the DPJ have? Now that the LDP and the DPJ have swapped preferences regarding election timing — after years of demanding an immediate election, the DPJ has backed down due largely to Ozawa Ichiro's struggles, and the prime minister, enjoying what could be a temporary shift in his favor, is contemplating an election sooner rather than later — the DPJ has every reason to cooperate if it means depriving the government of an issue which it can use as justification for a snap election. Although there is some debate within the party about the right course of action, it seems likely that the DPJ will opt for this strategy, forcing Aso to decide whether he will live up to his oft-repeated commitment to putting policy and the resolution of the economic crisis before politics or whether he will opt to exploit what looks like a window of opportunity for a general election.

At the same time, the DPJ ought to engage in good-faith debate for reasons having nothing to do with its political standing. Given the amount of money the government is pledging to throw at Japan's crumbling economy, the leading opposition party and master of the upper house ought to be thoroughly reviewing the government's plan and questioning whether its components are intended to stimulate domestic demand or buy the votes of straying LDP constituencies (or throw money at the prime minister's hobby). The press coverage of the government's plan makes the mistake of treating it as wholly dedicated to fiscal countermeasures. As Ikeda Nobuo notes, emergency measures comprise 4.9 trillion yen, compared with 6.2 trillion yen for the government's "growth strategy." Ikeda, a libertarian economist, says that the growth strategy measures could be conceived as old-fashioned LDP pork-barrel spending, but they should also be understood as an effort to revive old-style MITI targeting — and which Ikeda rejects as inconsistent with the latest economics research and likely to do more harm than good. The DPJ ought to be raising questions about whether the government's spending plans have the slightest chance of nurturing new industries and reorganizing the Japanese economy. Hatoyama Yukio has already started on this line of argument, but the DPJ may have a hard time continuing in this vein given its own spending plans.

Nevertheless, there are plenty of questions about the government's proposal that can and should be asked. Looking at Prime Minister Aso's statement about the stimulus package, a number of questions came to mind.

The prime minister himself said, the goal of the government's proposal is "to prevent the bottom from falling out of the economy," meaning that the government's emergency measures have less to do with stimulating consumption than with minimizing the hardship suffered by laborers and small- and medium-sized businesses. To that end, the government has pledged more subsidies for businesses that have retained employees and greater support for retraining for laidoff employees, and greater access to credit from public financial organizations for small- and medium-sized businesses. (Jun Okumura notes the importance of this measure here.) Additionally, Aso pledged greater support for working single mothers, higher child allowances, scholarships and tuition reductions for private school students, and some 310 billion yen in subsidies for rural medical institutions.

The third part is the portion criticized by Ikeda, the government's medium-term growth strategy. Central to this plan is environmental technology, and thus Aso called for spending to promote greater use of solar panels in schools, homes, and businesses and the development of electric cars. The government will also ease the burden on local authorities for public works projects (i.e., greater central government spending), will promote the construction of a Tokyo ring road, and raise the level of subsidies to localities. He also alluded to medium-term tax reform that includes a consumption tax increase, prompting Nakagawa Hidenao to criticize the prime minister sharply for speaking of a tax increase as the economic outlook worsens. (Yosano Kaoru acknowledged in a TV appearance Saturday that as the government debates fundamental tax reform it needs to set a new target for balancing the budget now that 2011 is out of the question.)

The first thing that stands out is just how much Aso has lowered his sights since January. Recall that in January Aso insisted that he would make Japan the first country to escape the crisis. No longer. Now his government is merely trying to stave off complete collapse. Aso appears to have lost much of the optimism that characterized his response to the crisis earlier this year.

The question is whether this will be too much, too late, whether the fate of the economy rests in non-Japanese hands, making the government's plan a gambit to buy time in the hope of economic recovery elsewhere. It's an expensive gambit, and the DPJ should be concerned. If the government's salesmanship works, the massive stimulus package might be enough to convince the public that the LDP is steady and reliable in troubled times and deserves to be returned to office. And if the latest stimulus package fails, it will have the unintended consequence of leaving a new DPJ government facing an economy in freefall with its options even more limited on account of the additional debt the government will issue to pay for the stimulus package (which suggests that despite Yosano's desire for progress in the direction of tax reform, the LDP has every reason to wait until after an election to commit to a course of action — why should the LDP commit itself to a politically fraught policy when it could be the DPJ's problem in a matter of months?).

The uncomfortable question raised by this debate is whether the Japanese government is wholly powerless in the face of the worsening economy. Monetary tools? Limited. Fiscal policy? How many more stimulus packages can the government pass while waiting for recovery, ensuring that future generations of Japanese will bear an ever greater burden of paying for the current government's restless impotence?

April is the cruelest month

April is here, the new fiscal year has begun, and Prime Minister Aso Taro is in London for the G20 summit.

For once, he leaves behind a favorable domestic situation. After months of bad news, with his approval ratings skirting single digits, the press is full of reports about how Aso and DPJ President Ozawa Ichiro have traded places; Ozawa's leadership under threat from members of his own party, at the same time that LDP members have all but conceded that Aso will lead the LDP into the next election.

The prime minister should not be too cheerful, despite the early arrival of cherry blossoms and the bump in the polls.

First, as Claus Vistesen notes at considerable length, the best one can say about the Japanese economy is "while indicators are still on the decline they are now declining less rapidly." The great adjustment is under way. The pain continues to be felt among Japan's irregular workers, as 192,061 have already been laid off in the period beginning in October 2008 and continuing until June, compared with 12,502 regular employees who were laid off by April. The unemployment rate rose to 4.4%, and not surprisingly the number of new hires has dropped off substantially. 4.4%, then, is only the beginning. Is Japan facing its second lost generation in as many decades, another generation with all too many members unable to access the regular labor force? Presumably there will be more opportunities for mid-career hires when the economy recovers — surely Japan learned something from the lost decade — but in the meantime I wonder whether there will be political consequences for the burden carried by irregular employees. Can the LDP really win reelection under such circumstances?

The economic collapse is dire enough, but the malaise in which the public is mired may have even more lasting consequences. I was going to say crisis of confidence, but I think it's bigger than that: the public appears to be exhausted, fed up with leaders who appear to be powerless to stop the deterioration of the Japanese economy and indifferent to public concerns. The latest indication of the public's wearyness comes in a new cabinet office poll concerning "social consciousness." Reflecting the recent Asahi poll on political attitudes, 80.7% of respondents said national policy either does not really reflect the popular will or does not reflect the popular will at all, a five-point increase on the previous cabinet poll on this matter. The responses when asked how to fix this problem were mixed, with a plurality of 27.5% blaming the politicians for not listening sufficiently to the voice of the people, 18.8% suggesting that the people need to take a greater interest in policy. When asked what they think is going well in contemporary Japan, only technology (28.1%) ranked higher than the "nothing/don't know" response "(25.4%), although the 28.1% for technology marked an increase from 21.2%. Meanwhile, the negatives were consistent with the state of the economy: 68.6% of respondents saw economic growth as a problem, up from 43.4%; 57.5% saw employment and working conditions as a problem, up from 31.1%; and 42.9% saw national finances as a problem, up from 37.5%.

Perhaps the public is overreacting to the economic crisis, their imaginations stirred by bleak media coverage. But I suspect that might be optimistic. Something tells me Japanese households know precisely how bad things are. As the above figures suggest, the economic crisis has only deepened preexisting malaise and a sense of detachment felt by the governed regarding their government. Maybe Jesper Koll, borrowing the prime minister's message about Japan's latent power, is right to be bullish on Japan. Koll presents a range of statistics about Japanese R & D spending and patents to suggest that Japan is poised to emerge from the global financial crisis a technology superpower, that its people — again, channeling Prime Minister Aso — "possess a basic power and discipline that build a strong foundation for future recovery." He is convinced that the crisis is accelerating generational change in Japan and that it "thrives in times of hardship and global turmoil."

But for all the technological developments praised by Koll, Japanese households — "balance sheets are very strong, since Japan's deleveraging already happened during the 1990s" — still remain reluctant to invest their hoard (which recently took a sizeable blow). Koll assumes that generational change will be enough to solve the paradox of thrift, but he has little to support this assertion other than an intangible sense that companies are looking to the future. Notably absent from Koll's account is any mention of demographics, which, incidentally, are central to Vistesen's treatment of the economic crisis. "Japan," Vistesen argues, "does suffer from a a chronic lack of domestic demand and consumption and it does so exactly because relying on consumption with the current demographic profile is not viable." If anything, the demographics will only worsen as a result of the latest economic crisis, as more Japanese decide to postpone, perhaps indefinitely, marriage and childrearing.

Indeed, given the findings of the March Tankan, the worst on record, it is hard to see the basis for Koll's optimism. The survey did find large manufacturers optimistic about conditions three years ahead, but that is surely overwhelmed by short- to medium-term pessism in nearly every other category, and by the deepening gloom felt by the Japanese people. Far from "rediscovering...capitalist roots," the Japanese people appear to want nothing more than to be shielded from capitalism through more robust job protection and social security. They appear no more eager to risk their savings than at any point during the past twenty years. It is too early to say what precisely the intellectual consequences of the global financial crisis will be, but in Japan it seems that what public support existed for "neo-liberal" reforms has dried up. It might return with economic recovery, but it is unclear how that will happen — if the Japanese people cannot be convinced of the necessity of reform during a "once-in-a-century" crisis, how will they be convinced once times are good again?

The one category of reforms that enjoys public approval continues to be administrative reform, because the bureaucrats remain about as popular as the politicians. Little wonder that this year's election is shaping up to be an administrative reform election. The DPJ has, for obvious reasons, made the case that regime change will be the basis for sweeping changes in how Japan is governed. Now the Aso government has answered with its own administrative reform plans.

On Tuesday, after a prolonged battle the cabinet approved the government's plan for administrative reform, which includes the creation of a cabinet personnel agency that will be responsible for appointing the top officials in ministries and agencies in the hope of combating administrative stovepiping.

The cabinet decision, however, by no means guarantees that the government will get its way: Ozawa has dismissed the plan as mere windowdressing on an administration that will be left fundamentally unchanged, while Jiji quotes an LDP member "with experience as administrative reform minister" as warning of dissatisfaction within the LDP over the bill, not to mention opposition from the bureaucracy itself, especially the National Personnel Authority. Given the government's focus on another stimulus package, will it fight for this bill? DPJ opposition might be useful for the government, if it can paint the DPJ with the dubious label of being opposed to reform outright, but plenty of LDP members might be happy to see the bill die.

And thus while I understand Jesper Koll's desire to question the conventional wisdom, the unpleasant reality is that things are set to get worse in Japan before they get better. There is a degree of unpredictability going forward, not least in the political situation, but even the best-case scenarios suggest that Japan will be struggling with domestic problems for years to come. Even the election of a DPJ government — should it occur — will only be the beginning of the process of addressing the many challenges facing Japan.

Japan loves risk (Noah Smith)

In the past year, Japan's exports fell 45.7%. Exports to all regions were hit - down 52% to America, 45% to China, and 46.7% to Asia as a whole. Japan's mighty national champions, its automakers, have been hit the worst: Toyota's exports are off 56.2%, Honda's 46.3%, Nissan's 62.1%.

That's absolutely stunning. It is catastrophic. Words fail.

What this should demonstrate conclusively is that world economies are much more tightly linked than many economists had thought. The "decoupling" hypothesis — the idea that booming Asia could keep chugging along while America and Europe fell — has been decisively smashed (subscription required), at least in the short run.

(As an aside for the more technically minded, the "decoupling" idea rested on the same faulty assumption as the bubble in American mortgage-backed assets, namely the assumption of constant correlation. When times are good, they are unevenly good, so correlations are low and economies appear to be decoupled, but as soon as things turn bad everyone falls together and correlations shoot up.)

In any case, what does this mean for Japan? It means that being a "surplus" country has proven to be just as risky, if not more so, than being a "deficit" country. Relying on exports exposes you to big shock and wild swings. The myth that Japan, as a nation or as a people, is more risk averse than other countries should thus be exposed as the outdated stereotype that it is. Over-reliance on exports, as it turns out, is similar to playing roulette. For the LDP, it may very well have been Russian roulette.

The last time the dice came up snake-eyes for exporters was a very long time ago — the 70s, in fact. But Japan was still a fast-growing country then, still playing catch-up to the West in technology and capital. Japan responded to the world recessions of the 70s by moving up the value chain, developing global brands and launching headlong into high-tech industries like autos, electronics, and machine tools. The recession was sharp but brief, the party quickly resumed, and the LDP lived on.

Today, that scenario is more likely to befall China than Japan. The record of the last two decades should decisively show that Japan is a fully developed country — it has hit the frontiers of technology and capital. There is no more low-hanging fruit. And that means that recessions are much more likely now to expose the structural flaws in the Japanese economy...of which there are, sadly, still many.

After the LDP goes, the DPJ will have two basic choices: fix structural flaws (the Bill Clinton approach), or encourage bubbles (the George W. Bush approach). I'd advise leaning heavily on the first approach, of course, but the problem is that structural flaws are often politically motivated. Powerful construction, agriculture, and small- and medium-sized business lobbies will use recessions as an excuse to delay reform, and booms as an excuse to ignore the need for reform. Without electoral reform that decreases the clout of these lobbies, the DPJ may find itself forced to turn to more dubious strategies of economic revival.

Whatever happens, though, let no one in Japan now doubt that export dependence is a very high-risk strategy for any nation.

— Noah Smith

The long and short of it (Noah Smith)

Gerald Curtis's article in the Financial Times deserves a response from me as well. The short version of my response is that I agree with Tobias: the fact that the DPJ will not be able to avert a depression is not sufficient reason to write them off.

The longer version is this: Curtis is right when he says that "whatever the political goings-on, there is no optimistic short-term scenario for Japan." But he is wrong to blame that fact on Japan's current political mess. With international demand collapsing and public debt at well over 100% of GDP, Japan's government is essentially unarmed. Were Japan led by a triumvirate of FDR, the Meiji emperor, and Yoda, there would still be next to nothing the government could do to stave off a steep drop in exports, and thus investment, and thus GDP.

This does not mean, however, government action is unimportant. Keynes may have said that "In the long run, we are all dead," but we should be thankful that leaders in his day did not take that to heart. I may be a short-run pessimist on Japan, but I'm a long-run optimist and a medium-run agnostic. In the medium and long run, government will be the key to Japan's performance.

What can be done to boost Japan's performance three or four years from now? By my count, at least two big things. The first is free trade. As soon as worldwide demand begins to recover, Japan could get the jump on rivals like South Korea and Taiwan by signing real — not cosmetic — free trade agreements with Asia, Europe, and the US. And a lowering of food prices would instantly boost Japan's real per-capita GDP without Toyota having to sell one more Prius.

The second is to get more women into the workforce - and fast. Ken Worsley notes that women, who make up half of the labor force in the West, comprise only 40% in Japan. This means that Japan's labor force participation rate is much lower than America's. Although not measured in the low official unemployment rate — stay-at-home women are more likely to say they "don't want to work" than that they "can't find a job" — Japanese women's de facto status as a quiet economic underclass represents a huge loss in national output. A big push by METI to encourage companies to hire more women, coupled with an expansion of day care, could work wonders when the depresion runs out of steam.

Will the DPJ do these things if it is elected? Your guess is as good as mine. But then there is the long run.

Economists believe that national crises — wars and depressions — represent opportunities in disguise, for it is only during these fluid times that nations can change their basic institutions. This is evident when we look at America in the Great Depression. FDR's stimulus spending may or may not have made things better — the debate continues to this day — but few would deny the long-term importance of Social Security and the FDIC. Japan's next group of leaders will be offered a similar chance.

The three institutions that must urgently need changing are, of course, the bureaucracy, corporate governance, and fiscal mechanisms. The DPJ proposes to shake up the cozy, stifling relationship that has turned all three of these institutions into pipelines for waste, pork, protection and inefficiency.

Imagine if this had been done a decade ago. If Japan had not thrown trillions upon trillions of yen at constuction companies, it might have the fiscal ammunition to fight today's slump. If inefficient companies had not been sheltered from harm, Japan might not have built up the overcapacity that is making its current depression even deeper. Women would be working more and labor markets would be more flexible. Yet nothing was done, two decades passed, and, pace Keynes, most of us are still alive to face the consequences.

This is why I agree with Tobias. If the DPJ did nothing except reform Japan's central institutions — if it utterly ignored the medium-term — that would still lead to an incalculable improvement ten or fifteen years down the road. To throw up one's hands, as Gerald Curtis does, is to encourage a false sense of helplessness. Which, in a sense, is the only thing we have to fear.

- Noah Smith

The can kicks back (Noah Smith)

In my earlier post, I stated that Japan's current-account surplus can vanish in one of two ways: either Japan can consume more (which it won't because of debt and demographics), or it can (over)produce less. That is true. But when the adjustment happens is not set in stone.

A casual observer might think that Nakagawa Shoichi's speech condemning protectionism might sound a little hypocritical, coming as it does on the same day that he threatened to intervene in currency markets to weaken the yen. But from the perspective of very-short-term Japanese national interests, the policies are complementary: the only way to stave off the day of reckoning I described earlier is to pump up exports. Naturally, that will only make the adjustment more painful when it happens, but given current electoral politics one could understand why the LDP isn't exactly planning for the long term. Instead of letting Japan take its lumps now and planning for a brighter future, it seems fairly certain that the LDP will fall back on the old "developing-country" export-promotion, and kick the can a few feet down the road.

But kicking the can carries another, little-mentioned risk. So far, American and British economists and executives have been holding the line against a rising protectionist tide, evoking the memory of "Smoot-Hawley" like a mantra. So far the line has held, as America's Democratic politicians have been too afraid to reach for the bazooka. But the consensus is badly fraying, with Paul Krugman saying he can see the case for "Buy American" provisions in America's stimulus bill. The monster is straining the bars of its cage. And if America's ire is ever roused against Japanese currency manipulation, the US will be far quicker to act than it has been against China; after all, US multinationals do not have their factories in Japan.

No one knows how much a modern-day round of "Japan bashing" would hurt Japan's economic model, but I suspect it would be more severe than nearly anyone can imagine. Japan's much-discussed "dual economy" relies on a compact in which the bureaucracy distributes the rents from world-beating export industries to a host of less efficient domestic industries and small businesses. In the 70s and 80s those rents came from the superior operational efficiency of Japan's auto, electronics, and machine-tool champions; in the mid-2000s they came from the costs saved when those champions moved their operations to China. If America closes its doors to Japanese imports, those rents will vanish and the compact will be broken.

So a best-case scenario for the LDP's kick-the-can strategy is a delayed, more-painful adjustment in maybe three or five years. A worst-case scenario is that American protecionism rises from the dead and smashes Japan's economic model like the hammer of a vengeful god.

In choosing to run the dreadful risk of delaying Japan's day of reckoning, the LDP has proven what many of us always knew — that it represents only a subset of the Japanese people, all its claims to the contrary.

- Noah Smith

A twenty years' crisis

"Japan is an economy that is almost certainly producing well below its productive capacity - that is, the immediate problem facing Japan is one of demand, not supply. And it gives every appearance of being in a liquidity trap - that is, conventional monetary policy appears to have been pushed to its limits, yet the economy remains depressed. What can be done?"

So wrote Paul Krugman in his 1998 analysis of Japan's prolonged economic crisis, in which he argued that to escape its liquidity trap, it was necessary for "the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs."

Four years later, then-Fed governor Ben Bernanke, in his noteworthy speech on deflation, echoed Krugman, arguing "We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation" — but then concluded that Japan's prolonged crisis was not the result of ineffective monetary policy but reluctance on the part of political actors to implement structural reforms, reforms that, Krugman argued, may be necessary but would do little to "induce people to spend more."

A decade after Krugman, Japanese authorities are once again stuck trying to stimulate aggregate demand.

Economist Ikeda Nobuo, in considering Japan's sluggish aggregate demand, concludes, like Bernanke, that the high liquidity preference of Japanese households — nearly half of Japanese household assets are held in cash or low-risk, low-return bank accounts — is a response to inefficient Japanese companies. Pessimistic that the Japanese government is capable of stimulating Japanese demand in the absence of foreign demand for Japanese goods, Ikeda concludes that the lost decade never ended: Japan is in the midst of a "lost twenty years."

A group of fifteen LDP lawmakers, however, has decided to embrace Krugman's solution, calling for the government to run the printing presses, expanding the money supply by 50,000 billion yen independently of the Bank of Japan in order to finance further economic stimulus. The "Diet Members League to consider the issuance of interest-free government bonds and government money" will hold its first meeting on Tuesday, with upper house member Tamura Kotaro chairing. Former finance ministry official Takahashi Yoichi will address the inaugural meeting.

The group's motto is essentially "desperate times call for desperate measures." Acknowledging that running the presses has positive and negative consequences, the group believes that the economic situation is sufficiently dire to merit the risk of hyperinflation. Quoted in an FT article, Mr. Tamura clearly has read his Krugman: "We are facing hyper-deflation, so we need a policy to create hyper-inflation. We have to do something to undermine the central bank and government’s credibility or else we won’t be able to halt the yen’s rise. So, while we know this is drastic medicine, we will do it."

The new study group has drawn the opposition of senior LDP and cabinet officials. Yosano Kaoru, minister without portfolio for economic and fiscal policy, suggested that the government should issue more bonds instead of printing currency. Shirakawa Masaaki, president of the BOJ, insisted that the policy would do precisely what its proponents intend, namely undermine the credibility of his bank and the health of the currency. The heads of the LDP's factions were equally critical of the proposal, with Tsushima Yuji, the eponymous head of the Tsushima faction, likening the proposal to the enten ponzi scheme.

In other words, this is yet another policy upon which the LDP is divided and unsure of how to proceed, yet another sign of the governing party's flailing about in hope of finding some way to save itself (and Japan).

Not being an economist, I cannot say whether this group's proposal is appropriate. After years of weak domestic aggregate demand, it may be that only drastic inflation may be the only way to make Japanese spend at home — or demand less liquid assets with higher returns — no matter how politically risky it is for the LDP. Pensioners, already angry at the government, will presumably be no less angry as they watch inflation erode their fixed incomes.

But however appropriate the inflationary proposal, it may be beyond the power of the Aso government to implement. Whatever legitimacy the LDP-Komeito government had is now in tatters. The prime minister's latest misstep is to call for the revision of the postal privatization scheme, the very basis of the government's parliamentary supermajority. Mr. Aso questioned whether it is appropriate to divide the postal system into four companies, and stated that now is the time to revise the privatization scheme. He blithely stated that this position is wholly unrelated to the 2005 election that gave the government its mandate. Public opinion may have changed since 2005, but to backtrack now makes a mockery of democratic legitimation. If the government wants to revert from a policy that was critical to returning the coalition to power, it should have to go to the people and ask for approval to change course. (Nakagawa Hidenao made this argument at his blog, as did DPJ member Nagashima Akihisa.)

Naturally LDP proponents of postal reform have been quick to criticize the prime minister for his naked appeal to find some issue that will rescue his sinking government. (It bears noting that Mr. Aso has spoken of preserving the quality of postal services, a major concern of the public when it comes to privatization.) Koizumi confidante Takebe Tsutomu was perhaps the most succinct in his criticism: "What nonsense! I wish he would be more discrete in his speech."

In short, the prime minister is gradually losing whatever ability he has to rally his party and the public to an agenda. He is incapable of setting priorities or taking decisive action. The halls of power echo with rumors of plots to unseat him.

It is unlikely that this shiftless prime minister is capable of deciding on so risky and decisive a policy as proposed by the new league.

This prime minister, his party, and his government are bereft of authority and legitimacy — and they appear determined to drag Japan into the abyss with them.

As MTC so eloquently observes, hopefully Secretary Clinton will take heed of the stench of decay when she visits Japan later this month.

Aso calls for a new Japan

Prime Minister Aso Taro, having had his second stimulus package pass the Diet Tuesday, appeared before the Diet on Wednesday to deliver his latest policy address.

Rhetorically, the address contains few surprises. In the opening sections, in which Mr. Aso addressed the principles behind his policies. He spoke of the "once in a century economic crisis" (although he omitted the phrase "emanating from America"). In discussing the work of building a new society and overcome Japan's third major crisis in the past two centuries, he once again stressed the importance of the virtue of industry, of hard work. To ensure Japan's continuing prosperity, he said, "It is necessary to build a society in which hard work is rewarded, a society in which senior citizens, the handicapped, and women find it easy to work." The fact that he needs to group women with the elderly and the handicapped when talking about remaking the Japanese labor force speaks volumes, doesn't it? As before, when Mr. Aso speaks of the elderly working, he speaks of it as a virtue, as opposed to something that should be kept to a minimum. Once again he gives the impression of a coach giving a pep talk to the Japanese people instead of a leader who understands the hardships his people are facing today. And as the Japanese press has noted, Mr. Aso has joined in the anti-capitalism boom, marking an "about-face from the Koizumi structural reforms." (Of course, such talk assumes that the LDP has not already moved away from Mr. Koizumi's agenda, which it clearly has.)

After explaining his principles, Mr. Aso addressed policy specifics, making the case for a three-stage process in making his new Japan. Step one is short-term economic stimulus, as contained in the two 2008 supplementary budgets and the 2009 budget to come. Far from saving Japan, however, the measures come across more as treading water in the midst of a tsunami than as a carefully designed plan to make up for lost foreign consumption. Japan's fate may depend more on what's happening in Washington than on what's happening in Tokyo.

Having explained the government's stimulus plans, Mr. Aso proceeded to the next phase, the medium-term phase in which the Japanese government is to set its fiscal house in order. This phase entails both the introduction of a consumption tax increase from 2011 — depending on the health of the economy — and cutting waste by lowering expenditures on public corporations and cutting the number of bureaucrats. In a single line Mr. Aso also promised to shift all of the road construction special fund into the general fund, a policy question that readers will recall wore down Prime Minister Fukuda's resolve in spring 2008. He also promised to accelerate decentralization.

Finally, the medium- to long-term phase of Mr. Aso's vision calls for a "new growth strategy." At the heart of this plan is the creation of a world-leading "low carbon society." He also calls for Japan's becoming a world leader in medical care for the elderly and rebranding Japan as a country with beautiful countryside, world-famous pop culture and fashion, and delicious, safe food. Connected to this, he promised to introduce a bill during the current Diet session that will trigger the Heisei agricultural reform, with the goal of raising Japan's self-sufficiency in food production. Mr. Aso's plan calls for a shift from "ownership" to "use" of agricultural land. He also wants greater use of rice-based products and more production of wheat and soya.

Mr. Aso also promised to remake the Japanese welfare state, starting with the pensions system. He apologized for the still-unresolved pensions scandal while stating that the government is making steady progress in cleaning up the mess. He addressed concerns about the declining quality of medical care, promising an increase of doctors working in the public service. Near the end of the speech, he actually mentioned education reform, which may be the most important piece of any effort to rejuvenate the Japanese economy and implement a "new growth strategy." Mr. Aso celebrated the introduction from April 2009 of a ten-percent increase in the number of math and science classes and new restrictions on cell phones in schools, but he actually says very little in this section about reform to how Japan educates its children. After mentioning forthcoming changes, he devotes the rest of the education section to discussing the achievements of Japanese scientists and researchers. A serious plan for reforming Japanese economy and society would treat the education system as more than an afterthought.

Mr. Aso concluded the speech by discussing a three-pronged foreign policy based on the US-Japan alliance, relations with Japan's Asian neighbors, and the UN and other international organizations, in short an approach wholly consistent with Japan's foreign policy mainstream and not altogether different from the DPJ. Mr. Aso and Mr. Ozawa might emphasize different legs of the three-legged foreign policy, but the differences are less than meet the eye. Mr. Aso did speak at some length about cooperating internationally to promote freedom and prosperity and combat terror and piracy, but his appeal lacked the same spirit that his calls to promote an arc of freedom and prosperity once had.

Bringing his speech to a close, Mr. Aso took a swipe at the DPJ for slowing down the political process and dismissed the talk of pessismists, who he says ought to look back and see how Japan rebuilt itself after the war into the very model of a high-tech, culturally attractive society.

There is very little of note in this speech. After mentioning the need to make it easier for women to work (see above), Mr. Aso offers few specifics for how to equalize the Japanese workplace. He has no real solutions to reversing demographic decline. Education reform is given a passing mention. While Mr. Aso is right to emphasize the "rebranding" of Japan, starting in stagnant rural areas, he says very little about how this transformation will actually be achieved. As is typical of these policy speeches, the connection between policy inputs and the desired outcomes is more often assumed than explicitly demonstrated.

Mr. Aso seemed more willing to acknowledge the extent of the economic collapse facing Japan today, but he also seemed as defiantly optimistic as ever, convinced of Japan's ability to overcome all challenges.

It is possible, however, that the current crisis may be too much for Mr. Aso and his weary LDP.

Tax rebellion averted?

The LDP appears to have forged a truce in the incipient war over writing the timing of a consumption tax increase into law.

In the best LDP tradition, the LDP leadership has decided to muddle the message of the bill. The LDP has produced a draft with language that calls for implementing "essential legislative measures by 2011" for fundamental tax reform including the consumption tax, but also adds that the precise timing of said measures will depend on "the state of the process of economic recovery and an examination of trends in the global economy." The draft also calls for a two-stage increase of the consumption tax. Finally, it included language designed to appease the potential rebels by calling for appropriate measures to promote administrative reform and eliminate wasteful spending.

The LDP leadership hopes to secure a cabinet decision on the draft by Friday.

Amazingly, these minor edits appear to be sufficient to quell the discontent among the LDP's reformists. Said Nakagawa Hidenao in response to the additions: "The supplementary provisions cannot be said to be a tax increase bill; they are nothing more than instructional provisions." His fellow malcontent, Yamamoto Ichita, is less impressed with the compromise.

"Anywhere you look in the world," he writes, "there are no governments saying things like, 'Depending on the situation we will raise taxes after three years.'" He believes that far from being "merely instructional," the plan will appear to the public as a solid commitment to a tax increase, a tax increase that Mr. Yamamoto does not deny may one day be necessary but argues that for now is political and economic folly to discuss.

The compromise may be a way for the tax hikers to create a foothold; if the LDP somehow survives this year's general election and if the reformists are diminished by the returns, they now have a basis for going forward with a firmer commitment. Instructions now, substance later.

For the same reason, I wonder whether the Japanese press is declaring a truce in the tax rebellion prematurely. Mr. Yamamoto's response does not sound like someone who is content with the party's compromise — and I'm sure he's not alone. It may be that the rest of the reformists do not share Mr. Nakagawa's desire to accommodate the party.

Meanwhile, I think I am with Kono Taro on this debate. At his blog, Mr. Kono muses on the growing severity of the downturn and wonders why the LDP is wasting its time on whether to hike the consumption tax in 2011 — a time at which, he notes, the LDP may not even be the ruling party — when sales are falling, company debt is growing, credit is freezing, and manufacturing is shrieking to a halt. He assumes that another stimulus package will be unavoidable, and that the LDP should be doing all it can to stop the bleeding instead of debating whether to raise taxes once the economy recovers.

The conservatives humbled

Perhaps one of the positive consequences of Japan's economic crisis is that it has silenced Japan's conservatives.

By silenced I do not mean literally silenced — they're still fulminating. What I mean is that they have been rendered irrelevant by events. Despite their media power, their ability to churn out a seemingly infinite amount of books, magazine articles, and op-eds, it turns out that they have remarkably little to say about Japan's economic problems. Former Prime Minister Abe Shinzo is indeed the conservative poster child in this respect: eager to flaunt a rising Japan and its newfound powers, he was almost completely indifferent to the hard work of remaking the Japanese system.

But it is not just the economic crisis that has silenced the conservatives. It is the marriage of the LDP and Aso Taro, one of their own, that has been responsible for quieting the conservatives. The conservatives, with Mr. Aso as prime minister, Nakagawa Shoichi as finance minister, Amari Akira as administrative reform minister, and Hatoyama Kunio as general affairs minister, are now responsible for what happens to Japan in the coming months and years. The fate of the modern conservative movement — which has enjoyed a meteoric rise over the past two decades — is now tied to the LDP and the Aso government. Of course, it is for this reason that Hiranuma Takeo's quixotic quest to create a new conservative party (yes, he's still at it, although now the plan is to create a party after the general election) is so foolish. Japan already has a conservative party, and it is drowning as (in Mr. Aso's words) the "tsunami" of the global financial crisis washes over Japan.

What I am not saying is that the conservatives are vanquished evermore. They still have considerable power and their ideas appeal to a sizable minority. What I'm saying is simply that events have rendered the conservative movement irrelevant to the policy debate. It is little surprise that Mr. Abe has attempted to carve out a middle ground in the LDP's tax debate — Mr. Abe and his compatriots barely have a position on the issue to advance.

All of this is a way to introduce this stemwinder by Sakurai Yoshiko.

Published in the January 15th issue of Shukan Shincho, the title says it all: "In the Sino-Japanese War, China had more fighting spirit than Japan."

The essay is the latest attempt to rewrite the history of World War II along terms that exculpate Japan and pin blame for the war on China (and communism). Actually, not only does she pin the second Sino-Japanese war on the Cominform, she finds a new, somewhat surprisingly culprit in the widening war: the Nazi Party, which she blames for providing military assistance to Chiang Kai-shek during the 1930s. In other words, Ms. Sakurai blames any outside power that enhanced the ability of Chinese forces to resist Japan for widening the Sino-Japanese war, instead of blaming the military that was invading China, as if the Chinese people were just supposed to accept the advance of the Imperial Military passively.

I don't want to get bogged down in the history, because the conservative obsession with history is precisely the problem. The conservatives are so obsessed with making the case for the Pacific/Great East Asian War as a just war that they have nothing relevant to say about the many problems facing the Japanese people today.

As such, the more the conservatives are ignored, the better. Japan and the world have too many problems to be consumed with fighting old wars and nursing old hatreds, while looking to stir up new ones. This is, to some extent, the message of President Obama's inaugural address: "...an end to the petty grievances and false promises, the recriminations and worn out dogmas, that for far too long have strangled our politics." He was talking about American politics, but he might as well have been talking about the history problem in East Asia.

Obama says what Aso can't

The impression I got from watching President Barack Obama's inaugural address is that he is acutely aware of the burden that has now fallen upon his shoulders.

But I also think that in this address he accomplishes what Prime Minister Aso Taro has thus far failed to do. He does not hesitate to state his appreciation of the darkness of the hour, but that does not stop him from maintaining that the United States can and will overcome its problems and emerge stronger for it. In his remarks Mr. Aso hurries through the first part to give vague assurances of a speedy recovery.

As President Obama said:

Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age. Homes have been lost; jobs shed; businesses shuttered. Our health care is too costly; our schools fail too many; and each day brings further evidence that the ways we use energy strengthen our adversaries and threaten our planet.

These are the indicators of crisis, subject to data and statistics. Less measurable but no less profound is a sapping of confidence across our land - a nagging fear that America's decline is inevitable, and that the next generation must lower its sights.

Today I say to you that the challenges we face are real. They are serious and they are many. They will not be met easily or in a short span of time. But know this, America - they will be met.

Omission vs. commission (Noah Smith)

There's been some discussion on this blog about how much responsibility the LDP bears for Japan's current economic woes. Has Japan been helplessly swept up in a crisis of America's making? Or did LDP policies leave Japan more vulnerable than necessary to the storms sweeping the global economy?

The answer, as I see it, is "both." To understand exactly where the LDP's faults lie, it's important to understand the multiple channels through which global economic crises spread.

One channel of contagion is the financial channel; falling demand for assets in one part of the world reduces the price of those assets, which causes capital losses to financial institutions in other parts of the world. In the current crisis, those assets are U.S. mortgages, mortgage-backed securities, CDOs, CDSs, asset-backed commercial paper, and other various debt-related securitized products. And, remarkably, Japan's financial institutions have relatively little exposure to these products — much less exposure, in fact, than any other large rich country.

In other words, Japan dodged a huge bullet. If Japanese banks, hungry for profits after years of capital rebuilding, had jumped into US debt and derivatives markets as European banks did, Japan would now be facing a financial meltdown to rival 1990. The fact that Japanese banks didn't jump on the bandwagon is a huge coup. It's unclear how much, if any, of the credit for this goes to the LDP. A lot of it is simple luck and timing.

The Japanese economy, however, has still been hit hard, through the second channel of contagion: exports. Japan remains an export-dependent economy, one that is still structurally weak in many ways. How much of the blame does the LDP take for that? A lot, I would argue.

Many have noted that Japan's export dependence is a result of sluggish consumption growth during the Koizumi years, a weakness that continues today; the reason for that sluggish growth is less discussed. One reason is the demographic transition; Japan's market size relative to the world economy has shrunk. Whether the LDP deserves the blame for that is the subject of the ongoing debate about fertility.

A second reason for sluggish consumption growth is stagnant wages. Globalization takes part of the blame for that, but much of the effect is due to shifts in the labor market. As Japan's baby boomer men retire, many have been replaced not by full-time workers with lifetime employment guarantees and seniority-based wages, but by low-paid, insecure temporary workers. That helped Japan's companies cut costs, but it put a huge damper on consumption, because generational turnover has made mean wages fall automatically.

I blame the LDP not for allowing the rise of temp workers, but for encouraging the creation of a two-tiered employment system in the first place. Baby boomer salarymen, with their secure jobs and non-performance-based wages, were and are getting paid more en masse than their productivity justified. Which means younger generations are getting paid less than their productivity justifies. That's made Japan less efficient, and left it more exposed to an export slump than it might have been.

The LDP has done other things over the years that had the effect of suppressing Japanese consumption — nontariff trade barriers, restrictions on FDI, inadequate antitrust enforcement, etc. And of course, there were all the mistakes of the Bubble Era, which have left Japan's companies (and therefore domestic investment) in a weak position to this very day. The LDP should have been banished in 1993, giving opposition parties the chance to reform the bureaucracy and other broken institutions. Fifteen years of reform could have left Japan stronger in 2008, but that ship has sailed.

To sum up: Japan's lack of direct exposure to America's financial crisis offered it a golden opportunity to come out of the world recession with a head start on every other economy in the world. But because of decades of LDP failure to address other problems in the economy — sins of omission and commission — Japan missed that opportunity, and must suffer alongside everybody else.

The next key question is: Would the DPJ do better? Going by Ozawa's promises, I'd conclude that in the short term it would not. Japan's best hope now is for the long term - embarking now on a path of institutional reforms will make Japan much stronger ten or fifteen years in the future. Better late than never, I say.

— Noah Smith

Mr. Aso's unbearable optimism

In his book Totetsumonai Nihon (2007), Aso Taro outlined an approach to governing Japan that amounts to a pep talk for the dispirited Japanese people.

Time and time again, Mr. Aso suggests that the key to saving Japan is for its people to rediscover and celebrate their "latent power," to look cheerfully to the future, and to accentuate the positive.

The best example of this may be his chapter on aging society, in which he calls for a new respect for the aged and permitting those who want to work to continue to do so. As an aside, does Japan really have a problem of elderly would-be workers being denied their opportunity to do so? And does Japan really want to be forced to rely on elderly workers?

In any case, Mr. Aso has once again shown his boundless optimism, bordering on the delusional, in his New Year's message.

Mr. Aso opened his remarks by praising the Japanese people for overcoming the slump that followed the bursting of the bubble. If it weren't for the "what is said to be a once in a century global financial and economic crisis emanating from America," he suggests, Japan would not be facing a crisis once again. In response the global crisis, Mr. Aso promised that his government would do everything in its power to make Japan the fastest country in the world to escape the global recession. As Ken Worsley notes, Mr. Aso neglected to provide any specifics for how he intends to meet this goal.

This is the point at which optimism turns into self-delusion. I say self-delusion because I don't think the Japanese people are fooled by Mr. Aso's promises.

The Japanese people know better than their prime minister that they did not in fact accomplish the feat of overcoming the bubble economy — Japanese firms were spared by growth in the US and China, but Japanese consumers did not see enough of the windfall to provide the Japanese economy with a stable foundation to weather a crisis. Contrary to Japan's being dragged into a "once-in-a-century" (there's that phrase again) global crisis despite having escaped its earlier downturn, Japan's latest crisis is the direct consequence of having failed to fix the Japanese economy. Despite the "longest postwar boom" — another phrase commonly heard from government officials in recent years — it appears that the boom did not to put Japan on surer footing.

The Japanese people do not need to be told this. They're fully aware that something is rotten in Japan, or else they would have been spending more. The last thing they need is a pep talk from the prime minister. But that's what he gave them in this speech. After promising to be the first country to escape the recession, Mr. Aso proceeds to remind the public of Japan's successful responses to bakumatsu and the occupation, and urges his audience to believe in Japan's "latent power."

I understand that optimism sells, that no politician wants to be seen as simply a bearer of ill tidings. But there is surely a middle ground between selling optimism and hope and peddling delusions. Franklin Delano Roosevelt, for example, managed the trick. In his first inaugural address, he diagnosed the problem facing the United States in clear, stark terms, and offered a way forward in terms no less stark. He also had a message for Mr. Aso: "Only a foolish optimist can deny the dark realities of the moment."

Mr. Aso should focus a bit more on the dark realities of the moment — and offer some more precise proposals for how he intends to escape them — instead of simply encouraging the Japanese people to believe in themselves and work harder, while denying the underlying causes of the current crisis.

Endgame

As 2008 enters its final week, the LDP and Aso Taro, its beleaguered head, are being written off as doomed in the year to come.

No one, it seems, is willing to offer an explanation for how the LDP can save itself in a general election. The LDP may yet win the general election, but its fate is out of its hands.

Some are starting to measure the LDP's coffin, so to speak. AERA, a weekly magazine, notes that Yamada Shinya, an elections forecaster, has predicted that the DPJ will win 230 seats to the LDP's 191 seats. Mr. Yamada foresees sluggish turnout and notes the importance of the change in the Communist Party's election strategy — nothing too different from my own assumptions about the next election. (I have started — and hope to finish — my own analysis and predictions for the 300 single-member districts.)

In the meantime, Mr. Aso's situation continues to worsen. The latest blow to his government is a dispute with Komeito. Last week Koga Makoto, the LDP's chief elections strategist, noted that it was strange that the LDP would tell supporters to vote for the LDP in single-member districts and Komeito for proportional representation seats, a statement interpreted as a hint that the LDP is reconsidering the terms of its electoral partnership with Komeito. Mr. Koga was quick to reassure Komeito that the LDP remains committed to working with Komeito to win a majority for the coalition — the LDP can hardly afford to do otherwise, given the support Komeito is said to provide for LDP candidates. Komeito head Ota Akihiro was dissatisfied enough with Mr. Koga to call for an apology. The question now is whether LDP candidates will receive the support from Komeito that they have received in the past. Will Komeito voters continue to be loyal to their party or will they stay home or vote against LDP candidates in a general election? Along with the JCP question, the Komeito vote is of course an important variable in determining whether the LDP will be returned to power.

Of course, events may render all of these factors irrelevant in a general election. If the bottom continues to fall out of the Japanese economy — Japan Economy Watch and Ken Worsley's Japanese Economy News are essential sources for the bad news — it may simply be impossible for the LDP to reverse itself in time for a general election. The latest news is that in its monthly assessment of the Japanese economy, the government has determined that the economy has worsened (as opposed to weakened) for the first time since February 2002. There appears to be no end to the bad news. Little surprise that the prime minister's approval ratings may be headed into the single digits, having fallen to 16% in a recent Mainichi poll.

The most pressing question now is how long the government will wait before calling an election. Abe Shinzo, quickly becoming a younger version of Mori Yoshiro, has called for the election to be delayed until May at the earliest, until after the passage of the 2009 budget. I expect that Mr. Aso will wait until he has a budget in hand before going to the voters, although I do not expect the budget to make much of a difference. The Aso government and the LDP have simply been overwhelmed by problems: sluggish domestic demand, a shift to reliance on temporary and part-time workers, growing pensions and health care liabilities, an intolerable debt burden, stagnant regions, and so on. The economic crisis is only exacerbating these problems. The result is that the LDP is on the brink of collapse. The party has simply overwhelmed by a cascade of systemic failures. As Thomas Homer-Dixon, a political scientist at the University of Toronto wrote in The Upside of Down, "When a society has to confront a bunch of critical problems at the same time, it can't easily focus its resources on one and then move on to the others."

The LDP, trapped by previous decisions that created or exacerbated these problems, is unable to take a definitive step in any direction. This is the essence of the LDP's ongoing debate over tax reform and a consumption tax increase. The government needs more revenue to meet current and future liabilities without increasing the national debt; for a number of LDP members, most notably Yosano Kaoru, the economy minister, a consumption tax increase appears to be the answer to the government's problems. But passing a consumption tax — or even committing to a timeline for phasing in a consumption tax — is a thorny political problem that has involved tortuous negotiations within the LDP and between the LDP and Komeito. Facing an election and an economic crisis, Mr. Aso has been understandably reluctant to make a firm commitment to the timing of a consumption tax increase. A consumption tax increase may solve one problem, but it may exacerbate others (sluggish domestic demand, low growth, and perhaps growing social inequality, as a consumption tax increase would presumably hurt low-income Japanese most). Japan is ensnared in a web from which there is no easy escape.

Not surprisingly, a recent Yomiuri-Waseda poll found that the public more disappointed in the LDP than hopeful about the DPJ. Regime change alone will not cut Japan's Gordian knot. It is entirely plausible that a DPJ-led government will be equally stymied. But the public is at least willing to give the DPJ a chance, an entirely reasonable proposition given the LDP's record.

It may be, however, that Japan's problems are insoluble, and Japan still has a long way to fall. The greatest reason for pessimism may ultimately be that despite having experienced nearly two decades of stagnation, the establishment has yet to come up with any better ideas for organizing Japanese society. As a result, the global financial crisis, rather than providing an opportunity for Japan to take a leadership role, has paralyzed Japan. To return to Thomas Homer-Dixon, he argues that an essential quality for dealing with crises is a "prospective mind."

"We can't possibly flourish," he writes, "in a future filled with sharp nonlinearities and threshold effects — and, somewhat paradoxically, we can't hope to preserve at least some of what we hold dear — unless we're comfortable with change, surprise, and the essential transience of things, and unless we're open to radically new ways of thinking about our world and about the way we should lead our lives. We need to exercise our imaginations so that we can challenge the unchallengeable and conceive the inconceivable. Hunkering down, denying what's happening around us, and refusing to countenance anything more than incremental adjustments to our course are just about the worst things we can do."

Despite the best efforts of Koizumi Junichiro, I fear that this is precisely how the Japanese establishment has responded to the lost decade. Public debates are stale. Even minor change is watered down. Or as Yeats wrote, "The best lack all conviction, while the worst / Are full of passionate intensity." Watching the irresolution of the LDP's reformists, and the strength with which the LDP's old guard resisted any attempt to redirect gasoline tax revenue away from road construction earlier this year, I cannot help but think that Japan simply lacks the ability to adjust, that despite a history of making radical changes in the face of crises, the current crop of leaders is simply not up to the task. Perhaps as bad as things look today, they aren't nearly bad enough to force radical change — the decay of an economic system hardly compares to the threat of colonization and the blow of defeat and occupation. After all, despite the lost decade, Japan remained the world's second-largest economy, its companies respected globally. Perhaps Japan is more capable of responding to short, sharp shocks than to prolonged, barely visible social problems.

Of course, Japan is hardly alone. I was reading Thomas Homer-Dixon Sunday while waiting in Boston's Logan Airport, where the TV was tuned to CNN's Late Edition. Wolf Blitzer was struggling to moderate a discussion between Democratic Congressman Barney Frank and Republican Congressman Eric Cantor on the financial crisis. Congressman Cantor insisted that when apportioning blame for the crisis, Congress must bear much of it for encouraging risky lending, which is to say that it is not necessarily the market but the government that failed.

I can think of no better illustration of what Homer-Dixon calls "hunkering down, denying what's happening around us, and refusing to countenance anything more than incremental adjustments."