There has been remarkably little market reaction to Prime Minister Koizumi’s decision to call early elections for 11th September, following defeat of the postal reform bill. If anything the markets are moving in the opposite direction to what might have been expected: the Nikkei and yen are slightly stronger and bonds are slightly weaker. This suggests that, following the increasingly negative press coverage in recent days, defeat was largely priced in. But might it also just be calm before the storm?
At first sight at least, defeat of the bill is a double whammy for financial markets: it is a blow to the programme of economic reform, and has increased political uncertainty.
Starting with the economics, defeat of the postal reform bill is a disappointment, but not a disaster. The Koizumi administration has already achieved a great deal, including: reform of the public highway corporations; liberalisation of the energy and telecommunications sectors; improvements in labour market flexibility; and measures to facilitate corporate restructuring. Most visibly, the restructuring of the banks and measures to tackle bad debts have put the financial system on a much firmer footing.
Postal privatisation would have been the icing on the cake, helping to improve fiscal discipline (by taking away an easy source of cheap money) and accelerating the development of a more dynamic and market-orientated financial sector. Nonetheless the Koizumi plan was not the only way in which these objectives can be met. It was also so ambitious in scope that the timetable had to be spread over many years: privatisation would not have been completed until 2017. A more piecemeal approach might have a better chance of success.
One alternative would be to remove the subsidies and tax breaks enjoyed by postal savings and insurance, and allow greater competition to erode their dominant market positions. Another would be to privatise savings and insurance but leave mail delivery and the management of post offices in public hands: this would be politically less sensitive than privatising the lot in one go. These options remain feasible even after today’s events. Defeat of the Koizumi plan is therefore not necessarily the end of the road for postal privatisation, nor does it diminish the impact of the other economic reforms that have already been made. These reforms have delivered clear benefits and now have a momentum of their own.
Turning to the politics, the outcome of the elections on 11th September is unusually hard to predict. This uncertainty is an obvious worry for the markets. One big unknown is what will happen to the LDP. The leadership has said it will not support candidates who voted against the postal reform. This threat has increased the risk that the LDP will break up. What’s more, the leading opposition party, the Democratic Party of Japan (DPJ) is probably not yet strong enough to form a government on its own. This raises the prospect of an unsettling period of coalition building and policy paralysis.
Our initial thoughts are as follows. First, early elections are not necessarily a bad thing. The chances are that the LDP will lose the next general election in any event whenever it is held. Thus the real political uncertainty could be when this government will fall, not if: getting that uncertainty out of the way sooner rather than later might even be a positive.
Indeed, this is also happening in Germany where a similarly reform-minded administration (led by Chancellor Schröder) has called an early election for September which it is likely to lose. The German financial markets have reacted positively to the prospect of an early end to political uncertainty. The key point is that in both Germany and Japan there is now a broad consensus in favour of economic reform: what is now needed is a new administration to take reform forward.
Moreover, Prime Minister Koizumi was not and is not essential to the reform process. Foreign observers often give him a great deal of personal credit for driving reform and reviving the economy. But this is not how politics works in Japan, where factions and consensus make things happen, not individuals. Indeed, a change of government might be better than a LDP victory that allowed Koizumi to remain in power as a lame duck Prime Minister until his term as party leader expires in September 2006.
Finally, the DPJ is at least as committed to economic reform as the LDP. Although untested in government, the DPJ’s economic programme is sound and credible. For example, the party is willing to make tough choices, such as raising consumption taxes and cutting welfare benefits to reduce the budget deficit. In fact, given the long and dismal record of the LDP in post-war government, anything that weakens its grip on power is arguably a good thing. It is also worth emphasising that the DPJ’s electoral gains have so far largely been at the expense of the Japanese Communist Party, which has strongly resisted reform.
The upshot is that the momentum behind economic reform is not dependent on who holds the premiership, or indeed on any one party. We may well see increased market volatility in the run up to the elections in September, but a change of government is unlikely to derail the economic recovery.
By Julian Jessop, Chief International Economist at Capital Economic