Down But Not Out... Yet

August 2007 Rosalia Tan

After only ten months in office, fifty-two-year-old Shinzo Abe, the first Japanese Prime Minister to have been born after World War II, has led the ruling conservative Liberal Democratic Party to its worst ever defeat in the upper house (the House of Councilors) elections held on Sunday, July 29.

With a total number of 242 seats in the upper house, half of which are up for election every three years, the LDP needs 64 seats in order to form a majority during each term. However, the ruling party and its partner, New Komeito, have clearly failed to meet the minimum requirement this time, with a disappointing total of 46 seats. On the other hand, the party’s main opposition, the Democratic Party of Japan, replaced the LDP as the majority in the upper house for the first time since 1955 with 60 seats, an astounding success for an opposition persistently overshadowed by the governing party’s stable administration during most of the past fifty years.

Though this election will not affect Mr. Abe’s position, as it is the more powerful lower house (the House of Representatives) that decides on the prime minister, it is still regarded as a stinging blow to the ruling party. While the upper house theoretically cannot prevent significant decisions made by the lower house from taking place, such as budgets and the selection of prime minister, it does however have authority when it comes to the passage of general bills. Hence the reason for despair among the LDP. With such poor nation-wide performance and a shift of voters toward the opposition, potential high political and economic uncertainties may loom in the near future.

From an approval rating of around seventy percent, which began plummeting almost the instant Mr. Abe took office last September, this figure currently stands around thirty. Mr. Abe, whose goals include revising Japan’s pacifist constitution, amending the country’s troubled ties with its economic neighbors China and Korea, and reinstating nationalism among children, largely avoided the general Japanese voters’ domestic economic concerns such as jobs, stagnant salaries, a frail pension system, growing income disparity, and the rising percentage of elderly in a dramatically aging population. As a result, domestic consumption continues to lag, deflation still remains and interest rates are still low at 0.50%. One cannot also forget the number of scandals that took place among the LDP cabinet that have led to the suicide or resignation of four ministers, not to mention the misplacement of fifty million pension records that angered the aging nation. In addition, the DPJ campaigned to aid the rural communities and blue collar workers, the key citizens who have fallen behind in Japan’s economic development. It is no surprise that the Japanese population showed its desperation towards its seemingly incompetent leader by voting for the alternative. Still, one should not underestimate the LDP’s influence given that, historically, previous prime ministers have been in similar situations and the ruling party had always managed to get back on its feet.

Despite the fact that polls indicate almost half of Japanese voters, including supporters of his very own party, want to see him resign, Mr. Abe resisted the pressure to step down after a humiliating defeat. With no clear successors to take his place, in order to avoid repeating the same mistake in the next general lower house elections, Mr. Abe must carry out the previous prime minister Junichiro Koizumi’s economic reforms and shift his priorities to restore public confidence by correcting the pension fiasco and listening to voters’ worries. Economically speaking, Japan needs to increase productivity, encourage consumption, adjust to the severely aging population, and produce long-term growth while continuing to reduce its budget deficit and slowly increase its near-zero interest rates. If Mr. Abe continues to neglect these domestic issues while remaining prime minister, it will be difficult for the country to maintain its economic predominance, especially now as China is challenging Japan to become the world’s second largest economy.

From a financial standpoint, we have already seen the Nikkei 225 tumbling 2.4 percent in the three trading days after the elections. The yen, however, managed to reverse a weakening trend by strengthening around 4.2 percent over the month of July due to slumps in the global market which caused investors to avoid higher yielding currencies and unwind the carry trade. Nevertheless, given the political instability over the near future, both the domestic stock market and the yen should maintain their downward trend, which means that the carry trade may continue to be employed by international market participants. In addition, the Bank of Japan may be unlikely to raise interest rates next month, despite earlier predictions, due to these domestic doubts, persistently weak CPI data, and a fragile U.S. credit market. However, the recent industrial output number came out stronger than expected, rising 1.2 percent in June.

With the LDP now temporarily losing control of the upper house, it will be much more difficult for the lower house, controlled mostly by the ruling party, to pass bills without the consent of the main opposition. The domestic markets should also respond negatively in the near term due to ambiguities among the political structures. Japan seems to stand at a crossroad with a possible two-party system on the way. Thus, if the prime minister does not either resign or alter his agenda to suit the frustrated nation, it will be difficult for the LDP to continue its reign over Japan. The lower house elections, which must occur before September of 2009, will give voters true power to establish a new government, perhaps bring a new prime minister and a new direction for Japan.