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5 "Tells" that the Stock Markets Are About to Reverse

Prelude to a Japanese Revival

Politics / Japan Economy Apr 28, 2015 - 02:05 PM GMT



John Minnich writes: Japanese Prime Minister Shinzo Abe has arrived in Washington, the third stop on his maiden voyage to the United States since assuming office in 2012. Over the next two days, he will hold a summit with U.S. President Barack Obama on U.S.-Japanese defense and trade cooperation, attend a state dinner in his honor and address a joint session of the U.S. Congress. In his speech before Congress, Abe will reaffirm Japan's commitment to promoting peace and security in East Asia and extol the virtues of the Trans-Pacific Partnership, a 12-country free trade agreement that spans the Pacific Ocean Basin and pointedly excludes China.

As always with such occasions, the real work, whether on revising guidelines for U.S.-Japanese defense cooperation or negotiating the finer points of Japan's accession to the Trans-Pacific Partnership, will take place long before Abe sits down with Obama. In this sense, his visit is largely symbolic. But this does not make it insignificant. The significance of Abe's trip, like that of the work that precedes and surrounds it, rests in what it tells us about Japan's strategy and what that strategy reveals about Japan's evolving interests and environment.

Stratfor has long argued that the post-Cold War status quo of relative introversion and economic stagnation in Japan was unsustainable. We believed that internal and external pressures ultimately would compel Japan to play a far more proactive role in regional and global affairs. And we said this process would likely entail a fundamental break with the social, political, economic and foreign policy order that has defined Japan since World War II.

In Abe's visit to the United States and his efforts to deepen trade and defense cooperation with Washington, and more broadly in his struggle to resuscitate the Japanese economy and to normalize Japan's defense forces, we see the embryonic stage of just such a transformation. The question is whether these moves will be sufficient to achieve Japan's long-term economic — and therefore foreign policy and security — imperatives, or whether the Abe administration's reforms are merely the prelude to more profound changes. Answering this question is no trivial matter. To a great extent, how we approach this question will shape our understanding of Japan's role in the global system in the years to come, and by extension its relationship with that system's lone superpower, the United States.

With this in mind, Abe's visit, and the defense and trade deals likely to follow from it, is occasion to think more broadly about Japan's evolution. To do so, we must outline Japan's current situation and identify the center of gravity — the core compulsions and constraints, both internal and external — of Japan's emerging strategy.

Fraying at the Edges

For the past 20 years, the economic and political order that guided post-World War II Japan has been caught in a slow-burning crisis. During these so-called Lost Decades, Japanese economic growth remained essentially flat, while per capita gross domestic product, income and household spending levels all fell slightly. Economic stagnation coincided with the exhaustion of Japan's demographic dividend in the 1990s. Since then, a rapidly aging population and outright population decline have taken their toll on the country's economic vitality and fiscal and financial health.

Between 2005 and 2015, Japan's working-age population fell by an estimated 7.7 million people, while its elderly population grew by more than 8 million. During the same period, the household savings rate collapsed, and social security emerged as the single largest government expenditure, followed closely by debt-servicing payments — a result of Japan's deepening budget deficits and mounting sovereign debt. Rising underemployment rates among Japan's shrinking workforce have exacerbated the financial effects of population aging. In the 1990s, less than 20 percent of Japan's employed workers held "non-regular" (temporary, part-time or contract-based) jobs. By 2002, that figure had risen to 29 percent. Now it is nearly 40 percent, a stark reminder of the effects two decades of offshoring have had on the manufacturing and electronics industries that once formed the backbone of full-time employment in Japan.

Incoherence, volatility and inflexibility in Japan's political sphere mirror the Lost Decades of economic stagnation. Since 1993, Japan has had 13 prime ministers, many of them serving for one year or less. The elite civil bureaucracy that once made Japan a paragon of efficient administration and state-led economic development has proved lethargic when it comes to implementing reforms that cut against the desires of powerful interests like the agriculture lobby. Meanwhile, apathy among young and urban voters, combined with demographic trends and a parliamentary districting system that favor older and rural segments, have forced political parties to compete ever more fiercely for the "organized" vote controlled by those same interest groups. Certain prime ministers, most notably Junichiro Koizumi between 2003-2006 and now Abe, have attempted to reform Japan's political system from within, but to only limited effect.

Nonetheless, despite its lack of growth for two decades, the Japanese economy remains the world's third largest, and the country enjoys high standards of living. Although some Japanese companies have lost market share to Korean, Chinese and other foreign competitors in recent years, many others remain global leaders in their respective industries. Japan claims one of the highest research and development expenditure-to-GDP ratios in the world, and it remains by many measures one of the world's most innovative economies. And despite creeping popular dissatisfaction with establishment parties and declining administrative effectiveness, Japan's political system is fundamentally stable, its government comparatively corruption-free, and its social contract between government and populace strong. To the extent that Japan's post-World War II political and economic order has entered into crisis, it is by most counts a fairly mild one.

This brings us back to the question of the center of gravity in Japan's emerging strategy. Certainly, addressing the effects of demographic decline and dwindling economic vitality are central to the Abe administration's reform platform. They form the crux of his administration's signature initiative, the economic growth program known colloquially as "Abenomics." But it is unclear whether these problems, in and of themselves, will be pressing enough to force a break with Japan's status quo anytime soon. After all, they have been around for more than a decade without prompting such change.

More likely, left to its own devices, Japan would find the means to manage demographic decline and economic anemia without dramatically changing the way its economy and political system function. Indeed, as long as its leaders can ensure that the rate of population decline outpaces the rate of economic decline, then they can, in theory, continue to provide high standards of living — high enough, at least, to prevent a rupture in Japan's political status quo. With the pace of population aging and workforce shrinkage set to slow in the coming decades — the next generation of Japanese to retire is considerably smaller than those who retired between 2005 and 2015 — and the rate of outright population decline set to rise precipitously as Japan's post-1945 baby boomer generation passes away, such a scenario becomes feasible. At the very least, it is difficult to say with much confidence that internal pressures stemming from demographic decline and economic decay, which will play out slowly, will be powerful enough on their own to drive Japan to break with the post-World War II political order. Considered in a vacuum, we expect Japan can manage.

But Japan is not in a vacuum. It is in an economically dynamic and geopolitically tempestuous region, one increasingly defined by two interconnected structural shifts that weigh heavily on Japan's interests. To understand Japan's strategy, both for reviving its economy and for expanding its regional political and security footprint, we must look to these shifts.

The Effect of China's Rise

The first is the rise of China. The country has long been the demographic heavyweight of East Asia and for most of its history also acted as the regional political, economic and cultural hegemon. But starting in the mid-19th century, internal and external pressures drove China into one of its many cycles of political fragmentation, social upheaval and introversion. Though China reunified in 1949, the preceding century of chaos had left the country's economy in tatters and prevented China from translating its demographic heft into regional economic, let alone political and military, dominance within the 20th century.

After three decades of rapid economic growth, China now has the region's largest economy and is investing heavily in transforming its economic size into diplomatic influence and military power. China is far from ready to overturn the East Asian security status quo — the U.S.-led alliance structure that includes Japan, South Korea, Taiwan, Australia and parts of Southeast Asia. However, its military power is growing, and its maritime forces are becoming larger and more technologically and operationally sophisticated. China now possesses one of the region's most powerful navies, especially when including coast guard forces.

More important than what China is now is what it seeks to become, however unrealistically: the regional hegemon of East Asia, with military power sufficient to ensure that no competing power can block its access to crucial sea lines of communication or hinder its ability to protect overseas assets and operations in far-flung regions. Underscoring China's rise is its deepening reliance on overseas supplies of energy and raw materials. China no longer has the option, so readily exercised throughout Chinese history in times of internal turmoil, of closing itself off to the world. It must press outward.

This creates a qualitatively new reality for Japan. Modern Japanese history — the story of Japan's industrialization and geopolitical ascent that begins with its limited opening in 1853 and ignites with the Meiji Restoration of 1868 — takes place against the backdrop of a weak, fragmented and introverted China. The weakness of China played a crucial role in shaping Japanese behavior throughout its centurylong "miracle," both generating opportunities for an ascendant Japan to exploit and, just as critically, removing a key source of external pressure on Japan. Regardless of the real trajectory of Chinese power over the coming decades, Japan's leaders must plan as if China's economic, political and military influence will continue to grow.

The Role of American Grand Strategy

But even China's rise, taken alone, is not sufficient to necessitate a Japanese economic resuscitation and an expansion of Tokyo's regional political and military footprint. The pressures imposed by China's rise must be understood in context of another structural shift: the maturation of the American grand strategy. As we have argued, the United States is transitioning from a grand strategy grounded in direct, tight and costly control of the balance of power in other regions to one in which the United States relies more heavily on regional partners to maintain the balance of power on its behalf. Certainly, this strategy will not unfold uniformly across all parts of the world. The United States historically has sought to exert tighter control over its Asian allies than those in Europe, working largely through bilateral rather than multilateral alliance frameworks, in part to deflect those allies', and especially Japan's, ambitions. The Asian "pivot" initiative, though progressing slowly, suggests the United States will seek to maintain a more robust diplomatic and security presence in the Asia-Pacific region for the time being.

Nonetheless, as Japan's lurch toward military normalization and a more proactive regional security posture attests, the United States' approach to East Asia is evolving in line with its maturing grand strategy. Simply put, military normalization and expansion in Japan would not happen without at least tacit approval from the United States. More important, these steps would not happen unless Japan felt compelled by the shift in American strategy to become more proactive in shaping and protecting its regional interests. After all, Japan endured decades of threats from the Soviet Union and North Korea without adopting such a posture. In part, this is because the United States actively constrained Japan throughout the Cold War and after. In part, it is because the United States made sure in decades following World War II that Japan's security interests were taken care of.

The confluence of China's rise with the maturation of American grand strategy is the core compulsion driving Japan's effort to revive its economy and expand its role in regional political and security affairs. These external pressures are inextricable from the internal pressures of demographic decline and loss of economic dynamism. Technological advances in the coming decades — namely, the proliferation of hypersonic precision-guided and space-based munitions systems — could loosen the connection between sheer economic size and military power, at least among the larger advanced economies. But they will make economic dynamism and innovation, and above all a world-class computing industry, all the more essential. It is not a coincidence that Abe's first visit to the United States involves a trip to Silicon Valley.

This is the framework for understanding Japan's emerging strategy. For now, economic revival remains the heart of that strategy, for without a dynamic economy, Japan will struggle to achieve its broader regional imperatives. But it is important to understand that this is not economic revival for its own sake. Ultimately, Japan is changing its behavior in response to the conjoined external pressures of China's rise and the United States' transition. Of course, other external factors will shape how Japan's strategy unfolds — Russia's potential collapse and eventual Korean unification come to mind — just as population aging and underemployment will. But these are contributing factors, not the center of gravity.

Japan Beyond Abe

The question is whether the Abe administration's measures will be sufficient to restore Japan's economic dynamism, particularly on a time frame amenable to its internal and external compulsions. The Abe administration is still relatively young, but so far the available evidence suggests that Abenomics, at least as currently conceived, will not be sufficient. After two years, it has failed to generate consistent economic growth. Underemployment is rising, not falling. Quantitative easing has benefited larger conglomerates with extensive operations overseas but appears to be hurting small and medium-sized businesses that account for the bulk of Japan's domestic economy and employment — and thus will likely hit a political limit before long. Fiscal stimulus measures, namely corporate tax cuts, have not yet drawn significant volumes of new corporate investment to Japan. Consumer spending remains anemic. The list goes on. While the administration looks poised to introduce long-awaited structural reforms in labor, agriculture and other spheres later this year, bureaucratic and political wrangling will almost certainly dilute their impact. And recent efforts to cultivate a "Japanese Silicon Valley" are promising but will take many years to reach fruition.

We nonetheless watch Abe's moves, including his visit to the United States, with great interest, for the theory of geopolitics tells us that Japan's song is far from over. Abe may be only the prelude to that song, but in his administration's efforts we see the core structure and motifs of the transformation to come.

"Prelude to a Japanese Revival is republished with permission of Stratfor."

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