Call: Economic recovery but political gridlock in Japan

By Ian Bremmer

This week’s headlines have painted a dire picture of the state of Japan’s economy. GDP contracted by 4 percent over the first three months of 2009, the worst quarterly performance on record. Year on year, Japan’s economy shrunk by more than 15 percent, the steepest such decline in more than half a century. But my latest visit to the country has convinced me that there’s already light at the end of Japan’s dark economic tunnel. Instead, it’s the political situation we ought to be worrying about.

Despite the alarming headlines, I was pleasantly surprised to see the beginnings of a turnaround in economic sentiment. The prevailing gloom I felt in talks with Japanese business leaders earlier in the year has given way to cautious optimism that a recovery in China is about to lift the rest of Asia out of its malaise. Executives had lots of questions for me on threats to stability in Pakistan (mostly because President Asif Ali Zardari visited Tokyo last month asking for money), on Venezuela (because Japan has signed a deal with Hugo Chavez to build an energy partnership), and even a surprising curiosity about opportunities in Iraq. In other words, Japanese investors have resumed their shopping.

Japan’s political situation, on the other hand, has only gotten murkier. Prime Minister Taro Aso and the ruling Liberal Democratic Party (LDP) have managed to climb their way out of single-digit approval ratings, but numbers in the low 30s still leave the party facing likely defeat in an election that must be called by early September. And the LDP’s recent recovery took place at a time when the unpopular, scandal-ridden, and ailing Ichiro Ozawa still ran the opposition Democratic Party of Japan (DPJ). Now that he’s announced his resignation, public focus will return to the country’s dire economic performance — and the LDP’s inability to turn it around. Recovery is coming, but not fast enough to bail out the ruling party, and Aso has neither the track record nor the temperament to reverse his fortunes as the far more talented Junichiro Koizumi managed to do four years ago.

So what will the next Japanese government look like? When my turn arrived to ask questions of knowledgeable friends in political and business circles, I got some very interesting answers. More than one well-informed source warned me that Japan is about to have a centrist third party, one comprised of disgruntled factions from within the LDP and DPJ. How successful the new party will be is open to question, but the plans are well underway — one of the LDP’s leading politicians and a younger DPJ maverick (referred to as a "rising star" by one official) have been busy raising cash for the new party (to be announced right after elections) from senior Japanese executives.

The risk is of political paralysis. In other words, it’s starting to look like Japanese politicians will be fully occupied with sorting out their new alliances and rivalries over the next couple of years just as China resumes its rise, the Obama administration works to build ties with Japan on new ground, and gradual economic recovery offers opportunities for much-needed structural economic reforms. That’s bad news — for Japan and for its friends in Washington.