The Shock Therapist

Heizo Takenaka blows into his small outer office, flying in from the hall with a crew of eager aides in tight echelon. He shakes hands, fires off a roomful of smiles and gestures toward his private office: "Let's talk." Perhaps he needs a moment to return some phone calls, to handle some paperwork? He has, after all, just come from an urgent meeting with new Japanese Prime Minister Junichiro Koizumi. "No." He turns and walks quickly into his tennis court-size office, rattling the orchid pots that sit next to his door. Takenaka-san is in a hurry.

It is the nature of Japanese politics that all is not as it seems. The guy you think is running international trade, for instance, may be a puppet for some bureaucrat deep in his administration. The Prime Minister who seems energetic and bright may be just a prop for the conservatives in his party. The latest Japanese government has its share of opacity too. It arrived in office four weeks ago to the highest hopes of any government in the past decade. Koizumi is a charismatic reformer who speaks his mind and has a plastic, Clintonian charm. His arrival represented a victory over the old-line politicos who have run Japan for decades. And in an early sign of his thinking, he has turned over economic-policy management not to the Ministry of Finance, an organization that is the ne plus ultra of bureaucratic lethargy and intellectual suicide, but to the fast-moving Takenaka, 50, a U.S.-inspired economist and academic.

Japan has become known as the land where economics comes to die. Interest rates have been cut so many times that they now rest at just .05%. The Japanese government has spent more money on public works than any other country in the world, but blowing all that cash has been useless. There is a hole in the center of Japan--a deep lack of confidence that comes from an overhang of trash loans from the early '90s and from a decade of failed policy. Smart Japanese consumers are nervously waiting for those loans to blow up. So encouraging consumers to start spending is like encouraging a man strapped to a time bomb to fix his hair. They have other things on their mind. That has paralyzed reform.

Enter Takenaka, moving fast. In Japan the phrase that dare not speak its name right now is shock therapy, but that's exactly the kind of quick economic fix he has in mind. "How fast can we clean it up?" he asks me as we sit over tea. Five years, I guess. "We think two to three years, but we need to accelerate." The reason for the haste is simple: the reforms are likely to cause unemployment. That puts the reform package into a race with electoral confidence. If voters get fed up before the reforms have time to finish, they may throw Koizumi and Takenaka out.

Takenaka is largely keeping his plans from the Japanese press for now, but he tells me he is looking to adopt a three-step approach: scour nonperforming loans from bank books quickly, increase Japanese growth by opening closed industries to competition and cap government spending with a limit that will bulge upward only in an emergency.

It won't be enough. If reform is really going to work, Takenaka and his planners need to build out Japan's social safety net, providing economic padding--and a political bulwark--for the inevitable layoffs and business collapses. Koizumi and Takenaka also need to go into sales mode, a Japanese version of the Bush road show on taxes. And, on a technical note, Japan needs to let its currency slide. A weaker yen--say, 135 to the dollar--would strengthen corporate profits. The danger is that a sliding yen could set off a round of devaluations, as neighboring economies rush to slash their exchange rates. Here is where the U.S. can, finally, help Japan. By nodding support to a slow devaluation and not screaming about the impact on U.S. trade, Washington can help persuade other countries in the region to keep their currencies strong. It may be a tough sell in a recession-wary U.S., but it would be invaluable to Tokyo. If Takenaka has his way, a healthy boom could follow.