A Clouded Outlook

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Andreas Seibert for TIME

Up against it Salarymen in the town of Sendai take a cigarette break. Many Japanese companies are no longer as competitive as before

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Reformers Beware
The business-as-usual approach in Sendai shows how stale Japan's bureaucracy-led economic model has become. "Japan still craves the old structure, but that structure is preventing the emergence of new industries," says Kazunori Kawamura, a political scientist at Tohoku University. "The bureaucrats create a system that benefits themselves. They are reluctant to invest in something that has a chance of failure. They'd rather invest in something with a track record. We need to take the relationship between the bureaucrats and the economy apart."

A few bold politicians have tried. Junichiro Koizumi, Prime Minister from 2001 to 2006, believed Japanese required more freedom to take risks to get the economy moving again. He undertook a wide-ranging American-style liberalization program, loosening up inflexible labor markets and deregulating the corporate sector to encourage new investment and entrepreneurship. But in a society that prides itself on egalitarianism, the disparities in welfare brought about by the Koizumi reforms made many Japanese queasy. The public was shocked when unemployed workers set up tents in downtown Tokyo during the Great Recession. The idea of market reform has become so tainted in Japan that the DPJ actively campaigned against it during last year's general election. Yukio Hatoyama, the first DPJ Prime Minister, decried what he called "market fundamentalism" as inherently immoral.

The DPJ is trying to fix Japan in a very different way. Kan, as Hatoyama also intended, wants to snatch policymaking power from the bureaucrats and put it into the hands of the Cabinet. The DPJ has also realized that selling reform to the average Japanese will be difficult without a major upgrade of the country's often weak social safety net. The party has already waived high school tuition fees and introduced a state subsidy for families with young children, and it has promised to strengthen medical and child-day-care services. In doing so, Kan hopes to restart growth by bolstering consumer confidence and convincing Japanese families to spend more and save less. Kan has also raised the idea of cutting the corporate tax rate, which is higher than those in most other industrialized countries, to spur investment and create jobs. "The economy has continued to be stagnant because of the pursuit of economic policies that did not match the changes in the structure of industry and of society," Kan said in a June policy speech.

Doubts about Kan's plans are already mounting. Decades of wasteful fiscal spending — which previous Prime Ministers had used to stimulate growth with "bridge to nowhere" construction projects while sidestepping reform — have restricted Kan's ability to create growth with government policy. Kan himself has called the country's financial position "dire" and has warned of "fiscal collapse" if action isn't taken. In June, Kan rolled out a fiscal austerity package that would balance the budget over the next decade. Kan also floated a controversial proposal to double the sales tax to 10% to help fill depleted coffers. He argues that his administration can simultaneously rein in fiscal deficits and fund his social-welfare expenses.

Yet his argument is unconvincing. Raising taxes would stifle the very consumer spending he wants to stimulate, while possibly only denting the country's fiscal problems. Carl Weinberg, an economist at research outfit High Frequency Economics, warns the Japanese government will have to take far more severe measures if it wishes to reduce its debt. "We presently have no plausible scenario in which the ratio of debt to GDP ever declines," Weinberg wrote in a recent study.

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