Can Shinzo Abe Make Japan a Superpower Again?

Will Prime Minister Shinzo Abe become the real-life Lord Bag of Rice? In Japanese folklore, a brave warrior, Hidesato, helps a dragon king kill a giant centipede that is carrying off his children night after night. With only three arrows in his quiver, Hidesato confronts the centipede. The first two arrows glance harmlessly off the creature’s body, but after reviewing his options, Hidesato courageously lets fly his third arrow. The third arrow strikes the centipede square in the middle of the head. As a reward Hidesato is given an inexhaustible bag of rice, which feeds his people for generations, earning him the title of Lord Bag of Rice.

Unstable leadership, a stagnant economy, and a fear of failing are segments of Japan’s giant centipede that have prevented the country from tapping into its domestic talents during the last two decades, and caused it to lose competitiveness against rivals such as China. Mr. Abe fired his first two arrows soon after assuming office: monetary revolution led by the Bank of Japan, and a stimulus package worth $116 billion USD. But as in the fairytale, Mr. Abe will not prevail until he fires his third arrow, structural reform. He hopes with this arrow to see Japan leave behind its cautious mindset and become a regional economic force that can challenge the strong-arm tactics of China.

Experts at the World Bank warn that without structural reform, Abe’s economic plan will only be “competitive devaluation” that does not remove current barriers to competition and investment. If Abe is to achieve structural reform and revive Japan’s once-great economy, he must capitalize on the majority support his party won in the Upper House a few weeks ago. To guarantee long-lasting economic success, he needs to move forward with cutting corporate taxes, easing barriers to immigration, liberalizing the labor market, and encouraging international trade by lowering tariffs.

Corporate Tax

Executives from powerful companies such as Hitachi Ltd., want Prime Minister Abe to cut corporate taxes so they are in line with other nations. Japan’s 35.6% corporate tax rate, one of the highest among developed nations, reduces the incentives for companies to invest at home. However, even a reduction to a 25% corporate tax rate may draw criticism from voters who are looking forward to April 2014 when higher consumption taxes will be instituted.

High corporate tax rates are not pro-growth or pro-business. Long-term investors look to economic indicators such as gross domestic product to see if a country is attractive for business. Japan’s corporate tax rate is strapping the ability of well-established companies to expand, making it hard for start-ups to grow, and preventing the country from attracting foreign investment.

An alternative to reducing the corporate tax is to give tax breaks to companies willing to invest funds they currently have on hand in promising sectors. The prime minister could also extend support to Japanese companies operating overseas.

Immigration

Although Mr. Abe faces public anxieties that foreigners moving to Japan will increase crime rates and dilute the national identity, there are strong economic reasons why barriers to immigration should be lowered. In 1995, the retired population in Japan was 4.8% of the total population. In 2012, the number rose to 24% of the population and by 2055, it is expected to rise to be 40% of the population. The United Nations found in its 2001 report on replacement immigration that if Japan wants avoid the consequences of a declining birthrate and aging population, immigration needs to rise to 650,000 people annually. Expanding immigration might also reinvigorate Japan’s entrepreneurial spirit, but as in other areas targeted for structural reform, Mr. Abe’s strategy will need to be as “much about cultural change as economic change” as he tries to “persuade more Japanese to take more chances.”

Labor Market

Japan’s highly restrictive employment rules bar companies from firing workers unless the company is entering bankruptcy. Seniority-based wage schemes also decrease workforce flexibility by increasing the opportunity cost of leaving the firm, either to move to a better company, or to found a start-up. Fixing the Japanese labor market means firms must be allowed to dismiss workers with compensation during periods of prolonged economic downturn. Reforms need to reduce inequality between regular workers and the non-regular workers hired during short boom periods, perhaps by mandating a minimum length of time that a company must employ a non-regular worker.

Prime Minister Abe also needs to consider ways to promote risk-taking and tolerance in a society that traditionally finds shame in failure. If talent is to flow from mature industries to those of the future, workers need the ability to move from one firm to another.

Regional Trade

Mr. Abe’s decision to apply for membership in the Trans-Pacific Partnership (TPP), signals his commitment to long-term steps that will push Japan out of its low-growth rut. The TPP will reduce tariffs between member states, thus boosting trade between them. Japan is home to many powerful companies, such as Sony, that have lost market share to companies of other nations that are tariff-free, such as Samsung. Opening domestic markets to competition should reinvigorate the economy, driving up Japan’s GDP, a signal of incremental improvement that investors need to stay committed. Other advocates of joining the TPP argue that it will improve the competitiveness of the agricultural sector, encouraging farmers to consolidate fragmented farmlands to make them more productive, or to lease their lands to large-scale farmers. Despite opposition from the farming lobby, a long-standing supporter of the Liberal Democrats, Mr. Abe should push forward with Japan’s membership in the TPP because it will ensure that Japan sits at the table when regional rules are made, limiting the ability of China to isolate Japan.

Redefining Postwar Japan

Voters demonstrated their support for Mr. Abe’s economic policies by casting ballots that helped his party win 65 of the 121 seats up for grabs in the upper house elections on July 21. Those who voted for opposition parties did so predominately because Abe’s hawkish and nationalistic gestures and statements give them reason for concern. Mr. Abe’s desire to revise Article 9 of the country’s constitution, which denounces Japan’s right to make war, disturbs China and South Korea, who bore the brunt of Japanese aggression in past decades. His desire to revise the constitution and reestablish a regular army could derail his economic strategy, and increase disputes in the South China Sea. As guarantor of Japan’s military security, the U.S. hopes Abe’s nationalist fervor will not spill over into international relations, such as the dispute over the Diaoyu/Senkaku Islands between China and Japan.

When Abe first served as prime minister briefly from 2006-7, he showed his willingness to be pragmatic. Hopefully pragmatism will again prevail as he pulls the third arrow from his quiver. Accepting Japan into the TPP will help offset tension between the U.S. and Japan over military base issues on Okinawa and provide a hedge against China’s influence in the Indo-Pacific region. The TPP will allow Japan and the U.S. to reach their economic and political aims, and is truly an agreement “at the nexus of foreign and defense policy.”