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After Japan's Election, Test of "Abenomics" Begins

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Thanks to popular support for his economic revitalization platform, known as "Abenomics," Japanese Prime Minister Shinzo Abe and his ruling Liberal Democratic Party (LDP) won a solid victory in Sunday's upper house election with its coalition partner New Komeito. The much anticipated result ends the country's "twisted parliament," giving the LDP control of both chambers of parliament for as long as three years, barring early elections.

After his party beat the Democratic Party of Japan (DPJ) last December, Abe has fired three "arrows" from his economic policy quiver--loose monetary policy, new fiscal spending, and economic reform--in an attempt to end two decades of economic stagnation.

Now that the election hurdle has passed, however, the true test of Abenomics will begin. To date, Abe has tackled the easy part of economic revitalization, leaving the more difficult parts for after the election. Will Abe use the next three years to win over skeptics of his economic agenda or will he instead pursue a more right-wing, militarist agenda?

Predictions are divided. Some analysts believe the LDP's victory was big enough to give the prime minister a mandate to push through needed economic reforms but not big enough for anything more politically radical. He must listen to voters' calls to focus on the economy. Indeed, Abe said after the polls closed Sunday that his lead reflected public support for Abenomics: "This is a powerful message telling me to proceed with my economic policies. I want to make sure people feel the effects of the economic recovery as soon as possible."

But others argue that now that the LDP controls the entire Diet, Abe will be free to pursue his dream of revising Article 9 of the Constitution to unleash its primarily defensive military and allow for collective defense. Although the LDP failed to gain the two-thirds majority needed in the Diet to revise the Constitution, an undeterred Abe may instead try to alter Article 96 to lower the threshold majority needed to revise the Constitution. Abe also could follow a more nationalistic path by revisiting the country's post-war apology with Korea and presenting a more hard line stance on territorial disputes with China.

A third possibility, as always, is that Abe will do what many of his predecessors have done: as little as it takes to stay in power without having to make tough decisions.

Since Abe returned to power, views on his political priorities have fallen into two camps. The optimists argue that, "This time is different," despite two decades of economic stagnation and failed attempts to revive the economy. This camp believes the LDP and prime minister learned bitter lessons from the party's defeat in 2009 and Abe's resignation in 2007.

Moreover, the LDP appears to be listening to calls from Japan Inc. for more aggressive monetary stimulus, a weaker yen, fiscal stimulus, lower corporate taxes, labor law reform, and participation in the Trans-Pacific Partnership (TPP) trade agreement. Businesses that have benefited from a weaker yen and players in the equities market who have profited from rising stock prices have served as a chorus cheering on continued optimism.

The other camp comprises skeptics. In response to Abenomics, they say, "We have seen this before, and it's just more of the same." Over the past 15 years, Japan has tried several rounds of quantitative easing, a zero-interest rate policy, and numerous fiscal stimulus packages.

Many skeptics were previous optimists who feel they have been burned by past do-nothing administrations. They look at the players in politics today and see the same people who have been presiding over Japan's stagnation--dynastic rulers who pay little heed to an apathetic public and have no personal interest in change. Abe is the son and grandson of politicians; the political lineage of his deputy Taro Aso goes just as far back. Are these really the people who will shake-up Japan?

Answering that question may depend on what kind of nationalist Abe is. If Abe simply believes that his job is to create a strong Japan with a growing economy and bigger strategic footprint, he may be steered toward following through with economic reform. Scholar Kevin Doak holds that view, arguing that Abe wants a liberal or "civic" nationalism, one that would emphasize sports teams, patriotic pride, liberal values, and civic virtues. Not so, says scholar Tessa Morris-Suzuki, who contends that this "rebranding" of Abe's nationalism merely whitewashes his illiberal predilections.

The direction Abe takes over the next few months may help to clear up these questions. Back in April, for Abe's first arrow, the newly anointed Bank of Japan governor Haruhiko Kuroda announced an unprecedented move by the central bank to double the country's monetary base by 2014. Kuroda, the former head of the Asian Development Bank, said by buying government bonds, he aims to double the monetary base to ¥270 trillion ($2.9 billion) by 2014 and reach an inflation target of 2% per year.

The second arrow, a fiscal stimulus worth ¥10.3 trillion ($116 million) was aimed at creating 600,000 new jobs and increasing the GDP by 2 percentage points, as well as aiding economic growth and sparking inflation.

The third arrow of economic reform, announced in June, had the most potential to offer something new but so far has been a disappointment. Rather than targeting labor reforms, it lifted bans on online sales of drugs and suggested the development of special economic zones. Strangely, one of the elements of the third arrow was to target wage increases, which should be a consequence of the first two arrows if the policies go according to the government's plans. A generous view would have it that these targets foreshadow future policies rather than wishful thinking.

Abe's arrows have mostly zeroed in on the easy targets: looser fiscal and monetary policies. The politically-sensitive reforms are yet to come and much of the enthusiasm has been based on expectations. To use a non-archery analogy, fiscal and monetary stimulus without economic reform is like super charging a car's engine without fixing the transmission. The effect will be very temporary. Economists predict that the stimulus will wear off by next year and that growth will stagnate without reform.

So what has been accomplished? Since Abe has taken office, the country has witnessed increased GDP growth, consumer prices, household spending, and bank lending. Meanwhile, labor reforms that make it easier to hire and fire employees and lowering corporate taxes would help increase dynamism in the corporate sector. But a coming fourth arrow, fiscal consolidation, would dampen some of these stimulative effects. It includes a planned doubling of the consumption tax starting next April in two stages to 10% by October 2015.

One of the most significant long-term reforms for Japan could come through its participation in the TPP trade agreement. Japan joins the talks in Malaysia on July 23 and the final day will be devoted to Japan. Such a comprehensive trade agreement could provide external pressure for Japan to reform and put the country at the rulemaking table of a partnership that will integrate 40% of the world's GDP and a third of world trade. The TPP also gives businesses an economic policy blueprint in Japan and gives Japan leverage vis-a-vis China, which is not a party to the TPP.

The problem is that it is unclear whether the LDP has the support needed to ratify TPP legislation via simple majority once it is submitted to the Diet. Toru Hashimoto of the Restoration Party surmised (link in Japanese) that the LDP's the victory on Sunday may actually encourage opposition to the TPP. The anti-TPP group within the LDP is headed by Kagoshima politician Hiroshi Moriyama. By some estimates (pdf in Japanese) at least 137 members in the lower house and 47 members in the upper house opposed TPP before the election.

Passing TPP legislation therefore will likely hinge on cooperation from coalition partner New Komeito as well as a disorganized political opposition. The DPJ, which is the largest opposition party, hopes to protect the agricultural sector and has not stated clear support for the TPP in its latest policy platform. The LDP and DPJ both use the vague notion of putting "national interests" first in TPP negotiations--a phrase often use to justify protectionism.

A ray of hope may be found in the increased optimism of the Japanese people themselves, a necessary though insufficient ingredient of national revival. Despite a recent slip in consumer confidence, there have been improvements in business confidence, the stock market, and the overall atmosphere in the country's urban neighborhoods.

But that won't be enough. Sunday's election was tainted by the lowest voter turnout for the upper house since 1995. Without an active, engaged public, Japan's politicians will not feel the pressure to deliver on promises. In the words of the late economist Albert Hirschman, Japan's low voter turnout suggests the public has plenty of "exit" from politics, but not enough "voice" in politics.

This essay originally appeared in Quartz.