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Economic News & Analysis—December 17, 2012

Japan’s election: Back to the future?

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

Like Marty McFly traveling to the past in the 1985 hit movie Back to the Future, Japanese voters elected to restore the Liberal Democratic Party (LDP) to power after three years of rule by the Democratic Party of Japan (DPJ). The LDP held power from the end of World War II to 2009 when the DPJ won power. Since then, the country has experienced natural disasters and continued economic problems. Sunday’s election in Japan signifies a dramatic shift in power, handing the LDP a majority and the ability to push through practically any program it wants. Can the new administration restore growth to Japan or just perpetuate the economic funk the country has been in since the late 1990s?

While the LDP’s election platform was a little light on details, it did include a massive infrastructure spending program as well as forcing the Bank of Japan to set a 2% inflation target. The party has also struck a nationalistic tone, seeking to change the pacifistic constitution. An important distinction between the competing parties is their stance on nuclear power. The DPJ wants to phase out nuclear power, while the LDP is more open to keeping, or even expanding, the use of nuclear power.

Will the LDP be able to kick-start the Japanese economy? Like Marty McFly, can the new prime minister, Shinzo Abe, right the wrongs of the past and set the country on the path to greater prosperity? I have my doubts. Simply setting a higher inflation target for monetary policy won’t cure what ails the Japanese economy. With a significant debt load (a gross debt-to-gross domestic product ratio of more than 220%), increasing inflation will likely increase interest rates, making the debt load even more expensive to finance. While a dramatic increase in economic growth could create the tax revenue needed to finance that debt, growth might not jump fast enough, or soon enough, to offset higher debt costs. This is likely to be exacerbated if the government embarks on a massive spending spree on infrastructure spending, which will likely need to be financed with even more debt.

A weaker yen could help the major exporters in Japan, but it is unclear how smaller businesses will be able to grow rapidly under the new regime. It’s also unclear whether the LDP will actually implement reforms. The LDP did rule for nearly 50 years, including during the time when the economy entered its protracted deflationary recession. Instead of a happy ending, it might just be the same old thing over and over again, much like how Back to the Future Part II and Back to the Future Part III felt to me.

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