Inside Japan's Election

Of all the headwinds plaguing Japan's economy in recent years, one of the biggest is political uncertainty. Japan's had seven prime ministers in as many years, making it difficult for leadership to enact meaningful economic reform—something Japan could use in spades. And with the lower house of Parliament dissolved November 15 and a snap election now scheduled for December 16, the revolving doors may soon turn again.
The contest will pit incumbent Yoshihiko Noda of the Democratic Party of Japan (DJP) against Shinzo Abe, new leader of the Liberal Democratic Party (LDP). If the LDP takes control, it'll be Abe's second turn at the helm—he succeeded Junichiro Koizumi in 2006 but stepped down less than a year later citing health reasons (more on this in a bit).
The campaign should be … interesting. Noda, who was forced to call early elections after 50 DPJ members left the party to protest his sales tax increase, has put free trade at the center of his manifesto. He's pledged to complete Trans-Pacific Partnership trade talks and a trilateral free trade agreement with China and South Korea. These agreements would no doubt benefit Japan over time, broadening end-markets for domestic exporters and providing consumers more choices and cheaper goods. But they'll likely prove a tough sell in historically protectionist Japan, and Abe's stance against lowering agricultural tariffs may win more support.
Of course, tariffs are but a small piece of Abe's campaign platform, which features a nationalist agenda—likely to win big points with voters amid territorial disputes with China and South Korea, which have raised nationalist fervor to a fever pitch. In recent weeks, Abe has visited the infamous Yasukuni Shrine—the memorial to Japan's war dead whose honorees include Class A war criminals—pressed China on human rights, advocated removing Japan's constitutional ban on waging war and suggested establishing a military presence around the contested Senkaku/Diaoyu islets. All have helped him curry favor amid rising anti-Chinese sentiment: He and the LDP lead current polling, while support for Noda and the DPJ is below 20%.
Compounding matters, however, are two nationalist fringe candidates, former Tokyo governor Shintaro Ishihara and Osaka mayor Toru Hashimoto, who recently created the Sunrise and Japan Restoration parties, respectively. Eighty-year-old Ishihara's long been considered a loose cannon—his threats to use Tokyo money to purchase three of the Senkaku/Diaoyu islets from their private owners are what forced Noda to nationalize the islands (an attempt to preempt tensions with Beijing that backfired), and he's regularly denied the Nanjing atrocities ever occurred. Hashimoto also denies Nanjing and other WWII-era Japanese brutality (particularly aimed at Korean women) and, like Ishihara, has pushed for Japan to acquire nuclear weapons.

While Abe's more moderate nationalism (hey, everything's relative) has earned the LDP a 10-point lead in the polls, voters are more skeptical of Ishihara and Hashimoto's extreme views. This suggests that if Abe skews further right, it may backfire—a logical assumption if one recalls how voters reacted to Abe's nationalism the last time he was in office. Then, he allowed Koizumi's planned reforms to die while he pushed for “patriotic” school curriculum, military enhancements and more assertive foreign policy. Meanwhile, scandal plagued his cabinet, economic malaise set in, his approval ratings cratered and the LDP lost control of Japan's upper house for the first time in almost 50 years. He may well have been “exhausted” by the end, but political failure, rather than cited health reasons, drove his downfall.
Voters may have seen five prime ministers since Abe, but they likely remember his fecklessness. And if his campaign descends into caricature, the unpopular Noda might have a shot. Anything could change over what will be a short, heated campaign, and it's impossible to handicap the outcome this early. But it seems unlikely either man would have sufficient clout to do much when in office—there's a fair chance the next government will be a coalition, and Abe and Noda both face a fair amount of opposition within their own party. Plus, with Japan teetering on its 5th recession in 15 years, whoever wins will be on a short leash. If Noda wins, one likely shouldn't expect Japan to tear down trade barriers overnight. If Abe wins, he might find it difficult to enact his proposed overhaul of Japan's central bank, which includes amending the charter to force the BOJ to be more accommodative.
Now, the latter might sound ok, considering unlimited quantitative easing would only put a Band-Aid on Japan's deep structural problems, which include weak demographics and waning productivity. Japan needs to make it easier for small firms to compete with the keiretsu (huge, heavily protected conglomerates), kick-start privatization, reform labor markets to boost its aging workforce and allow painful but necessary creative destruction to work its magic. But until Japanese citizens can hand a strong leader a firm mandate to reform their economy—another Koizumi, who oversaw a raft of market-oriented changes—true reform likely remains maddeningly out of reach.
Not that Japan's in terrible shape, mind you—the nation's proven remarkably adept at muddling through, and the economy's clawed its way back from the Great Tohoku Earthquake and Fukushima Daiichi nuclear disaster. Japan may not have the most dynamic economy in the world, but it is highly advanced and has proven its ability to persevere despite a dysfunctional political system that prevents further economic opening. Japan remains an important link in the global supply chain, and its status as a key exporter remains intact (the spat with China hurt exports in September and October, hitting headline growth, but these impacts tend to be short-lived). It's likely Japan can rebound from recent contraction and continue achieving ok growth. There are simply several policies leaders could implement so that Japanese economic policy shifts from headwind to tailwind. Alas, those policies seem unlikely as long as the revolving door keeps turning. 
This article constitutes the views, opinions, analyses and commentary of the author as of November 2012 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.