It has been a quiet quarter for the U.S.-Japan relationship. The dispatch of troops to Iraq notwithstanding, there have been no serious, specific bilateral problems for the two governments to address. While they have diverged on some multilateral questions, the goodwill accumulated over the last two years has bridged those differences.

In both countries, domestic politics dominated decision making. Japan Prime Minister Koizumi Junichiro focused on re-election as Liberal Democratic Party (LDP) president; having won that campaign he now turns to the general election expected in early November. U.S. President George W. Bush has begun to concentrate on the 2004 campaign with U.S. voters increasingly concerned about their economic prospects. Fortunately for Japan, in this context, China looms larger in the American mind. Attention will now turn to the Oct. 17 summit between the two men. Both governments will do their best to ensure the meeting goes well. It should: U.S.-Japan relations are one of the few unquestioned successes for both administrations.

Mr. Koizumi Wins Again

To no one’s surprise, Prime Minister Koizumi won a second term as LDP party president. In the Sept. 20 ballot, he claimed 399 of 657 votes – 60.7 percent of the votes cast, swamping his three challengers. His new term as party president runs until September 2006. The victory has important repercussions for Japanese party politics – at least the structure of power in the LDP. (For more on this, see “Koizumi’s Reelection and Its Implications for U.S.-Japan Relations,” by Yuki Tatsumi, PacNet 40A.) For our purposes, the victory means that U.S.-Japan relations will continue on their current track. Key figures carried over into the new Cabinet: Defense Agency head Ishiba Shigeru maintains his old portfolio, as does Foreign Minister Kawaguchi Yoriko. Of equal importance – and to be discussed in more depth below – Takenaka Heizo continues to serve as economic czar.

The prime minister and his party will now turn their energies to the upcoming general election, which is anticipated to be held Nov. 9. The government will benefit from a spike in public approval ratings that followed the appointment of the new Cabinet: A Yomiuri Shimbun survey put its support rate at 63.4 percent (up from 57.7 percent three weeks

earlier, but still down from the 75 percent approval rating garnered by the first Koizumi Cabinet). Mr. Koizumi cannot assume that all will be smooth sailing, however: while 54.7 percent believe that the new government should focus on boosting growth, more people – 56 percent – doubt that the new Cabinet will do much for the economy. The prime minister and the LDP can take some solace: 38.5 percent of those surveyed preferred the LDP to govern, while 10.8 percent supported the party to be formed from the merger of Minshuto (Democratic Party of Japan) and Jiyuto (Liberal Party).

Backtracking on Iraq?

While the election results promise a continuation of current Japanese policies toward the alliance, they have thrown a shadow over one facet of bilateral cooperation with the U.S. The prospect of casualties forced the prime minister to backtrack from his pledge to send Japanese forces to support nation-building in Iraq. No government wants to contest an election as it dispatches soldiers to a free-fire zone; in Japan the allergy is even more acute.

Tokyo’s reluctance to dispatch forces has obliged U.S. officials to step up their “urgings” of Japan to take action as Washington tries to demonstrate international support for its policies there. The Asahi Shimbun reported that Mr. Bush has called Mr. Koziumi several times requesting forces, U.S. Ambassador Howard Baker has been similarly insistent, and Deputy Secretary of State Richard Armitage is said to regularly remind Japanese visitors of the need for Tokyo to put “boots on the ground.”  The Asahi says that Mr. Koizumi has decided to dispatch a small military and air force contingent to Iraq – no more than 100 army engineers and some C-130 military transports – although the actual announcement may not come until after the election. Tokyo decisionmakers are thought to worry that a failure to act promptly will force them to increase future financial contributions. The historic dispatch, the first deployment of Japanese troops overseas without UN authorization since World War II, was made possible by legislation that passed both houses of the Diet early in the quarter.

For the record, Mr. Armitage has said that he applauds the prime minister’s decision “to stand on the ground as a player rather than staying in the stands as a spectator,” and remains “certain” Japan will make a “generous” offer to support Iraqi reconstruction. Even if reports of U.S. pressure are exaggerated, there is a widespread perception in Japan that this is so.

According to the Nihon Keizai Shimbun, Ambassador Baker asked Foreign Minister Kawaguchi for $1 billion. Then-Chief Cabinet Secretary Fukuda Yasuo responded saying Japan is ready to bear “a due share” to help rebuild Iraq, but did not specify an amount. Expect a figure to be revealed during President Bush’s Oct. 17 visit to Tokyo.

Oil and Atoms in Iran

Mssrs. Bush and Koizumi are likely to spend a bit of time during that meeting discussing the Middle East. In addition to Iraq, Iran is an issue of concern. The discovery by the International Atomic Energy Agency (IAEA) of traces of enriched uranium in Iranian centrifuges supported allegations that the country has a clandestine nuclear weapons program. Washington has long warned that Tehran has nursed nuclear ambitions and the IAEA reports provide independent confirmation of those fears.

The news poses an acute dilemma for Japan. Tokyo has been looking to Iran to diversify its energy suppliers. In particular, Japan had hoped to win exclusive rights to develop the Azadegan oil field, thought to contain some 26 billion barrels of reserves. But a consortium of Japanese firms failed to reach agreement on a deal with Tehran by a June 30 deadline, and Iran has announced that it will seek bids from other firms.

The primary obstacle to a deal – the largest supply of oil that Japan has ever had access to – is U.S. concern over the prospect of financing Iran’s nuclear program. Japan had maintained that the two issues were separate, but Nakagawa Shoichi, the new minister of economy, trade and industry, announced at his inaugural press conference that “Iran’s nuclear issue is not a matter that Japan can overlook,” and that the government would deal with it “in its totality taking into consideration all these aspects.” He emphasized that “We will not pursue the project at all costs just because an oil field is expected to be discovered.”

Mr. Nakagawa denied that U.S. pressure had influenced Japanese policy. That is hard to credit, given consistent reports of U.S. displeasure at Tokyo’s apparent readiness to go ahead with the deal only a month before.  Nonetheless, nuclear nonproliferation has been a centerpiece of Japanese foreign policy and to dismiss the importance of antinuclear sentiment out of hand – in this or any other issue – would be a mistake.

Eye to Eye over North Korea

When it comes to the third member of the terror trifecta – North Korea – there was no daylight between Washington and Tokyo. The two governments worked closely with Seoul to coordinate positions ahead of the six-party talks that were held in Beijing during Aug. 27-29. The U.S. was Japan’s strongest supporter before and during the talks, arguing that Tokyo deserved a seat at the table and standing behind Tokyo’s demand for the release of the families of the five Japanese kidnapped by North Korean agents and who are still being held in the North. For its part, Tokyo has resolutely backed the U.S. demand for the “complete, verifiable and irreversible” elimination of North Korea’s nuclear weapons program. The two governments showed the strongest solidarity among all the nations participating in the talks. The bilateral consultation and coordination has continued after the first round of talks.

Japan showed its displeasure – and gladdened the hearts of nonproliferation hawks in Washington – by stepping up inspections of the Mangyongbong-92, the North Korean ferry that operates between the two countries and is thought to be a conduit for the supply of money and technology to North Korea. North Korea protested the moves, calling them harassment and temporarily suspended the visits. They have since resumed.

Japan has also been a supporter of the U.S.-led Proliferation Security Initiative (PSI), currently an 11-nation “coalition of the willing,” that is designed to thwart the proliferation of weapons of mass destruction (WMD). During the quarter, Japan participated in a four-nation maritime exercise to intercept and board vessels suspected of smuggling WMD. The Coral Sea drill included the U.S., France, and Australia, along with observers from the other seven PSI members, and used 800 personnel, ships, and aircraft.

Off the Fence with Missile Defense

The North Korean threat also galvanized Japanese thinking about missile defense. North Korea’s bluster and fiery rhetoric and a missile flight time of less than nine minutes have escalated Japanese fears and sense of vulnerability. After several years of hemming and hawing, Prime Minister Koizumi has finally decided to go ahead and deploy a missile defense system to protect Japanese cities in the case of attack. The government’s plan envisions a multilayer-shield consisting of Aegis-equipped destroyers deployed at sea and advanced Patriot missile batteries on land. The proposal would cost about $1 billion a year over four years, and will require significant legislation, perhaps even a constitutional amendment. The Asahi Shimbun also reports that the Defense Agency wants to link Japanese fighters to a U.S. satellite-guided bombing system to facilitate the use of precision-guided munitions and has requested some $110 million to do so. U.S. missile defense advocates took heart from Japan’s decision, and touted it as proof that fears that U.S. deployment would alienate friends and divide alliances were exaggerated.

Never Too Soon to Start Campaigning

Prime Minister Koizumi wasn’t the only leader obliged to factor electoral considerations into foreign policy thinking this quarter. Mr. Bush is being forced to look ahead to next year’s campaign. Since the conventional wisdom is that voters vote their pocketbooks – although Iraq may assume real salience in the 2004 ballot – that means increasing attention to economic issues.

Even though the recession is officially over, U.S. voters are not happy. And with good reason: if current trends continue, Mr. Bush will be remembered for presiding over the greatest loss of jobs – 2.7 million – since the Great Depression. The losses are especially high – and likely to be permanent – in the manufacturing sector, giving rise to claims of unfair competition and in particular, currency manipulation to retain competitiveness.

China is the biggest target, given its $103 billion trade surplus and the “made in China” label attached to most consumer goods sold in the U.S. And indeed, according to Japan’s Ministry of Finance’s August statistics, that country’s surplus with the U.S. narrowed for an eighth straight month, to ¥474.7 billion, the lowest level since August 1996.  Exports to the U.S. fell 7.8 percent and imports dropped 10.2 percent.

The question is whether it is possible to complain about China’s currency being artificially undervalued at its current peg to the dollar and ignore Japan’s unprecedented intervention in foreign exchange markets to halt or slow the rise in the value of the yen. The answer seems to be “yes.” The U.S., primarily in the person of Treasury Secretary John Snow, continues to applaud Japan’s progress in reform and says nothing about the apparent inconsistency of its position. Japan does not appear ready to help resolve the dilemma.

While Japan signed the G-7 statement issued on Sept. 20 that called for market determination of exchange rates, it has not hesitated to intervene to protect the value of its own currency. By one estimate, Japan has spent more than ¥13 trillion ($117.6 billion) this year – more than the GDP of Ireland – in a fruitless attempt to keep the yen from escalating in value. It continues to rise, hitting three-year highs this quarter.

There are two explanations for Japanese action. The first, and most obvious, is the desire to improve the competitiveness of its exports. The second rationale is novel: The Bank of Japan is hoping that higher import prices will help inflate the economy. With interest rates already at zero, traditional monetary tools are useless. Its ability to print endless amounts of yen to buy dollars allows it to compensate for that. Richard Jerram, chief economist at ING Barings in Tokyo, has put it quite nicely: “With interest rates at zero, Japan can simply create as much yen as is needed to satisfy world demand. So if the foreign exchange market has developed a sweet tooth for yen, the BOJ has a chocolate factory with infinite capacity to meet that demand.”

The G-7 statement has had no impact on Japanese behavior. After taking his place in the new Cabinet as finance minister, Tanigaki Sadakazu said the government would continue to intervene. He even said that the language of the statement – that “foreign exchange rates reflect economic fundamentals” – justified Japanese action.

The Urgency of Real Reform

Unfortunately for Mr. Tanigaki, by that standard, the strengthening yen might just be accurate. In its monthly assessment of the nation’s economy, the BOJ in August upgraded its evaluation of Japan, crediting expanding exports. The unemployment rate in August fell to 5.1 percent, a two-year low. More significant, data released in September showed the Japanese economy grew a blistering 3.9 percent in the second quarter (on an annualized basis), the fastest growth in two and a half years, making Japan the best performer in the G-7.

While Tokyo’s support for U.S. foreign policy has made criticism of its economic policies off limits, a recovering Japan might be called upon to shoulder more international economic burdens, especially if the U.S. continues to founder. That is in line with Japanese notions of burden sharing, but Tokyo’s behavior this quarter didn’t show a readiness to step up. In addition to flouting the G-7 agreement, there have been criticisms of Japanese contributions to the world trade negotiations that were held in Cancun, Mexico in September. Quite simply, Japan appeared more concerned with protecting its agricultural sector than working to reach a trade deal. While that is neither new nor unique behavior, it does raise questions about Tokyo’s readiness to play a “leadership role” on international economic issues, its natural area of competence. If trade becomes an electoral issue, Tokyo could find itself the target of unwanted attention, albeit in a new way.

There is another reason why Tokyo might be slow to pick up the burden: its “recovery” might not be real. The jobless figures are open to question because much of the fall in unemployment can be attributed to a shrinking labor force. The surge in second quarter growth is primarily the result of strong capital spending, which increased over 20 percent, but the volume is exaggerated because the price of capital goods has dropped dramatically. In other words, the Japanese economy remains fragile, the “recovery” potentially a phantom.

Mr. Koizumi Stays the Course

Yet the U.S.-Japan alliance, and the international economy, cannot afford another several years of Japanese stagnation – and certainly not if the U.S. remains in the doldrums and Europe succumbs to its version of “the Japanese disease.” This underscores the importance of a renewed commitment to reform on the part of the Japanese government.

To his credit, Mr. Koizumi appears to understand what is expected of him. Upon announcing his new Cabinet, the prime minister said that its members were picked to help forward his “commitment to reform. … It is a reform Cabinet, and we will not make a policy shift.” Indeed, “it is time for us to pursue structural reform even more aggressively.”

The problem is that there are good reasons to be skeptical about its members’ ability to deliver. The new METI minister, Mr. Nakagawa, has raised doubts about his commitment to weeding out weak and noncompetitive companies, arguing that “when companies are engaged in activities that have value, we should be able to keep them.” Shortly after taking his portfolio, Public Management Minister Aso Taro expressed doubts about proceeding with the prime minister’s plan to privatize the postal service. Mr. Koizumi countered by giving that assignment to Minister of Economy and Financial Services Takenaka Heizo.

Mr. Takenaka is probably the most controversial figure in the Cabinet. Many LDP members wanted him removed when Mr. Koizumi shuffled posts, but the prime minister remains committed to him, perhaps because he serves as a convenient lightning rod – and his replacement would have signaled quite plainly Mr. Koizumi’s retreat from a reform agenda. When asked about the reappointment, Mr. Koizumi said, “I believe that the
direction of his economic policy is correct.” Mr. Takenaka’s continued presence was intended to demonstrate that the prime minister has “no intention of altering my reform path.”

Yet the Koizumi government’s journey down that path has been a winding one, Mr. Takenaka’s guidance less than inspiring. While there are signs that (some) companies are restructuring, there is little indication of a genuine political commitment to reform. Banks are still pressured to support marginal and failing businesses. When they don’t, the government steps in. Privatization of semigovernmental entities is proceeding fitfully at best. The bureaucracy continues to facilitate the restructuring of industry and businesses. The foreign exchange interventions reveal a reluctance to let market forces do their work.

None of these questions will be raised Oct. 17 when Mr. Bush and Mr. Koizumi meet. Instead, they will focus on issues much closer to home – how best to deal with North Korea – and applaud the strength of their partnership. Each man will also have one eye on the electoral calendar and if they are honest with each other, they will admit that events in Iraq may hold both of their fates hostage.