UPPER HOUSE ELECTION COMPLICATES ECONOMIC

C O N F I D E N T I A L SECTION 01 OF 03 TOKYO 003660

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DEPT PLEASE PASS TO USTR/MBEEMAN

E.O. 12958: DECL: 08/05/2017
TAGS: ECON JA
SUBJECT: UPPER HOUSE ELECTION COMPLICATES ECONOMIC
POLICYMAKING


Summary
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1. (C) The stunning defeat Japanese voters handed the ruling
Liberal Democratic Party (LDP) on July 29 stems primarily
from domestic concerns the Diet will have to tackle when it
reconvenes in the autumn. The Democratic Party of Japan
(DPJ) takeover of the Upper House complicates the LDP's
ability to resolve issues like pension reform, tax reform,
agriculture reform, and various economic trade agreements
expediently and without compromise. Following is an outline
of Embassy expectations for these issues, a brief discussion
of the future of the Council for Economic and Fiscal Policy
(CEFP),reactions of investors and key business leaders, and
an explanation of the mechanics for passing legislation. End
Summary.


Pension Reform Gets Messy
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2. (C) Putting aside the issue of finding owners for 64
million unclaimed pension fund accounts -- the most important
issue in the election according to all exit polls -- the LDP
and the DPJ remain far apart on how to reform Japan,s
pension system, which consists of three parallel structures,
each with a different premium structure, client base and
financial capacity. The ruling coalition had planned to
combine part of the company employees' pension plan and part
of the government employees' mutual aid pension plan
beginning in 2010. The DPJ on the other hand has proposed
unifying all three programs, including the national pension
plan into which the self-employed contribute. One problem
this approach poses is that self-employed contributors often
lack the income transparency that is common among salaried
workers. In addition, many of these self-employed workers
form the LDP's power base and they likely would oppose such a
system.


Fate of Consumption Tax Increase Uncertain
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3. (C) The Ministry of Finance had hoped to introduce a
consumption tax hike in 2009 but this could be delayed due to
strong DPJ opposition. The DPJ has said it wants the
consumption tax to remain at its current level. Government
tax panel head Yutaka Kosai, with the support of Finance
Minister Koji Omi, announced on July 31 that a debate on the
tax would begin in the autumn as scheduled but he admitted
that DPJ views would have to be considered. Chief Cabinet
Secretary Yasuhisa Shiozaki commented in the press on July 30

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that the change in Upper House control meant the ruling and
opposition parties would have to work together on how to
proceed on the issue. Ministry of Finance Vice Minister
Hiroki Tsuda announced on July 30 that "fundamental tax
reform" discussions will be carried out in the autumn, which
likely will include discussions about a consumption tax hike,
a possible lowering of the corporate tax rate, and a review
of taxes on financial income. This threatens the tacit
understanding between the government and the ruling parties
that the consumption tax would be raised to offset the
planned increase in the state contribution to the pension
system from the current one-third to one-half in fiscal 2009.
The business community also had hoped for a decrease in
effective corporate tax rates following an increase in the
consumption tax, but an increase in the consumption tax
without pension system reform could further anger the voting
public.


Doha, FTAs and Agriculture
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4. (C) The LDP's election loss likely will delay any movement
Japan has shown toward a more open trade regime and slow even
further -- if that is possible -- agricultural reform. One
issue raised in the press is the possible slowdown of the

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consolidation of farmlands because the DPJ has introduced new
plans for compensating small farms for lost farming income.
The ruling coalition had crafted policies that focus on
larger-scale farms in an effort to encourage greater
consolidation. Ministry of Agriculture, Forestry and
Fisheries officials, who are suspicious of farm sector
reforms, have said they may need to implement "DPJ policies
that protect small farms" -- in effect seizing on the DPJ's
opportunistic farm sector approach as a reason to delay
reform. Such an approach on agriculture will make it more
difficult for Japan eventually to do the right thing --
should the opportunity arise -- on a multilateral Doha Round
trade deal. Moreover, ongoing FTA discussions with Australia
as well as possible future discussions with the United States
and the European Union are also under threat. Certainly the
United States and Australia, as potentially significant FTA
partners, have made it clear that all sectors, including
agriculture, would have to be on the table.


CEFP and Public Works Spending
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5. (C) The Council on Economic and Fiscal Policy (CEFP) under
the Koizumi administration played an important role as policy
advisor by setting government budget guidelines used to
formulate the budget, but its influence has declined under
the Abe administration due to a lack of leadership. Economic
and Fiscal Policy Minister and CEFP head Hiroko Ota, a
non-politician, recognizes that Japan must boost economic
growth and promote fiscal consolidation in order to meet the
challenges of globalization and Japan's rapidly aging
society, but she lacks the leadership and Diet support
necessary to further these goals. In addition, the Prime
Minister himself has not uniformly backed the priorities of
the CEFP, resulting in a lack of direction on economic policy
from the top. A key test of the ability of the CEFP to move
forward with its plans is the status of public works spending
in the next fiscal budget. It was expected that the
government would cut public works expenditures by about three
percent in line with its commitment to reduce expenditures by
a maximum of 14.3 trillion yen over five years, but after
major LDP losses in the rural regions, the ruling coalition
may be forced to adopt a more cautious approach. The CEFP
also could tackle such issues as the minimum wage to address
growing economic disparity and convince the public it is
serious about the downside of reform.


Business Groups Maintain Support for LDP
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6. (SBU) Leaders of Japan,s major business organizations --
Japan Business Federation (Nippon Keidanren) Chairman Fujio
Mitarai, Association of Corporate Executives (Keizai Doyukai)
Representative Director Masamitsu Sakurai, and Japan Chamber
of Commerce and Industry leader Nobuo Yamaguchi -- have all
indicated continued support for Abe and his reform policies.
Mitarai also has expressed a desire to deepen talks with the
opposition DPJ, however, and reportedly is seeking a balance
between the DPJ and the ruling coalition. Mitarai and
Yamaguchi have called for new party executives and a cabinet
reshuffle. All three agree that economic concerns, including
the pension problem, led to the LDP defeat. Keidanren was
notably absent from the campaigning leading up to the
election, unlike during the 2005 race when senior Keidanren
officials under former Chairman Hiroshi Okuda actively
supported the ruling coalition.


Investor Reaction Muted
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7. (SBU) Investor reaction to the political turmoil has been
muted probably because the outcome was largely expected and
already reflected in market prices. The Tokyo stock market
initially fell sharply the day after the election before
recovering later in the day, but this related mostly to

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developments the previous Friday in New York markets. Some
market analysts have suggested that if Abe,s new cabinet is
less reform-minded than the current one it could have an
impact on the Bank of Japan's (BOJ's) expected decision to
raise interest rates in August, although most agree that the
political situation is unlikely to affect the outcome of the
BOJ monetary policy board meeting later this month. The BOJ
has already indicated in the press that it would study the
current situation further before deciding on raising rates.


Turning Legislation into Law
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8. (SBU) The Upper House and Lower House each have the
ability to introduce new bills in the Diet, but to become law
the bills must be approved by both chambers. If legislation
is produced by the Lower House, for example, the Upper House
can either put the bill to a vote or ignore it. If the Upper
House ignores the bill for 60 days, the lower chamber then
can either over-ride this with a second two-thirds majority
vote or it can convene a joint committee of both chambers to
look for a compromise. If a compromise is produced, the new
bill must be approved in the Lower House before going to the
Upper House. If the committee fails to agree, then the
legislation dies. (Note: The Lower House has never in
practice overridden the Upper House. Currently, out of a
total of 480 Lower House members 306 belong to the LDP and 31
to Komeito giving the ruling coalition 337 votes. The
opposition DPJ has 113 seats and the remaining 30 seats are
divided among smaller opposition parties. A two-thirds
majority is 320.)


Comment
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9. (C) The government has told us its first priority in the
upcoming Diet session will be to extend the Anti-terrorism
Special Measures Law. Once that is done, we expect economic
issues will be key points of contention. The election
setback may force Prime Minister Shinzo Abe's government to
abandon economic growth policies and heed opposition demands
for a more equitable distribution of income. The DPJ has
been handed an historic opportunity to work cooperatively and
constructively on issues such as reforming the pension system
and raising the consumption tax but it may choose to obstruct
legislation instead. With the lower chamber in the hands of
the LDP and the upper chamber in the hands of the DPJ, Japan
at last will experience something akin to a two-party system
and all the demands for compromise this entails. Whether the
two parties are up for the task remains to be seen.
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