Time For Hardball?

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Koizumi's challenge is to orchestrate another bailout of Japan's banks (the fifth since 1998) while forcing them to call in nonperforming loans. For four years, Washington has been urging Japan to resolve its banking woes by setting up a government bailout fund, as the U.S. did during its savings-and-loan crisis in the 1980s. But Japan's bank debacle dwarfs the S&L crisis in both size and political complexity. Real reform means unraveling decades of interlocking commitments blessed by a system that rewards support with favors.

It is not that Koizumi has done nothing. Analysts applaud his decision to guarantee only the first $75,000 in new time deposits, beginning April 1. The regulation is a warning that Tokyo cannot back the status quo forever. Still, as bankruptcies and layoffs increase, it's harder to introduce tough reform measures. "They are writing off loans, but the bad loans are growing faster," says C. Fred Bergsten, director of the Institute for International Economics in Washington. "That feeds a lack of confidence that brings more nonperforming loans--and that is a death spiral."

The ominous force currently ripping across Japan is the hollowing out of the nation's industry. When Aiwa came to the sleepy rice-farming town of Yahaba in 1968, a year before it became affiliated with Sony, six other companies followed and set up factories that brought new highways and bullet-train lines, civilization and riches. In January, Aiwa closed all its factories in Japan. Yahaba, a 2 1/2 hour bullet-train ride from Tokyo, is now just another township in despair. "People working at the Aiwa plant at first said [the slowdown] wouldn't affect them," says Genkichi Kon, who operated a snack shop at the factory. "Gradually, one by one, they were restructured, and in the end they gave up." Today, says Mayor Mitsuro Kawamura, most residents live off their savings.

Made in Japan? That may be a disappearing concept. These days most of Japan's manufacturing jobs are migrating to China, where quality is high and labor is cheap. Sony, for instance, makes all its first-generation PlayStations there--about 7 million of them last year--and has plans to move PS2 manufacturing to China as well. Nearly half of Toshiba's 45 plants are now in China, cranking out air conditioners, mobile phones, TVs and whatever the next hot product is likely to be. In an astonishing twist, Japanese engineers and factory managers are lining up at employment agencies in search of jobs in China. "They need experienced people," explains Tomoko Hata, a manager at PaHuma, a private employment agency that finds jobs in Asia for unemployed Japanese. "People here will take a job there even though the pay is half what they were making. They're desperate."

Japan's desperation is running deep enough now so that it is feeding on itself. One argument contends that a further devaluation of the yen would help cushion the country against the sharpest edges of Koizumi's structural reforms. On the other hand, tough-minded economists argue, the only way the country will reform is through a true crisis--the kind that gets unemployed workers to the barricades. Thus far, Japanese have been remarkably benign over their plight. But as joblessness and misery spread, there is bound to be a backlash.

Abroad, the overarching fear is that Japan's woes will ripple through the rest of the world, triggering a financial crisis of unprecedented proportions. When its economy dipped precipitately in 1997, Japan allowed the yen to devalue, eventually destabilizing currencies in the rest of Asia and touching off the December 1997 financial crisis. Leaders in Beijing and elsewhere are determined to avoid a similar contagion this time around.

Now comes a very delicate and dangerous dance. Officials in Tokyo last week hinted that a new bank bailout is around the corner. Meanwhile, though U.S. Treasury Secretary Paul O'Neill has warned against a weak yen, a quiet consensus is emerging that as long as the currency doesn't sink much below current levels, Washington will look the other way, despite calls from U.S. industry for pressure on Tokyo. That and Bush's plaudits for Koizumi ought to give the Japanese Prime Minister some leeway in his quest for reform. There is no longer much room for error.