Abe on the Outs?

These are bad times indeed for the reigning Liberal Democratic Party (LDP) in Japan. Despite the recent history of pro-market reforms and economic stability, newly installed Prime Minister Shinzo Abe is in real danger of losing his post. MarketMinder readers know thinking globally is integral to a successful stock portfolio today, making an update and primer on politics within the world's second largest economy an apt topic heading into the first days of summer.

Approximately half the seats in the Japanese Upper House are coming up for elections scheduled for July 29. The election is widely viewed as a test of Prime Minister Abe's pro-reform government, and there's speculation Abe will step down if the LDP fails to maintain control of the Upper House. (Note: for a primer on the composition and workings of the Japanese government, see the end of this commentary.)

Immediately after taking office, Abe enjoyed immense popularity, but the honeymoon, as they say, appears to be over. A series of political gaffes caused a rapid decline in approval ratings. Support for Abe's government has fallen to 36% since his election in September 2006—a far cry from the 71% approval rating Abe enjoyed at the beginning of his term and the consistent +50% approvals predecessor Junichiro Koizumi garnered.

It's been a bit of a mess so far. The reforms spearheaded by Abe made strides in areas the public has little interest, such as constitutional reform. Yet, pension, welfare, and other social security policies remain the most important issues to voters, but the LDP has not taken much action. A recent public fiasco involving miscalculations of pension benefits increased distrust of Abe's authority. To wit, Abe announced he'll return his ¥2.3 million summer bonus over the pension issue.

It's widely believed Abe would be forced out of office should the LDP lose its power. As a matter of fact, this wouldn't even be the first time Abe stepped down from office following poor election results. Years ago, Abe stepped down from his position as secretary general of the LDP after a failed vote on postal privatization in the Lower House, only to be inserted into the post of Chief Cabinet Secretary the following year.

Despite all this, the most likely election outcome is little real change. There doesn't seem to be an overwhelming mandate for upheaval from the people of Japan. The Japanese economy is steadily improving, real estate prices are rising, unemployment is low, and the LDP continues to put very popular economic and social reforms on their agenda. This election is more likely to serve as a stern wake up call than anything else.

Anyway, a LDP loss would be largely symbolic with few real ramifications. Abe hasn't officially indicated he would step down if the LDP suffers a defeat, and they'd still control the more powerful Lower House. (Interestingly, rumors abound that if Abe were to step down, it's possible Koizumi could take over again. But this is pure speculation.) In the short term, it wouldn't be surprising to see the LDP promote pro-growth initiatives like corporate tax reform and a smaller consumption tax increases to shore up popular support.

What does it all mean for stocks? The elections will undoubtedly receive a lot of press in the next few months and cause some political risk aversion, but solid economic fundamentals and relatively cheap valuations should remain the more significant drivers of equity prices in Japan looking past the elections. If anything, the results are likely to put more pro-market reforms at the top of the agenda…a good thing for Japanese stocks and global trade. But for now the risk remains of a very poor showing by the LDP that could inhibit the implementation of reforms. Stay tuned.

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A Brief Primer on the Japanese Bicameral System of Government

Japan's national legislature, or Diet, is bicameral, comprising the House of Representatives, also known as the "Lower House"; and the House of Councilors, also known as the "Upper House." The Lower House has 480 members elected every four years. It may be dissolved earlier, however, if the Prime Minister or the Lower House decides to hold a general election before the end of the term (this is what occurred following the postal privatization vote in 2005). Because the Lower House can be dissolved, it is considered to be more sensitive to public opinion than the Upper House. The Upper House has 242 members elected for six year terms with half elected every three years. The Upper House cannot be dissolved.

The Lower House is more powerful than the Upper House because it has several powers not given to the Upper House. Generally, a bill is presented to both houses to become law. If a bill is passed by the Lower House but is voted down by the Upper House, the Lower House can override the decision of the other chamber by a two-thirds vote. In the case of the budget, treaties and the selection of the Prime Minister, the Upper House can delay passage, but not block legislation. If both houses cannot agree on a budget or a treaty, even through the appointment of a joint committee of the Diet, or if the Upper House fails to take final action on a proposed budget or treaty within 30 days of its approval by the Lower House, then the decision of the Lower House takes precedent. If both houses cannot agree on a candidate for Prime Minister, even through a joint committee, or if the Upper House fails to designate a candidate within 10 days of Lower House's decision, then the nominee of the Lower House becomes Prime Minister.