In the July 11 House of Councilors election, the main opposition force — the Democratic Party of Japan — made big gains while the leader of the ruling coalition — the Liberal Democratic Party — fell short of its modest target of a one-seat gain. Nevertheless, the LDP-led coalition government still has a comfortable majority in the upper chamber (only half of the seats were up for grabs), and the results are not expected to create serious political turmoil.

The LDP was criticized for lawmakers who failed to make mandatory payments into the national pension scheme and the government’s deployment of the Self-Defense Forces to Iraq, but its economic policies weren’t among the key campaign issues.

Instead, pre-election media surveys had forecasted losses for the LDP, creating anxiety about the future of the nation’s economic management and triggering falls in share prices. But when Prime Minister Junichiro Koizumi emerged from the election aftermath and confirmed he would “maintain” his structural reform initiatives, those concerns dissipated and share prices turned up.

Over the past three years, the Koizumi administration, while accelerating efforts to dispose of the bad loans crushing the banking industry, has attempted to form an economic structure that will no longer be dependent on public-sector demand. And his efforts may have paid off; there was rapid progress in corporate structural reform.

The “tankan” survey released July 1 by the Bank of Japan showed that business sentiment in both large and small companies is at its highest level since the 1990s. Earnings remain brisk, and Japanese firms are expected to make sharp gains in profits for a third consecutive year in fiscal 2004. While the recovery in the household sector has so far been slow, consumer spending is on an uptrend, given the decline in unemployment from its peak of 5.5 percent to 4.6 percent, according to the latest data.

In other words, a positive cycle — improved corporate earnings leading to higher household spending — is emerging.

But risk factors remain. The biggest risks include the future course of the economies of the United States and China, the trend in long-term interest rates in the U.S. and Japan, the surge in crude oil prices, the recent trend in Japanese prices, and the potential impact of curtailing the national guarantee on bank deposits in April next year.

However, these concerns are not being taken as seriously as they were at the beginning of the year.

For example, there was widespread speculation that the U.S. economy would lose steam once the impact of the tax cuts dissipated, but that is now a minority opinion in Japan. And many critics say the cooling measures taken by Chinese authorities will probably have a positive effect on its long-term growth.

In Japan, deflationary pressures have eased and wholesale prices have in fact turned upward. BOJ Gov. Toshihiko Fukui has repeated that the central bank will ensure the nation never again enters a deflationary spiral.

Of course, Japan should not be overconfident about its economy the way it was in the late 1980s. The economy must still face up to its medium and longer-term problems, including privatization of the postal system, comprehensive social security reforms to deal with the aging population, and reform of local governments’ fiscal structures. The government cannot afford to ease up on structural reforms.

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