Earlier in his administration, Prime Minister Junichiro Koizumi projected an image of aggressive leadership as he called for “no pain, no gain” structural reform. His bold plans included streamlining the bloated government budget. With the economy still struggling to recover, however, he seems to have lost much of his enthusiasm for fiscal reform.

The fiscal 2003 budget guidelines approved by the Cabinet on Wednesday reflect the “recovery-first” position of the ruling Liberal Democratic Party. Although the budget’s final shape is subject to negotiation, it is unlikely that the 2003 budget will give a big push to structural reform and fiscal consolidation.

First of all, the prime minister has made a symbolic retreat by effectively lifting the 30-trillion yen cap on annual bond issuance. This debt limit, designed to stop runaway budget growth, now exists only in name because the proposed tax cut of 1 trillion yen or more — designed chiefly to boost business activity — is to be financed through bond sales.

Koizumi’s structural reforms have suffered another setback under the pressure of a prolonged economic slump. His decision to dilute the plan to remove the blanket bank deposit guarantee next April — a decision purportedly aimed at preventing runs on small banks — also indicates that he is tilted toward economic recovery.

Of course recovery remains an urgent priority. Koizumi may have made “bold and flexible compromises” in order to get the economy moving again, but the impression is that he is backing off from his initial reform plans. When he was running for LDP president, for instance, he repeated that a budget gap of over 30 trillion yen was “abnormal.” And after taking office he put deficit reduction at the top of his reform agenda.

The announcement of the budget guidelines signals the start of the annual budget-making process. Not surprisingly, Diet members and top bureaucrats are moving to get as large a slice of the budget pie as they can. But precisely for this reason the prime minister must exercise leadership from the broad perspective of fiscal reform. Unfortunately, such leadership is not in evidence. The Council on Economic and Fiscal Policy, the blue-ribbon panel he chairs, is falling short of expectations.

The point to remember is that fiscal policy alone cannot save the structurally sick economy. For more than a decade since the bubble burst, the government has continued to stimulate demand through pump priming. But the economy has continued to stagnate. Mr. Koizumi’s “no reform, no recovery” slogan is losing its appeal.

He has been trumpeting another slogan, “no revenue, no tax cut” — meaning in effect that a tax cut should be coupled with a matching spending cut. The de facto lifting of the bond cap indicates, however, that the government may be returning to the “borrow and spend” policy of the past. This should not happen.

The prime minister is reportedly seeking to offset tax cuts by tax hikes over a number of years. This “revenue-neutral” approach is explained as a safeguard against fiscal laxity. Experience shows, however, that matching tax cuts by tax hikes over a given period is not always feasible given fluctuations in the economy. A future recession could easily postpone or cancel planned tax increases.

The guidelines call for a 3-percent cut in public works spending; a 2-percent reduction in discretionary spending, including official development assistance; a 5-percent cut in government subsidies; and downward adjustments in public pension payments. It remains to be seen, however, whether the general expenditure (excluding debt servicing costs and revenue transfers to local governments) will be held to the same level as that for fiscal 2002, 47.5 trillion yen.

The ballooning government debt is a clear and present danger, as pointed out by repeated warnings from international credit rating agencies. Yet, with the budget battle about to begin, politicians and bureaucrats alike seem concerned more about securing appropriations than defusing the crisis.

Deflation, to be sure, is an albatross around the neck of the Japanese economy. Removing it, however, requires structural reform because the burden stems essentially from structural problems. Under the circumstances, conventional stimulus measures like tax cuts are not the best way of curing the chronically ailing economy.

The Koizumi administration should reaffirm the basic tenet of its economic policy: promoting structural reform to achieve a sustainable recovery. We know that is no easy task. But, as the prime minister has been saying all along, the economy cannot get back on its feet unless its structural ills are addressed. That is why fiscal reform must be pushed.

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