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Will Koizumi's Reforms Be As Tough As His Talk?

Since he was elected Prime Minister in April, Junichiro Koizumi has excelled as a tactician. Appealing to Japan's jaded public over the heads of his opponents, he has rallied voters behind his simple message: The country reforms, or it is finished as an economic superpower. As BusinessWeek went to press on the eve of the July 29 elections for the Upper House in the Diet, polls showed Koizumi's ruling Liberal Democratic Party cruising toward a big win.

But the next few months will test Koizumi's skills far more severely. The Japanese economy is in much direr condition than when he took over. The Nikkei index is down about 20% since April and hit a 16-year-low on July 23. Meanwhile, the global economic slump has cut off export growth to the U.S. and Asia. All this makes Koizumi's politics of pain more difficult to implement--and riskier politically.

HIGH-WIRE ACT. The Japanese Prime Minister has just a few months to show real progress with his master plan to overhaul the banking system, get a handle on Japan's escalating government debt, and slash a runaway $300 billion public-works political machine down to size. If he pushes too little, he will be labeled a fraud by the Japanese press and lose popular support. If he pushes too hard, the current mild recession turns into an ugly one. Then, Dr. Pain won't be allowed to stay around to fix the mess.

How will Koizumi manage this improbable high-wire act? He faces yet another political hurdle in September, when LDP party elders meet to vote on his leadership. Koizumi is expected to win, but he may have to go easy on reform until after the ballot to avoid antagonizing his rivals in the LDP, who want to protect their backers in the construction, banking, and property industries from tough restructuring. Despite the prospect of that September showdown, some analysts think Koizumi could soon kick off his campaign to rid the banking system of its bad loans. But he might cut some backroom deals to appease LDP leaders he needs to keep on board.

The big question is whether Koizumi will speed up reforms after his place at the top of the party is assured. "This fall will be the test," predicts Edward J. Lincoln, an expert on Japan's economy at Brookings Institution in Washington. "Will there be [a financial] crisis, and will he seize upon the crisis to move forward aggressively?" The key moment will come in late September, when banks will be required to disclose for the first time the actual gains and losses on the huge stock portfolios they hold, which form a part of their capital base. This accounting exercise could reveal that several major Japanese banks are violating capital requirements, which means they are essentially bankrupt. That could provide an excuse for Koizumi to take dramatic steps.

A lot depends on whether Koizumi is truly a reformer--or just another ambitious politician. Opposition Democratic Party of Japan Chief Yukio Hatoyama says Koizumi is already caving in to LDP special interests. But Koizumi and his team insist they won't flinch. Economic & Fiscal Policy Minister Heizo Takenaka predicts the government will win legislative victories on two issues--capping bond issuances to $250 billion in next year's budget and fixing the banks. Come this fall, "people will see how serious [Koizumi] is about reform," Takenaka vows. But that will mean layoffs in politically connected industries.

If all else fails, Koizumi has two cards left to play. He could bank on his 70%-plus popularity rating to call a snap election of the Diet's Lower House in a bid to win a stronger mandate. Or he could quit the LDP and form a new party with LDP dissidents and opposition parties. However Koizumi plays it, the politics of pain look like a rough game this autumn. If former Chancellor Kenneth Clarke wins the race to succeed William Hague as leader of Britain's opposition Conservative Party, that could increase pressure on Prime Minister Tony Blair to join the European single currency. Clarke pulled off a surprise win among Tory members of parliament on July 17 and now faces the runner-up, Ian Duncan Smith, in a vote by the party's 300,000 members. The result is expected in September.

If the better-known Clarke wins, that would mean that two out of three of the main British parties would have leaders strongly in favor of Britain's entering the single currency. The Liberal Democrats and their leader, Charles Kennedy, have long backed such a move. Blair, who says he is in favor in principle but has set all sorts of conditions, could wind up looking like the main obstacle to Britain's joining. That could make things tough for him at meetings of European leaders. EBay (EBAY) may be the quintessential New Economy company, but France is treating it the old-fashioned way--with a strike. On July 23, uniformed guards used tear gas to disperse employees who barricaded the entrance to the headquarters of iBazar, a Paris-based online site that eBay is acquiring. Workers walked off the job to protest eBay's plans to lay off about half of iBazar's 90 employees. The controversy isn't likely to slow eBay's march across Europe. It's the top auction site in Britain and Germany, and its acquisition of iBazar gives it the No. 1 spot in France, Italy, and Spain.

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