Although still the world’s second economy, Japan has taken quite a beating in recent years. The 1990s were a decade of prolonged stagnation with government spending, a steadily increasing public debt and an almost nonexistent interest rate hampering economic progress. The recession came on top of that and hit the country hard.

Urban dissatisfaction with Japan’s traditional ruling party, the Liberal Democrats, had been rampant for several years until this August, rural voters joined them in electing the Democratic Party of Japan to power. Established in 1998, the Democrats claim to be more liberal in the classical sense than their opponents, favoring the taxpayer and “self-reliant individuals”. The government should, in their view, limit itself to “building the necessary systems” for a society that is framed by “transparent, just, and fair rules.” Supposedly they prefer to let the market run its course but even before they won a majority and got to form a government, the Democrats distanced themselves from the small-government policies of former Prime Minister Junichiro Koizumi. His approach was to take the blame for recent job losses and a widening social inequality. Economically then, we do not have to expect a radically different course from these new power-brokers.

In spite of East Asia’s resurgence during the last quarter there are reasons to be cautious about a speedy recovery for Japan, notes Edward Hugh at A Firstful of Euros. Japanese manufacturers continue to curb on capital spending and salaries, making any recovery in domestic demand unlikely in the short run. Moreover, Japan’s long-term prospects are gloomy. The country’s workforce is shrinking and aging, writes Hugh, which, if the new government refuses to compromise on social security, will inevitably demand greater financial sacrifices from the rest of the population not too long from now. Lastly, Japan’s economy still faces the risk of “getting caught in yet another deflationary spiral,” especially after retail prices dropped dramatically last October.

Government stimulus measures did strengthen consumer spending and exports to Asian neighbors during the third quarter of 2009, producing a modest 1.2 percent growth rate over the previous quarter when Japan’s economy had already moved out of recession. Yet retail prices plunged by 2.6 percent during the same period; the fastest pace of price decline recorded since 1958. Consumer spending also fell during the third quarter after it had risen slightly earlier in the year when the government handed out money and rebates for people buying energy saving home appliances. Industrial output is still down by 15 percent compared to last year while Japanese companies are reluctant to invest as uncertainty over exports and a weakening currency persists.

It is exactly this anxiety about Japan’s export driven economy that continues to upset economists and investors alike. Cheaper products from nearby East Asian states, China foremost, threaten to upset the structure of Japan’s economy under which it has prospered for more than half a century. Meanwhile, the country’s domestic market simply isn’t strong enough to ensure continued growth should exports fail.

An aging Japanese workforce is only part of the problem. The long-term effects of repeated shortterm interventions in the private sector during the 1990s are starting to be felt and not just in the shape of a mounting public debt that exceeds GDP twofold. Labor productivity has been impaired due to substantial labor hoarding in non efficient sectors, according to Hugh while “expanded credit guarantees, intended to counter tight credit, have had similar adverse side-effects.”

Unfortunately, in spite of their rhetorics, there is little to suggest that with the Democrats in power, Japan will denounce big government spending to allow its domestic market to gain strength. As is typical during times of economic turmoil, the government feels that it has to fix the problem while especially in Japan’s case, government has been and continues to be the real problem.