Backsliding in Japan; With Koizumi drifting and his reform czar in political purgatory, the conservative bureaucrats are striking back.

Byline: Christian Caryl and Akiko Kashiwagi

A senior official in the administration of Japanese Prime Minister Junichiro Koizumi is worried. "There are so many things we have to tackle," he says, asking not to be identified because of the sensitivity of his statements. But when he scans the halls of government, he sees little appetite for change. The once redoubtable Koizumi, who is scheduled to step down from his post this fall after five years in office, is already looking forward to the delights of retirement. His star policy architect, an academic and political outsider by the name of Heizo Takenaka, has been consigned to political purgatory. And the "vested interests"--once all-powerful bureaucrats and hidebound pols within the prime minister's ruling Liberal Democratic Party--are staging a quiet comeback. "Over the last six months," says the senior official, "it's as if we've gone back five years."

Could things really be that bad? Perhaps not; insiders do sometimes exaggerate. But the view from the outside doesn't look so great, either. In recent days Japan's much-heralded economic revival has hit an air pocket. The hitherto buoyant stock markets plunged last week, triggered by a nasty mix of worries over rising oil prices, negative economic data from the United States and possible tightening by Japan's central bank. And that's not all. Last week another prominent financial renegade--investor and shareholder activist Yoshiaki Murakami--was arrested on charges of insider trading, leading to fears in some quarters of a retrenchment against confrontational, "American-style" investment tactics. All these developments are exacerbating worries about the fate of Koizumi's reform agenda once he leaves the scene. "I think there is a bit of a quite natural backlash in Japan now," says Peter Ennis, an editor at The Oriental Economist, an investor newsletter devoted to things Japanese. "People are questioning so-called market fundamentalism."

It's a remarkable shift, considering that, not all that long ago, few officials could compete with Takenaka--then the finance czar, now Telecommunications and Internal Affairs minister--when it came to holding the prime minister's ear. Just last September, Koizumi won an overwhelming electoral victory by casting the vote as a referendum on his ambitious reform program--most of it cooked up by Takenaka in his personal policy shop, which he staffed, in a stark departure from tradition, with independent economic experts who had no ties to either government or the LDP. On May 22, by contrast, Takenaka's economic-policy council was superseded by a new body run by rival Kaoru Yosano, 67, an LDP grandee who has now brought economic policy back into the cozy fold of the party. "The [previous] council was an engine to promote structural reforms," Takenaka complained soon after the move. Now, he said, "the council has changed into a forum that merely expresses the opinions of its members." Kenji Yumoto, chief economist at the Japan Research Institute, agrees: "Takenaka's confrontational style and tough stance brought about results. But we won't be seeing that sort of radical approach for a while."

Suddenly, Yosano's name-- rarely mentioned until just a few months ago--is on everyone's lips. Rather than advocating dramatic reforms, though, he's grabbed headlines with a broad campaign to sanction a range of financial misdeeds by companies and individuals. The targets have ranged from banks to accounting firms, and in some cases the measures have zeroed in on precisely the kind of collusive bid-rigging that long characterized Japan's corrupt "iron triangle"--the cozy relationships between bureaucrats, businessmen and politicians. And the government has been steadily tightening rules to improve oversight of the country's financial system--the one area, it could be argued, where reform has been ongoing.

But the crackdown has also encompassed two prominent challengers to Japan's business establishment. In January, investigators lowered the boom on Internet tycoon Takafumi Horie, 33, who was arrested on charges that he used corporate fraud to boost his flagship company, Livedoor. Then, on June 2, Murakami, 46, admitted to charges of insider trading, announced his withdrawal from the world of finance and shortly thereafter found himself in the same Tokyo prison where Horie had been held until his release on bond in April. Before their downfalls, both Horie and Murakami had transformed themselves into highly public ...