“The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy.” These were the words of Martin Luther King. These are, indeed, challenging times for Japan’s economy and society, and much leadership is required to tackle a laundry list of problems. Shinzo Abe, prime minister of Japan since December 2012, has elevated himself to show leadership to grow the economy and fight deflation. Will he be up to the challenge?
Japan’s economy has been essentially stuck in deflation and low economic growth for the last twenty years, which has also been called the “Lost Decade”. The high economic growth years of the post WW II era (averaging 10% annual growth) turned to relatively lower growth in the 1975-90 period (averaging 4%), but since the early-1990s, economic growth has ground to a halt. It was 1.19% per annum in the 1990s, and 0.75% per annum in the 2000s.
What has happened in the 1980s is that since Japan was forced to raise the value of the yen compared to the dollar in the Plaza Accord of 1985, the economy briefly went into a recession as Japanese products became more expensive to export. The Bank of Japan (BOJ, central bank) reacted by lowering key interest rates to stimulate borrowing and investments. But much of the additional liquidity was funneled into the real estate sector, which led to a dramatic increase in housing prices and created a huge speculative bubble. Sensing a bubble the BOJ began to raise interest rates to prevent a further growth in the bubble, and it finally came crashing down in 1991 as default rates crept up, while housing prices plummeted. The banks were holding billions of dollars in liabilities, which required more than a decade of clean-up with the help of government bailouts. The banks continued to lend credit to firms that were struggling, and were deemed bankrupt without the loans. This created so-called zombie firms, which has kept the unemployment rate relatively low, but at the same time led to smaller growth in profits and productivity, thus reducing any incentives for more investments.
On the other hand, the stronger Japanese firms generally reacted by increasing their investments overseas, especially in more dynamic China, and accelerated automation, which explains why Japanese workers have seen their wage share falling while productivity is continuing to expand. The stagnation of wages and many over-indebted and cautious businesses implied a deteriorating consumer and investment environment. In combination, with virtually no immigration, an aging population and a falling birth rate, the Japanese economy has remained mired in a low-growth and deflationary situation. The collapse in the economy has largely been averted by the increasing fiscal stimulus provided by the state, which borrowed significant sums of savings from Japanese people and businesses to finance various infrastructure schemes to boost the economy. The BOJ has attempted to aid in the recovery through lowering the key interest rates close to zero (a policy in place since the mid-1990s), but lending has continued to remain very sluggish, which does nothing to reduce deflation or expand the economy at a quicker pace.
It is in the context of this economic environment that Shinzo Abe is promising a better outcome with his leadership. Leadership, in part, does seem to be rooted in the very political Abe family. Abe’s paternal grandfather Kan was an elected representative in the Japanese parliament, the Diet. His father Shintaro served as foreign minister in the 1980s. His maternal grandfather, Nobusuke Kishi, was prime minister in the late 1950s. After a brief stint in the private sector, Abe became a government official serving as executive assistant and secretary in different offices. He was first elected to the Diet in 1993, winning the seat of his late-father. In 2003, Abe was appointed the general secretary of the ruling Liberal Democratic Party. He became party leader and prime minister in 2006, and served a one-year period, where he focused on pushing for increased sanctions against North Korea for its nuclear tests, and for shoring up the pension and health care system. Abe’s government received huge criticism for mishandling the nation’s pension funds, which led to Abe’s resignation in 2007. Abe remained in the Diet and was politically quiet until he ran again as party leader and premiership in late 2012, ousting the ruling government of the Democratic Party under Noda Yoshihiko.
For his second term in office, Abe aggressively campaigned for strong economic measures to end deflation and restore economic growth to Japan. These set of policies are called ‘Abenomics’. The crux behind Abenomics is a mix of fiscal, monetary and structural reform policies to stimulate the Japanese economy and encourage business investments. These policies are essentially a continuation of past tools, but on a much larger and unprecedented scale. Abe’s government appointed a loyalist, Haruhiko Kuroda, to become the new BOJ governor. Kuroda promoted a 2% inflation target, radical quantitative easing and a devaluation of the yen in expectation of greater exports and more confidence among consumers and investors. The BOJ announced an increase in the money supply from 60 to 70 trillion yen. As a result, the yen devalued by 25% against the dollar between June 2012 and June 2013.
Abe’s fiscal policy was to massively expand spending on public projects, unveiling two separate packages worth a total of 15.8 trillion yen. Since Japan will host the 2020 summer Olympics it will have to spend lots of money to build the stadiums. Abe also boosted job creation schemes targeted at young people, and boosted the reconstruction fund to repair the damaged infrastructure resulting from the devastating 2011 tsunami. As a nationalist leader, who defied Chinese criticism by visiting the Yasunuki shrine honoring the Japanese war dead (and war criminals), Abe also prioritized on more defense spending to assert the country’s regional interests (also mainly directed against China). The third pillar of Abe’s reform plan is so-called structural reform of the labor and product market, where traditionally protected industries, like agriculture, pharmaceutical and electricity, expose themselves to greater competition from abroad. This should in large part be accomplished with Japan’s negotiation and ratification of the free trade agreement called Trans-Pacific Partnership (TPP).
The effect of all these policy measures have been an increase in the inflation rate of 1.1% as of October 2013. This beats the long years of falling prices. Stock markets also rallied with a 56.7% increase in 2013. First quarter GDP growth in 2013 was 4%, in the second quarter 3.6%, but slowed down to 1.1% in the third quarter. By May 2013, Abe’s popular approval rating had increased to 70%. The weaker yen has stimulated the export sector. Toyota has seen its net income increase by 52% in the last quarter of 2013. Other large employers like Panasonic and Hitachi have also seen increases in revenues. Consumption also increased (0.9% in Q1 and 0.7% in Q2 2013), though this may be partly due to the fact that the government announcement to raise sales taxes from 5 to 8% in April 2014 stimulates upfront purchases before the sales tax hike comes into effect. The Japanese government has pledged 5 trillion yen in additional stimulus measures to partly offset the impacts of a sales tax hike.
There is no doubt that Abenomics provides a useful lesson for policy leadership, but Shinzo Abe’s policies also has constraints and has drawn in some criticism. First, the devaluation in the yen might induce a currency war with other nations, as other countries become equally eager to devalue their currency to gain a price advantage.
Second, rising inflation has not yet been coupled with any measures to correspondingly raise the wages of Japanese workers, which is crucial for any sustained recovery, because a falling purchasing power of wages implies a fall in consumption, which undermines Abenomics (60% of the economy consists of consumption). Real wages of workers declined by 2% between August 2012 and 2013. A Kyodo news poll conducted in January 2014 finds that 73% of the Japanese respondents have not felt any impacts from Abenomics. Only 28% expected a pay increase, while 70% of respondents anticipated cutting their consumer spending, especially after the April tax hike. Abe has tried his best to convince employers to raise their employees’ wages amid rallying stock markets and rising corporate profits. But the profits can easily be invested abroad, and don’t have to benefit Japan as a nation.
Third, the weaker yen coupled with rising fuel imports resulting from the Fukushima nuclear disaster have produced a significant trade deficit (11.5 trillion yen, $113 billion) and current account deficit (592.8 billion yen, $5.7 billion). This is contrary to textbook expectations that a devaluation will result in reduced imports and reduced trade deficits. Expensive imports of foreign oil have a tendency to limit growth.
Fourth, Abe’s free-spending fiscal policies have added to the national debt, reaching 230% of GDP as of August 2013, and increasing interest costs on the JGB (Japanese government bond) to $257 billion, or a 14% increase from the previous year. This is the highest national debt burden as a proportion of the GDP in the world, and has largely been maintained by aggressive BOJ bond buying (which is part of the quantitative easing), and re-directing the nation’s savings to buy the JGB at low interest. Since 2009, outstanding interest on the national debt has outstripped tax revenues.
Abe is facing very tough choices here. If he continues with the fiscal stimulus, then the national debt will grow larger and interest rates on the JGB will need to go up, which will curtail any further policy options for the government, and will likely yield in default or even more devaluation and hyper-inflation. And even if interest rates do not increase, the public debt will eat into the national savings and might force the country to start borrowing more from abroad. On the other hand, this might take a long time, because Japan is still the world’s largest creditor with 296 trillion yen ($2.93 trillion) in net foreign assets. Ironically, if the economy recovers, then investors might sell off the JGB hoping better returns elsewhere, and this will also raise JGB yields. On the other hand, if the fiscal stimulus stops, then the economy will not recover, because scared consumers and wary businesses will also pull back their spending.
Fifth, the BOJ policy of quantitative easing, which had the objective of raising private sector borrowing, might not work. Even with additional capital, domestic banks are stuck with more deposits than they can lend out, implying that businesses and consumers are still very reluctant to spend money. This shows the limitation in terms of what a very aggressive BOJ can do. It has already kept interest rates close to zero for almost 20 years, and it has now added trillions of yen into the banking system, but not enough of it actually enters the economy, and is instead kept in the reserve of the BOJ.
Finally, some experts would argue that it does not matter what monetary or fiscal policy Abe is implementing, so long as the population is declining and immigration is virtually zero. With a declining population it is simply not realistic to expect sustained increases in total consumption and investment. Abe, a nationalist politicians, is very unlikely to relax the rigid immigration laws, and rising nationalist sentiments in the country will probably deter any political moves to liberalize immigration.
Abenomics consists of policies that are not completely novel. But the ambition and the scope with which Shinzo Abe tries to address the current economic challenges in Japan are certainly unprecedented. If Abe succeeds to stimulate the economy and end deflation despite all the aforementioned constraints, he will be celebrated as a great politician, whose policies could serve as a role model for other European countries or even the US to abandon their quest for fiscal austerity. If he fails, then one can at least not blame him for not having tried. As Martin Luther King said, good leadership has to be tested in bad times, not in good times.
History of the crisis and bubble: http://www.brookings.edu/~/media/Projects/BPEA/1996%202/1996b_bpea_ito_weinstein.PDF
Zombie banks: http://economics.mit.edu/files/3770
Falling labor share of national income, Japan: http://www.imf.org/external/pubs/ft/wp/2009/wp0997.pdf
Demographic problems in Japan: http://www.bloomberg.com/news/2012-04-25/three-reasons-japan-s-economic-pain-is-getting-worse.html
Abe biography: http://www.britannica.com/EBchecked/topic/1109913/Abe-Shinzo
BOJ/government policies: http://edition.cnn.com/2013/12/10/business/japan-abenomics-three-arrows/
Stock market growth: http://money.cnn.com/2013/12/31/investing/japan-nikkei-stocks/
GDP growth, though with lower growth in Q3 2013 http://online.wsj.com/news/articles/SB10001424052702303560204579246774206858170
Japan raises defense spending: http://blogs.wsj.com/japanrealtime/2013/12/24/japan-steps-up-defense-spending-as-china-tensions-simmer/
Rising corporate profits in Toyota and other firms: http://www.bloomberg.com/news/2014-01-29/automakers-fuel-japan-s-longest-profit-growth-streak-since-2007.html
Consumer spending Q1 and Q2 2013 http://www.cnbc.com/id/100951357
Sales tax hike and stimulus http://www.reuters.com/article/2013/11/01/us-japan-economy-gdp-idUSBRE9A006W20131101
Yen devaluation leading to currency war: http://www.reuters.com/article/2013/05/10/us-japan-economy-yen-idUSBRE94902T20130510
Japan’s current account deficit: http://www.bloomberg.com/news/2014-01-14/japan-posts-record-current-account-deficit-as-import-costs-swell.html
Japan debt to GDP and interest expense: http://www.zerohedge.com/news/2013-08-27/japans-2014-debt-interest-rise-record-257-same-singapore-gdp
Monetary and debt expansion might trigger hyper inflation: http://blogs.reuters.com/anatole-kaletsky/2013/05/17/the-radical-force-of-abenomics/
Japan tax revenues less than interest payment: http://metanoodle.blogspot.com/2011/12/in-japan-total-tax-income-is-less-than.html
Japan remains top creditor http://online.wsj.com/news/articles/SB10001424127887323855804578510221802364326
Economic growth will increase JGB yield http://www.merkinvestments.com/insights/2014/2014-01-14.php
BOJ Quantitative Easing might not work http://www.zerohedge.com/news/2013-11-18/failure-abenomics-one-chart-and-when-even-japanese-press-admits-easing-not-working-a
Immigration would benefit Japan: http://www.murthy.com/2013/05/24/japan-times-aging-population-needs-immigrants/
Resurgent Japanese nationalism: http://www.eastasiaforum.org/2013/09/25/the-twin-faces-of-japanese-nationalism/
Eamonn Fingleton argues the Japanese economy is doing fine. Only the stagnant population explains lack of growth. Exports are still strong. http://www.forbes.com/sites/eamonnfingleton/2013/08/11/now-for-the-truth-the-story-of-japans-lost-decades-is-the-worlds-most-absurd-media-myth/