At the beginning of December, Japanese sources rehashed old figures proving that the country’s third quarter contraction, at 1.9 percent, was 0.3 percent greater than first feared. With many still reeling from the realisation that the country had entered into its fourth recession since 2008, the revised figures exasperated concerns that the world’s third largest economy was fresh out of options. Higher taxes and shrinking wages have dampened consumer sentiment, inflation is still performing far below expectations, and the same old structural weaknesses continue to dog the ever-volatile economy. And while the country appears to have escaped its deflationary trappings, the shortcomings associated with the Japanese economy, even today, pose more challenges than they do solutions, which begs the question, is Abenomics actually working?
Barely before Abenomics had been christened, analysts began to warn that the reform drive would bring only disaster, with Ryutaro Kono of BNP Paribas highlighting that it could bring fiscal crisis by 2015, and Goldman Sach’s Naohiko Baba stating more recently that the plan is “approaching a moment of reckoning”. Fast-forward to today and Abenomics remains a divisive topic, with countless experts still at odds over its supposed success or failure.
Fueling the fire is the fact that last year – as ever – was a rollercoaster ordeal for the Japanese economy, and though the powers that be have grown accustomed to indicators that bear little resemblance to any economy like it, there is work still to be done to steady the ship. “We see the economy recovering modestly next year, but stagnant real wages will remain a headwind for consumer spending. The outlook for consumer spending will be shaped by how the combination of a weaker exchange rate, lower energy prices, and higher spare capacity since the sales tax hike will influence inflation”, says Marcel Thieliant, Japan Economist at Capital Economics. “We think that inflation will fall further in the first few months of the new year, which should provide some support for households, but we also think that wage growth will remain sluggish.”
Abenomics must make a measurable impact on the country’s economic wellbeing, or else run the risk of becoming an out-and-out failure
Still, citizens fear daily for their financial wellbeing and key structural problems remain, meaning that 2015 is the year that Abenomics must make a measurable impact on the country’s economic wellbeing, or else run the risk of becoming an out-and-out failure. “In terms of Abenomics, one of the key issues for next year will be to stay focused on economic reforms, where progress has been disappointing so far.”
Plans for 2015
On the face of it, 2015 will be shaped by three key events: for one, the central bank in October introduced a raft of additional easing measures, in the hope of meeting a two percent inflation target, and an approaching election for LDP presidency will dictate the ease by which Abe can pursue his reforms. However, chief among Abe’s plans for the coming year is – or was – a second consumption tax hike; a policy that has recently lost its colour after an eight from five percent rise in April sunk the economy to historic lows. After the initial rate rise, GDP contracted 7.3 percent in the following quarter and again 1.9 percent in the third, and many observers believe any further increases could wreak havoc on an already-fragile economy. It came as no surprise then, when in November Abe postponed the 2015 tax hike to 2017, only hours after news of Japan’s surprise recession hit.
Delaying the move reeks of short-terminism, and although the decision paints a prettier picture in the short-term, doing so only detracts from the real issues at hand. Some sources, the IMF included, insist that the second tax hike is essential if the country is to meet rising welfare costs and wayward debt obligations.”Given very high public debt, implementation of the second consumption tax increase is critical to establish a track record of fiscal discipline but is likely to take a toll on domestic demand, underscoring the importance of a pickup in confidence and investment”, according to the IMF in its October World Economic Outlook.
By most estimates, the impact of a 10 percent rate would result in an ever-so-slight back step for the economy, and the ramifications would only be temporary. Sources at the IMF estimate that introducing a higher rate would curtail the country’s economic growth by 0.3 to 0.4 percent, but the decision to do so would at least demonstrate that the administration is willing to make good on its pledge to remedy deep-set fiscal problems.
As is so often the case, approval ratings in the immediate term have taken precedence over long-term considerations, and the decision to delay a second hike is indicative of the slow and overly cautious pace at which Abe is enacting much-needed reforms. Granted, the decision to hold fire aligns with the Consumption Tax Law of 2012, which stipulates that any changes to tax policy must stop short of jeopardising an annualised real growth rate of two percent. However, the prevailing issue for Japan is not GDP growth, or lack thereof, but unmanageable fiscal deficits and longstanding labour market deficiencies.
In defence of Abe
In choosing to delay the second tax hike, Abe has given weight to the words of those who say he’s not strong enough to introduce the painful reforms the country so-desperately needs. However, although criticism of Abenomics is rife, it’d be unfair to say that no progress has been made by his three arrows, and given that the regime’s stated ambition is to set the economy on a course of sustainable inflation, the programme could even be considered a raging success. “All in all, Japan’s economy has done fairly well since the start of “Abenomics” considering the sizeable demographic and fiscal headwinds. To the extent that the policy helps eradicate deeply ingrained deflation with all its associated economic costs, some short-term pain for consumers is surely no reason to abandon it”, says Thieliant.
“Japan’s growth performance in recent years has not been as poor as often believed. Most of the growth shortfall relative to other large advanced economies can be explained by the fall in the working-age population, while productivity growth has been fairly strong. Nonetheless, there is still scope to close the sizeable gap in the level of productivity relative to the US.”
As far as government response is concerned, by choosing to tread cautiously, affected parties can more easily come to terms with market changes – or so the administration believes. Though for Abenomics to be considered a success in the long-term, the PM must work hard – and loud – to ensure his policies are both significant and effective. Sure, debate on tax policy is fine, but far more important is the issue of addressing known structural problems and setting the country on a path of sustainable growth.
A defining year
Expansionary monetary policy has succeeded in reducing the unemployment rate and closing the deflation gap, and the BoJ should be pleased with its part in boosting inflation. However, the fiscal policy and structural reform side of the programme have been all-but-non-existent, and the supply-side of Abenomics has failed to turn progress. Looking only at headline indicators, the country is in better shape today than it was two years ago, yet the problems that landed it in such a sorry state in the first place have somehow shied away from the limelight. Therefore, any discussions on Japan’s future prosperity are inexplicably tied to its structural problems.
In only 2013, the country’s working-age population shrank by 1.6 percent – a percentage point greater than the decade previous and higher than any other G7 nation – and the national workforce is projected to plummet further still in the years ahead. Beginning most notably in the mid-90s, Japan’s shrinking workforce has posed a considerable threat to its continued wellbeing, and without taking precautions to boost the numbers, there could be 30 million fewer workers by 2050 and, by 2100, the population could be half or even a third of what it is today. What’s surprising is that the problems associated with the issue are well documented and the consequences rightly feared, yet only two percent of the population are foreigners and only a minority of the voting public support measures to tackle the issue head on.
Most worrying of all is that the PM clearly opposes unshackling tight controls on immigration, which, in and of itself, shows a blatant disregard for what has for 20 years been Japan’s most damaging problem. “In countries that have accepted immigration, there has been a lot of friction, a lot of unhappiness both for the newcomers and the people who already lived there”, he said on a television programme at the beginning of 2014, in perhaps the most damning indictment of his stance on the issue.
As was shown previously with his earlier decision to delay a second tax hike, Abe is unwilling to introduce measures that might shorten his term in office. One recent survey undertaken by Capital Economics shows that only 37 percent of Japanese support immigration as a tool to stem the decline, despite there being a greater number of vacancies than there are available workers. It’s no surprise then that ever-so-slight changes to immigration laws have been talked up in public by Abe, in a bid to appease both those concerned about the labour shortage and those against making any considerable changes to the system.
The leadership qualities required of Abe and his administration are plainly not there. Calls to boost female participation have been muted, and what little progress has been made has been poorly targeted and unpopular. The crucial point of raising the retirement age is another issue that Abe has voiced support for in the past – and understandably so – though little to no progress has been made to actually address the problem.
“Unfortunately, we fear that reform progress will remain glacial in coming years, leaving potential growth pegged at around 0.5 percent”, says Thieliant. “The upshot is that higher inflation remains the only viable way to restore the health of the public finances.” For more than 20 years now, an ageing population has brought only deflation and debt to Japanese shores, and though lively economic indicators are critical in boosting consumer confidence and balancing the books, doing so is meaningless without first tackling the structural issues that lurk beneath.
The real test of Abenomics in the coming year will be how far the Prime Minister will go to unpick the ties on foreign entry, boost female labour participation and raise the retirement age. And only by focusing on the country’s structural problems will he build on the minor advances made since he took office.