Monday, August 8, 2016

Abenomics and Further Descent Into Japanese Economic Dispair

Since the Japanese asset price bubble popped in the early 1990s, Japan has been marred with economic sluggishness and recessions. Although elected as Japan's Prime Minister for 2006-2007, Shinzo Abe was re-elected as Prime Minister back in December 2012, and has been in power ever since. In January 2013, Abe addressed the National Diet, which is the legislative branch, and said that economic revival is the greatest issue facing Japan. Abe's economic plan, which has been dubbed with the portmanteau of Abenomics, comes with "three arrows": monetary policy, fiscal policy, and structural reform.

Monetary policy came with the easing of monetary policy with the goal of 2 percent inflation. This easing included an unprecedented level of quantitative easing, and as of early 2016, negative interest rates. Fiscal policy consisted of a fiscal stimulus with economic recovery measures of 20.2 trillion yen ($210B USD), 10.3 trillion yen ($110B USD) of which was a direct government stimulus package for public works and priming smaller businesses. The third arrow is a bit more complex because of the hodgepodge of initiatives in the third arrow. Although it initially focused more on the Trans-Pacific Partnership, the third arrow included the liberalization of the agricultural sector, promoting women's participation in the labor market, measures to aid entrepreneurs via deregulation, overhauling healthcare regulations, and a modest cut in the corporate tax.

This mishmash of Keynesian stimulus with market deregulation has met up with its fair share of criticism over the past three years, and begs the question of whether Abenomics has brought the economic revival Abe was expecting. The International Monetary Fund (IMF) released a report on Japan's economic progress last week, and it was not particularly flattering: "While Abenomics made initial headway in boosting expectations and revitalizing the Japanese economy, structural impediments and policy shortfalls, especially not the structural side, are making it difficult to achieve a sustained lift off." As to whether or not Abenomics has been successful in the short-run, we play the statistics game and look through economic statistics to discern short-term success (see IMF figures below).

  • Debt and GDP Growth. The past two years of real GDP growth have been at an anemic 0.25 percent (see quarterly GDP figures). The reason for this was instead of investing the stimulus money in creating jobs, companies tended to stash it in corporate cash holdings. This doesn't compare to what Japan has been raking up in debt in recent history. In terms of debt as a percent of GDP, Japan continues to wade in further disastrous territory. In 1980, Japan only had a debt-to-GDP ratio of 50 percent. With stimulus packages it has been enacting since the 1990s to deal with that initial asset bubble burst, debt-to-GDP ratio has more than quadrupled to 248 percent. The IMF predicts that it will reach 280 percent by 2030 (p. 48).
  • Stock Market: If we need more proof, look at the Nikkei 225, which is Japan's stock market index. In 1990, the Nikkei 225 reached a high of 38,712. Now, it hovers slightly higher than 16,000. 
  • Tax Burden: Tax rates in Japan were already high, and are getting higher. At the beginning of 2015, Japan increased its marginal income tax rate from 40 to 45 percent. Having one of the highest statutory corporate tax rates in the developed world doesn't help. Although they are cutting the corporate tax rate to 29.97 percent, a high corporate tax rate like that still adversely affects the economy. In 2014, Japan greatly increased its value-added tax (VAT) from 5 to 8 percent. The Japanese government is looking to increase it to 10 percent in 2017, although that will probably have to wait until 2019. The VAT has adversely affected consumption in Japan (ibid., p. 5), which can further be illustrated with Japan's consumer price index. Even with higher taxes, Japan has not been able to collect beyond 13 percent of the GDP (World Bank). 
  • Monetary Policy: The U.S. Federal Reserve recognized that quantitative easing might have helped Japan avoid deflation, but did not do nearly enough to meet inflationary target goals (De Michelis and Iacovellio, 2016). While the Brookings Institution was initially happy with Abenomic's results, it since changed its tune in October 2015, when it found that the monetary policy [of quantitative easing] had no visible effects (Hausman and Wieland, 2015, p. 2). If we need more proof, take a look at the inflation rates. Per the annual IMF data above, there was some success with meeting inflation targets. However, looking at the monthly breakdown, those figures were most probably brought about by the outliers right around when the VAT was increased in April 2014.
  • Currency Appreciation. Negative interest rates have been a relatively untested form of monetary policy. The reason for implementing the negative interest rates and the quantitative easing is to depreciate the yen, which in turn, makes the yen more attractive relative to other currencies. These more attractive rates make purchasing Japanese assets more likely, hence boosting the economy. What Japan has ironically received is an appreciating yen, which not makes these assets less attractive to purchase, but also makes yet another recession more likely. 
  • Lower Unemployment Rate. Japan not only has an unemployment rate of about 3 percent, but it has an increasingly high labor force participation rate of about 76 percent, which is higher than the United States. While this is certainly preferable to mass unemployment, it hides another issue in play in addition to the high rate of part-time work: demographics.
  • Demographic Considerations: Part of why Japan is able to keep such pristine employment statistics is because of the aging populations. Japan is experiencing a contracting workforce, and is expected to lose more than a third of its population over the next fifty years. Look at the United Nations 2015 demographic figures for dependency ratios, particularly with the old-age dependency ratio (p. 411). By 2050, the old-age dependency ratio will be at an alarmingly high rate of about 70 percent, which signals an incapability of Japanese to be able to support their elderly in the future. While Abe is trying to focus on policies targeted at increasing the birth rate, there is still a question of whether Abenomics can alter this demographic decline.

With a declining savings rate, maturing debt obligations, falling consumer prices, and an aging population, Japan has more than its fair share of problems if Abenomics is to actually be successful. As stated by the Council of Foreign Affairs, "Confidence [in the Japanese economy] must rest on something more substantive than inflation: meaningful structural reforms to reverse Japanese companies' lagging competitiveness." This is confirmed not only by the previously cited IMF and Brookings Institution research, but also by the Asian Development Bank Institute, which showed even with Keynesian theory, Japan is stuck in a liquidity trap, at which point monetary policy is ineffective (Yoshino and Taghizadeh-Hesary, 2015, p. 8-9). As the Brookings Institution pointed out, Abe's problem is that he put way too much emphasis on monetary easing and fiscal stimulus, and hardly any on the deep structural reforms of that "third arrow" that are needed (see Chamber of Commerce recommendations here), which is what the OECD postulated in its Economic Outlook on Japan earlier this year. Whatever Japan ultimately decides to implement, it needs to be as bold and impactful as the Meiji Restoration in the nineteenth century. Without something more drastic, Japan will continue to sink into an economic abyss.

For one, Japan needs to get past its ethnocentrism and bring in more immigrants. Otherwise, it cannot sustain its population with its current marriage rates, birth rates, and life expectancy. Passing the Trans-Pacific Partnership is also important, as the IMF predicts that it would grow the GDP by 2-3 percent in the long-run (IMF, p. 7). Japanese companies also need to integrate its operations into the greater global economy so it can speed up the economy. Lowering the punitively high corporate tax rate can allow for greater foreign direct investment. Lowering the VAT would also create greater consumer confidence. Japan should modify its bankruptcy laws to shrink corporate cash holdings so that those holdings can be invested in the Japanese economy. Fiscal consolidation and special economic zones would be other alternatives. Whatever structural reform that Abe does end up taking, it needs to be bolder than what he has done so far.

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