About the author:
Alicia Garcia-Herrero, Senior Research Fellow, European think-tank Bruegel, Brussels; Adjunct Professor, Hong Kong University of Science and Technology
Japan’s longest-serving Prime Minister Shinzo Abe’s assassination is one of the most shocking and saddest events in contemporary Japanese history. Prime Minister Abe surprised Japanese citizens with his sudden health-related resignation in 2020. Abe’s resignation opened the path for Japan’s former Foreign Minister, Fumio Kishida, to win Liberal Democratic Party (LDP) support and the general election of November 2021 by a reduced majority, to become Prime Minister.
With the dust now settled on both Abe’s assassination and the first 18 months of Kishida’s government, one important aspect of Abe’s legacy, Abenomics, can now be more clearly evaluated. Since Abe’s ascension to power in 2012, Japan’s economic recovery hinged on three key economic policies. The so-called three “arrows” of Abenomics were, respectively, monetary and fiscal policies and structural reform. This article analyzes and evaluates the progress made by each of the three arrows of Abenomics.
The first and best-known arrow is monetary policy. It relied on massive quantitative easing (QE) as well as the introduction, in February 2016, of negative rates and, by September 2016, of a ceiling on the yield of the 10-year Japanese Government Bond (JGB) - the so-called yield-curve control (YCC). First pioneered by the Bank of Japan (BoJ), the introduction of a YCC was later emulated by a number of other central banks. In particular, the Reserve Bank of Australia (RBA) introduced YCC to keep the cost of funding low after the economy crashed during the Covid pandemic.
However, unlike Japan, Australia quickly moved out of its rushed YCC, choosing to reverse QE by both shrinking the RBA balance sheet and introducing rate hikes several times in the first half of 2022. The BoJ chose to continue with its ultra-lax YCC policy and purchased huge amounts of JGBs to the point where the BoJ now holds the majority of the publicly traded stock, but also by maintaining negative short-term interest rates. The latter has become particularly problematic as other major central banks, especially when the U.S. Federal Reserve (Fed), have tightened monetary policy by aggressively hiking rates. Moreover, the growing negative differential between Japanese and US short-term rates has pushed the yen further towards rapid depreciation. By losing some 30% of its value against the USD and a significant amount against the currencies of other trading partners, Japanese imports have become more expensive, and Japanese households have seen a sizable decline in their disposable income. The weak yen has increased the negative effects of years of stagnant consumption, partially explained by insignificant wage increases in Japanese households and signaling even further economic difficulties well into the future.
On a more positive note, mitigating inflation, which is the BoJ’s main focus, and a key objective for Abenomics, is finally working. This is in line with the global inflationary wave, although at a far slower pace. As a result, the consumer price index has finally reached and even surpassed the BoJ’s target of 2% (2.4% in June) compared to 0.8% in December 2021. While Japan’s inflationary surge is fully explained by energy and food prices, core inflation, which excludes these two volatile items, remains below 1%, indicating the entrenchment of deflationary forces in the Japanese economy. In sum, it is hard to argue that Abenomics’ first arrow has been very successful, as core inflation remains stubbornly low and the BoJ’s balance sheet has ballooned, which makes an exit strategy from such aggressive use of monetary policy very costly indeed. In fact, Japanese financial institutions, habituated to two decades of meager rates, have clearly reduced their net interest margin and, thereby, their profitability. While Japanese institutions should welcome a sudden turn towards positive rates, the exit from such an ultra-lax monetary policy would be very costly for financial institutions whose liabilities need to be repriced to higher rates, and assets would be negatively affected during the adjustment period.
Beyond the repricing issue, which mainly affects financial institutions, another important concern is the rapid accumulation of public debt, which relates directly to Abenomics’ second “arrow,” namely, fiscal policy. This second arrow calls for fiscal policy to be actively used to support the economy, but with an overall objective of fiscal consolidation given the country’s very large public debt, which is amongst the largest - if not the largest - globally. The cornerstone for the fiscal consolidation objective, which was announced when Abenomics was launched, was a moderate increase in Japan’s consumption tax. However, such an increase could only be accomplished through two separate rate hikes, the first in 2014 from 5% to 8% and the second in 2019, from 8% to 10%. Furthermore, by the time both hikes were finalized, Japan’s public debt had increased by 30 percentage points of GDP, from 233% of GDP to 263%. The cause of this massive increase, the accumulation of huge fiscal deficits coinciding with the beginning of Prime Minister Abe’s mandate, was due to years of negative economic performance, which considerably worsened with the 2020 onset of the Covid pandemic. In response to the pandemic, the Abe administration launched a massive fiscal package of more than 20% of GDP, which further enlarged public debt.
Against a background of rising public debt, fiscal consolidation is a moving target, increasingly hard to achieve. By the same token, debt sustainability is of increasing concern for the Japanese economy as the Bank of Japan’s potential debt monetization will bring about further depreciation of the yen. In other words, few options remain for Japan’s public debt to enter a sustainability pattern. The best would be reflation, i.e., higher growth and higher inflation, but both have a disappointing record before Abe and during Abenomics. Not only does Japan’s core inflation currently remain below 1%, but GDP growth has also remained below 1% on average since Abenomics was launched in 2014 to today. The cause of Japan’s low productivity is a failure to ensure an increase in nominal GDP, which dictates that Japan will require close-to-zero interest rates to serve its public debt. Other options, such as massive cuts to government expenditure, seem improbable given Japan’s rapidly aging population. Significantly the small but painful increase in sales tax signaled the difficulty of increasing tax pressure on Japanese households without injuring the economy.
The third and final arrow, often seen as the most important, is structural reform. There are many types of structural reforms that an aging society like Japan needs. One generally positive aspect is how Japan has managed to contain health care expenditure compared with the U.S. and other advanced economies, despite its significantly larger proportion of elderly citizens. However, the critical structural reform of Japan’s labor market remains unaccomplished. The importance of these reforms stems from Japan’s increasingly low labor productivity, which industrial-level data reveals at barely 0.5%. The loss of industrial capacity over previous decades, as Japanese companies preferred to invest in countries with lower labor costs, is another key factor behind Japan’s low productivity. Japan was unable to create enough high-paying jobs in the service sector as job creation primarily occurred in restaurants and convenience stores. A key cause for this trend lies in Japan’s dual labor market, which provides lifetime employment on one side and a precarious part-time or short-term labor market dominated by young people and women on the other. A labor market reform successfully liberalizes the rigidities in the full-time labor market and reduces the role of part-time/low-productivity jobs. It would be essential but faces intense opposition from incumbents, who are a substantial share of the Japanese population. Another vital challenge Japan faces is the increasingly large part of government expenditure dedicated to the elderly and their pensions. As such, funding is restricted to research and development, which has long been a critical feature of Japan’s economic success. Finally, corporate Japan faces corporate governance challenges for which reform is sorely needed. The focus on research and development, and improving corporate governance and enhancing entrepreneurship, are generally key factors behind any country’s increase in total factor productivity, which underpins economic growth.
Overall, it is difficult to predict how Japan could undertake in-depth reforms if it has taken five years to increase the consumption tax by only five percentage points, aided by two strong fiscal stimulus packages. For Japan to achieve relevant labor-market reform, the amount of fiscal anesthesia would exceed government means, given the already huge stock of accumulated public debt. Thus, at best, Abe’s economic legacy can be assessed as delivering only mixed results. The first arrow, exceedingly lax monetary policy, has failed to achieve its stated inflation objective, or at least not when focusing on what matters in the medium-run, which is core inflation. Abenomics’s second arrow of fiscal consolidation has not been realized, nor have large increases in fiscal expenditure catalyzed economic growth. Finally, structural reforms have been scarce with a missing mark for the most important one: the labor market.
Notwithstanding all the above, I still consider Abe’s economic legacy a half-full bottle and not an empty one. In fact, for a country that pioneers the challenges that many others will soon be confronting, Japan has performed reasonably well. Given its rapid aging and the related structural challenges, Japan has managed to keep a high standard of living and a more equal income distribution than most countries around the world. In other words, Japan has managed to age gracefully while keeping harmony in its society. The fact that Japan has managed to keep such advantages while aging rapidly is an economic and societal success that should be recognized as part of Abe’s legacy among others.
Please note: The above contents only represent the views of the author, and do not necessarily represent the views or positions of Taihe Institute.
This article is from the August issue of TI Observer (TIO), which is a monthly publication devoted to bringing China and the rest of the world closer together by facilitating mutual understanding and promoting exchanges of views. If you are interested in knowing more about the August issue, please click here:
http://www.taiheinstitute.org/Content/2022/08-26/1651431263.html
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