Can Abenomics Succeed? Overcoming the Legacy of Japan’S Lost Decades

Can Abenomics Succeed? Overcoming the Legacy of Japan’s Lost Decades

Rating Take-Aways

8 Importance • Japan has traveled an extraordinary and unique economic journey since the 1980s. 8 Innovation • Strong deflationary pressures and a lack of demand have afflicted Japan since the 6 Style 1990s. 7 Japan’s central bank was a pioneer in quantitative easing, which it started in 2001. •

• Although its nominal 2013 GDP was 6% lower than it was in the mid-1990s, the nation Focus still boasts the world’s third-largest economy, with relatively low unemployment. • The “three arrows” of Abenomics, Japan’s economic recovery program, are “aggressive Leadership & Management monetary easing, flexible fiscal policy and structural reforms to raise potential growth.” Strategy Launched at the end of 2012, Abenomics has turbo-charged the Bank of Japan’s asset- Sales & Marketing • purchase program. Finance Human Resources • Japan is “aging in fast forward,” with the highest life expectancy globally, a slowing IT, Production & Logistics fertility rate and minimal immigration. Career & Self-Development • Japan plans to reform the protected agricultural sector and create special economic Small Business zones. Economics & Politics Industries • Abenomics aims to increase innovation, the corporate profit motive and risk taking. Global Business • Recent estimates say that Japan’s staggering 240% debt-to-GDP ratio will climb still Concepts & Trends further to 280% by 2030.

To purchase personal subscriptions or corporate solutions, visit our website at www.getAbstract.com, send an email to [email protected], or call us at our US ofﬁce (1-877-778-6627) or at our Swiss ofﬁce (+41-41-367-5151). getAbstract is an Internet-based knowledge rating service and publisher of book abstracts. getAbstract maintains complete editorial responsibility for all parts of this abstract. getAbstract acknowledges the copyrights of authors and publishers. All rights reserved. No part of this abstract may be reproduced or transmitted in any form or by any means – electronic, photocopying or otherwise – without prior written permission of getAbstract Ltd. (Switzerland). 1 of 5 getabstract Relevance getabstract getabstract What You Will Learn How Japan’s economy has fared since the 1990s,r1) How Abenomics aims to bolster growth, 2) What outcomes Prime Minister Shinzō Abe’s policies have had as of 2015, and 3) How Japan’s economic future may unfold. getabstract Review Japan’s economic journey since the 1980s has been intriguing. In some ways, the country’s problems are unique, but it has also had to tackle issues similar to those of other Western nations, only more so – and first. To some, Prime Minister Shinzō Abe’s raft of reforms, called Abenomics, is a disconcerting mix of right-wing structural adjustments and left-leaning quantitative easing and massive deficit spending. While many of Abe’s proposed reforms seem uncontroversial and sensible, they also entail attempts to make corporations less prudent and more profit-hungry – an aspiration that may startle Western observers. Japan’s strengths – including the size of its economy, its robust currency and its global trading position – contribute to an economic picture that feels simultaneously extreme and logical. This compendium of essays by economists Dennis Botman and Stephan Danninger, professor Jerald Schiff and a team of area experts and International Monetary Fund contributors is quite dry in places, as you might expect, and the different contributors often go over the same ground – sometimes with slightly different conclusions. But their explanations are fascinating, and their top-notch factual content is comprehensive. getAbstract recommends this text to economists, executives and investors with the note that Japan’s economic progress may offer some important lessons for other countries. getabstract getabstract Summary getabstract getabstract Japan’s Lost Decades: Low Growth and Mild Deflation In the decades after World War II, the formidable success of Japan’s manufacturing and export sectors brought with it an extreme asset price bubble that began to implode around 1990. The economy was slowly starting to recover when the 1998 Asian financial crisis getabstract hit. It triggered a full-blown banking panic and severe credit crunch in Japan, and it “The last 20 years exposed the extent of the nonperforming loans hiding on corporate balance sheets. The have not been easy for Japan.” Great Recession pulled Japan back into recessionary territory again, and the 2011 Great getabstract East Japan Earthquake delivered another economic shock to the system.

A particular and, in some respects, unlucky combination of factors culminated in strong deflationary pressures and a lack of domestic demand in Japan during its lost decades. These factors included a worldwide trend toward lower inflation and a frequently over-strong yen, thanks to Japan’s resilient exports, its people’s propensity for saving and the yen’s attractiveness as an inherently safe-haven currency in difficult economic times. During getabstract “Each time the that period, companies that were still performing well found that holding cash was more economy appeared attractive than investing. Tax revenue fell. Deflation generally undermined the functioning to get back on its of financial markets and reduced the effectiveness of using interest rates as a monetary tool. feet, adverse shocks such as the Asian financial crisis, the But as the strength of the yen illustrates, Japan doesn’t conform to the usual picture bursting of the dot-com bubble and the global of a country in trouble. Although its nominal 2013 GDP was 6% lower than in the financial crisis beset mid-1990s, the nation still boasts the third-largest economy in the world, with relatively the country.” getabstract low unemployment. It has steady productivity growth, a solid presence in growing Asian markets and a strengthening “upstream position” in international supply chains. For example, Japanese companies contribute an average 10% of the value added in China’s

Can Abenomics Succeed? getAbstract © 2015 2 of 5 electrical equipment exports. So although Japan’s economy has worsened in some ways, its position in global trade has gone from strength to strength. getabstract Since recovering from its banking crisis in 2000, Japan has enjoyed a relatively healthy, “Persistent deflation… has costs as it stable financial system. It remains one of the largest providers of global liquidity, thanks undermines the effective to its current account surplus. Japan’s now-healthy banks earn 30% of their gross profits functioning of financial markets and the ability abroad, and they’re well-positioned to increase their lending to fast-growing Asian of macroeconomic economies. Even Japan’s staggering 240% debt-to-GDP ratio – the highest among the policies to stabilize the economy.” developed countries – is mitigated to some degree by the fact that domestic savers hold getabstract 90% of the government’s bonds.

In 2013, Prime Minister Shinzō Abe’s administration launched an economic recovery program, dubbed Abenomics, which consists of “three arrows”: “aggressive monetary easing,” “structural reforms to raise potential growth” and “flexible fiscal policy.” getabstract Arrow 1: Aggressive Monetary Easing “The experience during the Lost Because of its unusual economic history, Japan’s central bank was a pioneer in quantitative Decade suggests that… easing (QE), starting its program in 2001. In 2006, Japan went through a tapering scenario, a higher inflation target and more where it demonstrated the value of clear forward guidance and a transparent, flexible QE aggressive monetary policy. easing…would have substantially improved the economy’s More recent studies conclude, with the benefit of hindsight, that Japan’s unusually low performance.” getabstract inflation during the lost decades required more easing than the central bank undertook. The nation’s “stop-go fiscal stimuli” did little good in the first lost decade. Experts say, however, that QE did work to some degree in that period, since equity markets strengthened and volatility declined. The purchase of private company assets reduced risk premiums, showing how “the composition of asset purchases matters.” Quantitative easing suppressed the interest rates on government bonds and made commercial assets more attractive, thereby inducing portfolio rebalancing toward more growth-producing investments. getabstract “Once the health of the banking sector Abenomics turbo-charged the Bank of Japan’s asset-purchase program. A target of 2% improved…these [QE] measures also started to inflation is central to its forward guidance approach The central bank has increased its show some effectiveness purchases of new government bonds from the 70% it was already buying, with the aim of in supporting real doubling Japan’s monetary base to 54% of GDP, “with greater emphasis on longer-dated activity.” getabstract government securities and expanding purchases of risk assets, such as commercial paper [and] corporate bonds.” The magnitude of the QE push in 2013 increased annual purchases of Japanese government bonds from ¥50 trillion to ¥80 trillion.

Japan has demonstrated the significance of forward guidance in communicating monetary policy. When lowering interest rates no longer has an impact and the financial system is weak or risk averse, information from central bank authorities becomes critical, since only getabstract “Unconventional they can clarify their approach to markets. The expectation of a future continuation of their monetary policies had a policy, or of a coming change, can be as important as the present-day operations. statistically significant impact on bond yields, risk sentiment and Arrow 2: Structural Reforms equity prices, but Many of the structural economic reforms Abenomics proposes will help address the no notable effect on the exchange rate or “headwinds” of Japan’s aging population. The average life expectancy in Japan – “the inflation expectations.” highest in the world” – along with a slowing fertility rate and minimal immigration has the getabstract country “aging in fast forward.”

Beginning in the mid-1990s, the impacts of this demographic trend started to manifest as a

Can Abenomics Succeed? getAbstract © 2015 3 of 5 decline in the working population from a peak 87 million workers in 1995 to a forecast 55 million by 2050. The drop in the labor pool accounts for much of the economy’s previously weak annual growth, and it is “likely that the declining working-age population since the getabstract mid-1990s contributed to the mild deflation.” So analysts can trace Japan’s main problem “The positive effects on growth and fiscal areas of poor growth, an overly strong yen and deflation, in part, to its aging population. sustainability are mainly due to the rise in inflation expectations, Experts expect land prices to fall as older people move to smaller accommodations. which lowers the Spending patterns will shift from housing, transport and education to medical and utilities real interest rate and stimulates investment.” expenditures. Investment changes will occur as older individuals move their savings to getabstract safer assets such as bonds, driving down yields. Certainly, greater state spending on health care and pensions will strain budgets already dealing with smaller tax bases. The fiscal implications of an aging population include an increase in pension spending from 5.2% of GDP in 1990 to 10.9% in 2010. Long-term care and public health spending over the same period rose from 4.1% to 8.3% of GDP. getabstract “A key vulnerability The old stereotype of the Japanese “salaryman” with a job for life is still partly true. of Japan’s financial system is its high However, a growing proportion of the workforce consists of “nonregular” employees who exposure to interest don’t attain the security and privileges of regular Japanese workers. Employers hampered rates as a result of large Japanese by inflexible work policies have contributed to a growing two-tier labor market in Japan. Government Bond This negatively affects productivity by keeping women, immigrants and older workers out holdings…[findings] suggest that this of the labor force. The combination of more nonregular contracts and regular workers’ risk will persistently prioritization of security over pay increases has contributed to low wage growth. decline if Abenomics is successful.” getabstract However, a “middle ground” exists in the two-tier labor market: Open-ended employment contracts that provide escalating benefits and security as time goes on, modeled on similar contracts in Spain and the Netherlands, could help Japan address its labor problems.

The government has offered tax incentives to companies that increase their workers’ pay, and it has reversed its own public-sector wage cuts. Other structural reforms include policies getabstract “Monetary policy that raise the pension age, an effort to increase married women’s participation in the depends not just on workplace and proposals for controlled immigration. the current value of the policy rate but on public expectations of Arrow 3: Flexible Fiscal Policy future settings of that The third arrow of Abenomics creates a flexible fiscal policy that shows financial markets rate.” getabstract that the nation has a credible plan for tackling government finances. Abenomics includes growth-friendly proposals to reform the protected agricultural sector, create legislation for special economic zones and conduct further Trans-Pacific Partnership negotiations.

Japan’s total tax revenue is fairly low compared to that of other advanced countries, and a change in emphasis from income taxes to consumption taxes, which are especially low, is underway. Consumption taxes don’t dampen either job creation or corporate investment incentives. getabstract “Japan’s growth performance over Japan’s world-beating automotive and electronics sectors are known for their process the past two decades innovation, but entrepreneurial risk taking and radical product innovation aren’t Japan’s has been robust if population aging is strong suits. Abenomics calls for addressing the undersized venture capital industry and excluded.” the nation’s relatively small foreign direct investment inflows. The government wants to getabstract “restore credit discipline” and to reduce the practice of keeping unprofitable businesses alive, which impedes innovation. The state also plans to open domestic sectors to greater competition. It also supports further financial and manufacturing integration with Japan’s fast-growing Asian neighbors, including regional trade agreements.

Can Abenomics Succeed? getAbstract © 2015 4 of 5 Japanese savers are notoriously risk averse. They helped mop up the huge volume of low- yielding Japanese government bonds, but the ultimate success of Abenomics depends partly on encouraging enterprise investments with higher risks. This portfolio rebalancing effort aims to pull the economy away from the stimulus spending and bond-buying patterns of recent decades and toward a more conventional, self-sustaining private enterprise economy. getabstract “Introducing a single open-ended In January 2014, Japan launched a new stock index – JPX Nikkei 400 – composed of [employment] contract native companies whose governance focuses on shareholder returns and profitability. The would…drastically reduce firms’ marginal government underlined its commitment by investing part of its employee pension fund in costs of converting the index. Officials are also seeking to introduce reforms that will raise the amount of risk nonregular to regular positions.” capital investors provide by improving underdeveloped risk management tools. getabstract How Is Abenomics Going? The announcement and start of Abenomics at the end of 2012 had a decisive effect on Japan’s economy. The Nikkei equity index rose 80% between September 2012 and April 2013, with especially large gains for export-oriented firms. First-quarter 2013 GDP grew 4.1%, but the tightening labor market still didn’t experience wage growth. Quantitative and qualitative easing have had the desired effects of lowering bond yields, cutting the prices of more risky investments, and reducing the prospect of further individual institution or systemic credit issues in financial markets. getabstract “Productivity growth However, export and investment growth have “remained surprisingly flat.” Banks have has remained solid in Japan.” used their newfound financial space to accumulate reserves with the Bank of Japan rather getabstract than increasing their lending to companies. The hoped-for move to a private investment- and consumption-led recovery has proved “elusive.” A consumption tax increase from 5% to 8% in April 2014 knocked the wind out of the recovery, leading to the October 2014 postponement of a second increase to 10%. A further jump to a 15% consumption tax remains a future possibility. Meanwhile, inflation expectations have proven harder to turn around but have improved slightly.

Quantitative easing hasn’t affected the yen to the desired extent, but demand for exporting more fuel from abroad in the wake of the March 2011 earthquake, as well as the calming getabstract of the euro crisis that reduced safe-haven flows into yen assets, has helped on this account. “The yen is widely Recent estimates point to Japan’s staggering 240% debt-to-GDP ratio climbing still further considered a safe-haven currency…Since 2008, to 280% by 2030. This makes the interest rate payable on this debt a key factor in Japan’s the yen appreciated growth and sustainability. steadily against the US dollar in effective terms in the aftermath Japan’s economy has encountered – and will continue to face – some unique challenges, but of various shocks.” getabstract its policy levers and progress may offer some important lessons for the rest of the world. getabstract getabstract getabstract getabstract getabstract getabstract getabstract About the Authors getabstract getabstract Dennis Botman and Stephan Danninger are economists with the International Monetary Fund. Jerald Schiff is an adjunct professor at American University in Washington, DC.