Broken arrows? With Abenomics stalling, Japan should prioritise structural reforms
Japanese Prime Minister Shinzo Abe has unveiled a new spending package to revive the economy. But if Abenomics is to succeed, Japan needs more than fiscal stimulus, writes Mary Nicola.
The Chuo Shinkansen railway line will carve a route through the forests and mountains of central Japan, connecting the cities of Tokyo, Nagoya and Osaka. Currently under construction, the line will accommodate futuristic magnetic levitation (‘maglev’) trains that will hurtle above the rails at more than 300 miles per hour.
This high-speed railway is one of the main beneficiaries of Prime Minister Shinzo Abe’s new ¥28 trillion (£207 billion) fiscal stimulus package. Announced on August 2, the plan allocates more government capital to the Tokyo-Osaka maglev project, bringing forward its completion date by eight years to 2037.
This pledge is symbolic of Abe’s ongoing attempts to accelerate the growth of the Japanese economy. Abe’s Liberal Democratic Party (LDP) was elected in 2012 after promising to ease monetary policy, spur investment and enact structural reforms. The objective: to lift Japan out of its decades-long slump and recapture the energy and dynamism of the country’s post-1950 boom years.
Despite the initial optimism that surrounded his return as prime minister and ambitious reform programme, ‘Abenomics’ has largely failed to live up to his bombastic rhetoric. Inflation lags the Bank of Japan’s (BoJ) target of two per cent; consumer spending remains low and gross domestic product (GDP) growth is sluggish. The economy expanded at an annualised rate of just 0.2 per cent in the second quarter of 2016.
With the effectiveness of Japan’s monetary policy under constant scrutiny, the question is whether Abe’s latest round of stimulus will be enough to revive Abenomics.
The August 2 package repeats the formula of Abe’s previous fiscal efforts, which have centred on direct spending on infrastructure and government-backed loans to the private sector.
As well as the extra capital for Chuo Shinkansen, Abe has promised more investment in ports for cruise ships as part of a wider drive to improve facilities for tourists ahead of the 2020 Olympic Games in Tokyo. He also announced financing for reconstruction projects in earthquake-hit regions and investments in agricultural processing plants to help exporters.
Despite the headline figure of ¥28 trillion, however, there will be only ¥7.5 trillion in new spending over the next two years. Of this amount, ¥330 billion will be deployed in the form of cash hand-outs of ¥15,000 to 22 million pensioners and low-income families in an effort to spark consumer activity. Taken together, the government expects these measures to deliver a 1.3 per cent increase in GDP growth.
That target is ambitious. In the initial phase of Abenomics after the LDP assumed power in December 2012, the combination of fiscal stimulus and aggressive monetary easing by the BoJ brought impressive results; the yen weakened by almost 25 per cent against the dollar and GDP grew four percent on an annualised basis over the first half of 2013. Further rounds of stimulus since then, however, have brought diminishing returns.
It is evident that Abe’s attempts thus far to rejuvenate the private sector have fallen short. Capital spending by businesses has declined in 2016. During the three months to June 30, companies reported on average a 24 per cent decline in net profits, according to data from SMBC Nikko Securities, a Tokyo-based research firm.
As for monetary policy, despite the BoJ’s best efforts to weaken the yen and hit its inflation target, the currency has actually grown stronger in recent months, rising nine per cent against the dollar and 10 per cent against the euro in the second quarter. This is the result of competing measures by other major central banks and the yen’s enduring status as a safe haven asset among foreign investors.
The BoJ is running out of options. On July 29, the bank said it would accelerate its purchases of exchange-traded funds, but held interest rates at -0.1 per cent. The announcement underwhelmed markets, which had expected a more far-reaching easing package.
BoJ governor Haruhiko Kuroda said the bank would launch a comprehensive review into the effectiveness of its policy framework, including its quantitative and qualitative easing (QQE) asset-buying programme, which may presage a bolder stimulus announcement at the BoJ’s next meeting in September. But Kuroda has played down the possibility of ‘helicopter money’, whereby the bank would print money to finance direct cash transfers to the private sector, amid fears such a policy could eventually stoke hyperinflation.
The third arrow
While the effectiveness of fiscal and monetary policy is waning, it may be premature to condemn Abenomics to the scrapyard.
Abe appears to have successfully seen off deflation, for example. When energy and fresh food prices are removed from the metrics, Japan’s core consumer prices have risen for 32 months in a row; before Abe’s election, prices had been on a downward slope for 10 years. Unemployment has fallen. And, after a mistimed hike in consumption tax in 2014, which temporarily derailed Japan’s growth path, GDP is chugging along a little faster than before. Overall, the economy is undeniably performing better now than it was in 2012.
This being said, Abe had a more radical transformation of Japan in mind when he unveiled his reform programme in late 2012. If his administration is going to make Abenomics work, however, it must do more to ensure the so-called ‘third arrow’ of Abenomics – structural reform – hits home. After taking office, Abe pledged to introduce a host of measures to overhaul an ossified corporate system: he would bring more women into the workforce, embolden shareholders and liberalise the country’s labour market, among other reforms.
Abe has confronted vested interests in agriculture sector, successfully reducing the power of agricultural cooperatives to help smaller independent producers and boost competition. He has also improved wider corporate governance standards. In 2012 a minority of Japanese companies had independent directors; in 2016 it is rare to find one that doesn’t. Shareholders wield more power than they once did.
But progress in other areas has been painfully slow. Abe’s much-trumpeted campaign to boost female employment (dubbed ‘womenomics’) has been only a qualified success. In 2014, Abe said he wanted women to occupy 30 per cent of all senior positions in both public and private sectors by 2020. He has now scaled back these targets to just seven per cent for senior government jobs and 15 per cent at companies. While more women have entered the workforce under Abe, many fill insecure temporary jobs – women account for 60 percent of Japan’s temporary workers.
Meanwhile, labour-market reforms designed to make it easier for firms to fire employees and to restructure pay scales based on performance have languished at the planning stage. And wage growth and consumer spending remain disappointing. The ‘shunto’ wage negotiations in Spring 2016 resulted in smaller hikes in base pay for employees at large car makers and electronics firms than in 2015; overall wages are flat.
Last roll of the Diet?
Greater labour-market flexibility is crucial if Japan is to adapt as its population ages and the workforce shrinks. But there are suspicions that the government’s true priorities lie elsewhere.
In September 2015, the LDP abandoned a relatively minor amendment to the Labour Standards Act, which would have enabled firms to pay employees according to their performance rather than the number of hours they work. Instead, it focused on forcing through national security bills that allowed Japan to provide military support to its allies overseas. This controversial legislation prompted angry confrontations in the Diet, the country’s usually-sedate parliament.
In June 2016, the International Monetary Fund (IMF) stated that “more structural reforms, especially in the labour market, are the only viable option to significantly raise growth prospects” in Japan. The IMF recommended Abe’s government bring in measures to encourage profitable companies to raise wages, promote ‘intermediate’ contracts to bridge the chasm between part-time and full-time work and increase the availability of childcare services to enable more women to join the workforce.
The LDP won a bigger majority during elections to the Diet in July, which should in theory give Abe greater power to enact such policies, and he has pledged to improve access to childcare since the vote. But many suspect he will use his renewed political clout to rewrite Japan’s pacifist constitution instead.
If structural reforms fall by the wayside, Abenomics is unlikely to succeed. The country’s fiscal and monetary stimulus packages need to be supported by deeper changes to Japan’s corporate framework if they are to have the desired effect. Until that happens, the Japanese economy will continue to look more like a sputtering steam engine than a levitating juggernaut.
The Japanese bond market is increasingly being driven by market expectations as to central bank policy rather than underlying fundamentals. If the BoJ extends its quantitative and qualitative easing programme after its policy review in September, this is likely to send bond yields even further into negative territory. The bank currently holds 25-30 per cent of all government bonds in the market; further bond-buying will increase its holdings even further and this may have a negative impact on market liquidity.
While the downside risk is limited, there is currently little value in Japanese government debt. However, there is a possibility that further coordinated fiscal and monetary stimulus in Japan – especially if it is combined with meaningful structural reform – may have the desired effect of lifting inflation and pushing yields higher. We are looking at yield-curve spread trades, which is a relatively cheap way of gaining exposure to a potential steepening of the yield curve on Japanese government bonds.
When it comes to equities market, we believe that further monetary stimulus in September is unlikely to improve Japanese companies’ fundamentals in the short-term. Moreover, the strengthening yen is hurting exporters, especially car manufacturers and machinery companies. With this in mind, we reduced our allocation to Japanese equities in the second quarter of 2016. As for the longer-term prospects for Japanese equities, much will depend on whether Abe is able to enact promised structural reforms.
 Abe first held office between September 2006 and 2007 as the country’s youngest ever prime minister.
 “Abenomics One Year On,” Financial Times, October 27, 2013
 “Abenomics: Overhyped, Underappreciated,” The Economist, July 30, 2016
 “Womenomics Continues as a Work in Progress,” Japan Times, May 2016
 ‘‘White-collar Exemption’ Falls by Wayside in Push for Broader Defence Powers,” Nikkei, September 2, 2015
 “Japan: Staff Concluding Statement of the 2016 Article IV Mission,” International Monetary Fund, June 20, 2016
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