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Abenomics

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Prime Minister Abe discussing his economic policies in a speech in London, June 2013.

Abenomics (アベノミクス, Abenomikusu) refers to the economic policies advocated by Shinzō Abe since the December 2012 general election, which elected Abe to his second term as Prime Minister of Japan. Abenomics is based upon "three arrows" of fiscal stimulus, monetary easing and structural reforms.[1] The Economist characterized the program as a "mix of reflation, government spending and a growth strategy designed to jolt the economy out of suspended animation that has gripped it for more than two decades."[2]

The term "Abenomics" is a portmanteau of Abe and economics, and follows previous political neologisms for economic policies linked to specific leaders, such as Reaganomics, Clintonomics and Rogernomics.

Background

The Japanese government raised value added tax rates from 3% to 5% in 1997, which worsened the recession and deflated the economy. The government raised the sales tax in 1997 for the purpose of balancing its budget, and then the government revenue decreased by 4.5 trillion yen because consumption stumbled. The country recorded a GDP growth rate of 3 percent in 1996, but after the tax hike the economy sank into recession.[3] The nominal GDP growth rate was below zero for most of the 5 years after the tax hike.[4][5]

During the global economic recession, Japan suffered a 0.7% loss in real GDP in 2008 followed by a severe 5.2% loss in 2009. In contrast, the data for world real GDP growth was a 3.1% hike in 2008 followed by a 0.7% loss in 2009.[6] Exports from Japan shrank from 746.5 billion in U.S. dollars to 545.3 billion in U.S. dollars from 2008 to 2009, a 27% reduction.[7] By 2013, nominal GDP in Japan was at the same level as 1991 while the Nikkei 225 stock market index was at a third of its peak.[2]

In 2012, the Diet of Japan under the government of Yoshihiko Noda passed a bill to increase the consumption tax rate to 8% in 2014 and 10% in 2015[8] in order to balance the national budget; this tax hike was expected to further discourage consumption.[9]

Abe's economic policy is also related to the rise of China as an economic and political power. Abe's supporters drew explicit parallels between Abenomics and the Meiji era program of fukoku kyohei (enrich the country, strengthen the army). In addition to providing a stronger counterweight to China in the Asia-Pacific region, strengthening the Japanese economy is also intended to make Japan less reliant on the United States for defense.[2]

Economic Outlook in Japan 1994-1999[10]
Year Nominal GDP
(billions of yen)		 NGDP Growth
(%)		 Unemployed persons
(thousands)		 Economically active population
(thousands)		 Unemployment
(%)
1994 486526.3 1.19 1920 66450 2.88
1995 493271.7 1.38 2100 66660 3.15
1996 502608.9 1.89 2250 67110 3.35
1997 512248.9 1.91 2300 67870 3.38
1998 502972.8 -1.81 2790 67930 4.10
1999 495226.9 -1.54 3170 67790 4.67

Note: NGDP is valued at 2006 market prices

Implementation

Abenomics consists of monetary policy, fiscal policy, and economic growth strategies to encourage private investment. Specific policies include inflation targeting at a 2% annual rate, correction of the excessive yen appreciation, setting negative interest rates, radical quantitative easing, expansion of public investment, buying operations of construction bonds by Bank of Japan (BOJ), and revision of the Bank of Japan Act.[11] Fiscal spending will increase by 2% of GDP, likely raising the deficit to 11.5% of GDP for 2013.[12]

Two of the "three arrows" were implemented in the first weeks of Abe's government. Abe quickly announced a ¥10.3 trillion stimulus bill, and appointed Haruhiko Kuroda to head the Bank of Japan with a mandate to generate a 2 percent target inflation rate through quantitative easing. But Kikuo Iwata, the deputy governor of Bank of Japan, suggested that BoJ does not strictly aim for[13] the 2 percent price target in two years. Iwata implied that BoJ would not loosen again its monetary policy, aimed at halting economic stagnation, soon after the increase in the sales tax in April in 2014.

Structural reforms have taken more time to implement, although Abe made some early moves on this front such as pushing for Japanese participation in the Trans-Pacific Partnership.[2]

The mid-2013 House of Councillors election gave Abe complete control over the Diet, but the government showed some internal division over specific structural reforms. Certain cabinet members favored lower corporate taxes, while others were wary of the potential political backlash for cutting taxes on large firms while raising taxes on consumers. Labor laws and rice production controls have also become contentious issues within Abe's government.[14]

Quantitative Easing

On 4 April 2013, the BoJ announced its quantitative easing program, whereby it would buy ¥60 to ¥70 trillion of bonds a year. [15]

On 31 October 2014, the BoJ announced the expansion of its bond buying program, to now buy ¥80 trillion of bonds a year.[16]

Effects

Abenomics had immediate effects on various financial markets in Japan. By February 2013, the Abenomics policy led to a dramatic weakening of the Japanese yen and a 22% rise in the TOPIX stock market index.[1] The unemployment rate in Japan fell from 4.0% in the final quarter of 2012 to 3.7% in the first quarter of 2013, continuing a past trend.[17]

The yen became about 25% lower against the U.S. dollar in the second quarter of 2013 compared to the same period in 2012, with a highly loose monetary policy being followed.[18] By May 2013, the stock market had risen by 55 percent, consumer spending had pushed first quarter economic growth up 3.5 percent annually, and Shinzo Abe's approval rating ticked up to 70 percent.[2] A Nihon Keizai Shimbun survey found that 74% of the respondents praised the policy in alleviating Japan from the prolonged recession.[19]

The impact on wages and consumer sentiment was more muted. A Kyodo News poll in January 2014 found that 73% of Japanese respondents had not personally noticed the effects of Abenomics, only 28 percent expected to see a pay raise, and nearly 70% were considering cutting back spending following the increase in the consumption tax.[20]

Under a weaker Yen, Abenomics increased the cost of imports, including food, oil and other natural resources upon which Japan is highly reliant. However, the Abe government viewed this as a temporary setback, as the weaker yen would eventually increase export volumes. Japan also managed to maintain an overall current account surplus due to investment income from overseas.[21]

Analysis

Austerity policies

Anatole Kaletsky was an early supporter[22] of Abenomics, but since Japanese government decided to raise the country's consumption tax rate to 10 percent, he expressed his concern that the tax hike could deal a more devastating blow to Japanese economy than expected. In 1997, the Japanese government raised the rate to 5 percent from 3 percent to tackle its debt of 50 percent of its GDP at that time, promising that the tax hike would be offset[23] by income-tax reforms. But the tax hike ended up making the domestic consumption stumble, pushing the economy into recession. The country fell into[24] a deflationary trap. Due to the country's long-running malaise, the government gross debt reached 200 percent of its GDP despite the increase of the sales tax. The IMF forecast that the tax hike in 2014 would cut Japan's economic growth from 2.5 percent in 2013 to 1.4 percent in 2014, but Kaletsky argues that this economic downturn is underestimated.

In March 2014, at a conference in Abu Dhabi, Lawrence Summers expressed his concern[25] about the negative effects of the tax hike, saying that the tax hike could damage the Japanese economy more seriously than early estimates. Although the Japanese government expects the Japanese economy to recover after the economy goes into short recession, Summers suggested[25] that Japan's rebound was overestimated.

Koichi Hamada, a monetary adviser for Shinzo Abe, warned that the planned VAT hike could hurt Japan's economy which started to recover from long recession and deflation. He says that the Japan government should defer the tax hike so that it could not discourage consumption, adding that economists such as Jeffrey Frankel have suggested[26] the gradual increase of the rate of the tax by one percent annually. Although Hamada is concerned about the effects of the tax hike, he expects that monetary easing by BoJ can offset its negative effects, applying the Mundell-Fleming model to Japan.

Depreciating a domestic currency can boost its export if the Marshall-Lerner condition is met. If it is not, the trade balance initially becomes worse.

See also: Marshall-Lerner condition

Since the disastrous nuclear incident in Fukushima in 2011, all nuclear power stations in Japan have been shut down. Making up for lost electricity generation, Japan has imported[27] extra fossil fuels, which worsened the country's trade deficit partly because of weaker yen. The increasing cost of electricity may hurt businesses in the country, and hamper the country from boosting its economy. But Shigeru Ishiba said that people were noticing that electricity could be supplied without nuclear power generation. Thus, restarting the reactors is still controversial: a nationwide poll showed that 76 percent either opposed nuclear power or wanted Japan to reduce the reliance on nuclear energy, while in some regions[28] such as communities close to Sendai city, where nuclear power plants create jobs and relating subsidies are granted, restarting the reactors is widely supported. Unless nuclear reactors are restarted, the Marshall-Lerner condition will not be met due to a heavier dependence on fossil fuels and an increased reliance on imports.

Deflation

Deflation causes consumers to expect goods and services to be cheaper in the future, discouraging present spending. In turn, this causes the economy to shrink, as consumer's spending is vital. Richard Koo explained this phenomenon as fallacy of composition, that is to say that while correct behaviour is desirable individually, it can cause undesirable consequences on the economy as a whole. [29] [30]

Japan's nominal output has decreased by more than $1 trillion due to falling land prices and equity since 1990. Richard Koo said that in human history Japan was the only country suffering such a loss during peacetime. In 2003 speech in Tokyo, Ben Bernanke suggested that BoJ should implement quantitative easing in order to put an end to the deflation spiral.

5 years after his speech, Bernanke started quantitative easing as chairperson of the Federal Reserve, to fend off a Japanese-like lost decade due to a bubble in housing prices. [30] The US central bank has since then bought financial assets like bank debt, mortgage backed securities and US government bonds. This amount to nearly 4.5 trillion USD. Despite the massive monetary easing, there is still a risk that the world largest economy can slide into deflation: its consumer price index (CPI) fell 0.4 percent in December 2014, and is forecast to fall again in January 2015. [30]

Japanese wages began to decrease from 1997–98, and Hiroshi Yoshikawa, a professor at University of Tokyo, said that Japan's tenacious deflation was caused by this decline. He argues that the monetary easing by BoJ becomes powerless[31] because the interest rate is already close to zero. The solution he offers to beating the deflation is to push companies to pay their workers more. Kikuo Iwata, Etsuro Honda and Koichi Hamada disagreed with Yoshikawa. Hamada said if the wages just increased, companies would become incapable of maintaining current level of employment.

See also: Liquidity trap

Debate

VAT increase

Support

LDP Secretary General Sadakazu Tanigaki said that it was difficult to cope with risks stemming from sidestepping the planned VAT hike to 10 percent, suggesting that the Japanese government should increase the VAT as scheduled.[32]

Haruhiko Kuroda, the governor of Bank of Japan, said that raising Japan's sales tax is a confidence-building measure and the measure could stabilize the social security[33] which would strengthen Japan's economic growth. He stated that the stagnation due to the tax hike would be temporary, while he mentioned the possible scenario in which BoJ would additionally conduct quantitative easing. He warned that the cut of its corporation tax could worsen its fiscal position.

BoJ governor Kuroda argued that if the second hike was delayed, the markets would perceive that Japan is unlikely to tackle its government debt, and then the yields of the government bonds would soar.[34] BoJ's former deputy governor Kazumasa Iwata said that if the second hike was put off, the hike could be permanently postponed, and it would become difficult to reach a new agreement on the schedule of the hike. He said that implementing stimulative measures was the only way to alleviate the tax hike's negative impact.[34]

Criticism

One BOJ board member expressed concern over the planned tax-hike set to take effect in 2014 and 2015.[35]

Paul Krugman said that the VAT hike from 5 percent to 8 percent raised serious doubt about Japan's economic recovery, and that in order to lift the economy, the government should decrease the VAT to 5 percent and work to build up inflation expectations.[36]

Lawrence Summers supported the view that the Japanese government should postpone the planned vat hike, suggesting that a steady economic growth should be more important for the country than fiscal discipline.[37] He says that if its economic growth accelerates, the world-third-largest economy can tame its government debt. He says that fiscal policy is much more effective than monetary policy, because the former can inject income directly into the spending stream.[37]

When Summers was the US Deputy Secretary of the Treasury, he told the Japanese government not to raise the VAT from 3 per cent to 5.[38] But the government ignored his warnings, and raised the tax in 1997 for the purpose of balancing its budget. Although the country recorded a GDP growth rate of 3 percent in 1996, the economy sank into recession in 1998.[39] On top of that, the revenue of the government decreased by 4.5 trillion yen in 1998 mainly because Japan's domestic consumption stumbled. Figure A shows the government revenue of Japan between FY 1994 and 2006.[40] The tax revenue reached a peak of 53 trillion yen in FY 1997, and declined in subsequent years, being still 42 trillion yen[41] (537 billion USD) in 2012.

Joseph Stiglitz said that Japan's economy was still fragile, and the planned VAT hike from 5% to 8% would plunge it into recession.[42]

See also: Atkinson-Stiglitz theorem

Demand management

Support

The International Monetary Fund characterized the program as "a unique opportunity to end decades-long deflation and sluggish growth and reverse the rise of public debt," but argued that "all three arrows need to be launched for the policies to succeed. Uncertainty about the ambition of fiscal and structural reforms is adding to underlying risks."[43]

Economist Joseph Stiglitz has explained how Shinzo Abe's programme for Japan's economic recovery has led to a surge in domestic confidence, and questioned how far Abe's "Abenomics" could claim credit. He referenced Momcilo Stanic, saying there is every reason to believe that Japan's strategy to revive and boost its economy will be a success.[44]

Washington Post journalist Neil Irwin cited successful expansion by Toyota, with operating profit rising 88 percent in the second quarter of 2013, as evidence that the economic program of Japan is working. He has stated that "the fact that one of Japan's biggest and most important companies is again finding ways to make money on the homefront is a good sign that the nation's economic torpor may not last too much longer." He has also argued that Abenomics could "change the economic psychology of Japan domestically" by providing export hikes through currency devaluation.[18]

Criticism

In addition, there is a rising skepticism regarding Abenomics, pointing out that the policy is too much focused on the demand side of its economy, not on the supply side, such as the case of the Japanese government's push for generic medicines within its Universal Healthcare System without actually addressing the root causes.[45] One of the fundamental problems that Japan is facing is its aging population. As the population pyramid becomes inverted, the labor pool shrinks from year to year. This brings about a number of problems for the Japanese economy.[46]

First, the government commitment in spending on pensions, medical expenses and social security will continually act as a substantial burden to the already indebted country with a public debt of 240% its GDP.[46] This will further worsen the financial integrity of the Japanese government leading to an erosion of international confidence in Japanese economy. The lack of confidence can raise the risk premium (CDS).

Secondly, its dwindling workforce cannot sustain the economic output level that is maintained in the future. The Japanese demography will drastically change so that more young people will have to support for the older population, which implies that this change in demography is the main culprit for the last two decades of deflation and stagnant economic growth.[46] This has another implication to why the consumer demand might be falling behind.[46]

Goldman Sachs chief economist Naohiko Baba has criticized the infrastructure spending component of Abenomics, arguing that the Japanese construction industry is inefficient and short of workers.[14]

In January 2013, German Chancellor Angela Merkel said that the German people believed that central banks should not make up for bad political decisions, and she criticised Japan and US of their expansionary monetary policies to enhance their competitiveness.[47] Bundesbank chief Jens Weidmann accused the Japanese government of politicising exchange rates and threatening independence of the central bank.[48] And two years after their criticism, European Central Bank launched quantitative easing programmes of their own.

Tax cuts for the rich

Support

Koichi Hamada countered the criticism that only big firms and the rich benefitted from abenomics, saying that it had a trickle-down effect on rest of the economy. He said that the Japan needed to lower corporate taxes from about 35% (current level) to 24% to attract investment.[49]

Criticism

Thomas Piketty said that Japan needed to change the structure of its taxation in order to help Japanese young generation, suggesting that the world third largest economy should increase taxes on the wealthy and big firms from 10% to 20%.[50] He took the view that redistribution of wealth could be the fourth arrow of abenomics. He added that raising VAT was a bad way to reduce inequality in the country.

Joseph Stiglitz suggests that even if tax cuts for the rich are done in US or UK, big firms just try to use them for their personal gains, not for raising wages of their employees.[42]

Results

GDP

IMF affirmed that Japan's nominal GDP contracted by $1.8 trillion during 2012-15 while real GDP contracted at an annual rate of 6.8 percent[51] in the second quarter of 2014, after the Value-Added Tax hike came into effect in April. This fall is the worst since the devastating earthquake and tsunami disaster[52][53] hit Japan in the first quarter of 2011 when the GDP shrank by an annualised 6.9 percent. In the third quarter of 2014, the GDP shrank by an additional 1.6 percent, largely thanks to the VAT hike.[54] The VAT hike to 8 percent has made a significant negative impact on the Japanese economy. In 2014, the revised real GDP growth of the second quarter was minus 7.1 percent on an annualised basis,[55] contrary to economists' expectation that the economy would shrink at an annual rate of 3.5 percent in the second quarter.

Household spending fell 5.9 percent in July 2014 from the same month a year earlier, more than the median forecast of economists polled by Reuters of a 3 percent drop, because of the higher VAT.[56]

See also: 2011 Tohoku earthquake and tsunami

Economics minister Akira Amari[53] said that the Japanese government would take necessary measures, depending on its economic condition, although he at the moment did not feel that those measures needed to be done. Amari expressed confidence [57] that the effect of the VAT hike began to wear off and the economy would recover later in 2014.

Kyohei Morita and Yuichiro Nagai[53] said that they believed that Japan's real GDP would return to growth exceeding potential, mentioning economic indicators such as public works and housing construction orders.

Economists' forecast said that the Japanese economy would grow by annualised 2 percent in the third quarter of 2014, but in reality the country's GDP contracted at an annual rate of 1.6 percent in the quarter. Japan's second consecutive contraction meant that technically the third largest economy slipped into recession. [58] [59] Revised figures said that Japan's GDP shrank at an annual rate of 1.9 percent in the third quarter of 2014, which is 0.5 percent contraction on a quarterly basis. The VAT hike in April continued to have a negative impact on its economy. [60] Business spending decreased by 0.4 percent from the previous quarter. Abe determined to call for a snap election to win a mandate to delay the second VAT hike which was scheduled to be done in 2015.[60]

Akira Amari, however, said that there was a positive ongoing cycle in the economy and they could not sum it all up with the word recession, conceding that the vat hike in April 2014 dented consumer spending.[58]

Figure B compares the 1996-1999 period with the 2013-2015 period, in terms of Japan's real GDP. During the 1996-1999 period, the VAT was raised from 3 per cent to 5, and during the 2013-2015 period, the VAT was raised from 5 to 8. For the 1996-1999 period, the GDP of the first quarter of 1996 is set 100. For the 2013-2015 period, that of Q1 of 2013 is 100. The interval of the horizontal axis is one quarter, and the quarters when the VAT were raised are set zero. And therefore, the GDPs of Q1 1996 and of Q1 2013 correspond to values evaluated at quarter -5. If the growth rate of Q2 2015 is negative, the both curves may have a similar trend.

In the first quarter of 2015, Japan's economy grew by 0.6 per cent on a quarterly basis. Increase of inventories helped the economy to expand, and the momentum can be lost in the second quarter. This suggests that the VAT hike from 5 cer cent to 8 continues to have a negative effect on the economy.[61]

OECD reports that Japan's real GDP is expected to expand by 0.7 per cent in 2015. This growth rate is lower than US's 2.0 and UK's 2.4.[62]

Trade balance

As external demand on Japan's goods declines, Japan's export fell 2.7 percent[63] in May 2014 from a year ago. But its imports fell by 3.6 percent from a year ago as well, which narrowed Japan's trade deficit by 8.3 percent. The Japan trade deficit with other countries was over 1 trillion yen in April 2014, and it went down to 909bn yen ($8.9bn, £5.2bn) in May 2014. But the country is still running a trade deficit for the 23rd[63] straight month.

Inflation targeting

In late January 2015, BoJ governer Haruhiko Kuroda admitted that the central bank would not achieve the 2 per cent inflation target by April 2015, adding that he expected the price level to get to the target level in another 12 months. In February 2015, he said that the escape velocity to lift the economy out of tenacious deflation needed to be tremendous.[64] Although in 2013 he pledged to meet the target, the actual core CPI in was 0.7 per cent in January 2015.[65] Oil prices were about 100 USD in April 2014, and then they decreased about 50 per cent by the end of 2014. He maintained that the decline in oil prices made it difficult for BoJ to meet the target.

GDP deflator

Abenomics aimed at ending the deflation which continued for more than 15 years, focusing on massive monetary stimulus to build up self-sustaining expectations of moderate inflation. But the expectations were dulled by the VAT hike, and the country eventually fell back into deflation: the growth rate of GDP deflator was minus 0.3 percent in the third quarter of 2014.[59]

Impacts on the world economy

In the early October 2014, the IMF revised its 2014 global growth forecast downwards from 3.4 percent to 3.3 percent, although many central banks continued to provide liquidity to the world financial market. Weaker expansions in Japan, Latin America and Europe worsened the outlook for the world economy. [66]

In October 2014 the World Bank's chief economist Kaushik Basu said that the world economy was taking the risk of stagnation, adding that Eurozone and Japan were the main slowdown areas.[67]

The Eurozone has been brought to the verge of recession.[68] Italy has suffered from recession for a long time, and France is forced to balance its budget by Germany despite the fact that its economy is depressed.[69] Germany's economy is likely to contract for the second consecutive quarter in 2014.

Japan, the world's third largest economy, can be likely to sink into recession due to the VAT hike.[69] Although the IMF's previous forecast assumed that Japan would grow 1.6 percent in 2014, the forecast was revised downwards to 0.9 percent.[66]

The US economy is not so weak as other advanced economies, and investors have rushed into the US dollar. But its growth is still slow and some people are concerned that the world's slowdown can damage the world's largest economy. Top officials of the Federal Reserve Bank, including its second-in-command, said that the global stagnation could cause the Federal Reserve Bank to be forced to postpone the planned interest rate hike.[68] US Treasury Secretary Jacob Lew rejected the idea that the US alone could boost the world economy.[66]

See also

References

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  28. ^ Japan puts two reactors on shortlist for restart screening Reuters, Mar 13, 2014
  29. ^ For individuals it is rational to hoard and balance their budgets, but if everyone engages in hoarding, its economy contracts.
  30. ^ a b c Falling Prices Are Bad For You B. Powell, News Week, 26 Jan 2015
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  34. ^ a b Japanese government urged to delay sales tax rise S.P. Chan, Economics, The Telegraph, 14 Sep 2014
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