A New Era for the Japanese Economy: Will Abenomics Succeed?November 1, 2013
Atsushi Nakajima, Chairman, Research Institute of Economy, Trade and Industry (RIETI)
Atsushi Saito, Group CEO, Japan Exchange Group, Inc.
Paul Sheard, Executive Managing Director; Chief Global Economist and Head of Global Economics and Research, Standard & Poor’s Ratings Services
John Bussey, Assistant Managing Editor and Executive Business Editor, The Wall Street Journal
On November 1, 2013, a panel of distinguished leaders in economics and financial markets met at Japan Society to discuss the efforts being made to revive and reinvigorate economies in Japan and around the world.
These are economic experiments of an importance not seen since World War II, moderator John Bussey of The Wall Street Journal said. The U.S. program to re-inflate its economy "seems to be getting some traction, but the question is whether or not it will get enough." Meanwhile, "Europe has managed to forestall a serious crisis and to keep its banks intact," but has ahead of it the "enormous task" of integrating monetary policy with the political agenda.
Japan has launched the three arrows of Abenomics. China seeks "to find its own new economic model," one that relies less on government investment and more on investment by the private sector.
"Around the world there seems to be a major rethink and a huge dice roll going on by the central banks," Mr. Bussey said. Will these economies revive fast enough to produce true economic growth? Or will the financial markets end up saying "we have lost faith, therefore we’re going to start charging you a higher interest rate for the money that we lend you, and then all bets are off."
Atsushi Nakajima on the Larger Goal
Japan's GDP grew 4.1 percent in the first quarter of this fiscal year and 3.8 percent in the second—a "dramatically improved" performance, Atsushi Nakajima of RIETI said. Abenomics, the weaker yen and higher stock prices, joined together, have produced "very balanced" exports and consumption. Steady growth is likely to continue in the latter half of the year.
Abenomics is founded on three arrows of growth—bold monetary policy, agile fiscal policy and growth strategy—but it's "not to be analyzed or decided by these three arrows," Mr. Nakajima said. They are tools; "the aim of Abenomics, the main task, is to revitalize the Japanese economy from low growth and persistent deflation over the last decade through the reactivation of corporate activities."
Levels of investment in the Japanese corporate sector are "very, very low" in comparison with U.S. and German corporates. In the past two years, growth in company profits was mainly due to cost-cutting, particularly in labor's income share.
Changes are starting to happen. In the second quarter of this year, growth in current profit came not just from cost-cutting but also from rising sales profits. According to the Ministry of Finance, the ratio of corporate current profit to sales in the quarter was the highest since 1954.
At 4 percent, Japan's unemployment rate is very close to the so-called equilibrium rate at which demand and supply in the labor force are in balance. There are many signs that the Japanese economy is moving into a moderate inflationary period where wages, employment and consumption are all trending upward—marking a shift in the economy "from a vicious cycle to a virtuous cycle."
The consumption-tax rise set for April 2014 represents a deadline of sorts for raising household income, Mr. Nakajima said. Abenomics "has to serve as a catalyst to stimulate the economy to have higher profits for Japanese companies, then to break the trade-off situation of wages and employment in Japan so that both wages and employment go up from now on." This is the reason why the "tripartite discussion" among employers, labor unions and the Japanese government has started at this time.
Atsushi Saito on Abenomics and the Capital Markets
Atsushi Saito of Japan Exchange Group, the parent company of the Tokyo Stock Exchange and Osaka Securities Exchange, discussed the dramatically positive impact of Abenomics on the capital markets.
Between November 2012 and today, he noted, the Nikkei stock index has gone up by 80 percent, and the value of the Tokyo market has soared from ¥280 trillion to ¥400 trillion. "That means that the individual investor’s wallets swelled up by about ¥24 trillion to ¥30 trillion, corresponding to 20 percent or slightly more of the ¥120 trillion increase, in a short time."
Real GDP growth in the period April to June this year turned positive—as did capital investments "for the first time in six quarters. Private consumption is up for the third consecutive quarter."
The Abenomics policies are "aimed at stimulating the supply side and developing a foundation to facilitate corporate activity and investment instead of resorting to industrial policy," he continued. Japanese corporates are being encouraged to take much better advantage of the approximately ¥1,500 trillion that Japanese households have in low-risk financial assets.
The Tokyo Stock Exchange is leading the way towards improvements in corporate governance, Mr. Saito declared. More and more companies in the Tokyo market have put outside directors on their boards. The Exchange is prodding issuers to pay more attention to return on equity and other concerns deeply held by shareholders.
"I also expect to see more investment in Japan from overseas," encouraged by "corporate tax cuts, deregulation, labor market reform" and the establishment of special economic zones.
TPP, the Trans Pacific Partnership, will have significant positive effects on the Japanese economy, Mr. Saito observed. Government estimates show that lower transaction costs under the TPP will boost GDP by ¥3.2 trillion a year. And "there is another estimate, particularly from Professor Motoshige Ito of the University of Tokyo, of ¥10 trillion in annualized GDP growth" for the following decade.
"JPX is tasked with the crucial mission of improving the Japanese capital market environment," he commented. "This is a subject which is indispensable to Abenomics. At present we have already integrated our cash equity market in July and are working to integrate the derivatives market in March 2014.... We also developed a new stock price index to remind investors of the appeal of Japanese companies—encouraging attractive companies to turn public, striving to broaden the domestic and overseas investor base."
And "the entire security industry is also aggressively broadening the local retail investor base with the upcoming implementation of NISA," the Japanese version of individual savings accounts.
Paul Sheard: "Cautious Skepticism"
The "three arrows" metaphor in Prime Minister Abe's description of his economic policy refers to a well-known Japanese fable, remarked Paul Sheard of Standard & Poor’s Ratings Services. The moral, delivered by a famous warrior to his three sons: a single arrow can be bent, but three arrows clasped tightly together will not give way.
"If you think about this for a moment as an economist, which I am," the three arrows are "actually a very conventional policy mix," Dr. Sheard said. Abenomics is even better conceived of in simpler terms as two pillars: one, "use macro policy, monetary, and fiscal policy to try to end deflation once and for all," and two, use "supply side reforms to try to enhance the real growth potential of the economy."
For Dr. Sheard, the most significant thing about Abenomics is that Abe "has owned the reflation objective." In appointing Governor Kuroda to head the BOJ, Abe "signaled a dramatic turnaround—I would say almost a 180-degree turnaround in monetary policy communication, thinking and action."
Governor Shirakawa, the incumbent head of the BOJ when Abe took office in his second stint as prime minister, regarded Japan's stubborn deflation as caused by the decline in the country's real potential growth, largely because of demographics.
"Mr. Kuroda does not subscribe to that theory. Mr. Kuroda has come in with a message which says, 'The Bank of Japan, like any other central bank in the world, can control inflation. After all, that's our job. Give me two years and I will do this. How will I do it? Two ways: by changing the message from 'No we can't, No we won't' to 'Yes we can, Yes we will' and backing that message up with aggressive action."
Regarding the structural reform arrow, it's "easier said than done in any country," Dr. Sheard reflected. "It's a slow slog. There is a reason that you need structural reform: often there are vested interests in place. And so there is a political process that it has to go through."
"The key issues [are] how do you start to grow the labor force and make it more productive," he said. There's no lack of talk about building up labor force participation. To achieve the Abenomics targets, however, "Japan needs to take dramatic steps."
"I don't think Japan will have any hope whatsoever of achieving those targets unless it gets very serious very soon and very aggressive about turning the fertility rate around so that you have both female labor force participation and the ability of working women and working families in Japan, including the men... to have larger families, and, at the same time, participate in the labor force."
Will Abenomics work? "I don't really have very high expectations.... But the good news is, I agree with Governor Kuroda, the growth strategy is not actually needed for Japan to achieve success with the reflation objective."
Will reflation work? Dr. Sheard expressed "somewhat cautious skepticism." After 15 years of deflation, getting the economy to shift away from a zero-inflation expectation and attach itself to a new inflation target of 2 percent will be far from easy.
Moreover, the Bank of Japan "is playing serious catch-up." The BOJ balance sheet will grow by 165 percent by year-end 2014. This is aggressive, yes, but less so when you compare the Fed's balance sheet, which already has been expanded by some 330 percent and is set to rise by another 25 percent.
"So, my concern here may be that for the Bank of Japan to actually achieve its objective—I think it can do it; the question is will it do it—it may have to embrace much more radical monetary easing than we have seen to date. And I just have my doubts about whether that may be a bridge too far."
Doubling the consumption tax "may be just not the best way to go here," though not because the policy of raising the consumption tax is objectionable. "The question is all about the timing and the sequencing. Unfortunately we have seen policy misses similar to this in the past."
All in all, Dr. Sheard said, his assessment is mixed: "cheerleading, but skeptical."
The moderator, John Bussey of The Wall Street Journal, began the Q&A:
The markets are going sideways after a huge jump. What is structural reform, this third arrow that we have not yet seen implemented?
Dr. Sheard responded: "Relative to the amount of—I won't say hot air, but the amount of policy rhetoric and piles of paper that are sort of expended on this issue—it's not entirely obvious exactly what the Japanese need to do to raise their productivity."
True, given three basic ways that an economy can grow—increased labor, increased capital accumulation and innovation—it's "pretty obvious" how Japan might increase labor, he added. Increasing innovation could involve quite simple things. "Maybe what the government needs to do is just step back from some of these areas" like medical innovation.
Mr. Nakajima, when we talk about labor force flexibility, this is a nice way of saying that we want to be able to fire people more easily at companies and hire new people. With agriculture, we want to combine small family farms into big agribusinesses. These are pretty dicey in political terms. We've been talking about these things for 20 years. Will politics stop us this time too?
"We also have to say that one of the big task of the growth strategy is to change the mindset" of both the Japanese corporate sector and the household sector, Mr. Nakajima said. "Abenomics in my view is not limited to three arrows."
Japan came late to the TPP negotiations, its hand a little bit forced by the U.S.-Korea Free Trade Agreement. The U.S. is looking for very significant concessions, including in agriculture. Is Japan going to have the political willpower to meet the rules of the TPP and to be accepted into the partnership?
"The Japan problem is very simple," Mr. Saito responded. For 40 years, up until the 1990s, isolation was too successful for Japan. Japan threw up barriers, especially in agriculture, fishing and medical care. "They hated the internationalization.... Even Mr. Koizumi didn’t touch on these matters." Abenomics is working on this, "step by step."
The consumption tax increase is looming in the spring, and the government says, don't worry, this won't be constrictive, because we're going to take 80 percent of the receipts from the tax increase and spend it wisely on stimulating the economy. What's your thought on this?
"Mr. Abe, to his credit, campaigned on a very clear package of Abenomics, and he has won landslide victories in the lower house and the upper house. So, he has a mandate from the Japanese people to implement Abenomics," Dr. Sheard reflected.
Moreover, and this surprised many commentators, he didn't wait until after the upper house elections to declare that Japan will enter the TPP negotiations. TPP is one of the most important of the structural-reform elements: "Not because anything is going to happen anytime soon. TPP has not yet been even agreed upon, let alone put into effect. But it is a huge atmospheric game changer in Japan."
Can you talk further about how you view the tax increase?
Mr. Nakajima replied that there's ¥5 trillion in additional stimulus money that will offset the effect of the ¥5 trillion consumption tax increase. And be aware that it is cuts in corporate taxes that are central to this endeavor instead of spending money as subsidies or to public works. "I’m thinking that this is very wise, because the aim of Abenomics is to stimulate the corporate mind.... Mr. Abe wants Japanese companies to invest more and to pay more to their employees."
Audience members joined in the dialogue:
The equal opportunity legislation 20 years ago was a breakthrough, but a very incremental change. What kind of drastic change can be made to empower women, which Mr. Abe has cast as a key measure for recovery and growth?
Hitachi is one of a number of companies that are adding foreigners and women to their boards, Mr. Saito observed. Unless sentiments against immigration become less dominant, "we have to ask women to participate more in business." Access to childcare is the difficulty. Yokohama City has achieved a zero waiting list for its certified nursery schools and other local governments are working to follow suit. At JPX, we have a flexible working hour arrangement where, for example, employees can come to work at 10 am or leave the office at 3:30 pm for childcare.
Dr. Sheard commented: "I would much rather see, if they’re going to do the consumption tax hike, taking that money out of people’s pockets and give it to families who want to have more children. I grew up in Australia. We have a program in Australia called Child Endowment. Every parent gets a check from the government every month for the children that they’re bringing up. It is recognized that incentives need to be made."
To what extent will the Tokyo Olympics overshadow Prime Minister Abe's current economic policies? What kind of fiscal changes do you recommend to maintain a good fiscal balance?
Dr. Sheard said that for a host country, "this is really all about a mind-shift change" rather than a boost to GDP. "If an economy is already running at full potential," there will be investment expenditures, but "you're just crowding out something else."
"The 1964 Olympics were a very important milestone and a turning point for Japan as well. That was when the Shinkansen—the bullet train—was launched. So, I think this is lining up very nicely," he added.
It will be possible for Japan to host the 2020 Olympics without deterioration of its fiscal balance, Mr. Nakajima said, but only "by doing a compact Olympics—not by saying that this is a good opportunity to have another massive public works not only in Tokyo, but also in overall all of Japan."