The Japanese economy has been largely stagnant since the bursting of an asset-price bubble in the early 1990s. ‘Abenomics‘ represents the current Prime Minister Shinzo Abe‘s attempt to restore prosperity to his country and is arguably more ambitious than anything tried since the bubble burst. It has three ‘arrows’: aggressive monetary expansion by the central bank, a sustainable fiscal expansion, and structural reform. The first is aimed at reversing deflation or falling prices, the second at expanding demand in the short run while consolidating or reversing the inexorable rise in public debt since the crash, and the third at promoting and sustaining growth in the longer run. This third arrow is perhaps the most difficult and the most vital, as without fairly dramatic structural change, the spell of stagnation is unlikely to be broken.
Monetary expansion has in recent days become more dramatic than any attempted by other major central banks since the Great Recession, with the Bank of Japan’s balance sheet expanding to 16% of GDP, significantly more than the US Federal Reserve or the Bank of England with their so-called Quantitative Easing. Such a policy will tend to put downward pressure on long-term interest rates, although they could hardly go much lower, and also on the Yen exchange rate, which could potentially boost exports, reduce imports and increase domestic inflation through higher import prices.
Fiscal expansion has arguably been undermined this year by the hiking of Japan’s consumption tax, which may have led to a sharp fall in GDP in the short term. However, these inflationary measures cannot be long-term solutions to Japan’s problems. The third arrow, as already measured, is the vital one.
As Martin Wolf argued in yesterday’s Financial Times, growth in Japan is beset by chronic surpluses by the corporate sector, which are reflected in a large government budget deficit. Japan’s trade surplus is more modest and has become more so in recent years, since the decision was taken to shut down nuclear reactors and source more energy from imports. The surplus in the corporate sector represents an excess of cash-flows over investment. As Wolf argued, this needs to fall to stimulate growth and reduce the budget deficit which is essential to even starting to reduce Japan’s massive government debt which stands at 240% of GDP. This fall can happen in three ways: either by expanding exports, raising private sector investment or through a redistribution of income from firms to households, and an increase in spending by the latter. As Michael Pettis has argued on his excellent blog, the third option is the right one, but Abenomics may not achieve it. Increasing net exports merely sustains net saving by firms without guaranteeing spending on investment or consumption, while investment is potentially misallocated in Japan, as it has remained reasonably high without stimulating growth.
So how to increase income flows to households from firms? This can happen by increasing dividend payments to shareholders and by raising wages. The latter is more likely to increase the share of consumption in GDP, as wage increases will tend to flow to poorer households than more pay-outs to shareholders who tend to be wealthier. In practice, some mixture of the two is probably essential. Rising wages should stimulate consumption which can in turn stimulate investment spending. Higher dividends could boost consumption to some degree while also reallocating the funds available for investment to more productive firms and projects with higher potential returns. This would represent a shift to a more shareholder-driven investment model, and this does have the potential for undermining long-term investment through the promotion of speculation of short-term returns encouraged by the stock market. Another flaw in this model is that higher returns can often be paid to shareholders rather than to workers in the form of wages. If a higher and sustained level of consumption is to be promoted, higher productivity and output should be reflected in rising wages across the economy. To his credit, Abe is trying to encourage this, alongside the strengthening of shareholder rights. If wages do not rise in line with productivity, then this will lead to either continued stagnation or a temporary burst of growth driven by rising household debt, which cannot be sustained in the long run. So the government has been moving in the right direction. If more productive investment is encouraged, productivity and output should increase, creating space for rising profits and wages, so that greater prosperity is fairly shared.
Of course, the positive outcomes described above cannot alter the fact of Japan’s rapidly shrinking working population, a demographic trend that severely limits investment prospects and therefore growth. Abe is trying to increase female labour market participation which would help counter the problem. Higher immigration is another way to counter this, but is Japan ready for even more disruption to its political economy and society?