Activity is easily mistaken for achievement. The frantic activity of the Japanese government has prompted optimism, notably among foreign observers, that Japan can achieve a reversal of its economic drift. Under second-time Prime Minister Shinzo Abe, Japan has initiated a ‘three arrows’ economic recovery plan, christened ‘Abe-nomics’.
The first arrow is a 10.3 trillion yen ($100 billion) fiscal stimulus programme increasing public spending. The second arrow is an easing of the monetary policy to increase demand, investment and inflation to 2 percent. The third arrow is structural reforms to increase incomes and improve industrial competitiveness and productivity. Japan’s total-factor productivity in the manufacturing, non-manufacturing and agricultural sectors is the same as in 1991.
The programme is designed to increase growth, income, spending and inflation, and reduce the value of the yen to increase income from exports. The hope is that it creates a self-sustaining cycle of rising prices, rising wages and increasing economic activity. The policies have been tried before, with limited success.
The government’s spending programme follows 15 stimulus packages between 1990 and 2008. Based on experience, it may provide a short-lived boost to economic activity but will not create a sustainable recovery in demand. Investment will be mainly in non-tradable, non-competitive sectors like public infrastructure and construction, frequently adding to over-capacity and earning poor returns. The OECD recently identified the inefficient and ultimately wasted investments that characterised previous packages.
Japan has maintained a zero interest rate policy (ZIRP) for over 15 years and implemented several rounds of quantitative easing. The new plan will assist the government to finance its spending. It may also help devalue the yen and boost asset prices. But given that short-term rates were near zero and 10-year rates around 0.50 percent before the plan was announced, the effect of monetary initiatives on real economic activity are likely to be less significant.
Structural reform requires deregulation of inefficient sectors, opening them up to domestic and foreign competition. Reforms are needed in taxation, trade policy, labour markets, environmental laws, energy policy, health care, services, population and immigration. Many ‘reforms’ are vague statements of objectives. Many of the ideas are old. Many policies have been tried unsuccessfully. The required changes are also politically and culturally difficult.
Reform of agriculture would require reducing or eliminating agricultural subsidies, tariffs as well as anti-import restrictions on rice and dairy products. It would require changes in land laws that limit the size of farm plots. But attempts at serious reform put the government in conflict with its own supporters and financiers such as the farm lobby.
Initially, the Japanese stock market responded positively, rising around 70 percent since late 2012, with foreign buying a significant factor. The yen fell against the dollar from around 80 to 100, a decline of around 25 percent. JGB (government bond) interest rates fell initially anticipating Bank of Japan buying.
But in May 2013, the financial market began experiencing increased volatility. The stock market fell by over 20 percent, with daily price moves of 3-7 percent. JGB interest rates rose from around 0.50 percent to 0.90 percent. The yen also reversed its fall.
The reversals require closer scrutiny of the programme’s inherent contradictions.
Historically, a 10 percent fall in the dollar/yen exchange rate results in an increase in GDP growth of around 0.3 percent. But changes in the structure of Japan’s economy mean that a lower currency may not have the same effect on exports and growth today.
The global economic environment is weak with Japan’s major trading partners such as the US and Europe trapped in an environment of low or no growth. In response to the stronger yen and cost pressures since the mid-1980s, Japanese manufacturers have moved production overseas, reducing the benefits of a lower exchange rate.
Japan’s export industries have declined over the last 20 years. In 1992 Japan exported about 67 percent of the total exports from major Asian mainland exporters such as China, South Korea, Thailand, Malaysia, Singapore, Indonesia, India, The Philippines and Taiwan. In 2003 Japanese exports were more than 30 percent of major Asian mainland exports. By 2012, it was about 15 percent the size of these Asian mainland exporters.