[M’s Opinion] No. 26 - Focusing on Abenomics
May 27, 2014
Will the “Three Arrows” hit the mark? Will Japan’s economy revive?
Professor, Graduate School of Governance Studies
The so-called Abenomics worked out by the second cabinet of Prime Minister Shinzo Abe aims to stop deflation and achieve higher economic growth through implementing measures based on the “Three Arrows”, which areaggressive monetary policy, expansionary fiscal policy, and a growth strategy to stimulate private-sector investment. However, not a few doubts remain about the effectiveness of these policies. I will examine the problems and issues on Abenomics.
A crucial moment in monetary policy and public works projects lacking in effectiveness
The first of the “Three Arrows” of Abenomics, aggressive monetary policy, sets out the goals of achieving an inflation target of 2% and unlimited quantitative easing. It has resulted in devaluation of the yen on international currency markets and better economic conditions. However, the crucial moment is yet to come. Amid inflationary conditions resulting from the increase in consumption tax and other factors, without an increase in workers’ wages the public’s buying power will decrease. While the Bank of Japan is buying large volumes of Japanese government bonds on the open market, this policy can be said truly to have reached a crucial point that will show whether the funds flowing into the market are finding their way to borrowers and stimulating corporate activities and whether improved business performance will lead to wage increases.
The second arrow “expansionary fiscal policy” involves numerous problems. While the two supplementary budgets included economic stimulus measures such as public works projects, for many of these their effects are open to question. While these economic stimulus measures are described as means of compensating deflationay shock caused by the increase in consumption tax, in fact they can be described as lavish rewards to localities that supported the Liberal Democratic Party in the December 2012 elections to the House of Representatives and the July 2013 elections to the House of Councillors.
These economic stimulus measures, may not be same as ones done in the past, could have the effect of putting pressure on the private-sector economy. A typical example is the case of public works projects, in which an increase in such projects by the government has led to shortages of labor and materials. Shortages of materials and labor cause the prices of these inputs to rise, resulting in pressure on private-sector investment. This phenomenon is known in economics as “crowding out.” In addition, an increase in public works projects outside the areas affected by the Great East Japan Earthquake will have the effect of delaying earthquake recovery efforts.
There is a possibility that public works projects could stimulate economic activity through greater convenience resulting from improvements to roads and bridges. However, in reality these are not the targets of investment. Instead, political forces cause funds to be used on projects offering little return on investment. Politicians direct the gains to their constituencies. Since the effects of economic stimulus measures soon are diluted, it is likely that voices calling for further stimulus measures will strengthen this summer or autumn. Economic stimulus measures are like a drug. While the first and second arrows of Abenomics are intended as temporary measures to bridge the gap until economic growth led by the private sector takes effect, in reality they may instead create a structure under which the private sector is dependent on the government. If so, then there can be little hope of sustained growth led by the private sector.
The Abe administration argues that economic growth achieved through Abenomics could enable fiscal consolidation as well. While it is true that economic growth is necessary for fiscal consolidation, economic growth alone will not be able to consolidate public finance . This is clear because the current deterioration in public finance is the result of past expansionary fiscal policies taken by successive governments for economic growth. The revenue of the supplementary budget for fiscal year 2013 saw an increase of 3.5 trillion yen in the general account, chiefly from corporate tax and income tax, but this was used to fund an increase in annual expenditure instead of debt repayment. Even if the economy recovers, politicians will use up any money that comes into government coffers. While the economy is improving, comparison with the previous government of the Democratic Party of Japan shows that the Abe government has lower levels of fiscal discipline. While I would not deny high growth as a political target, it is considered commonsense in the world to assume cautious rates of growth in budgeting and mid/long-term estimates of public finances. This is because the future involves risks, and overoptimistic assumptions of growth can lead to postponement of difficult reforms.
A possibility of national debt beyond financial assets held by individuals, and the start of borrowing from overseas
It is well known that Japan has a massive debt of roughly 1,000 trillion yen, and that that number is increasing from year to year. Why doesn’t Japan collapse like Greece as a result of this massive debt load? It is because more than 90% of Japan’s debt is owed to domestic lenders. Put another way, most Japanese government bonds are financed domestically, so that the government does not rely on borrowing from overseas lenders. However, this is no reason to feel safe and secure. The amount of financial assets held by individuals in Japan is said to be approximately 1,500 trillion yen, but not a few observers have identified the possibility that the national debt could surpass the amount of financial assets held by individuals over the coming five to ten years. In such a situation, the domestic economy’s ability to purchase Japanese government bonds would disappear and Japan would have to borrow from overseas. That would mean that the current account balance, an indicator of Japan’s economic transactions with foreign countries, would fall into deficit. While a current account deficit would not mean an immediate crisis, what would be problematic is the question of whether overseas investors would lend funds to Japan at low interest rates. While the United States currently has a current account deficit, it is not experiencing an economic crisis. This is because of the high regard for the dynamism and growth potential of the U.S. economy, which leads foreign investors to lend it money. But what about Japan? Although it has the world’s third largest economy, its society is ageing and its working population is decreasing at an accelerating pace. Under such conditions, would foreign investors believe in the growth potential of Japan enough to lend it money when its current account is in deficit? Regrettably, I doubt they would. Points common to countries such as Greece that have faced crises due to worsening public finances are current account deficits, rising interest rates, and the inability to finance budget deficits.
Numerous “growth strategy” policies: Is government an omniscient and omnipotent god?
Returning to the subject of Abenomics, the first and second arrows of that policy both are temporary measures. The most important is the third arrow, “a growth strategy to stimulate private-sector investment.” This growth strategy has been announced in stages, from stage one to stage three, and in June of last year these were combined together under the name of “Japan is Back”. A law to implement some programs stipulated in the strategy was passed in an extraordinary session of the Diet last year as well. The content of this growth strategy is broad and large-scale, and it proposes a surprisingly broad range of policies. One senses the strong enthusiasm of Prime Minister Abe in its challenging numerical targets. While it is clear that the government considers this growth strategy to be very important and it is an outstanding proposal, does the government really have the ability to decide on growth industries? From reading government documents, one gets the feeling that the government thinks of itself as an omniscient and omnipotent god, able to accomplish anything it wants.
A lack of analysis on why the Japanese economy is stagnated and and “Growth strategy” presented by the U.K. government
The biggest doubt one feels about the growth strategy concerns the fact that it is unclear whether its individual policies truly will contribute to Japan’s growth. For example, why should expanding the scope of advanced medical technologies that can be used together with treatment covered by health insurance or shifting to electronic medical records lead to economic growth? Another questionable policy is that of creating National Strategic Special Zones, one of the strategy’s headline policies. Without rejecting that idea itself, I wonder whether deregulation and other efforts targeting a single region alone can be expected to increase growth nationwide. Many of the other policies also leave one with doubts as to why they would increase growth. This is because the cause-and-effect relationship between the policies and growth is unclear, and they lack analysis of the problems preventing Japan from growing. For example, if a patient complains of a headache the doctor will identify the cause of the headache and then write a prescription to eliminate that cause. This is because it is impossible to cure the illness without identifing its cause. On the other hand, the growth strategy appears simply to be an exercise in writing prescriptions without making clear the true reasons for or causes of Japan’s inability to grow. This is because the large number of policies described in the growth strategy is merely a budgeting wish list for government agencies. They cannot secure budgets—in other words, money—without offering some kind of prescription. While the strategy brings together a number of plausible policies, in essence they simply represent compilations of materials provided by each government agency. The true essence of a growth strategy must consist of making clear the problems preventing Japan from growing and then investing resources on these in a prioritized, focused manner.
Let’s take a look at the Plan for Growth adopted by the United Kingdom in 2010. This plan proposed four strategies: “(i) to create the most competitive tax system in the G20; (ii) to make the UK one of the best places in Europe to start, finance and grow a business; (iii) to encourage investment and exports as a route to a more balanced economy; and (iv) to create a more educated workforce that is the most flexible in Europe.” It also adopted key performance indicators (KPIs)* to measure the degree of achievement on each of these targets. The specific measures for achieving these were practical measures with clear schedules, and the plan included budget amounts as well. In sum, rather than simply a list of the things each government agency wanted to do, like Japan’s growth strategy, the U.K.’s plan identified feasible measures needed to promote growth. It also included analysis of the current conditions of each industrial area, including competitive conditions and regulations. While it remains unclear whether the U.K.’s Plan for Growth will succeed, I think it is clear that there is a huge difference between it and Japan’s growth strategy. A growth strategy intended as fiscal stimulus or to secure budgeting is putting the cart before the horse.
* Quantitative indicators used to measure the degree of achievement of goals
Recommendations for reforming the social security system: A fourth arrow of Abenomics
The biggest challenge that Japan faces is that of finding a way to overcome its low birthrate and ageing society. As its working population decreases, social security costs centered on pension and medical costs will swell. It goes without saying that this is hindering efforts to put Japan’s public finances on a sound footing. Since its start, the Abe administration has set the fiscal consolidation target of achieving equilibrium in the primary balance by 2020. However, even if Abenomics has met its goals achieving a nominal economic growth rate of 3% and a real growth rate of 2%, it will not be able to meet its targets under the government’s medium-term fiscal forecasts. The real growth rate over the past 20 years has averaged less than 1%, and even if the growth rate over the coming 10 years doubles it will not be able to achieve its goal. This is due primarily to insufficient expenditure cuts in particular relating social security expenditure. While the Abe administration has decided to raise the consumption tax rate from 5% to 8% beginning this April, no matter how much consumption tax increases in the future without reforms to the content of the social security system it will be just like sprinkling water on the desert.
Overall, the Abe administration is good at managing the government over the past year. But still, this can be said to have been the result of putting off decisions on difficult issues such as reforms to the social security system, fiscal consolidation, and the Trans-Pacific Partnership (TPP). If Prime Minister aims to serve in office longer than Prime Minister Junichiro Koizumi and leave his mark on history, he must take on difficult issues such as reforming the social security system and fiscal consolidation. To do so, politicians need to convince the public of the need for reform. Basically there will be no national elections over the coming two and one-half years. This is the final chance for reforms. I would like to propose that Prime Minister Abe demonstrate his strong leadership in taking on reforms to the social security system, identifying such reforms as the fourth arrow of Abenomics. They key point in reforming the social security system is getting people who are relatively well off to refrain from using the system’s benefits. Needs should be prioritized and resources directed where they truly are needed. Today, Japan faces the question of whether it will wait on reforms until an economic crisis comes or will learn a lesson from other countries’ experiences and implement reforms even though they might cause some pain.
Professor, Graduate School of Governance Studies, Professional Graduate School, Meiji University
Academic Fields: Budget and Accounting Systems, Public Policy and Social Security Systems
Doctor of Policy Studies
Earned a master’s degree from the Graduate School of the Tokyo Institute of Technology in 1985. That same year, joined the Ministry of Finance. Worked at the Japanese government including the National Tax Agency, the Cabinet Secretariat, the Ministry of Foreign Affairs (at the embassy of Japan to Malaysia), and the Ministry of Health and Welfare (now the Ministry of Health, Labour and Welfare). Professor, Graduate School of Governance Studies, Meiji University, since April 2012.
Public Finance in Japan, 2013, (Chuokoron-Shinsha)
Examining the Failure of the Democratic Party of Japan Government, 2013, Chuokoron-Shinsha,(coauthor)
Fiscal Discipline and Budget System Reforms, (2011, Nippon Hyoron Sha and numerous others)
"Fiscal Rules and Targets and Public Expenditure Management: Enthusiasm in 1990s and Its Aftermath", Pacific Economic Papers, 2005,No.346,Australian National University
"Fiscal Consolidation and Medium-Term Fiscal Planning”, 2003, OECD Journal on Budgeting, Vol3, No.2, pp.105-137