How has Japan fared in its economic experiment-'Abenomics'?
In December 2012, Prime Minister Shinzo Abe launched an economic experiment to revive Japan's sluggish economy, fighting deflation from the start of the 21st century. The plan 'Abenomics', named after the Prime Minister seeks to use "three-arrows" to push demand and thus stimulate growth in the Japanese economy. To give a context, Japan's economy has been facing stagnation since two decades with the growth in real GDP averaging about 0.8% between 1993-2012.
The three arrows of 'Abenomics' (Easy monetary policy, government spending, and structural reforms)
The first arrow seeks to promote an easy monetary policy with an aim to reduce real interest rates, fight stagflation and cause a significant weakening of the yen. The aim of having a weak currency is to boost exports, mainly manufacturing. Japan, in the past, has not kept pace with the low cost of production around the world and thus a weak currency ensures that Japan's products are bought, with the consequence that the ensuing corporate income would translate into productive investments, increased share prices and higher wages. Monetary easing also hopes to fight the deflation in the economy and the target of 2% would be the highest that the economy has seen since the beginning of 1991.
The second part of the experiment seeks to revive growth by increasing demand through augmenting government spending and public investment. The government has agreed to advance total spending on the current five-year plan to about ¥25 trillion, from ¥19 trillion previously estimated.
The third and the most controversial part of the plan is to bring about structural reforms in the economy. This seems to be a more logical and sustainable approach to bring about changes in the medium term. Abenomics has identified core areas where reforms can be targeted – agriculture, labour markets, female participation in the labour force and healthcare. The Prime Minister is also set to form new special economic zones to attract foreign business and deregulate certain sectors of the economy. The ideas are promising, however the implementation would determine the true impact.
How has Japan fared so far?
Following the adoption of the economic reform Japan's economy has picked up and 2013 has reported positive growth rates of more than 2% per quarter. This can be well attributed to the increased demand for exports and government expenditure. The unemployment rates have come down and the stock markets have soared with Nikkei (225 stock average) growing by more than 70% since the inception of the reforms.
Inflation v/s Wage Growth
Bank of Japan has been successful in meeting its intermediate inflation targets , however the long term inflation expectations have remained below the target of 2%. The key concern is that people are still uncertain about Japan's commitment to maintaining high inflation.
Another concern is that the increase in inflation has offset the increase in the nominal wages, thus signalling that the real wages have not really risen. OECD has warned that Japan’s economy could face a slowdown if inflation goes up without wage expansion as OECD cut down its projections for the country’s economic growth in 2014 from 1.6% in November to 1.2% in their last bi-annual meeting.
Rising Business Confidence
On one front where the policy has definitely scored well is business confidence. It has successfully boosted confidence in the economy which has played a major role in stimulating growth above the sub 1 level. Shinzo Abe, supporting his policy framework , while addressing the OECD in Paris recently, highlighted that his economic policies have been successful in lowering down the unemployment rates and the job offer ratio now stands at 1.07 per jobseeker. He also mentioned that corporations are optimistic of Japan's revival and many of them have raised salaries of employees by up to 2%. The real question that the Prime Minister needs to answer is whether the real wages have actually risen or is he conveniently ignoring the ill-effects of his policy?
A major concern at this point is that though the corporate profits are increasing , desired amount of productive investments have not been seen which shows that until further reforms are undertaken, the first two arrows of Abenomics might not be able to sustain growth in the economy.
Fighting fiscal imbalance
One major area where Abenomics as a policy is likely to falter is the heavy reliance on government spending to increase demand and start the virtuous cycle of growth. With the government debt staggering at 230% of GDP, the sustainability of the plan is highly unlikely. The government can no longer infuse demand in the economy at the cost of their precarious fiscal health.
A positive step towards fiscal consolidation taken up by the government in Japan is to increase the consumption tax from 5% to 8% in April 2014. According to estimates the rise in consumption tax would lower the fiscal deficit by close to 1% of the GDP in Japan. However, the increase in tax is contradictory to the entire approach of Abenomics. The consumption tax increase is likely to reduce demand in the economy with the households cutting down on their expenditure. This would further heighten the central problem with Abenomics, eroding household wealth even more as inflation exceeds the increase in nominal wages (as mentioned above).
Increased exports but a worsening Balance of Trade
The rapid weakening of the currency has added pressure on the cost of imports and thus the value of imports has been rising over the months (barring a few exceptions). The rise in exports has failed to overcome this as reflected in the balance of trade which shows a downward trend despite Japan's latest efforts.
There is no denying that Japan's long stagnant economy has picked up in the past with the economic reforms in the name of 'Abenomics'. Demand has increased, increasing prices to corporate houses, business confidence and returns in the stock market. However it has not been a win-win situation. Consumers have been hurt by the price hike beating the hike in wages. The much desired spill-over from increased corporate income to household wealth has not been completely achieved. If Japan's has to revive the economy three things need to be targeted- Increasing expectations of inflation and growth; increased private investment and fiscal consolidation(controlled budget) ; and proper implementation of the structural reforms.
- Jasmine Makkar
Jasmine Makkar is a first year PGDM- Finance Student at SPJIMR. She has completed her graduation in Economics(H) from Lady Shri Ram College, DU. She enjoys writing, dancing and is a theatre enthusiast.
Follow Jasmine at jasminemakkar.insideiim.com