August 13, 2014 6:37 pm
In December 2012 Shinzo Abe was returned to power in Japan, pledging to revive his country’s economy after a long period of stagnation. Nearly two years on, the Japanese prime minister’s ambitious mix of economic policies – often dubbed “Abenomics” – is mired in difficulty.
Mr Abe’s strategy to shake up Japan has three broad components – or three “arrows” as he puts it, using the language of a Japanese folktale. Within weeks of coming to office, he implemented a huge fiscal stimulus to the economy. This was followed by a massive dose of quantitative easing, aimed at dragging Japan out of its deflationary spiral. Earlier this year Mr Abe spelt out details of his third “arrow” – a wide-ranging package of structural reforms aimed at boosting the country’s long-term growth rate.
A particularly alarming set of gross domestic product data has now raised concern that “Abenomics” is stalling. The data show Japan’s economy shrinking by 6.8 per cent on an annualised basis, the worst economic contraction seen since the earthquake and tsunami that battered the north-east of the country more than three years ago. This is a far more serious decline than economists were predicting back in the spring.
The GDP data need to be put in perspective. Mr Abe can point to much that is still going right with his economic strategy. Japanese companies are enjoying historically high profits, thanks in part to the impact of QE in weakening the yen. After years of crippling deflation, Japan’s inflation rate was running at 1.3 per cent on an annual basis in June. But despite this, Mr Abe and his government need to take another hard look at why economic growth is proving so elusive.
The biggest reason why GDP contracted so much is the government’s decision to increase a national sales tax. Japan’s public debt is the largest in the world, making revenue raising a crucial task for the government. To help achieve this, Mr Abe implemented a 3 percentage point increase in the sales tax last April, a change that skewed the spending pattern of many households and businesses. After this week’s GDP figures, Mr Abe will have to judge whether further planned increases in the sales tax remain justified. It may be prudent for him to put more of the fiscal burden on the country’s cash-rich companies, lightening the load on families.
It would be wrong, however, to pin Japan’s economic problems on tax policy alone. Other major constraints on growth need to be tackled. One fundamental problem is the lack of business confidence in Japan, which means companies are hoarding cash rather than investing in new equipment. Mr Abe needs to persuade businesses to inject new cash into the economy.
It is particularly important that the government reverses the fall in real wages. Since Japan’s population is shrinking fast, falling from 127m today to a projected 90m by 2060, economists might expect wages to rise in a tight labour market. Yet the Japanese workforce remains dominated by highly protected regular employees who are unproductive and difficult to fire. As a result, Japanese company bosses have been highly reluctant to award pay rises and additional security to non-regular workers. Wages for many employees are not catching up with inflation, thereby depressing demand
Mr Abe needs to throw as much of his political weight as he can behind policies that end the rigidities in the labour market. He also needs to give more momentum to his “third arrow” of structural reform. The Japanese prime minister has time on his hands, with no need to go to the polls until 2016 and an opposition that is in disarray. However, this week’s economic data have exposed just how big the task of turning round the Japanese economy has become.
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