February 25, 2014 4:07 pm

Abe has good medicine but Japan needs a stronger dose

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The effort is showing signs of success but requires renewed vigour, writes Adam Posen
Ingram Pinn illustration©Ingram Pinn

Japan’s recovery programme is showing promising early results. Last autumn the economy enjoyed its fourth successive quarter of growth, its best performance in more than three years.

Many observers rightly praise the Bank of Japan’s shift to positive inflation targeting for contributing to the country’s recovery. Yet monetary policy is only one of the three “arrows” called for in Prime Minister Shinzo Abe’s programme for the Japanese economy. Also important are fiscal consolidation and structural reform. These initiatives, too, are moving in the right direction with the right priorities. But like monetary policy, they need to be bold to succeed.

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This is a stronger endorsement than it may seem. Too often, economic reform programmes fail to deliver. Some get the analysis wrong and end up driving the economy further into the ditch. This was the case in Japan in the 1990s when policy makers failed to recognise the risk of persistent deflation. Arguably, it has been the case with US fiscal policy since the 2009 stimulus.

Others get the analysis right but fail to prioritise, going after too many small goals at once as in Indonesia in 1998 or Greece today. Sometimes this reflects a belief that austerity measures alone will reform the economy. Such misplaced faith lies behind many of the euro area’s failures, as it did in Argentina’s a decade earlier. All too often, even sensible economic policies are undermined by an emphasis on process ahead of substance. For example, policy makers in Italy have long laboured under the self-defeating belief that governance must be reformed before the economy can be tackled.

So far, Abenomics has avoided all of these errors. The economic analysis was correct: a return to inflation will make it easier for taxes to rise and reforms to take hold, as they must if the country is to return to a sustainable path. Mr Abe has prioritised a few key reforms – notably increasing female labour force participation, consolidating farms, breaking down labour market divisions and raising competition in healthcare – which are sensible and feasible. The government has not wasted momentum on administrative initiatives before starting its economic reform efforts.

What is needed now is more of the same. The Abe government already has the right ideas; it does not need to devise new initiatives. Instead, it needs to raise its ambitions for the programmes it is already pursuing.

On the fiscal front, the prime minister’s basic plan can be summarised as follows: do not panic. Raise the consumption tax permanently in steps. Spend for emergencies but make those expenditures temporary. Increase taxation and cut expenditure on the older generation that has already benefited from intergenerational transfers.

But Mr Abe needs to be bolder. On the consumption tax, for example, the limit of his aspirations is to increase the levy to 10 per cent over the next 20 months. Even this may be postponed. The government should commit to do far more – raising the tax to at least 20 per cent over the next several years, a level common in the OECD.

Similarly, increasing female labour force participation is the right priority for structural reform. At least 3m Japanese women who could work are neither in employment nor looking for a job. A few million more are squandering their capabilities in limited roles.

Providing affordable child care, and visibly removing the cultural and institutional barriers that prevent women from advancing in the workplace, are proven approaches for achieving this goal. Mr Abe is right to pursue them. But instead of providing 150,000 new nursery places, the government should be creating as many as 400,000. Instead of setting a target for 30 per cent of public sector managers being women, and voluntary guidance in the private sector, it should be setting a compulsory target of 40 per cent for both.

Likewise in the agricultural sector. Production quotas are being removed, which will raise productivity, but more should be done. Small farms should be merged to make them more efficient. Wage subsidies for new hires should be applied nationally, instead of current measures that loosen hiring rules only in special zones.

In short, the Abe government has understood Japan’s economic problems correctly and concentrated its efforts on areas where it can do most good. But the efforts have been insufficient. Far greater ambition is required. True, half a loaf of reform is better than none. But it is probably not enough to return the Japanese economy to sustained strength.

For Mr Abe and his cabinet, economic revival is a means to an end. They want Japan to remain a vital ally – in both senses, energetic and necessary – to the US and Asian neighbours worried by the potential pressures from China. That would require annual growth of about 2 per cent, and a tax base that permanently closes the structural budget deficit. Mr Abe’s current programme is insufficient to achieve this.

The good news is that meeting an external threat is a stronger impetus for reform than growth alone. The Meiji revolution of 150 years ago was prompted by Japan’s desire to stand up to colonial pressures, such as Admiral Perry’s fleet. It produced an economic transformation. If Mr Abe wants to restore Japan to strength, he needs to raise his ambitions.

The writer is president of the Peterson Institute for International Economics

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