|Satyajit Das: In Japan, Neither the 2020 Olympics Nor Abenomics Will Be Magic Bullet|
By Satyajit Das
SEP 09, 2013 11:30 AM
Tokyo's winning bid for the Olympics and Shinzo Abe's new economic policies have given the Japanese new hope. Outsiders still have doubts.
Activity is easily mistaken for achievement. The frantic activity of the Japanese government has prompted optimism, notably amongst foreign observers, that Japan can achieve a reversal of its economic drift.
Under second time Prime Minister Shinzo Abe, Japan has initiated an ambitious "three arrows" economic recovery plan, christened "Abenomics."
The first arrow represents a yen 10.3 trillion (US$100 billion) fiscal stimulus program increasing public spending. The second arrow represents a further easing of monetary policy to increase demand, investment, and inflation to 2%. The third arrow represents structural reforms to increase incomes and improve Japan’s industrial competitiveness and productivity. Japan’s total factor productivity in the manufacturing, non-manufacturing, and agricultural sectors is the same as in 1991.
The program is designed to increase growth, income, spending, and inflation, and to reduce the value of the yen to increase Japan’s exports. The hope is that it creates a self-sustaining virtuous cycle of rising prices, rising wages, and increasing economic activity.
The policies have all been tried before, with limited success.
The government’s current spending program follows 15 stimulus packages that were enacted between 1990 and 2008. Based on previous experience, new spending may provide a short-lived boost to economic activity but will not create a sustainable recovery in demand. The same applies to Olympics-related spending.
Investment will be mainly in non-tradable, non-competitive sectors like public infrastructure and construction, which frequently create overcapacity and earn poor returns. The OECD recently identified the inefficient and ultimately wasted investment that characterized previous packages.
Japan has maintained a zero interest rate policy (ZIRP) for over 15 years and implemented several rounds of QE. The new plan will assist the Japanese 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% before the announcement of the plan, the effect of monetary initiatives on real economic activity are likely to be less significant
Structural reform requires de-regulation of inefficient sectors of economy, opening them up to domestic and foreign competition. Reform is needed in the areas of taxation, trade policy, labor markets, environmental laws, energy policy, and health care, population and immigration services.
Many "reforms" are vague statements of objectives. Many of the ideas are old. Many policies have been tried before, unsuccessfully. The required changes are also politically and culturally difficult.
Reform of agriculture would require reducing or eliminating large agricultural subsidies 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% since late 2012, with foreign buying a significant factor. The yen fell against the US dollar from around yen 80 to yen 100, a decline of around 25%. Japanese government bond (JGB) interest rates fell initially anticipating Bank of Japan buying.
But in May 2013, the Japanese financial market began experiencing increased volatility. The stock market fell sharply by over 20%, with daily price moves of 3-7% being experienced. JGB interest rates increased sharply, rising from around 0.50% to 0.90%. The yen also reversed its fall. Financial market volatility was sharply higher.
The reversals reflect closer scrutiny of the program’s inherent contradictions. Historically, a 10% fall in the US dollar/ yen exchange rate generally results in an increase in GDP growth of around 0.3%. 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 relocated production overseas, reducing the benefits of a lower exchange rate.
Japan’s export industries have declined over the last 20 years. In 1992, Japan was the lead exporter among major Asian mainland exporters, specifically China, Korea, Thailand, Malaysia, Singapore, Indonesia, India, Philippines, and Taiwan; of this group Japan's exports accounted for 67% of total exports. In 2003 Japanese exports represented just over 30% of major Asian mainland exports. By 2012, Japan’s exports were about 15% the size of these Asian mainland exporters.
Many Japanese exporters based in Japan are financially weak. Japanese firms no longer have a significant technological advantage over competitors, primarily from South Korea, Taiwan, or China.
Devaluation of the yen also pushes up the cost of imports. Since March 2011, Japan’s trade balance has been negative, reversing decades of surpluses. This reflects the shift of production overseas by Japanese companies. But the most significant factor is the Fukushima nuclear disaster which led to the shutdown of Japan’s nuclear power plants. This has increased import of fuel, oil, and liquefied natural gas.
Increasing inflation to the targeted 2% level is designed to break the hold of disinflation or deflation on the economy. It is seen as essential to strong nominal growth, increased consumption, and ultimately the reduction of debt.
Unfortunately, the simple adoption of a target does not guarantee rising prices. Before the recent initiatives, inflation -- including energy but excluding the cost of fresh food -- fell 0.5% per annum in the year to March 2013 the highest rate of deflation in two years.
There are limited signs of higher prices in the wider economy, at least as yet. The new initiatives may also create the wrong kind of inflation.
Japan needs demand-driven inflation, reflecting the effect of increasing wages, higher consumption, and increased purchasing power. Lack of income increases, low economic growth, and also an aging population means a structural lack of demand. This is exacerbated by over-supply and excess capacity in many industries.
The regulatory environment and benign shareholders prevent industrial consolidation. Low interest rates encourage banks to maintain loans to zombie companies that can cover the interest cost but have no viable business, preventing rationalization of capacity. A stagnant market and oversupply mean permanent pressure on companies to maintain market share and minimal price increases.
Current policies are more likely to create cost-push inflation. Devaluation of the yen has increased the cost of imported goods, such as imported energy costs, which have driven an 11% increase in the cost of electricity.
Higher costs may, in fact, reduce consumption unless incomes rise commensurately. But wages reached their lowest level since 1992 in January 2013, albeit before the current initiatives.
Higher incomes would also increase Japan’s cost structure. In combination with higher energy and other imported input costs, it would reduce, not improve, Japan’s international competitiveness without significant labor market reforms.
Stagnant incomes are not offset by the wealth effect of higher stock prices. The bulk of Japanese savings are held as low-yielding bank deposits. Over 80% of Japanese households have never invested in any security; 88% have never invested in a mutual fund. Shares represent around 7% of Japanese household financial assets, compared to around 25% in the US. Rising stock prices affect a very small portion of the population, boosting consumption of luxury items rather than driving broad-based increases in consumption.
The conventional analysis that suggests the current initiatives will increase consumption may prove incorrect. Rising costs may reduce purchasing power, unless matched by rising wages and real incomes. This would reduce spending and confidence, reducing the effectiveness of Abenomics.
The chances of Prime Minister Abe’s program succeeding are limited. The failure of charismatic and popular Prime Minister Koizumi’s ambitious policies in the early 2000s evidence the difficulty of implementing even modest reform in Japan. Bloomberg columnist William Pesek summed up the increasing doubt like this: “This faith that Japan is just one huge spending package away from bliss is becoming more detrimental with each passing year and credit downgrade. Abenomics really is more religion than reality.”
No positions in stocks mentioned.
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