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When he assumed office in December 2012 Japanese Prime Minister Shinzo Abe pledged a radical course of action to deal with Japan’s economic downturn. Since 1990 the world’s third-largest economy has been plagued by deflation and sagging consumer confidence creating what Japanese policymakers call the “Lost Two Decades.” Abe’s program, dubbed “Abenomics,” called for a combination of expansionary monetary and fiscal policy and structural reform. Throughout 2013 the Japanese economy showed signs of recovery and inflation was moving upwards, but Abe’s decision to increase the country’s consumption tax from 5% to 8% in April has produced the country’s fourth recession since 2008. In response to disappointing economic numbers, Abe announced last week that he is postponing a future increase in the consumption tax until 2017 and he called for new parliamentary elections next month. He justified his call for new elections by saying that he needed a mandate from voters to continue his economic program and pledged to resign if his Liberal Democratic Party (LDP) coalition did not win. Although the LDP is expected to triumph in next month’s vote, analysts question whether Abe has the stomach to continue major economic reforms in light of Japan’s recent recession and some criticize the upcoming election as a useless exercise.
This topic brief will discuss some of Japan’s economic programs and the progress of Abenomics, analyze the circumstances that led up to the recent parliamentary election, and prognosticate how the election could affect the implementation of Abe’s economic agenda.
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Japan’s Economic Problems & The Abenomics Solution
Following the Second World War, Japan’s economy underwent a lengthy period of economic growth. International economists at the time dubbed Japan’s postwar growth an “economic miracle,” much like that experienced by the West German economy at the same time. The Japanese economy grew by an average of 5% per year and by the 1980s it was the second-largest economy in the world, surpassed only by the United States. In fact, the United States experienced a great deal of economic anxiety about the rise of Japan, especially because Japanese automotive companies became significant competitors to American automotive giants such as General Motors and Ford. Some of the anxieties about China taking over the global economy today were seen during the 1980s as pundits speculated about how Japan might reshape the world in its image. Time magazine in the 1980s even fretted about Japanese investments in Hollywood and what that might mean for American culture. However, some of Japan’s economic growth was artificial and close relations between big business and the banking sector created an asset bubble in the economy. Banks loaned money too loosely to businesses that were becoming less and less competitive and when the Bank of Japan (BOJ) raised interest rates in late 1989 to curtail inflation the credit bubbles that existed throughout the economy in manufacturing, real estate, insurance, and other markets burst. In many ways, Japan’s economic disaster resembled what would take place in the United States with the 2008 financial crisis as bad loans were exposed, jeopardizing the operations of businesses and banks. Like the American government in 2008, the Japanese government stepped in with emergency injections of cash and interest rates were lowered to reinvigorate the economy. However, deflation (a general falling of prices) took hold as Japanese consumers restricted their spending, requiring firms to drop the prices of their products. Cheaper goods from other Asian nations that were beginning their own economic booms compounded the problem. And to make that worse, the Japanese government raised the national consumption tax in 1997 when it thought the economy had recovered enough, but this merely prompted people to spend even less to pay taxes to the government. Deflation is a tough psychological nut to crack because consumers enjoy low prices and if they believe prices will fall in the future they will be reluctant to spend. This is the opposite of inflationary concerns, which will prompt consumers to spend immediately to avoid what they think will be a higher price in the near future. As The Wall Street Journal reports on November 19, consumer spending is two-thirds of Japan’s gross domestic product (GDP). Just like the United States, if Japanese consumers are not spending the economy is not moving in a positive direction, so Japan’s problem for two decades has been trying to reverse this deflationary problem and get people to spend more money of their money. By doing so, it is hoped that Japanese businesses will be more likely to invest, which will lead to greater employment, which will in turn put more money in the economy as more workers are paid, which will then result in a higher inflation rate as economic activity takes off. The BOJ wants a two percent inflation rate, but inflation in Japan is barely over one percent at the moment.
Dealing with the Japanese economy has been a proverbial riddle for Japanese policymakers and many a Japanese prime minister has been undone by their failure to solve it. One of the more proactive Japanese prime ministers in recent years was Junichiro Koizumi of the Liberal Democratic Party (LDP), who governed the country between 2001 and 2006. Koizumi pushed through the privatization of Japan Post, the Japanese postal service that did a lot more than deliver mail, in an attempt to create more efficiency in the economy. Historically, Japan has relied on large business conglomerates to direct economic activity. Prior to World War II this was done by the zaibatsu, which were large entities that controlled a diverse array of industrial, financial, and commercial activities. For example, a zaibatsu might have interests in insurance, real estate, electronics, etc. The United States tried to eliminate the zaibatsu after the Second World War, but they were so entrenched within the economy that America abandoned most of its plans. Japan Post was a government-owned corporation that coupled postal, banking, and insurance activities and Koizumi’s administration successfully privatized it. However, the fight against deflation was not won under Koizumi despite several significant structural changes taking place in the economy regarding the elimination of inefficient businesses and bad debts on banks’ balance sheets.
In December 2012, Japanese voters returned the LDP to power – the LDP has governed Japan for most of its postwar history – under former Prime Minister Shinzo Abe (Abe had served as prime minister between 2006 and 2007). The then-governing Democratic Party of Japan (DPJ), which ruled from 2009 to 2012, had grown unpopular due to internal party squabbles over the decision by Prime Minister Yoshihiko Noda to raise the consumption tax so that Japan could reduce its national debt. The DPJ was also criticized for not taking a tougher foreign policy position toward China and North Korea. In the 2012 elections, the DPJ suffered the fourth worst defeat of a governing party in Japanese history, losing seventy-five percent of the seats that it held in the Japanese Diet (the Japanese name for their parliament). The LDP captured 176 new seats in the Japanese House of Representatives, while the DPJ lost 173. The Komeito Party, a political ally of the LDP, won ten new seats in the election.
During the 2012 campaign, Abe championed his solution to the country’s economic ills. This program quickly acquired the name “Abenomics.” Under the proposal, the LDP pledged to pursue expansionary fiscal and monetary policy (which means increased government spending, tax cuts, and aggressive interest rate cutting strategies) to bolster consumer demand and business investment in the economy. Abe also promised structural reforms to make the economy more efficient. The idea was that these three economic ideas would be pursued simultaneously, thereby giving the Japanese economy a sudden jolt and bringing it back to life. The DPJ in the 2012 campaign lacked an inspired economic platform, which factored into its defeat.
After assuming office, Abe quickly began to fulfill his pledge to enact a fiscal and monetary stimulus for the economy. Bloomberg on November 20 reveals that in December 2013 Abe enacted a $47 billion stimulus package, which was meant to offset the consumption tax increase that the DPJ and LDP agreed to levy in April 2014 (this deal was struck prior to the 2012 parliamentary elections that returned Abe to power). On the monetary side, BOJ Governor Haruhiko Kuroda, an ally of Abe, adopted a quantitative easing (QE) policy for the country. Japan has had interest rates that are near zero for nearly twenty years, as the BOJ tried to discourage Japanese consumers from saving (since they would not receive a great deal of interest on the money they had placed in a bank). The Week on November 20 writes that using high and low interest rates to keep economies from overheating or to rejuvenate them has been economic orthodoxy throughout the post-World War II era, but new instruments are emerging for central banks to use such as QE. Under QE, central banks print money and then use that money to buy government bonds. The idea is to keep interest rates low, thereby encouraging more business investment in the economy as it is cheaper for companies to obtain loans to expand. Also, the purchase of government bonds on the open market puts new liquidity (money) into the economy, thereby providing the opportunity for more spending and more economic growth. Foreign Affairs on November 20 reports that the BOJ QE activities have seen the percentage of government bonds held by non-BOJ actors fall from 154% of GDP two years ago to 142% today. On October 31, the BOJ announced that it will buy $690 billion of government bonds, which is twice as much as the Japanese government’s current budget deficit. One of the side effects of QE has been a depreciation of the Japanese currency as more yen are being printed to make bond purchases. Foreign Affairs notes that the yen has lost 30% of its value under Abe. This has been a boon for the country’s exporters, but not that great for average families (which will be discussed below).
Where Abe has come up short is in structural reform. The Economist writes on November 22 that Abe initially pledged to confront several structural problems that the Japanese economy is facing: strict immigration controls, the lack of women in the workforce, a rigid labor market, and loosening trade barriers with agriculture. However, Abe has largely failed to make progress in these areas. While women are becoming a larger part of the Japanese labor market and corporate boards are allowing more independent voices on their boards of directors, Abe is not pushing as aggressively on structural reform as he has with monetary and fiscal stimulus. Part of this is due to opposition within the LDP ranks as the party still pays homage to the country’s rural areas that have a disproportionate share of the Diet. The New York Times on November 20 criticizes Abe for failing to institute reforms that would make it easier for entrepreneurs to establish a business, loosen the hold of central bureaucrats on economic development, and fight those who oppose more liberal economic policies toward trade and business activity. The whole purpose of Abenomics was to have stimulus and structural reform work together, but the structural reform element of the program is lagging at the moment.
So Why Have An Election?
Despite some difficulties, Abenomics appeared to be working last year and Abe himself told the Japanese people that “Japan is back.” The Business Insider notes on November 18 that unemployment is falling in Japan and its 3.6% rate is lower than the United States and Europe. Inflation also began to climb, nudging above 1% for most of the year. In addition, GDP grew by an average of 3.26% each quarter.
However, difficulties began when the Abe government oversaw the implementation of an increase in the national consumption tax from 5% to 8% in April. The purpose of raising the consumption tax, as Business Week reveals on November 20, was for Japan to close its budget deficit and pay down its national debt. Japan’s budget deficit is 9% of its GDP and its national debt currently stands at $8.5 trillion. Japan’s public debt is significant because the Brookings Institution notes on November 20 that it is 240% of GDP – meaning that Japan’s debt is more than two entire years of total economic activity – and that is the highest in the developed world. Compounding the country’s debt problem is that it is becoming older and costs for social security and healthcare programs are bound to rise in the near future. The consumption tax increase was a carryover from the DPJ-led government that preceded Abe and the LDP worked with DPJ lawmakers to pass it into law several years ago. The Foreign Affairs article previously cited argues that the Ministry of Finance was convinced the tax would not depress economic activity, but that does not appear to be the case. Business Week notes that in the second quarter of this year, during which the consumption tax hike was implemented, Japan’s GDP fell by 7.3%. In the third quarter, when Brookings says that Japanese policymakers thought the economy would grow 2.2%, the economy shrank by 1.6%. Back-to-back contractions in economic growth are the definition of a recession, which is Japan’s fourth since 2008.
The announcement of the economic slowdown in the third quarter was a significant blow to the Abe government’s proclamation that Japan was escaping its lost decades of growth. In light of the new data, Abe announced that he would delay the next scheduled increase of the consumption tax, which will raise the rate from 8% to 10%, until April 2017. Despite predictions that this would depress the Japanese stock and bond markets, as investors would believe that the government was not serious about reining in its debt, the announcement did nothing of the sort and in fact, Japanese voters appeared to be in favor of Abe’s decision.
In addition to announcing a delay of a future consumption tax increase, Abe also called for new parliamentary elections. This was expected by some observers, but surprised many Japanese voters who wonder why an election is needed. The Wall Street Journal on November 23 writes that only 21% of voters are “very interested” in the upcoming campaign versus 39% of voters that were engaged in the 2012 parliamentary elections. Part of the lack of interest is due to the fact that Abe’s LDP is expected to win as the opposition is very unorganized. The Economist on November 22 notes that the LDP’s opponents do not even have enough candidates to contest all of the races that will take place on December 14. Also, The Washington Post reports on November 18 that opposition parties still do not have a coherent economic platform that can constitute an alternative to Abenomics. Although Reuters explains on November 23 that 45% of Japanese voters are undecided for the elections, the LDP is still expected to triumph, although it may lose thirty or forty seats in the House. That would still give it a sizable governing majority, though, so Abe would still consider that a victory. After all, the LDP can afford to lose some seats as they control two-thirds of the chamber.
So why would Abe call an election that he was going to win anyway? One of the reasons might be that Abe is looking to get a new four year mandate, which Brookings says will give the LDP the chance to enact bolder reforms. The economic downturn has eroded Abe’s approval rating, as The Business Week article previously cited says has fallen to from 66% last April to 44%, so having the elections now, when the DPJ and other opposition parties are disorganized and before his popularity falls further, is probably a wise move by Abe. Additionally, the election might shore up the LDP ranks. The New York Times article previously cited from November 20 claims that there are dissidents within the LDP, notably within the Ministry of Finance, that do not agree with Abe’s decision to delay the additional increase in the consumption tax and that have questioned other elements of his economic policy. An election forces these dissidents to rally around Abe under the LDP mantle. Therefore, it appears as if the drive for an election is more driven by internal LDP factors and Abe’s political future as opposed to any direct call from voters, or even opposition parties, for a new poll to be held.
Effects of the Election on Abenomics
Several American economists, such as Paul Krugman, have praised Abenomics. In fact, they see Abe’s approach as interesting because it might offer a template for American and European leaders to implement in light of their own economic problems following the 2008 global financial crisis. The New Yorker on November 19 argues that the Japanese parliamentary elections are very significant because if Abe were to lose, which is unlikely, then it could illustrate the inability of developed countries to deal with their growing economic problems. Abe may not lose the election as The New Yorker fears, but he may not get the mandate he claims. The Reuters article previously cited warns that voter apathy may lead to the lowest turnout rate in Japanese history. The 2012 parliamentary election that Abe won saw 59% of Japanese voters turn out, the lowest in the modern era. If a low number of voters head to the polls, Abe may not be able to claim that he has a mandate from voters to pursue significant reform. Instead, opponents within the LDP and elsewhere may not believe that Abe has the political capital to force them to vote for policies that they are not in favor of, which could make implementing the structural reform components of Abenomics difficult in the years ahead. In addition, if the LDP lose more than forty seats in the House that would be a sizable loss for Abe and extempers should use this as the brightline, in conjunction with the turnout rate, for determining whether Abe succeeded in getting his mandate from the public
One of Abe’s concerns has to be the public’s attitude about his economic program. The Wall Street Journal reveals on November 21 that only 30% of Japanese think that Abenomics is working, while 39% say that it is failing. Based on the figures provided earlier in this brief, the reader may wonder why the Japanese public might be souring on Abe’s agenda. The answer can be found in analyzing the winners and losers of the way Abe has implemented his policies thus far. The BOJ’s QE policy has injected a lot of money into financial markets, but this has largely been to the benefit of larger firms and provided a great deal of wealth to those who own stocks. In other words, Abenomics has been much better in this regard for wealthier Japanese than the working class. In addition, the depreciation of the yen that the BOJ has produced via QE, referenced earlier in this brief, has been hard for working class families because imports have become more expensive since the yen is not worth as much as it used to versus other prominent currencies such as the U.S. dollar. This is significant because Japan has to import oil and other resources that are priced in American dollars. Higher import costs have produced higher prices at stores for Japanese consumers and wages for workers are not keeping up with these rising prices. As The Wall Street Journal noted on November 19, wages in real terms (meaning what those wages can buy each month compared with the previous one) fell by 3% in September and have fallen for fifteen consecutive months. One of the challenges for Abe is to make sure that working class Japanese think his program is working for them, whether in terms of employment or even more pocketbook issues because right now much of the wealth generated by Abenomics is being concentrated at the top of the economic spectrum.
Abe’s government must also be wary of the country’s debt situation. As stated earlier, Japan has the largest public debt burden in the world. Setting aside the consumption tax increase might be the best political move for Abe, but continued fiscal stimulus by the government must take future public expenditures into account, especially when it comes to welfare spending on the country’s aging population. However, The Economist on November 18 explains that although Japan must be cognoscente about its debt, its situation is not necessarily as bad some make it out to be. Yes, the country’s public debt of 240% of GDP is nothing to write home about, but The Economist argues that at least Japan can show investors that it has a central bank, unlike beleaguered European countries such as Italy, Spain, Portugal, and Greece, that can take militant action if need be to correct economic imbalances. The Economist also argues that even though extended QE invites fears of hyperinflation, since the central bank is printing new currency to finance its bond operations, Japan really would not mind that because it is trying to create inflation in the first place. While The Economist makes some good points, extempers should still make sure to bring up Japan’s public debt situation in speeches. Debt cannot grow forever and Japan will not be able to run up deficits forever either. The pressing size of the national debt burden may limit the ability of Abe to continue sustained fiscal stimulus packages in the future as those packages have to be financed by borrowing from future government revenue, and in turn future generations.
If Abe does get his mandate in the upcoming parliamentary election, what should be do with it? The clear answer is structural reform, which Abe has neglected. Paul Krugman of The New York Times chastises Abe’s approach in arguing that governments cannot enact stimulus without doing structural changes because political systems have a limited ability to enact long-term programs due to their short attention spans. Yet what are some of the structural reforms that Abe should pursue? First, as Time writes on November 14, Abe needs to be more aggressive with some reforms of the corporate tax code, which is the second-highest in the world at 35.6%. Lowering it might make Japanese firms more willing to keep their operations in the country. This is a debate that the United States is having right now. Another area that Abe wants to investigate is trying to change the country’s employment laws. Japan’s employment laws make it very difficult to fire workers after they are hired and what has developed in Japan since the 1990 economic downturn is a two tiered labor market where some workers have guaranteed jobs and others are working on a temporary basis. The Wall Street Journal explains on November 19 that more than one-third of Japanese workers are doing temporary, part-time work. These workers want guaranteed, sustainable employment, but they do not have this status because businesses are not sure that the national economy is back on its feet. These businesses need reassurance that good times are returning because otherwise they are loathe to be on the hook for adding workers to their payrolls that they will cannot fire. Japanese unions are largely reluctant to liberalize the nation’s labor market, fearing that laws that make it easier to fire workers will do more harm than good. Abe will have to overcome some of these entrenched interests to get labor reform enacted, but it could rejuvenate the Japanese economy by helping employ more people in higher wage jobs thereby changing some of the psyche of the Japanese workforce. Finally, Abe could pursue the Trans-Pacific Partnership (TPP) more aggressively. The TPP is a free trade accord that aims to include twelve nations in the Asia-Pacific region. Prominent nations involved in the discussions include the United States, Japan, Canada, and Australia. Foreign Affairs notes that Japan is dragging its feet on getting the TPP agreed to because it would require the LDP to confront Japan’s powerful farm lobby. This group does not want to see a reduction of import barriers that make foreign beef, pork, dairy, and wheat products more expensive. However, a reduction of these barriers would help millions of Japanese by making food prices cheaper because Japanese consumers pay 8% more for food than their American counterparts. This could enhance consumer spending in other parts of the economy. The TPP point is probably the weakest for Abe’s agenda only because he cannot control what other nations do. For example, President Obama would need fast track authority (FTA) to get the deal submitted to Congress without the chance of new amendments and that is outside of Abe’s hands. Nevertheless, Japan could provide more forceful action on the TPP and could do more to lower import barriers on farm produce in an effort to channel consumer spending into other sectors of the economy.
The biggest challenge for Abe, though, is that he must show the Japanese people that he is very committed to his economic agenda and has the willpower to push through painful, yet needed reform. Since 1990, the Japanese public has been anxious about the future. Anxious about the economy, anxious about Japan’s place in the world, and anxious about how they can manage an aging society, the Japanese public has been engaged in a long search for answers. Abenomics has not yet been proven a failure, but unless structural reform accompanies fiscal and monetary stimulus it will soon become one.