Monday, 5 August 2013

Japan – Don’t hold your breath

Hopes are high that Japan might be set for an economic reboot but a deeper look at the new policies and politicians involved suggests otherwise.

Your Neighbourhood Economist was once an optimist regarding the prospects for the economy in Japan after having lived there for nine years.  A nascent recovery in the seemingly morbid Japanese economy always seemed to be just around the corner.  It seems as if the economy in Japan is at another possible turning point with a string of new policies that could just do the trick.  The newish Prime Minister has taken on board some bold policies and optimism abounds, but after having been disappointed in the past, Your Neighbourhood Economist is not getting carried away and thinks that another let-down is the more likely outcome.

The despairing state of the Japanese economy is so bad that it makes the Eurozone crisis look like a day out at the beach (where many Europeans will be in August).  Not only is the government debt equal to around 230% of GDP (which makes Greece seem not so bad) but close to half of what the government spends each year is made up from borrowing.  Japan is still dealing with the consequences of perhaps the largest property bubble in history which burst in the late 1980s, but prices for property are still falling over two decades later and share prices are still only around a third of their peak in 1990.  To make things worse, Japan is also in the grip of deflation (falling prices) which typically stops consumers from spending and firms from investing.

Any optimism may seem surprising faced with such problems but the election of a new LDP government headed by Shinzo Abe has sparked hopes of a turnaround.  Abe has prompted a raft of new policies (referred to as the three arrows) encompassing monetary and fiscal policy combined with reforms.  The first two of the arrows have already been unleashed – a 10.3 trillion yen (US$116 billion) stimulus package (fiscal policy) and plans to double the money supply over two years (monetary policy).  The third arrow involves key reforms necessary to revive the economy but only piecemeal policies have been released so far leaving Your Neighbourhood Economist worried that the first two arrows won’t amount to much while the critical reforms will be stifled.

The best policy response to a temporary drop in demand is typically an increase in government spending to make up for the shortfall and keep the economy ticking over.  But this prescription for a fiscal stimulus has been tried over and over in Japan with little avail as the problems are beyond being fixed in this way (for more, see When Keynesian Policies won't work).  Neither does the doubling of the money supply hold much promise.  As shown in other countries with loose monetary policy, companies and consumers have shown that they would much rather pay back debt or hoard extra cash rather than spend or invest it.  So the extra funds from the central bank will only probably show up in the bank accounts and only a small portion of it will likely feed through to the real economy (see Why is the economy still stuck? for more on the poor track record of monetary policy).  An expansive monetary policy tends to be a favoured policy option for governments that are looking for a way to avoid unpopular but crucial measures to shore up the economy (for more detail, see Perils of doing too much).

The best hope for the Japanese economy is the reforms in the third arrow such as joining in on the new Pacific free trade agreement which would open up the economy to more competition from overseas.  The reforms are needed to cut through regulation in many areas which stifle innovation to the benefit of vested interests who resist any changes to this harmful regulation.  This is the nature of politics everywhere but the problem is more pervasive in Japan due to a culture that prizes consensus where making changes in the face of opposition is frowned upon.  The extent to which the Prime Minister is willing to go up against the vested interests is as yet unclear.  The reforms announced in June which were supposed to provide initial targets of the third arrow were disappointing.  While the announcement came at a crucial time ahead of elections (which the ruling LDP party won a sweeping victory), the signs are not good. 

The LDP gets the bulk of its support from the vested interests who oppose reforms and has little impetus to rebel against its support base considering that the main opposition party is in disarray.  The LDP has pushed ahead with reforms in the past – most notably under the leadership of Junichiro Koizumi who was Prime Minister between 2001 and 2006.  But Koizumi was a maverick from outside of the party mainstream while Abe is a party stalwart who has already had an unimpressive spell as Prime Minister.  Abe does not seem to be a true believer in the need for reforms as Koizumi was and Abe’s main focus instead seems to be changing the constitution to increase the military might of Japan.  So while it is high time for a turnaround in the fortunes, it does not look like any amount of arrows will slay the beasts sucking the life out of the Japanese economy.


  1. Here are some articles on the disappointing first attempts with the third arrow.

  2. Found you through some plugging on the FT, you now have a new regular reader!

  3. total drivel. the problem in Japan is not the structure of the economy but a policy of adjusting to global conditions by deflating domestic money wages - which has, precisely as intellectual Keynesianism would have predicted - led to a decline in the price level. Keynesian spending has not been tried in Japan except in 1997-8 and 2002-3 - both global recessions. Otherwise there has been no increase in managed expenditure. The budget deficit arises not out of rampant spending but collapsed tax revenues - another consequence of deflation. Japan does not need reform or a growth strategy. It requires a long period with a fairly valued exchange rate and a domestic bias towards raising money wages.

  4. There are a few point which need clarification. IMF data shows that government spending in Japan is 37% higher in 2012 in real terms compared to 1990 (which is the year when Japan first started to go downhill) while government revenues has edged down by just 2% in real terms. For a long time before the global financial crisis, Japan had a weak currency when one US dollar could buy around 120 yen due to the yen being used for the carry trade where investors would borrow in yen and invest in a currency where the interest rates were higher. Part of the reason behind monetary policy in Japan is to weaken the currency again after it reached the point where one US$ could buy only 80 yen. But rising money wages will require thriving and profitable companies which is trickier these days with Japanese car and electronic manufacturers facing increased competition from South Korean firms among others. A bout of deregulation and a more open economy would help to create a new generation of firms in Japan to drive the country forward.