Abenomics: The good, the bad and the unfinished

Author: Shiro Armstrong, East Asia Forum

After two decades of stagnant growth and the Fukushima triple disaster, Japan appears more confident both domestically and internationally. The economy has been inflated, much-needed social change is being discussed with some progress being made, and international diplomacy is once again active.

Slower growth is to be expected with an ultra-modern economy that has a shrinking population. And Japan has continued to contribute to the peace and stability of the region, underpinned by the US-Japan alliance and the Article 9 peace clause of its constitution.

Japan's Minister of Finance Taro Aso speaks with Bank of Japan Governor Haruhiko Kuroda as finance ministers and central bank governors of the G20 nations gather for a photo at the International Monetary Fund and World Bank meetings in Washington, 10 October 2014. (Photo: AAP).

As the last East Asia Forum Quarterly on Japan in 2012 concluded, if Japan was thought to have had two lost decades since the bubble burst in the early 1990s, perhaps we need to rethink what failure is. Japan is secure, rich and prosperous.

What has changed in the last 18 months is the renewal of Japanese confidence. The economic policy package of Prime Minister Abe — Abenomics — is bold and defines a clear strategy for economic growth.

In this week’s lead, from the latest issue of the East Asia Forum Quarterly, Adam Posen draws lessons from Abenomics for the rest of the world. ‘One of the striking things about the past few decades of Japan’s economic history’, he argues, ‘has been the fact that textbook macroeconomics could have predicted most of it. Back in the late 1990s, this was a controversial point of view’.

As Posen observes, ‘every once in a while, along come figures such as Junichiro Koizumi and Heizo Takenaka, or Shinzo Abe and Haruhiko Kuroda. And, with no fundamental change in the party system or the form of government, action is shown to be indeed possible’. Reform is always possible, as Posen argues, but without leadership and ambition, unlikely.

Prime Minister Abe has brought new leadership. He has forced regime change in the Bank of Japan, in willing partnership with Governor Haruhiko Kuroda, and set a clear target of reflating the economy through unconventional monetary easing — the first of the three arrows of Abenomics. There is unwavering commitment to that target which is well on the way to being met in the short term.

As Posen points out, one lesson from the Japanese case is that there is nothing wrong with central banks and fiscal authorities cooperating, so long as it is on a voluntary basis.

Yet the Abenomics strategy was never going to be easy. The second arrow of fiscal stimulus in the short term and fiscal consolidation in the medium term, which started with an increase in the consumption tax from 5 per cent to 8 per cent in April this year, has caused the growth rate of the economy to falter. This has shaken the confidence of some in Abenomics yet it is too early to write the strategy off.

All the action in Abenomics is in the third arrow of structural reform. It will make or break the strategy and the longer term health of the Japanese economy.

Japan needs to change how women and foreigners are treated in the economy, open up protected sectors to competition and rethink many of its institutions. The jury is still out and, the longer we have to wait for those reforms to be put in place, the bigger the risks to the economy from the first two arrows.

Structural reform requires Abe and his administration to take on entrenched vested interests across the economy. Japanese protection in agriculture, finance and services are extremely strong and progress has been slow. Posen’s message is that Japan is not a special case. Vested interests resisting change against the public interest is not unique to Japan.

The structural impediments in the Japanese economy that matter are the regulatory and institutional barriers that have made Japan an outlier among advanced economies, with foreign companies and women having too little effective participation in the economy. As Posen points out, ‘the returns on tackling the underutilisation of human capital in Japan dwarf the impact of everything else, including the problem of a declining workforce. If Japan were to get more of its university-educated women into the workforce, the demographic problem would go away for 20 years’.

There is no single quick fix.

Many see the Trans-Pacific Partnership and gaiatsu (foreign pressure) from the United States as a key solution, but the TPP will only deliver small if symbolically important gains. And Japan is resisting US pressure as strongly as it can and conceding as little as possible — playing the negotiating game rather than embracing the reforms needed to lift the performance of the economy.

Meanwhile, Japan’s international diplomacy has focused on strengthening alliances and is chipping away at Article 9 of the constitution. The latter makes many in Japan itself, as well as Japan’s neighbours in the region, anxious. Having visited 49 countries so far in less than two years since coming to office, Abe has re-activated Japanese diplomacy. But he has not visited China and the main test for Japan moving forward remains management of the relationship with China (the topic of three feature pieces in EAFQ that highlight the challenges), a relationship which under Abe has gone from bad to worse.

China is the largest economic partner for almost every country in the region, including Japan. The continuing strength of Japanese manufacturing competitiveness is built on offshore investments in China and Asian regional supply chains. The interdependence of the two Asian giants is so great that neither side can afford for the current political stalemate to drag on much further.

Shiro Armstrong is Co-Director of the Australia-Japan Research Centre at the Crawford School of Public Policy, ANU and Editor of the East Asia Forum.

EAFQ 6.3 on Japan will be launched at the annual Japan Update at the ANU this Friday the 17th.