The Abenomics Dilemma and Japan's Economic Outlook

□ Jiang Yuechun

The Abenomics Dilemma and Japan's Economic Outlook

□ Jiang Yuechun

The Japanese economy experienced a roller-coaster ride in 2014 through peaks and troughs. Short of growth momentum，Japan's economy underperformed not only in terms of domestic consumption， but also in terms of investment and export （these three domains were deemed as Japan's economic Troika）. With “Abenomics” being eclipsed， Japan's structural reform seemed to have a long way to go.

Diminishing Internal Demand

Diminishing demand caused by consumption tax increase

After Abenomics was adopted at the end of 2012， the Japanese economy experienced a leapfrog growth in 2013 and the growth lasted for six consecutive quarters. For instance， the growth rate in the first quarter of 2014 was 1.6% which translated into an annual growth rate of 6.7%. However， the Japanese government， adhering to its original plan of tax increase， raised the country's consumption tax rate from 5% to 8% after the second quarter of 2014. This brought an immediate turning point to the growth curve and the growth rate dropped to -7.1%.1“Japan's GDP Growth Rate from April to June Revised to Minus 7.1%”， Japan Economic News， Chinese Edition， September 8th， 2014， http：//cn.nikkei.com/politicsaeconomy/epolitics/10945-20140909.html.Such a radical change was to a large extent caused by the change in people's psychology and expectation about the future. At the end

Jiang Yuechun is Senior Research Fellow and Director of the Department for World Economy and Development， China Institute of International Studies.of 2013， fearing that tax increase would increase commodity prices and make people's life harder， many Japanese chose to hoard life necessities and bulky daily goods just before the tax increase. This caused spikes in the consumption of housing， automobiles and home appliances which in turn spurred private consumption that accounted for 60% of Japan's total economy. However， as the tax increase did not increase Japanese people's monthly salaries but suppressed their demand instead， a sharp decline in growth ensued in the second quarter of 2014. Many believed that following the consumption frenzy before the tax increase a slide in the second quarter was natural and the economy would soon stabilize in the third quarter. However， the reality turned out to be the opposite. After the second quarter slide， the third quarter saw a disappointing growth rate of -1.9% only， which meant the Japanese economy had slid into a“technical recession” for two quarters in a row. This was Japan's third recession in a time framework of four years.2Japan Statistics Portal， http：//www.e-stat.go.jp/SG1/estat/eStatTopPortal.do.According to Japanese government's latest statistics on February 16th， 2015， Japan's GDP growth in 2014 was zero.3Japan Cabinet Office， http：//www.esri.cao.go.jp/jp/sna/menu.html.

QE policies failed to boost internal demand.

Quantitative easing is a policy by which a country's central government buys back its long-term bonds to lower interest rates and inject liquidity into capital markets. The essence of Abenomics is using QE as leverage to manipulate people's expectation about inflation and eventually boost private consumption. Since the introduction of new QE policies by Japan's central bank in 2009， the fund to buy back government bonds had reached a scale of 70 trillion Yen （$1.0114 trillion）. In September 2012， Japan's central bank announced it would issue another 10 trillion Yen to buy back governmental bonds. To keep Japan's benchmark interest rate within the range of 0-0.1%，half of the money would be used for the purchase of short-term notes while the other half for the purchase of long-term bonds. In the wake of Europe's OMT and America's QE3 after September 2014， this move was actually the third QE program in the world. In November 2014， Japan's central bankintroduced another round of QE by injecting capital into an already hyperliquid capital market. Its purpose was said to be “ensuring Japanese businesses got sufficient interest-free capital for their investment activities”. According to the investigation of some authoritative agencies in Japan， while money flooded the whole Japanese society， commercial banks' lending to enterprises increased 2% only. This meant that most of the fund was just parking unused on commercial banks' reserve accounts and Japan's actual inflation rate excluding consumption tax increase and Yen depreciation factors did not grow much in 2014. As a result， there emerged a big gap between Japan's actual inflation rate and the 2% target rate set by Japan's central bank for April 2015. According to statistics， Japan's GDP lost 0.5% due to the sluggish internal demand in the third quarter of 2014. During this period，investment in civilian housing decreased by 6.7% qoq and capital expenditure by enterprises decreased by 0.2% qoq.4Japanese Cabinet Office， http：//www.esri.cao.go.jp/jp/sna/menu.html.

The depreciation of Yen failed to boost export

Japan is an export-oriented country and its export is influenced by exchange rate fluctuations. Generally speaking， the appreciation of Yen increases the prices of exported goods， lowers export and has negative influences on Japan's economy. Among other things， “Abenomics” was proposed to remove the negative influence of Yen appreciation during the DPJ ruling period （when the dollar/Yen exchange rate rose to 1：79）. The Abe Cabinet bet that as long as Yen was depreciated the competitiveness of Japanese goods pricewise would be restored and Japan's export would grow to improve Japan's domestic job market. To achieve this “virtuous circle”，the Abe Cabinet promulgated a series of monetary policies to depreciate Yen. Since the inception of “Abenomics”， under the dual pressures of Japan'sdomestic QE and the dollar's strong appreciation， Yen had depreciated 40%. This lowered the dollar/Yen exchange rate from its original high of 1：79 to 1：120. Nevertheless， the dramatic depreciation of Yen exacerbated the disequilibrium between Japan's real economy and its capital market as well as the disequilibrium between salary raise and price increase. More importantly，boosting export by depreciating Yen produced little effect this time， because many Japanese businesses， to offset negative effects of Yen appreciations in the past， had already relocated their productions overseas and Yen was seldom used in their overseas transactions. Therefore， when this round of Yen depreciation was initiated， except large enterprises in automobile and a few other industries， most businesses did not see any significant improvement in their export. According to the statistics of Japan's Ministry of Finance， Japan had incurred trade deficits for four years in a row since 2011. In 2014， its trade deficit was even as high as 12.78 trillion Yen （$102.24 billion）， representing a growth of 11.4% yoy and making a new record in the Japanese history.5Statistics of Japan Ministry of Finance， http：//www.customs.go.jp/toukei/shinbun/happyou.htm.

A Less Optimistic Prospect for Japanese Economy

With Abe Shinzo successfully reelected as Japan's Prime Minister， “Abenomics”was expected to continue and last. However， many international organizations predicted that even though Japan could recover a little bit in 2015， its growth rate would be no more than 1%.

Risks for short-term economic downturns

1） The difficulty with internal demand. In 2014， thanks to the increase of consumption tax and Yen's depreciation， sluggish internal demand became Japan's Achilles' heel officially. As people's income could not catch up with the speed of price increase in Japan， Japanese consumers' actual purchase power diminished. According to labor salary statistics from Japan's Ministry of Health， Labor and Welfare， the per capita monthly salary of Japanese workers（including basic salary， overtime allowance and bonus） averaged 316，600 Yen （$2，695） in 2014， 0.8% higher than that of the previous year. However，when inflation factors were introduced into the equation， an average worker's monthly salary was actually 2.5% lower than that of the previous year，revealing a curve of continual salary decrease that ran through the past three years.6Ministry of Health， Labor and Welfare， http：//www.mhlw.go.jp/toukei/list/30-1.html.As private consumption was an important part of Japan's economic Troika and accounted for more than 60% of Japan's total economy， languid private consumption naturally led to lackadaisical economic growth. The reduction in private consumption is less dramatic recently， but a full-scaled recovery is not yet in sight. Therefore， for the moment being， to stimulate internal demand， the Abe Cabinet has to persuade Japanese enterprises to raise their employees' salaries. Separately， resorting to capital investment can hardly produce satisfactory results in the short run. Although the new Abe Cabinet has plans to encourage capital investment by lowering corporate income tax and capital gain tax， such policies are not yet implemented. Besides， the effectiveness of these policies is still uncertain.

2） The difficulty with external demand. With the continual depreciation of Yen， Japanese businesses overseas began to adjust their strategies. Some large-scaled manufacturers， especially manufacturers of household electric appliances， relocated their production sites in China and Southeastern Asian countries back to Japan. These homebound moves doubtlessly improved Japan's domestic job market and internal demand， enhanced Japan's overall economic vitality and helped with Japanese economic recovery. However， such moves were largely in response to the depreciation of Yen. In other words， the low dollar/Yen exchange rate at 1：120 played its critical role in this process. But how long can such a low exchange rate situation last？ Nobody knows. As long as Japan's export-oriented industrial structure is not changed， Japanese enterprises' long-term global strategies cannot be reversed by short-term exchange rate fluctuations. In other words， even though Japanese enterprises show some willingness to produce at home， the likelihood of their full-scaledreturn and heavy investment at home is low.

3） Challenges and opportunities from low oil price. Oil prices decreased worldwide in late June 2014. Despite its shock to global capital markets，oil price decrease boosted Japanese consumers' purchase power， increased Japanese enterprises' profits and was therefore welcomed by Japanese businesses. As Japan imported 20 trillion Yen worth of oil and liquefied natural gas every year， oil price drop benefited Japan considerably. According to the statistics of Office of Resources and Energy under Japan's Ministry of Economy， Trade and Industry， the price of regular gasoline in Japan dropped to 149.10 Yen per gallon as of December 22nd， 2014， representing a decrease of 6.7% from its late October level. The continual decrease of oil price not only benefited Japanese enterprises， but also made possible salary raises for Japanese employees. As a result， Japanese managers and trade unions agreed to hold annual salary talks in April 2015. Meanwhile， Abe also took the opportunity of Japan Business Federation's annual meeting to call for salary raises. While low oil prices improved the profitability of some Japanese enterprises， some other Japanese enterprises suffered losses， especially those in the resource sector. For instance， JX Holdings， the largest petroleum supplier in Japan， achieved an annual profit of 302.3 billion Yen in 2013， but in Fiscal Year 2014， with its annual profit decreased by 280 billion Yen， suffered a loss of 100 billion Yen instead. Moreover， energy price decrease partially offset the effect of cost-driven inflation brought by Yen's depreciation and lowered Japan's CPI inflation rate to less than 1.5%. This doubtlessly distanced Abe further from his goal of 2% inflation rate.

Mid- and long-term structural barriers to economic growth

1） Heavy debt burden. According to the statistics of Japan's Ministry of Finance in February 2015， Japan's national debt reached 490 trillion Yen as of March 2014. This set a new record in the Japanese history.7“Japan National Debt Made a Historical High in 2013”， website of Ministry of Commerce， Feb. 2， 2015，http：//www.mofcom.gov.cn/article/i/jyjl/j/201502/20150200885311.shtml..After Abe's inauguration， Japan's national debt grew from 997 trillion Yen （$8.28 trillion） to 1，038 trillion Yen （$8.62 trillion， as of September 2014）. This left virtually little possibility for Abe to improve Japan's finances in the short run. Although Japan's national debt is already 200% of the country's GDP， Japanese government can still raise capital at low cost thanks to the country's high saving rates and sufficient money supply. However， with the aging of Japanese population， domestic savings will eventually diminish. When they diminish to a critical point， Japan's national debt market will be exposed to higher risks.

2） The challenge of aging population and low birth rate. Aging population and low birth rate are two obstacles to Japan's economic growth. They not only reduce Japan's population but also lower labor population's proportion in the total population. While aging population concretely slows down Japan's economic growth， low birth rate arouses pessimistic expectations about the country's sustainable growth in the long run. Due to long-term demographic problems， elders in the Japanese society tend to receive more incomes while younger generations have less financial resources to get married or support their children. As a result of this vicious circle which lowers birth rates， the Japanese population is growing older and older. In this background， therefore，unless a significant breakthrough in productivity can be achieved， the Japanese economy will keep growing at a low speed or experience a negative growth in the foreseeable future. Facing this grave challenge， Abenomics seems to be of no avail at all.

3） The exodus of foreign capital. As the growth of global economy further weakened， Abenomics was questioned by more and more investors. Many foreign investors believed that despite the good performance of Japan's stock market， investing in Japan was not worthwhile due to the depreciation of Yen. As a result， large amounts of foreign capital fled Japan. This phenomenon was not so obvious in the background of expanded national debt purchase and Japanese pension funds' entry into stock markets. However， if this trend continues， its negative effect will surface to the top sooner or later. In other words， as long as Japanese economy is not improved in the short run， Yen will continue to depreciate in the future. Consequently， even more foreign capital will flee Japan by then， leaving the country's economic recovery greatly thwarted.

Abenomics could not salvage Japanese economy

Practices in the past two years showed that Abenomics did not address structural problems hindering Japan's economic development. Abenomics seems to be completely useless in front of challenges such as diminishing population， accelerated aging， widening income gaps， burgeoning social security cost， hollowed domestic industry as well as low internal demand， etc.

Abenomics widened the gap between the rich and the poor.

With the adoption of Abenomics， the Japanese government introduced the largest QE movement in the Japanese history. Such moves successfully raised stock market indexes and brought down the exchange rate of Yen， butthey had little effect on reviving the country's real economy. Instead， they caused more and more problems and crises in the Japanese society. One of the most prominent negative effects was the widening income gap between the rich and the poor. QE policies benefited big enterprises and small- and medium-sized enterprises in varying degrees. Take the changes in exchange rate for example. Such changes benefited exporters， but they made imported raw materials more expensive and therefore hurt raw material importers. As statistics showed， the real income of Japanese workers had been on the decrease for 15 consecutive months. On the one hand， average Japanese' salary raises failed to catch up with price increases； on the other hand， rising consumption tax lowered people' living standards. For instance， the number of working-class people in Japan with annual incomes less than 2 million Yen（100，000 CNY） was 11.2 million in 2013， of which 300，000 were newly added in the year. In contrast， as Credit Suisse statistics showed， there were 2.73 million wealthy Japanese whose assets exceeded 100 million Yen in 2014，of which 90，000 were newly added in the year. These sharply contrasting figures exemplified that Abe's economic policies had virtually widened the gap between the rich and the poor. More poor people meant less tax revenue， lower consumption power and reduced national power. No wonder some Japanese scholars bantered that the dismissal of the lower house of Japan's Diet should better be called the “dismissal of Abenomics”.

Abenomics failed to power economic growth as a new engine.

With the adoption of Abenomics， monetary policies were formulated to promote the growth of stock market indexes； however， consumption tax increases offset the consumption power amassed by rising stock market. As a result， internal demand did not grow much in essence. Meanwhile， although Yen depreciated in value with the introduction of QE policies， export was not boosted much as expected. Consequently， the Japanese economy bogged down into a recession quite similar to the one prior to Abe's inauguration. It was against this backdrop that a heated debate about Abenomics was staged among Japanese elites. Those for monetary stimulation claimed that deflationwas the major cause of Japan's economic downturn and monetary policies should be further loosened. In comparison， hawkish figures claimed that inflating national debt would destroy Japan's future and they called on more stringent budgetary disciplines.

It is a common sense that economic power comes from market and the efficient organization of production factors according to market economy principles. But Abe chose to expand the role of government instead and change government into a consumer and distributor in the economic system. As a result， Abe's monetary and fiscal policies failed to bring about any new growth， because they changed nothing but the money supplies in the Japanese economic system and the wealth distribution in the Japanese society. Without substantial economic growth， continued borrowing cannot last. Lack of growth has therefore become the most deadly shortcoming of Abenomics. In retrospect， when Japan's consumption tax rate was raised from 3% to 5% in 1997， the Japanese economy sank into the swamp of deflation and recession. This directly caused the failure of LDP （then ruling party） in the general election next year and the collapse of Ryutaro Hashimoto's Cabinet. Shored up by various factors， the new Abe Cabinet manages to stay relatively stable so far， but economic pressures are still there and they will not disappear easily in the short run.

Abe Cabinet's stimulation program is a tough choice.

Monetary policies are Abe's major tools to combat economic downturn. However， high leverage constrains the role of financial stimulation. Currently，Japan's national debt is 238% of the country's GDP， making Japan a leader in this respect among developed countries.8Governmental Statistical Portals， http：//www.e-stat.go.jp/SG1/estat/eStatTopPortal.do.In this circumstance， raising consumption tax is obviously an important option to “reconstruct Japan's treasury”， even though doing so will deal a heavy blow to the country's economic recovery. In Abe's opinion， postponing tax increases would not only invalidate Japanese Government's commitment to cut fiscal deficit， butalso threaten his promise to achieve fiscal surplus by 2020. But the other way round， raising consumption tax could not save his government from crisis either. Eventually， Abe decided on postponing the original tax increase plan in 2015. In response， Moody's downgraded Japan's sovereign debt grading from AA3 to A1， primarily out of concerns that further delays in increasing consumption tax would increase the uncertainty over Japan's deficit cut and eventually threaten the sustainability of Japan's debt and the debt service power of Japan.

Structural Reform Targeting Roots of Economic Ailment

Social problems such as aging population and low birth rate are constraining Japan's economic development. More importantly， the unbreakable bond between politics and business in Japan's economic system has evolved into a major obstacle to Japan's economic growth. On the one hand， officials and politicians must seek financial support from businesses and bankers to maintain their political power； on the other hand， inefficient enterprises， to ensure their survival， must resort to “insider trading” to gain “special patronage” from the government. In other words， inefficient industrial sectors and financial institutions can easily secure financial support from the government to protect their vested interests in illegal manners， while efficient industrial sectors and new and high-tech ventures can hardly count on government for policy support. These are perhaps the root causes of Japan's long-term stagnation.

To make a fundamental change in Japan's economy， concrete and substantial progresses must be achieved in Japan's structural reform. But the inception and implementation of such a “structural reform” will inevitably encounter tremendous opposition and difficulty in Japan.

The first challenge comes from the so-called “hard shell” of Japan'sexisting system. The current economic system of Japan as a hybrid of power and money is collectively controlled by Japanese political and economic elites. These conservative forces in Japan's political and economic arenas are representatives of vested interests under the current system and they have forged unbreakable bonds among themselves. Therefore， reforming the current economic system is like declaring a war on the class of vested interests. Such a “disintegrative operation” will put the reform into danger， even though it meets the fundamental purpose of the reform. In the past， the Hashimoto Cabinet once declared “six major reforms”， but his cabinet was overthrown long before the reforms were implemented. Likewise， Prime Minister Koizumi Junichiro initiated “reforms without restrictions” to cut the “bad debt” of banks and reduce government deficit， but his attempts did not touch upon the essence of structural reform at all.

The second challenge is the contradiction between reform and economic stimulation. Structural reform will cause the bankruptcies of small- and medium-sized enterprises， large-scaled unemployment and inevitable “social pains”. This means that the reform will come at the price of prosperity. In this light， how to deal with the relationship between structural reform and economic recovery and how to help opposition parties and the general public to understand and accept the price of reform will be a grave challenge to the Abe administration.

The fact that “structural reform” is a new but multi-dimensional task poses another challenge. It not only concerns issues like how to improve international competitiveness， how to upgrade industrial structures and how to shift from an export-oriented growth model to a internal demandled growth model， but also necessitates fundamental changes in traditional political systems， especially in the system of party election. Although the“third arrow” of the Abe Cabinet includes many components of a structural reform， the complexities and difficulties to be expected in the reform process all indicate that such a structural reform is going to be long-term and does not come by easily.