Abenomics is at a crisis point. The economy slipped back into recession in Q3, prompting a delay to the second planned consumption tax hike and a snap election. The Bank of Japan meanwhile has also reacted to weak growth by expanding its monetary easing programme. The latter decision may avoid a return to deflation but unless the ‘third arrow’ of Abenomics – structural reform – is activated, Japan’s relative economic decline is set to continue.
Return to recession leads to crisis point
‘Abenomics’ is the name given to a new set of economic policies announced in early 2013 by the government of Prime Minister Abe – though some elements began in late 2012. Its key components were ‘three arrows’
•Large-scale asset purchases by the Bank of Japan; a major monetary easing in pursuit of a 2% inflation target
•A short-term fiscal expansion
•Structural reforms aimed at boosting long-term growth
The aim of the policies was to boost economic growth and release Japan from its long period of price deflation. But after almost two years, Abenomics has reached a crisis point with the Japanese economy slipping back into recession in Q3 2014.
The unexpected economic contraction in Q3 prompted three major developments. First, the government announced it was postponing the second planned rise in the consumption tax, planned for Q4 2015.
Secondly, a snap general election was announced – ostensibly this was to seek a mandate to ‘relaunch’ Abenomics, but it appears to be more about circumventing divisions within the ruling party and its advisors and among other policymakers as to the best way forward.
Thirdly, the Bank of Japan (BoJ) announced a substantial increase in its asset purchase programme – annual asset purchases will now total around 15% of GDP per year, much larger proportionately than the asset purchase programme recently ended by the US Federal Reserve.
This BoJ move should be enough to prevent Japan from falling back into deflation, though achieving the 2% inflation target on a sustained basis still looks a major challenge. In particular, wage growth remains weak and measures of long-term inflation expectations are below the BoJ target.
The decision to postpone the consumption tax hike also looks sensible; arguably the first tax hike in April was a mistake, coming too early in the policy sequence before the economy was ready to absorb it. A second tax rise next year would have been very risky.
But Abenomics can only be at best a partial success without the activation of the ‘third arrow’ – structural reform. Japan’s negative demographics mean that long-term economic growth will remain weak at less than 1% per year unless productivity growth can be accelerated markedly.
So far, Abenomics has been a great disappointment on this score, with only piecemeal and limited reforms. But there is considerable scope for action – tackling Japan’s woefully low female participation rate (around 50%) would be a real help in easing the decline of the working population and there are tentative signs of progress here. There is also a lot of room for opening up inefficient and protected sectors of the economy, particularly retail. Encouraging more FDI (extremely low at present) could also shake up parts of manufacturing that have seen their competitiveness gradually eroded over recent years.
Whether the new elections will lead on to such a structural reform programme remains open to question; many of the political and social barriers that have retarded reforms in these areas in the past will remain. But without reforms, Japan’s position in the world economy will decline further. Japan accounted for 12% of world GDP in 1990, falling to 8% now, and Oxford Economics estimates it will fall further to 5.5% by 2030 – compared to 16% for China and 21% for the US.
Adam Slate, Senior Economist, Oxford Economics