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Abenomics 2014: Expanded Content, More Uncertainty

Tags: Abenomics , Economic Growth , Structural Reform , Fiscal Policy , Corporate Tax

Yakushiji, Katsuyuki

August 26, 2014

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The revised New Growth Strategy released in June has brought the “third arrow” of Abenomics into sharper focus, revealing an ambitious program for sustained economic growth. But the structural reforms proposed this time around face serious opposition from industry lobbies and vested interests. Katsuyuki Yakushiji sums up the plan and discusses the challenges—internal and external—the prime minister must overcome to achieve his economic goals.

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In June 2014 Prime Minister Shinzo Abe released two new documents fleshing out his administration’s policies for fiscal reform and economic revitalization: “Basic Policies for Economic and Fiscal Management and Reform 2014” and the revised “New Economic Growth Strategy.” In general, the market gave the plans a thumbs up for clarity and specificity, at least compared with last year’s Growth Strategy. Yet their content has received surprisingly little attention in the media.

One major reason is the preponderance of policies oriented to long-term growth, as opposed to fast results. This is a good sign. It means that Abe’s economic program is done proving itself through flashy pump-priming measures and can devote its attention to low-key policies that emphasize patience and persistence. But the latest structural changes he has proposed are likely to prove much harder to accomplish, owing both to their longer timeframe and to powerful opposition from vested interests.

The Critical Third Arrow

Basic Policies for Economic and Fiscal Management and Reform is compiled annually by the Council on Economy and Fiscal Policy—chaired by the prime minister—and approved by cabinet resolution. It was first drawn up in 2001 under Prime Minister Jun’ichiro Koizumi as a way of strengthening the prime minister’s control over the budget process through general guidelines for allocations in the fiscal year to come.

arrowstory.jpgThe New Economic Growth Strategy is the current administration’s plan to bring about sustained private-sector investment and growth via a wide range of structural policies, including deregulation, labor reforms, and measures to prop up local economies. It is the third, and arguably the most important, “arrow” in the three-pronged economic program known as Abenomics.

The first two arrows, “aggressive monetary policy” (quantitative easing) and “flexible fiscal policy” (targeted stimulus), have largely hit their mark, allowing Abe to trumpet his cabinet’s economic achievements since it came to power near the end of 2012. At the June 24 press conference announcing the two new policy documents, the prime minister touted the successes of Abenomics, citing a 2% increase in wages among large corporations (according to a survey by the Japanese Trade Union Confederation), along with survey results indicating upward wage movement among 60% of the smaller companies polled.

But the short-term efficacy of this monetary and fiscal expansion, while welcome, is not sufficient to put the economy on a long-term growth trajectory, and Abe is well aware that the real challenge lies ahead. “We cannot yet say that the winds of economic recovery have reached every corner of Japan,” he acknowledged. The new policies approved by the Diet are designed to support the “virtuous circle” that the first two arrows set in motion and ensure that people in every community in every part of the country will feel the tangible benefits of the recovery. “This,” he declared, “is the essential mission of Abenomics. Everything hangs on the New Growth Strategy.”

Ambitious Structural Reforms

The 2014 Basic Policies and New Growth Strategy reinforce and complement one another to the extent that they are virtually inseparable. Their collective content can be summed up as follows.

The key economic challenges facing Japan today, we are informed, are (1) countering the negative economic impact of the consumption tax hike that went into effect in April; (2) achieving economic growth fueled by private-sector demand; (3) reforming institutions and systems to lay the foundations for sustainable long-term growth and vitality (including steps to stem population decline); and (4) achieving fiscal consolidation without sacrificing economic vitality.

With the exception of the first, none of these items is new. They are all issues that previous administrations have attempted to tackle, but with little success thus far.

The specific policy measures the government proposes to meet these challenges are many and varied. To make Japan-based companies globally more competitive, it seeks to lower the effective corporate tax rate from around 35%—quite high by international standards—to less than 30% over a period of several years. To reduce energy costs, it plans to restart the nation’s nuclear power reactors, all of which have been idle since September 2013. On the labor front, it pledges to boost the capacity of daycare and afterschool facilities to make it easier for women to enter the labor force and calls for immigration reform to bring more foreign workers into the country, albeit on a temporary basis. In the agriculture sector, it is calling for changes to the farm coop (JA) system, including measures to guarantee the independence of local coops, in hopes of breaking the powerful farm lobby’s resistance to long-overdue agricultural reforms.

Defusing Two Time Bombs

At the same time, the ruling Liberal Democratic Party cannot afford to ignore its rural base, especially with local elections scheduled for the spring of 2015. Among the policies set forth this past June are measures designed to stem the ongoing migration of young people from the regions to Tokyo and support small and medium-sized businesses outside the capital region.

Another priority is defusing Japan’s demographic time bomb. Japan has the oldest population and one of the lowest birthrates in the world. The population is shrinking and is projected to drop from slightly over 120 million today to 97 million in 2050 and 86 million in 2060, unless the fertility rate rises substantially. The Basic Policies calls for a wide array of reforms designed to keep the population at around 100 million for another 50 years.

Meanwhile, Japan must find a way to avert a fiscal crisis. The administration has reiterated its international pledge to cut the primary deficit to half of the 2010 level by fiscal 2015 and to eliminate it by 2020. While the former target appears reachable, primary balance is still a distant dream. Long-term fiscal sustainability will clearly require major cuts in social security spending, which account for about one-third of the budget, through wholesale reform of the national pension and healthcare systems. Unfortunately, the administration has yet to offer any concrete plans for social security reform.

Looming Battles

For the most part, the ideas presented in the Basic Policies and New Growth Strategy are neither new nor particularly controversial from a policymaking standpoint. But many of them take on “bedrock regulations” and other sacred cows that powerful industrial lobbies have successfully defended for decades. If the administration follows through on them, it will be a groundbreaking accomplishment.

The main question is whether Abe can succeed where so many have failed. Before the government can implement corporate tax cuts, changes in labor and immigration laws, or farm reform, it must draft the pertinent bills and shepherd them through the Diet. At each step along the way, it will have to contend with fierce resistance from industry, interest groups, and their allies in the ruling party. Abe will have to stay in power for quite a long time if he wants to give such legislation a fighting chance.

Moreover, even if the bills become law, it will be years before the reforms can bring about the kind of restructuring needed for sustained economic growth. Of the process charts that the government has published to provide a time frame for the New Growth Strategy, most extend all the way to 2017. Achieving these ambitious reforms along with the fiscal retrenchment that must accompany them will require years of determined and skilled implementation by the government in power.

Setting Internal and External Priorities

In the meantime, developments in the Asia-Pacific and around the world could deal further setbacks to the Japanese economy. One wild card is the outcome of negotiations for the Trans-Pacific Partnership. If the US-led talks break down or hit an impasse, the domestic economy will suffer. The conflicts that continue to break out around the Middle East are another cause for worry. With the nation’s nuclear power plants off line, Japan has become more dependent than ever on thermal power generation and has been obliged to import fossil fuels at prices above the international average. If prices jump even higher as a result of political instability in the Middle East, the impact on the Japanese economy could be devastating.

Japan’s frosty relations with China and South Korea provide further grounds for concern. The Japanese economy has grown increasingly dependent on trade and investment with its closest neighbors, but the chill in diplomatic relations is preventing Japan from taking this economic interaction to the next level. Although Abe has made overtures, these moves have yet to yield substantive results. If the status quo continues, this too will have an impact on the Japanese economy.

In short, to succeed in his bid to restore vitality and sustainability to the Japanese economy, Abe will have to juggle internal and external exigencies, skillfully steering Japan’s foreign policy even as he pushes ahead with ambitious domestic reforms. And he has only so much time in which to produce results.

While Abe has devoted much energy to the task of revising the cabinet’s interpretation of the Constitution to open the door to Japan’s participation in collective self-defense operations overseas, his attention, with autumn approaching, is likely to increasingly focus on the “third arrow” of Abenomics and the urgent diplomatic issues on which its success—and Japan’s future—hinges.

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