While the first two policies of Shinzo Abe’s three-pronged plan to revive Japan’s economy have been effective, discussions on the third policy—structural reforms—are just getting started.
Japanese Prime Minister Shinzo Abe’s administration completed a year this month. The past year saw “Abenomic” policies having a fairly successful impact on Japan’s economic growth, confidence, and inflation. While the first two policies of Abe’s three-pronged plan to revive the world’s third-largest economy have been effective, discussions on the third policy of structural reforms are just being initiated. The first move in this direction involves raising consumption tax in April 2014, but this action is being widely debated because it will probably impact consumer spending (which is yet to pick up momentum) and growth (which is still nascent). The slowdown in growth in Q3 2013 has heated the debate further. The risks of going back on promised reforms are high. However, for faster and more sustainable growth to counteract the fault lines in the economy, Japan needs structural reforms. This implies that structural reforms will have to be forceful in order to shift expectations and eventually change the regime, which will be a challenging task for Abe.
The year so far
Abe’s one-year-old administration has sought to re-energize Japan’s economy through what is referred to as the three arrows of growth: The first arrow refers to raising government spending to boost economic activity; the second arrow refers to the increase in money supply by the Bank of Japan to increase liquidity and raise inflation; and the third targets structural reforms in the labor market, agriculture, health care, capital allocations, and international relations.
The first two Abenomic arrows have already been implemented and have successfully boosted economic growth, weakened the Japanese yen, improved corporate earnings, and increased inflation as well as inflation expectations in the first half of 2013. Economic sentiments have improved sharply this year since the global financial crisis (figure 1). Consumer confidence rose to its highest in September since 2008, though it fell again in October, mostly due to concerns about typhoons and the US fiscal impasse. Consumer spending has slowly started gaining momentum, which is evident from the strong growth in household demand for credit, especially for housing loans, as indicated by a survey of senior loan officers on lending practices of large banks.1 The Bank of Japan’s Tankan index, which gauges the sentiments of the country’s largest manufacturers, has jumped since Abe’s election and has reached its highest level in the current quarter since the financial crisis.
The impact of expansionary monetary policy on prices are in effect with a lag; consumer prices have gone up 1 percent year over year this October, the highest in the last five years, while core consumer price inflation increased the most—0.3 percent—since 1998. Inflation expectation appears to be rising too, as witnessed in a survey by the Bank of Japan, where the number of respondents who expect prices to rise by more than 2 percent doubled to around 75 percent in just one year.2 High liquidity and easy monetary policy will likely keep the yen weak, which implies that exports are expected to be stronger in the near term.
However, despite monetary easing and fiscal stimulus, some quarters of the economy are not responding enough to Abe’s policies. Consumer spending is yet to pick up at a sustainable pace, while weakness in capital spending growth indicates that, despite improved sentiments and increased profits in the last quarter, corporates are not yet ready to invest (figure 2). This is also evident from the senior loan officers’ survey, which indicates that despite banks’ easing of lending standards to firms, firms’ demand for loans has not gone up much in the last year.3 Consumption spending, which accounts for approximately 60 percent of GDP, grew at an annualized rate of 0.4 percent in Q3 2013 relative to the previous quarter, while private business investment, which accounts for 13 percent of GDP, grew by a mere 0.7 percent. Exports too failed to grow, despite expectations that the yen’s depreciation would boost exports with a lag. All these indications suggest that structural problems are hindering growth. After strong growth in the first half of the year, economic activity weakened in the third quarter, as GDP rose at an annualized 1.9 percent, down from 3.8 percent in the previous quarter. Most of the gain came from government spending and an accumulation of inventories.
The other concern is that wages have failed to keep pace with rising consumer prices, as the economy tries to haul itself out of more than a decade of deflation. If the trend continues, falling real income will threaten growth in real consumer spending. This in turn will impact the sustainability of growth as well as inflation momentum in the economy. While the government is giving incentives to companies to raise salaries in order to sustain consumption, companies are still cautious about hiring or investing.
Near term optimistic
Economic growth is expected to rebound in Q4 2013 and Q1 2014, with consumers likely to increase spending ahead of a sales tax rise in April 2014. The government has announced a new stimulus package to minimize the impact of the tax hike on consumer spending and thus growth, part of which includes cash handouts to low-income families. Recently Abe’s cabinet approved 18.6 trillion yen ($182 billion) for the stimulus package, though the bulk of the package includes loans from government-backed lenders and spending by local governments that was already scheduled. New bills that include tax incentives to encourage corporate investment and the establishment of strategic economic zones with reduced business regulations are expected to boost capital spending and investment. All these measures will likely support growth in the short term.
However, it is the long-term outlook that appears uncertain. The concern for Japan, which has been fighting deflation and slow growth for a decade-and-a-half, is not the pace of growth or the recent slowdown. Instead, the focus is going to be on structural reforms, which will likely set a sustained growth path for a longer horizon. Japan needs credible structural reforms, and all eyes are on how the government implements the third arrow.
Japan needs credible structural reforms, and all eyes are on how the government implements the third arrow.
The complexity of the third arrow
Japan’s structural reforms must encompass deeper integration with global markets; more risk-based allocation of capital; domestic market reforms; reduction of public debt; deregulation and increased competition in sectors such as health, agriculture, and energy; and labor market reforms that emphasize increasing productivity and labor supply. However, implementing the third arrow is going to be the trickiest for Abe. The Japanese government has made a few big announcements this year on the economic reforms, but these plans are short on details. The success of the reforms will ultimately depend on the ability of the government to overcome political and corporate resistance to structural changes.
Abe has taken bold steps to jolt the economy, with reasonable success this year. However, whether or not he will be able to take the crucial challenge of implementing structural reforms will determine the persistence of Japan’s economic performance in the years to come.
EndnotesView all endnotes
- Bank of Japan, “Senior loan officer opinion survey on bank lending practices at large Japanese banks,” October 2013, http://www.boj.or.jp/en/statistics/dl/loan/loos/release/loos1310.pdf.
- Cabinet Office, Government of Japan, “Consumer Confidence Survey October 2013,” November 12, 2013, http://www.esri.cao.go.jp/en/stat/shouhi/shouhi-e.html.
- Bank of Japan, “Senior loan officer opinion survey.”