With inflation accelerating consumer spending and a declining yen boosting exports, Abenomics seems to be working. However, uncertainties about an anticipated tax increase and the degree to which the government will engage in deregulation continue to cloud the country’s growth projections.
After growing at a rate of about 4 percent in the first half of the year, the Japanese economy grew at an annualized rate of 1.9 percent in the third quarter. Surprisingly, there was a decline in exports and very weak growth in consumer spending. Business investment slowed down as well. On the other hand, residential investment significantly accelerated. Most of the economy’s growth could be attributed to inventory accumulation—not a sustainable way to grow in the longer run. On the positive side, this was the fourth consecutive quarter of positive GDP growth, the first time this has happened in three years.
Most of the economy’s growth could be attributed to inventory accumulation—not a sustainable way to grow in the longer run.
Looking toward the fourth quarter, there are some indications of improvement. For example, inflation has evidently returned to Japan. Excluding volatile energy and food prices, the consumer price index was up 0.3 percent in October from a year ago. This was the first time since October 2008 that this indicator had risen year over year. Moreover, it was the fastest rate of increase since 1998. When energy prices are included, the CPI was up 0.9 percent from a year ago. This was the highest rate of inflation in five years. Clearly, the new central bank policy of unlimited asset purchases is having the desired effect. The drop in the yen is boosting import prices, especially of energy products. That, in turn, is feeding through to other prices in the economy.
Japanese consumers are also responding to the new economic policy. In October, household spending, adjusted for inflation, was up 0.9 percent from a year earlier. There was a sizable increase in spending on homes, home-related products, and automobiles. It is likely that some of this increased spending was in anticipation of the sales tax increase that will take place in April. As such, it is not necessarily indicative of an underlying improvement in consumer spending. In fact, there is reason to worry. After adjusting for inflation, household incomes continue to decline. The average real income of wage earning households fell 1.3 percent from a year ago. This reflects the fact that, despite rising prices, businesses are not responding with wage increases. If this trend persists, there could be negative implications for household spending. Moreover, a lack of wage inflation means that the positive inflation Japan is now experiencing could be ephemeral. Inflation cannot rely on a declining yen to be sustained. There needs to be wage pressure as well. The government has pressured businesses to increase wages and has promised to enact legislation that will offer incentives for wage increases. It remains to be seen whether such efforts will bear fruit.
One positive impact of the declining yen has been an improvement in export performance. Japanese exports grew in October at their fastest pace in three years. Exports were up 18.6 percent from a year earlier, far faster than the 11.5 percent increase in September. As exports are generally priced in dollars, the increase in the yen value of exports was largely due to the impact of a weaker yen. However, even the volume of exports was up 4.4 percent from a year earlier, suggesting that the declining yen is starting to have an impact on overseas demand. It means that exporters are offering foreigners lower prices in order to move goods. It also means that Abenomics is having the desired effect on trade. The volume of exports to the United States increased 5.3 percent while the volume to Europe increased 8.0 percent. Volume to Asia, however, increased only 2.0 percent. Interestingly, despite the rapid rise in exports, imports grew even faster as Japan continued to import more fuel to offset the shutdown of nuclear power plants. As such, the trade deficit expanded in October to a record level. The main reason to worry about a trade deficit is that Japan’s government runs a large deficit and has a large stock of debt. Until now, this has mainly been funded domestically by tapping into Japan’s vast pool of savings. Yet a trade deficit will ultimately lead to net external borrowing. In other words, Japan will have to borrow from foreigners to meet its obligations. If Japan must rely on borrowing from abroad, this could lead to an increase in the cost of borrowing, thereby exacerbating the deficit.
The main reason to worry about a trade deficit is that Japan’s government runs a large deficit and has a large stock of debt.
There is growing concern that the third “arrow” of Abenomics (deregulation and reform) will not be as aggressive or as urgent as many people hope. Indeed, the government has postponed details about many of the reforms that it intends to implement until June of 2014. Nonetheless, there are positive signs. Japan’s government said it will end subsidies for small rice farmers by the end of the decade. Why is this important? There are two reasons. First, this action will lead to consolidation of rice farming from the current situation where 72 percent of rice farms are one hectare or less. This will boost productivity, expand production, reduce food prices, and render a considerable amount of agricultural land useless. That, in turn, could lead to a reduction in land prices in urban areas. This is because land that previously was used for rice farming will be converted to other uses. There is a surprising amount of urban and suburban land currently used for rice farming. Second, the fact that Japan announced such a significant reform indicates a willingness to take on vested interests. This bodes well for further important reforms as part of Abenomics. Nonetheless, the government did not announce any change to import tariffs on rice and other foods. Currently, there is a 778 percent tariff on imported rice. This ensures that Japan will maintain a domestic rice industry.