Abenomics: What follows the Money? A Response

Response by Chris Scicluna, Head of Economic Research, to the presentation by Professor Shumpei Takemori at a seminar held at Daiwa Capital Markets Europe Ltd. on 16th January 2014.  

In his guest blog on our website, Professor Shumpei Takemori of Keio University argued that Abe’s first arrow, BoJ easing, remains far more important than his structural-reform third arrow. This seems spot on. As Kuroda himself has argued, fifteen years of falling prices have brought significant macroeconomic costs, distorting the behaviour of households, firms and investors, and thus subduing actual and potential growth. So, Abe’s first arrow was long overdue. And it will remain key to Japan’s economic fortunes until the economy is in a position to generate and sustain positive inflation.

Moreover, the weakening of the Yen has been a desirable (and intentional) consequence of the BoJ’s initiatives, providing a direct inflationary impulse via higher import prices and offering a potentially important source of support for economic growth by restoring the competitiveness of Japanese exporters, which took a major hit following the Yen’s sharp appreciation between 2007 and 2011. Indeed, in real effective terms, the Yen is now back to its weakest level since the early 1980s.

Will export-led growth remain elusive?

Yet there are reasonable concerns that export-led growth may remain elusive. Over recent quarters, Japanese exports have risen much less than was typically the case in the past after similar-sized depreciations. Indeed, despite the Yen’s steep depreciation, domestic demand is likely to account for all of the present fiscal year’s GDP growth (probably an impressive 2½%).

When the consumption tax goes up in April, household spending will – at least for a while – fall sharply. And public expenditure, which has been highly expansionary over recent quarters partly thanks to Abe’s second arrow, will be broadly neutral. So, to minimise the chances of slipping in to the sort of the lasting economic malaise that followed the last consumption tax hike in 1997, we need to see the weaker Yen feed through to stronger export growth. But given changes in the nature of global supply chains; Japan’s failure to keep up with innovation in certain sectors; and corporate Japan’s recent preference for investment closer to high-growth markets; much of the market share lost seems likely to have gone for good. So, no matter how far the yen falls, there are risks that the recovery in exports will continue to disappoint, placing Abe’s growth strategy in jeopardy.

Trade liberalisation would boost productivity

More generally, as Professor Takemori suggests, the share of Japan’s GDP accounted by exports is woefully low for any industrialised country, let alone one with such a well-developed manufacturing sector. So, trade liberalisation, to increase that share, is a must for Japan. But greater economic openness can have significant positive supply-side impacts too. Increased exposure of Japan’s currently protected sectors to competition from imports should act as a key stimulus for higher productivity. And opening up protected sectors to inward FDI should bring better know-how and new technology too. Making concessions to expose Japan’s agricultural sector to competition from abroad to facilitate a TPP agreement should be a priority. And so, the electoral reforms to reduce the voting disparity between rural and metropolitan areas advocated by Professor Takemori seem absolutely necessary.

Does Japan really want change?

But from a supply-side perspective, the policy prescription for boosting growth could and should go wider than securing a trade deal and reforming agriculture. The contribution of the labour force to GDP growth could be boosted by increasing the participation of female workers and immigration, for example. And there is scope to increase productivity via policies related to R&D, innovation and education, as well as deregulation.

In some countries (not least Germany), policy-focused expert committees helped to neutralise some of the political obstacles and objections of vested interests to change policy. So, for now at least, I would not be quite so sceptical as Professor Takemori of the possible merits of Abe’s ‘witches’ soup’ of third arrow committees. But if we find Japan completing the present political cycle without any significant structural change, whatever the regional distribution of votes, this would strengthen the argument put forward by many that Japan merely has a preference for the policy status quo, and the relatively low potential GDP growth that goes along with it.

Chris Scicluna, Head of Economic Research

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