Will Prime Minister Abe save Japan's economy?

Long held up as a cautionary tale for the US and Europe, Japan’s economy is now being talked about in much more effusive tones.

Six months after he took office promising to drag the world’s third-largest economy out of two “lost” decades of stagnation, Prime Minister Shinzo Abe’s approach – inevitably dubbed Abenomics – is now being touted as an alternative to the West’s austerity drive.

The Tokyo stock exchange has risen some 50 percent and the yen has fallen about 25 percent against the US dollar since late last year, bringing respite to the country’s embattled exporters.

Today, the government said the economy had grown at an annualized rate of 4.1 percent during the first quarter of this year, up from an earlier estimate of 3.5 percent. Also today, the Bank of Japan (BoJ) raised its assessment of the economy for the sixth straight month, citing a rise in exports and solid private consumption. Recent jitters aside, the stock market surge has sparked fresh optimism among major firms, with business sentiment between April and June at its highest level since the third quarter of 2011.

Amid that backdrop of optimism, much of the credit is going to Abe’s multifaceted approach to tackling years of growth-sapping deflation: drastic monetary easing, fiscal stimulus, and promises of far-reaching reforms to generate growth over the next decade.

“Japan has taken the right steps so far, which is unusual for a Japanese government, and this is being reflected in the mood of optimism and support levels for Abe,” says Martin Schulz, chief economist at the Fujitsu Research Institute in Tokyo.

Abe’s vision is deceptively simple: to create a virtuous cycle in which profits trickle down to workers in the form of higher wages and, so the received wisdom goes, overcome their aversion to spending. To achieve that, he dispensed with any pretense of central bank independence and pressured the BoJ into signing up to his 2 percent inflation target.

But Abenomics is not without risks. Making government bond purchases to finance public investment has forced Abe to put off addressing Japan’s huge public debt, which stood at 246 percent of GDP last year – the highest debt-to-GDP ratio in the world. US public debt in relation to GDP was 107 percent, according to the International Monetary Fund (IMF). Russia has the lowest level, just under 10 percent, among the Group of Eight nations.

In a recent report, the IMF praised Abe’s attempt to end years of falling prices. But the Washington-based body said Abe must grapple with the debt by, for example, making good on a commitment to double the consumption (sales) tax to 10 percent by 2015.

“Despite the strong start, there are considerable downside risks to the outlook," the IMF said. "Lack of concrete fiscal measures to bring down public debt, or a delay in the consumption tax increase, could elevate risks of a rise in government bond yields, which would undermine fiscal and financial sector stability.”

The IMF is not alone in sounding a note of caution: South Korea and some European countries have voiced concern that the Japanese leader is driving down the yen to gain a trade advantage and spark a possible currency war.

Growth plans questioned

While the monetary and fiscal “arrows” in Abe’s quiver have had the desired effect at home, the third – focusing on growth – has received a lukewarm response.

In a recent speech, Abe talked of boosting income, creating special deregulated zones and expanding the online economy. But his plans for tackling structural issues in greatest need of attention were short on detail.
 
He has yet to explain how he will bring more women into the job market, help a shrinking workforce support the country’s rapidly ageing population, and open up the heavily subsidized agricultural sector to competition.
 
Investors were underwhelmed, with the Nikkei sliding to a two-month low after Abe’s speech. But the government’s top spokesman, Yoshihide Suga, hit back at speculation that market fluctuations had blown a hole in the prime minister’s economic strategy.
 
"We are not engaging in politics only for the sake of markets," Mr. Suga told reporters, adding that recovery remained on track.
 
Schulz says Abe would not be able to put flesh on the bones of his structural reforms until after the July 21 upper house elections, which his Liberal Democratic Party (LDP) is expected to win.
 
“Structural reform is the area in which he could get into trouble,” he says. “That is why everyone is taking this so seriously. This is Japan’s last chance to get it right before it finds itself at the edge of a very steep cliff.”
 
While sure signs of sustainable recovery could help Abe break the recent cycle of short-lived Japanese prime ministers, a prolonged focus on the economy could come at a different political cost.

After the economy…

After next month’s elections, the LDP will not have to worry about going to the polls for another three years, during which some analysts expect Abe to turn to his controversial plans to revise Japan’s pacifist postwar constitution and give its armed forces a bigger international role.
 
“The question is whether he will continue to focus on the economy after the election,” says Koichi Nakano, a political scientist at Sophia University in Tokyo.
 
“Some of his advisers will tell him to concentrate on structural reform. But the other half will be telling him that his popularity won’t last forever and that if he doesn’t implement his nationalist agenda now, he may never get another chance.”
 
Recent signs that the yen’s slide has been arrested may spare Abe criticism at the Group of Eight summit in Northern Ireland next week. Instead, he could find himself dispensing advice to leaders searching for an alternative to austerity.
 
“Abe hasn’t concocted a magic potion to solve the economic woes of our time,” says Mr. Nakano. “It’s not that Japan is doing anything particularly new. It’s more that the rest of the world is sinking and is keeping an eye on Japan’s economic experiment with a great deal of curiosity.”