Will the Japanese Grant ‘Abenomics’ a Fresh Mandate?

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Japanese Prime Minister Shinzo Abe is campaigning once again for a fresh mandate for his government, nearly five years after he took office in late 2012 vowing to restore the country’s past dynamism. Beset by cronyism scandals, facing new challenges from both the left and the right, Abe is relying heavily on the mixed success of his stimulus-driven economic policies, and worries over the threat from North Korea, as he fights to retain his ruling Liberal Democratic Party’s overwhelming parliamentary majority in the October 22 election.

With opposition divided among a raft of parties spanning the spectrum from communist to ultraconservative, the Liberal Democrats are expected to retain at least a majority in the pivotal Lower House of the Diet. But lukewarm public support for much of his policy platform and widespread opposition to his efforts to revise Japan’s pacifist constitution and build up the military, will likely lead Abe to stick to his playbook on the economic front, avoiding any dramatic reforms that might undermine approval among the traditional bastions of LDP support, Japan experts and economists say.

Element of Surprise

Having seen his support ratings recover from mid-summer lows in the 30% range, thanks in large part to fears fanned by repeated North Korean missile tests, Abe likely was counting on an easy win when he called for a snap election on September 25. Tokyo governor Yuriko Koike dashed those expectations by announcing, on the same day, that she would lead a new national party called the Party of Hope, or “Kibo no tou.” Koike’s announcement set off a major shake-up among the main opposition party, the Democratic Party, whose head Seiji Maehara effectively dissolved his party and recommended that its members campaign with Hope Party in a coalition against the LDP.

As of October 3, Koike said her alliance was fielding 192 official candidates, 109 of them from the Democratic Party. Even if Koike has more than 233 candidates, not all of them will win, so Koike’s coalition is unlikely to attain a simple majority of 233 seats in the 465-seat Lower House, let alone a two-thirds majority.

“That final arrow of his three-pronged strategy of monetary easing, stimulus spending and sweeping reforms has made little headway.”

At the same time, Koike has also said she will not run, leaving the Party of Hope without a clear choice for prime minister if it should triumph in the election. Still, given the raft of opposition parties contesting the election, the Liberal Democrats stand to lose at least a few of the 288 seats they held when Abe called the election, even if its partner — the Buddhist-backed Komeito — remains in the ruling coalition. Meanwhile, Yukio Edano, a popular liberal-leaning former leader of the Democratic Party, has further muddied the waters by setting up his own new party, the Constitutional Democratic Party of Japan.

Not the Economy This Time

Putting aside the risk of an upset thanks to Koike’s challenge, Abe’s timing was deft. Though the government downgraded its figure for second-quarter annualized GDP growth to 2.5% from an earlier estimate of 4% percent, April-June was the sixth-straight quarter of expansion for the world’s third-largest economy, the longest in a decade. Unemployment remains near a four-decade low of about 3%, share prices have held steady (hitting a 21-year high October 11) as have business and consumer sentiment.

For now, the “Abenomics” formula of lavish monetary easing, combined with strong demand for Japan’s exports and a boom in construction ahead of the Tokyo 2020 Olympics, appears to be working. The Cabinet Office is forecasting 1.5% annualized growth in the fiscal year that ends in March 2018 and 1.4% growth in the following fiscal year, relatively strong levels compared with much of the last five years.

That’s all good news for Abe, but not necessarily for Japan in the long run, says Masamichi Adachi, a senior economist at JPMorgan Securities Co. Ltd. in Tokyo. By pumping up to ¥80 trillion (tens of billions of dollars) into the economy every year, the Bank of Japan is keeping the yen weak in a boon for exporters like Toyota and Sony, whose profits have soared. But the strategy does little to address Japan’s long-term challenge of a shrinking home market, as the country ages and its population declines. “The Japanese economy is growing but it is like an old person who used to run 100 meters in 10 seconds but now runs it in 13 seconds,” he says. “Japan’s potential annual economic growth rate is less than 1% now,” Adachi says.

To achieve Abe’s promise to attain a nominal ¥600 trillion GDP for Japan by 2020, from ¥491 trillion yen in fiscal year 2014, would require nominal economic growth averaging more than 3% and real growth of 2% over the next five years.

While Japan is managing to eke out a respectable pace of growth for now, Abe’s economic regime has fallen short in other respects. A 2% inflation target set when Bank of Japan (BOJ) governor Haruhiko Kuroda took up his post in 2013 remains distant, with real inflation still about zero.

The core consumer price index, excluding volatile fresh food prices, rose by 0.7% in August. Excluding energy prices, it was roughly flat. “I do not think they can get to 2% anytime soon. The Bank of Japan has been trying for a long time, but I am not sure what else they can do,” says Franklin Allen, a Wharton emeritus professor of finance, now a professor of finance and economics at Imperial College in London.

Even if Abe wins a strong majority, he is unlikely to push for more monetary easing because it is apparent that there’s little more the BOJ can do on its own, says Shigeto Nagai, head of Japan economics at Oxford Economics Japan K.K. and a former BOJ official. With other central banks, especially the U.S. Federal Reserve, moving to raise rates, the BOJ is unlikely to push interest rates in Japan further into negative territory: The key interest rate charged to banks has been at minus 0.1% for almost two years. “But if the BOJ ends the negative interest rate policy, that will have a strong impact on the exchange rate, so they cannot do that at the moment,” Nagai said. “They will keep the rate negative for a while.”

“… Over the last one and a half years, the government put its heart much more on constitutional reform and security reform than economic reform.” –Martin Schulz

Stronger inflation would require faster growth in wages, which have stagnated as corporations reaping windfalls from the cheap yen have built up their cash stockpiles. Labor cash earnings, which include bonuses and other payments, rose 0.9% year-on-year in August after dropping 0.6% in July. Wages of full time workers rose an average of 0.7% in August, while the rate of increase for part-time workers was 0.4%, according to figures from the welfare ministry. That was the fastest pace of increase since July 2016. But to attain the 2% inflation target seen as necessary to drive a “virtuous cycle” of investment and growth, wages need to be growing at a pace of 3% or more, says Marcel Thieliant, senior Japan economist of Capital Economics.

The jobless rate stood at 2.8% in August, the lowest level in 23 years, which should push employers to raise pay to attract and retain talent. But the country’s limited job mobility means that companies, which already hold the upper hand given the near universal decline in the bargaining power of organized labor, have little incentive to raise pay, Thieliant says.

The Third Arrow Misses the Mark

Soon after he took office, Abe pledged to drill “deep into the bedrock” of Japanese bureaucracy and other factors that have stunted innovation and productivity. But that final arrow of his three-pronged strategy of monetary easing, government stimulus spending and sweeping reforms has made little headway. Efforts to reform labor laws, open up bottlenecks to competition in the medical industry and push ahead with other difficult structural problems have stalled as Abe expended precious political capital on pet issues such as revising the constitution to allow a wider role for Japan’s military.

“At least during the first three years, it was moving forward; but over the last one and a half years the government put its heart much more on constitutional reform and security reform than economic reform,” says Martin Schulz, a senior economist at Fujitsu Research Institute’s Economic Research Center.

In the meantime, the cost of putting off such needed but difficult changes has been allayed by good fortune. Japan’s economy was already emerging from recession in late 2012. Its recovery, with a brief downturn following a hike in the sales tax to 8% from 5%, has relied heavily on reviving demand for cars, electronics and other exports in China, the U.S. and other major markets, says Allen. “The fact that the global economic recovery is doing well is why Japan is doing well,” he says. “Abenomics helped to weaken the yen and helped stock prices, but I do not think it will have much effect on Japan’s long-term growth.”

With the recovery on autopilot, Abe has not done much on the economy in the past two years, says Hideo Kumano, chief economist at Dai-ichi Life Research Institute, a unit of Dai-ichi Life Group. “Japan’s current economic growth is driven by the recovery of the U.S. economy and strong Asian economic growth driven by the U.S. recovery,” he says. For example, relying on the “Trump bump” to growth is risky, given uncertainties over the direction of U.S. monetary policy. A U.S. interest rate hike could slow growth, resulting in an unwelcome weakening of the dollar.

Abe’s election platform includes only one new economic initiative, hiking the sales tax, as earlier promised, to 10% by 2019.

Clouds are already gathering on the horizon: The International Monetary Fund and other private economists are forecasting lower economic growth for 2018. The IMF said in its annual review of Japan published in July that Japan had a relatively good year in 2016 and the momentum carried into 2017 with growth projected at about 1.3%. It echoed other economists in saying the trend was largely driven by a favorable external environment, which for Japan means exports. But a rapidly aging population and shrinking workforce means the country needs to speed up reforms to boost wages and productivity and growth. The IMF expects GDP growth to slip to 0.6% in 2018.

Where to Next?

Regardless of whether the opposition makes inroads in the upcoming election, neither Abe nor other leaders are likely to make any dramatic changes. If Abe retains a two-thirds majority in the Lower House in coalition with the Komeito or another party, he’s likely to continue to focus on his effort to establish a legacy by changing the constitution, says Adachi. Abe wants to revise the constitution, shaped by the U.S. following Japan’s defeat in World War II, to clarify the legal status of the country’s Self-Defense Forces. Article 9 of the constitution renounces Japan’s right as a sovereign nation to wage war as well as the “threat or use of force as means of settling international disputes.” The Liberal Democrats’ election platform calls for amending that article after “sufficient debate within and outside the LDP.”

Abe’s election platform includes only one new economic initiative, hiking the sales tax, as earlier promised, to 10% by 2019 to support spending on social services and education. Abe twice postponed that hike in the sales tax, citing the risks to the economy. The sales tax is deeply unpopular with voters, despite the clear need for more revenue to fund pensions and health and other care for the elderly.

The increase in the tax is projected to raise an extra ¥5.8 trillion a year. About half of the ¥4 trillion earmarked for paying down government debt will instead be used to provide free preschool education for children three to five years; to pay for free child care for low income families with children under two years old; to cut waiting times by providing places for 320,000 more children in child care centers by 2020, and to cut college education costs.

While education is vital to Japan’s competitiveness, the shift in spending will make it difficult to meet promises to balance Japan’s primary budget by 2020 as previously promised. “This is a misuse for the VAT and it is like pork barreling,” Adachi says.

So far, the sales tax is the one economic theme that has dominated the run-up to the election, with Koike’s Party of Hope and several other opposition parties running against it. But other key issues, such as whether or not to allow more immigration to help fill labor shortages, are getting short shrift as campaign talk focuses on non-bread and butter issues such as North Korea and constitutional revision.

Though the repeated missile tests have rattled nerves in Japan, they may be distracting the public from vital domestic issues such as how to provide for the country’s rapidly aging population given the country’s precarious national finances. “There is no sense of crisis in Japan about various critical issues such as the population decline, aging and social security,” Adachi says. “The Japanese government has been is just putting off solving any of those critical issues.”

An election win for Abe will likely ensure that dithering continues, says Adachi. But it also will reflect the broad support among Japanese for keeping the status quo. Even if Koike manages an unlikely surprise victory, her “Yurinomics” will likely mirror Abe’s policies, says Takuji Aida, chief Japan economist at Societe Generale Japan Ltd in Tokyo. “Whatever happens, either Abe or Koike, the current monetary policy will continue,” he says.

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