Standard & Poor’s recently cut its long-term credit rating of Japan one level, down to A+, and markets do not seem to have reacted much, if at all. A key reason is that many Japanese bonds are owned by Japanese banks and other Japanese institutions, “which are not going to sell in large numbers,” says Wharton finance professor Franklin Allen.

But the move is one more straw in the wind pointing to how ineffective so-called Abenomics has been, he adds. It also comes at a time when there is other negative news for Japan. Wage growth bogged down in August along with industrial production, which fell half a point following a nearly identical drop in July. As Allen notes in parts one and two of this Knowledge in 5 interview, China’s slowdown is hurting many Asian exporters, and in Japan it appears to be offsetting at least some of the hoped-for effects from the “Abenomics” stimulus plan — a plan never destined to soar, says Allen.

An edited transcript of the conversation appears below.

Knowledge at Wharton: Standard & Poor’s recently cut the long-term credit rating of Japan one level down to A+, and markets do not seem to have reacted much, if at all. What do you think implications will be from this cut? Is it a signal that maybe Abenomics is not doing so well – that perhaps it has already failed?

Franklin Allen: I was always fairly pessimistic about the likely success of Abenomics, and I think that is what we are seeing, that it is not really working very much. They did manage to devalue the currency significantly in a short space of time and I think most of the effects we have seen have been the result of that, rather than sustained takeoff of growth and so forth.

They have still got the basic problems they have had for many years, which are: demographic issues, a very low or negative growth in the population; a lot of debt; and a little bit of deflation — they have not managed to get inflation up in any sense and that is likely to continue. So those issues are still there, and some way or another they have to deal with them.

Whether they will deal with them without some type of crisis is becoming more problematic. And that is why I think we may see some deterioration in other indicators. [Editor’s note: Recent reports suggest Japan is close to a technical recession after industrial production unexpectedly fell 0.5% for August. Then on October 5, the government announced that wage growth also slowed in August, which will be a drag on hopes that government policies can increase consumer buying power. Though corporate profits are up, companies have been reluctant to raise salaries much out of concern over the sustainability of economic growth.]

The effect on market yields and so on [from the S&P downgrade] is not likely to be big, because [many bonds and related financial instruments] are owned by banks and other institutions, which are not going to sell in large numbers. They are not going to take their money out of the country. So I wouldn’t put much weight on the fact that there was not much movement [in markets, following the announcement]. But I think Japan still has a lot of problems, which Abenomics has not managed to solve.

Knowledge at Wharton: To what extent has Abenomics not really been even tried, in the sense that there was always this talk of monetary stimulus, and fiscal stimulus – those were the first two arrows, and the third arrow was meant to be deregulation, in particular for labor markets. But almost nothing has happened with that third arrow. On top of that, there was allowed to go into effect a big increase in the national sales tax. To what extent has that … contributed to the lack of progress with Abenomics, or was it really just not a program that was likely to work in any case?

“They have still got the basic problems they have had for many years, which are: demographic issues, a very low or negative growth in the population; a lot of debt; and a little bit of deflation….”

Allen: Many people were skeptical about whether they would put in to place labor reforms, and some of the other reforms that they talked about. And as you point out, they have not really made much progress with that at all. And so, would it have made much difference? Who knows if that would have actually driven growth? It probably would not have hurt, and it may well have helped, and growth may have gone up.

But I don’t see them doing things like major labor reforms, and some of the other structural changes. They may do some of the agricultural things if TPP [the Trans-Pacific Partnership trade agreement] goes through…. They were supposed to have that meeting, which did [address] the last details, but as I understand it they still have not sorted those out yet. So I think that is part of the reason why things have not worked very well. But they may well not have worked very well, anyway.

I think there is too much emphasis that these kinds of structural reforms are silver bullets that solve the problem. They may have had some beneficial effect, but I am not sure they would have been huge. They tried … the monetary side obviously; the fiscal side they have tried somewhat. But yes, as you say, they have not tried much on the re-structuring side.