Abenomics and Japan's economic problems

Abenomics is an economic policy initiated by the Japanese government under Prime Minister Shinzo Abe during his second term. Named after Abe, Japan's longest-serving prime minister, the policy was aimed at revitalizing the economy after decades of stagnation. Abe's successor, Yoshihide Suga, has pledged to continue these initiatives after taking office in 2020.

Abenomics is based on the “three arrows” strategy: monetary easing by the Bank of Japan, fiscal stimulus through government spending, and structural reforms to boost economic growth. This approach aims to fight deflation and stimulate growth, and The Economist describes it as a combination of reflation, increased government spending and a growth strategy to revitalize Japan's sluggish economy.

Under Abe, Japan has achieved higher nominal GDP growth and stabilized its debt-to-income ratio for the first time in decades. However, structural reforms - the third arrow - have failed to meet expectations. The term “Abenomics” joined the tradition of naming economic policies after political leaders such as Reaganomics and Bidenomics.

Background

Japan's GDP grew by 3% in 1996, signaling a potential recovery from the collapse of the asset price bubble of the early 1990s. However, in April 1997, the government raised the consumption tax from 3% to 5%, planning a further increase in 1998. Shortly thereafter, the financial crisis in East and Southeast Asia caused by the collapse of the Thai baht peg in July 1997 exacerbated regional economic problems.

In Japan, consumer spending fell after the tax hike, reducing government revenues by 4.5 trillion yen. Nominal GDP growth fell below zero for most of the next five years. Although wages rose steadily from 1992 to 1997, they began to decline after the tax hike, outpacing the decline in nominal GDP.

In 2012, under Prime Minister Yoshihiko Noda, the Japanese parliament approved legislation to raise the consumption tax to 8% in 2014 and 10% in 2015 to address the budget deficit, although concerns were growing that the tax hike could further suppress consumption.

Japan faced severe economic challenges during the global recession, with real GDP contracting by 0.7% in 2008 and 5.2% in 2009. This contrasted sharply with global real GDP growth, which increased by 3.1% in 2008 and then declined by 0.7% in 2009. Japan's exports plummeted by 27%, falling from $746.5 billion to $545.3 billion over the same period.

By 2013, Japan's nominal GDP remained at 1991 levels, which indicating prolonged economic stagnation. Meanwhile, the Nikkei 225 stock market index was only one-third of its all-time high, indicating the long-term economic difficulties Japan has faced since the recession and previous financial crises.

Implementing reforms

Abenomics includes three main areas: monetary policy, fiscal policy, and an economic growth strategy aimed at increasing private investment. Key measures include targeting inflation at 2% per year, countering yen revaluation, adopting negative interest rates, aggressive quantitative easing, increasing public investment, Bank of Japan (BOJ) construction bond purchases, and revising the Bank of Japan Act. Fiscal spending was projected to increase by 2% of GDP, bringing the budget deficit to 11.5% of GDP in 2013.

The first two “arrows” were quickly implemented after Abe returned to power. A 10.3 trillion yen stimulus package was introduced and Haruhiko Kuroda was appointed as BOJ Governor with instructions to achieve the 2% inflation target through quantitative easing. However, BOJ Deputy Governor Kikuo Iwata later said the central bank may not stick to the two-year inflation schedule, especially after the planned sales tax hike in April 2014.

Structural reforms, the third “arrow,” progressed more slowly. Initial efforts included promoting Japan's participation in the Trans-Pacific Partnership. Despite gaining full control of parliament after the 2013 House of Councillors elections, the Abe government has faced internal disagreements over specific reforms. Proposals such as corporate tax cuts have met resistance due to fears of political repercussions, especially while raising consumption taxes at the same time. Other contentious issues include labor laws and agricultural reforms, particularly controls on rice production.

Japan's economy faces significant challenges through 2020, including high debt levels, aging demographics, and declining competitiveness. Efforts to address these problems, such as raising the consumption tax to 10%, have raised concerns from experts such as Anatole Kalecki and Lawrence Summers, who warned that it could hurt consumption and send the economy back into recession, as happened after the 1997 tax hike.

Fighting deflation

Deflation restrains consumer spending by creating expectations of future price falls, leading to an economic downturn. Richard Koo called this the “composition error,” where rational individual behavior leads to deleterious collective consequences. Koo argued that Japan's chronic deflation was not caused by an aging population but by weak demand as companies avoided borrowing and paying interest, which in turn led to retirees cutting back on spending.

Hiroshi Yoshikawa cited falling wages that began in 1997 as a key cause of deflation in Japan. He advocated raising wages to stimulate demand, but others, including Koichi Hamada, warned that such increases could strain companies and hurt employment.

The bottom line

Despite initial successes, the long-term results have been contradictory. Economic growth remained fragile, and the consumption tax hike in 2014 exacerbated demand problems. Public debt continues to rise, and many inflation and investment targets have not been met. Abenomics demonstrated the importance of a comprehensive approach to economic reforms, but also highlighted the difficulties in achieving sustainable change in an environment of demographic aging and high indebtedness.