Japan’s Fiscal Crossroads: Will Abenomics Mean Tougher Changes?
Japan has been up against it since its epic stock and real estate bubble burst in the late 1980s. An unwillingness to process economic failure condemned it to a slower-than-normal recovery. An inability to change a calcified work and corporate culture—one hostile to women and immigrants, fearful of competition, and insulated from disruption—prolonged the problem.
In recent years, Japan has exhibited signs of dystopia: men uninterested in having sex, a sharp fall in births, a rise in suicide, and a decline in the population. The remarkable story of Japan’s rise from the ashes of World War II to a global powerhouse seemed to be coming to an end. In 2010 China surpassed Japan as the world’s second-largest economy.
But there are signs that Japan is returning to life. Last December Shinzo Abe was swept into office as prime minister promising to combat Japan’s malaise with an arsenal of three arrows: aggressive monetary policy, fiscal stimulus, and structural reform. With the firing of the first arrow, the financial markets and the underlying economy have begun to react. Investors are taking note. “Notwithstanding all the problems we’ve had, the world is awash in liquidity,” notes Donald Marron, founder of private-equity firm Lightyear Capital and a former director at Japan’s Shinsei Bank. Japan would be a logical next step, and the market is willing to anticipate these changes.
The first—and easiest—effort was monetary stimulus. Central banks can conjure up vast sums of money at the push of a button. In April the Bank of Japan increased the pace of its bond purchases to about $79 billion per month, with a stated intention to double the nation’s money supply by 2015.
In addition to buying bonds—which is essentially Ben Bernanke’s quantitative-easing strategy at the Federal Reserve—the Bank of Japan is going a step further by wading into markets and buying financial assets such as shares of real estate investment trusts and exchange-traded funds. What’s the goal? Creating lots of new yen cheapens the currency, which is a boon for exporters and is modestly inflationary. Creating new money to bid up asset prices is also inflationary. And that’s the point. When an economy suffers deflation, as Japan has done for several years, nobody has any incentive to spend money today. Why buy a computer now when it’ll be cheaper tomorrow? When inflation—and the expectation of inflation—filters in, people decide to buy now rather than tomorrow. The result is higher growth.
And it has actually worked. The cheaper yen, off 22 percent against the dollar in the past 12 months, has stimulated higher exports. After several years of decline, in the first half of this year exports rose 4.2 percent compared to the year-earlier period. In June, exports were up a solid 7.4 percent from June 2012. That’s a tonic for an export-driven economy. In the first quarter of 2013, Japan’s grew 1 percent—that’s an annualized rate of 4.1 percent. What’s more, people now expect that inflation will rise.
Not surprisingly, Japan’s stock market has been on a tear, as the chart of the Nikkei 225 Index below shows. “The monetary arrow is very effective,” says Nariman Behravesh, chief economist at IHS. “You’re seeing the effect on the exchange rate, and through that on their exports. And you’re seeing the effect on the stock market.”
The monetary expansion has been like a shot of adrenaline, or caffeine. Pick your metaphor. Japan’s economic self-confidence seems to be rising. Elections this month solidified Abe’s political position and were seen as a partial ratification of Abenomics.
But the other two arrows remain sheathed. And when they are fired, they will encounter a great deal of friction. Take fiscal stimulus. Behravesh notes that the measures being proposed—spending on infrastructure and the like—amount to about 2 percentage points of gross domestic product. That’s “good, but not a game changer.” What’s more, he notes, the effect of any increase in government spending could be offset by higher consumption taxes that are slated to hit in 2014 and 2015.
And the third arrow, which packs the greatest punch, may never be pulled from the quiver. Abenomics has a big affect on short-term growth. But to improve its long-term performance, Japan will have to do what it has been unwilling to do for the last two decades: reform its corporate, financial, industrial, and agricultural sectors. Japan’s political system has yet to show the ability to engineer such changes.
More significantly, Japan lacks what might be called disruptive ownership: shareholder activists, CEOs like Jack Welch, hedge-fund managers and private-equity firms, startups. In the U.S., which may suffer from an abundance of disruptors, companies are in a constant state of restructuring and shape-shifting. It’s painful, but it helps the economy react.
But the track record of disruptive owners in Japan is pretty dismal. In her 2003 book, Saving the Sun, Gillian Tett of the Financial Times documented the efforts of American financiers to restructure a Japanese bank. Last December Michael Woodford, the British executive brought in to run Olympus, told me about his painful experience at the helm of that troubled Japanese company.
The latest foreigner to try shaking things up in Japan is Dan Loeb, the hedge-fund manager whose activism helped reverse Yahoo’s decline. Loeb has amassed a 6 percent stake in Sony and is pushing for significant restructuring. He wants the conglomerate to spin off its entertainment business to liberate what he views as locked-up financial value. Sony has pledged to consider the proposal, but there’s no timetable for action.