Why Abenomics holds lessons for the West

  • 18 December 2013
  • From the section Business

Monday marks one year since the election of Japanese prime minister Shinzo Abe, who has embarked on a bold economic experiment in the world's third largest economy.

The programme has been dubbed Abenomics, with Japan's government trying to raise economic growth in an economy that has been stagnant for more than two decades since a financial crash in the early 1990s.

For the UK and US facing a tepid recovery five years after their banking crises, whether Japan succeeds will matter.

It's not just the parallels after the crash. It's also due to Japan having a demographic profile that the West will soon face.

Limits to growth

Can a rich country with an ageing population grow quickly without relying on credit bubbles? In other words, has the debt-fuelled growth of the past couple of decades masked an underlying slow growth rate?

This is what the West worries about - permanently slower growth after the bubble burst.

If Japan can reverse this so-called "secular decline", then there are certainly lessons. If Japan can't, then it could be a glimpse of the future for other rich countries whose demographic profiles follow that of Japan.

First, the big question is why Japan has found it so hard to break out of deflation and grow well after its housing bubble burst. After all, its banking sector has been mended and the deleveraging or repayment of private sector debt has been completed after more than 20 years.

One culprit is slow productivity. Greater output per worker normally generates wage rises and demand growth and thus inflation.

So, without relying on credit bubbles, an economy's growth will depend a great deal on productivity-fuelled income, investment, and population growth. It's a big challenge for these post-bubble economies.

Elderly Tokyo
Japan is the "oldest" country in the world

Abenomics scorecard

So, how is Abenomics faring on its one-year anniversary?

Of the three arrows of Abenomics, the first shows promise in hitting the target, the second is a bit hit or miss, while the third hasn't been truly fired.

The first arrow is to reflate the economy through quantitative easing or cash injections.

The Bank of Japan aims to reverse two decades of deflation, where prices have been falling, through injecting cash into the economy. The target is to achieve 2% inflation by 2015.

There are initial signs of success. There's a bit of inflation, CPI is up 0.3%, to the highest in 15 years. But, if wages don't rise, then the price rises are hard to sustain since people won't spend more if they don't have more income unless they borrow, which the Japanese have been loathe to do after the debt bubble.

Plus, firms won't pay more unless workers produce more, so productivity needs to rise. For that to happen, structural reforms are needed — which hinges on the third arrow.

In terms of the second arrow, the Japanese government is spending money instead of the private sector to boost growth. But, they are also planning to raise the consumption tax.

Higher taxes and higher government spending are counteracting. But, with government debt at about 240% of GDP, steps toward a medium-term fiscal stabilisation plan may be warranted. As a consequence, the second arrow isn't quite pointing as straight as the first.

As both of these arrows are essentially short-term measures, the third arrow is the most important one in terms of having a lasting impact. Abenomics has ambitions to introduce structural reforms such as de-regulation to raise economic growth.

As I mentioned above, Japanese firms have to invest more to help raise the productivity of workers. A shrinking workforce means that more workers won't be added, so the existing ones have to produce more in order for firms to be able to raise wages if there's more output to justify the higher pay. And higher wages will raise disposable income which supports the economy.

Limits to growth

But, firms say that it also depends on more demand for their products and services. For about one-fifth of the population who live in greater Tokyo, the average size of a flat is 56 sq m. There may be a limit to how much can be bought for such a dwelling. This is one of the many explanations put forward for low consumption.

Overseas consumers can provide some of the demand. The yen has dropped by around 25% and has hit a five year low of 103 yen against the US dollar. The stock market, the Nikkei benchmark index, is up over 50% in the past year.

The two are related as Japanese firms have benefited from a more competitive currency. For instance, the increase in profit for Toyota can be attributed to yen depreciation. By raising firms' profitability as well as the monetary stimulus, the stock market gets a boost.

A key problem, though, is a shrinking population will consume less. Japan's population has been contracting since 2004 and fell by a record level this year at the rate of 0.2% per annum.

Mother and daughter Tokyo
Relatively few women work in Japan compared to other developed nations

Working women

This is the reason behind the other major prong of the third arrow's structural reforms — to increase female labour force participation. To counteract some of the demographic challenges, adding women to the workforce can raise the amount of productive assets in the economy.

Japan's female labour force participation rate is among the lowest for an advanced economy. The World Bank estimates that fewer than half of the working-aged women work. This compares with over 60% for the UK and US.

The addition of women to the workplace in post-war America has added at least 14% to per capita GDP. Similar estimates have been made for Japan if it can raise its female labour force participation rate to a comparable level.

From the people that I have spoken to in Tokyo this past week, the task seems daunting. Working women worry about a lack of day care centres and struggle with childcare as well as the demands of having to look after elderly parents. As a result, Japanese women have "blanks" in their work histories that make it difficult for them to re-enter the labour force at a comparable level.

And then there is the glass ceiling. This was described to me by the Japanese Minister for Gender Equality, Masako Mori, as not only a glass ceiling, but a glass wall with glass stones blocking the path of women to advance professionally.

Tellingly, I asked a number of Japanese salarymen — all of whom said that they had never had a female boss. But, reassuringly, most also said that it might be "weird" but fine so long as the woman was competent.

If Japan is successful in increasing the number of women in the workplace, then it could provide a boost to growth that Western Europe also experienced like America. But, the underlying demographic challenges remain as the population ages.

In terms of the UK and US, their population growth is slowing notably but not shrinking. They are, though, also ageing.

Japan is the "oldest" country in the world where a quarter of the population is aged over 65. Germany and Italy are not far behind as one-fifth of their populations is over 65. By 2030, older people will be close to one-fifth of the US population. The UK will hit that level about a decade later.

If Japan can reverse the slow growth rate associated with an ageing population which is a tough task, it will surely be watched with interest in the rest of the world.

Otherwise, rich countries may have to start getting used to a slower rate of economic growth.