Can Abenomics Succeed?

Overcoming the Legacy of Japans Lost Decades

Dennis Botman, Stephan Danninger and Jerald Schiff
IMF 2015
193 pages
[@] getab.li/24945
Book:

Rating Take-Aways

7
8 Importance Japan has traveled an extraordinary and unique economic journey since the 1980s.
8 Innovation Strong deflationary pressures and a lack of demand have afflicted Japan since the
6 Style 1990s.

Japans central bank was a pioneer in quantitative easing, which it started in 2001.
Although its nominal 2013 GDP was 6% lower than it was in the mid-1990s, the nation
Focus still boasts the worlds third-largest economy, with relatively low unemployment.

The three arrows of Abenomics, Japans economic recovery program, are aggressive
Leadership & Management monetary easing, flexible fiscal policy and structural reforms to raise potential growth.
Strategy
Sales & Marketing
Launched at the end of 2012, Abenomics has turbo-charged the Bank of Japans asset-
purchase program.
Finance
Human Resources Japan is aging in fast forward, with the highest life expectancy globally, a slowing
IT, Production & Logistics fertility rate and minimal immigration.
Career & Self-Development
Japan plans to reform the protected agricultural sector and create special economic
Small Business zones.
Economics & Politics
Industries
Abenomics aims to increase innovation, the corporate profit motive and risk taking.
Global Business Recent estimates say that Japans staggering 240% debt-to-GDP ratio will climb still
Concepts & Trends further to 280% by 2030.

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getabstract

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Relevance
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What You Will Learn
How Japans economy has fared since the 1990s,r1) How Abenomics aims to bolster growth, 2) What outcomes
Prime Minister Shinz Abes policies have had as of 2015, and 3) How Japans economic future may unfold.
getabstract
Review
Japans economic journey since the 1980s has been intriguing. In some ways, the countrys problems are unique, but
it has also had to tackle issues similar to those of other Western nations, only more so and first. To some, Prime
Minister Shinz Abes raft of reforms, called Abenomics, is a disconcerting mix of right-wing structural adjustments
and left-leaning quantitative easing and massive deficit spending. While many of Abes proposed reforms seem
uncontroversial and sensible, they also entail attempts to make corporations less prudent and more profit-hungry
an aspiration that may startle Western observers. Japans strengths including the size of its economy, its robust
currency and its global trading position contribute to an economic picture that feels simultaneously extreme and
logical. This compendium of essays by economists Dennis Botman and Stephan Danninger, professor Jerald Schiff
and a team of area experts and International Monetary Fund contributors is quite dry in places, as you might expect,
and the different contributors often go over the same ground sometimes with slightly different conclusions. But
their explanations are fascinating, and their top-notch factual content is comprehensive. getAbstract recommends this
text to economists, executives and investors with the note that Japans economic progress may offer some important
lessons for other countries.
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Summary
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Japans Lost Decades: Low Growth and Mild Deflation
In the decades after World War II, the formidable success of Japans manufacturing and
export sectors brought with it an extreme asset price bubble that began to implode around
1990. The economy was slowly starting to recover when the 1998 Asian financial crisis
getabstract hit. It triggered a full-blown banking panic and severe credit crunch in Japan, and it
The last 20 years exposed the extent of the nonperforming loans hiding on corporate balance sheets. The
have not been easy for
Japan. Great Recession pulled Japan back into recessionary territory again, and the 2011 Great
getabstract East Japan Earthquake delivered another economic shock to the system.

A particular and, in some respects, unlucky combination of factors culminated in strong

deflationary pressures and a lack of domestic demand in Japan during its lost decades. These
factors included a worldwide trend toward lower inflation and a frequently over-strong
yen, thanks to Japans resilient exports, its peoples propensity for saving and the yens
attractiveness as an inherently safe-haven currency in difficult economic times. During
getabstract that period, companies that were still performing well found that holding cash was more
Each time the
economy appeared attractive than investing. Tax revenue fell. Deflation generally undermined the functioning
to get back on its of financial markets and reduced the effectiveness of using interest rates as a monetary tool.
feet, adverse shocks
such as the Asian
financial crisis, the But as the strength of the yen illustrates, Japan doesnt conform to the usual picture
bursting of the dot-com
bubble and the global of a country in trouble. Although its nominal 2013 GDP was 6% lower than in the
financial crisis beset mid-1990s, the nation still boasts the third-largest economy in the world, with relatively
the country.
getabstract low unemployment. It has steady productivity growth, a solid presence in growing Asian
markets and a strengthening upstream position in international supply chains. For
example, Japanese companies contribute an average 10% of the value added in Chinas

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 electrical equipment exports. So although Japans economy has worsened in some ways,
its position in global trade has gone from strength to strength.

getabstract Since recovering from its banking crisis in 2000, Japan has enjoyed a relatively healthy,
Persistent deflation
has costs as it stable financial system. It remains one of the largest providers of global liquidity, thanks
undermines the effective to its current account surplus. Japans now-healthy banks earn 30% of their gross profits
functioning of financial
markets and the ability abroad, and theyre well-positioned to increase their lending to fast-growing Asian
of macroeconomic economies. Even Japans staggering 240% debt-to-GDP ratio the highest among the
policies to stabilize the
economy. developed countries is mitigated to some degree by the fact that domestic savers hold
getabstract 90% of the governments bonds.

In 2013, Prime Minister Shinz Abes administration launched an economic recovery

program, dubbed Abenomics, which consists of three arrows: aggressive monetary
easing, structural reforms to raise potential growth and flexible fiscal policy.

getabstract Arrow 1: Aggressive Monetary Easing

The experience
during the Lost Because of its unusual economic history, Japans central bank was a pioneer in quantitative
Decade suggests that easing (QE), starting its program in 2001. In 2006, Japan went through a tapering scenario,
a higher inflation
target and more where it demonstrated the value of clear forward guidance and a transparent, flexible QE
aggressive monetary policy.
easingwould
have substantially
improved the economys More recent studies conclude, with the benefit of hindsight, that Japans unusually low
performance.
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inflation during the lost decades required more easing than the central bank undertook.
The nations stop-go fiscal stimuli did little good in the first lost decade. Experts say,
however, that QE did work to some degree in that period, since equity markets strengthened
and volatility declined. The purchase of private company assets reduced risk premiums,
showing how the composition of asset purchases matters. Quantitative easing suppressed
the interest rates on government bonds and made commercial assets more attractive, thereby
inducing portfolio rebalancing toward more growth-producing investments.
getabstract
Once the health of
the banking sector Abenomics turbo-charged the Bank of Japans asset-purchase program. A target of 2%
improvedthese [QE]
measures also started to
inflation is central to its forward guidance approach The central bank has increased its
show some effectiveness purchases of new government bonds from the 70% it was already buying, with the aim of
in supporting real doubling Japans monetary base to 54% of GDP, with greater emphasis on longer-dated
activity.
getabstract government securities and expanding purchases of risk assets, such as commercial paper
[and] corporate bonds. The magnitude of the QE push in 2013 increased annual purchases
of Japanese government bonds from 50 trillion to 80 trillion.

Japan has demonstrated the significance of forward guidance in communicating monetary

policy. When lowering interest rates no longer has an impact and the financial system is
weak or risk averse, information from central bank authorities becomes critical, since only
getabstract
Unconventional they can clarify their approach to markets. The expectation of a future continuation of their
monetary policies had a policy, or of a coming change, can be as important as the present-day operations.
statistically significant
impact on bond yields,
risk sentiment and Arrow 2: Structural Reforms
equity prices, but Many of the structural economic reforms Abenomics proposes will help address the
no notable effect on
the exchange rate or headwinds of Japans aging population. The average life expectancy in Japan the
inflation expectations. highest in the world along with a slowing fertility rate and minimal immigration has the
getabstract
country aging in fast forward.

Beginning in the mid-1990s, the impacts of this demographic trend started to manifest as a

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 decline in the working population from a peak 87 million workers in 1995 to a forecast 55
million by 2050. The drop in the labor pool accounts for much of the economys previously
weak annual growth, and it is likely that the declining working-age population since the
getabstract mid-1990s contributed to the mild deflation. So analysts can trace Japans main problem
The positive effects
on growth and fiscal areas of poor growth, an overly strong yen and deflation, in part, to its aging population.
sustainability are
mainly due to the rise in
inflation expectations, Experts expect land prices to fall as older people move to smaller accommodations.
which lowers the Spending patterns will shift from housing, transport and education to medical and utilities
real interest rate and
stimulates investment. expenditures. Investment changes will occur as older individuals move their savings to
getabstract safer assets such as bonds, driving down yields. Certainly, greater state spending on health
care and pensions will strain budgets already dealing with smaller tax bases. The fiscal
implications of an aging population include an increase in pension spending from 5.2% of
GDP in 1990 to 10.9% in 2010. Long-term care and public health spending over the same
period rose from 4.1% to 8.3% of GDP.
getabstract
A key vulnerability The old stereotype of the Japanese salaryman with a job for life is still partly true.
of Japans financial
system is its high However, a growing proportion of the workforce consists of nonregular employees who
exposure to interest dont attain the security and privileges of regular Japanese workers. Employers hampered
rates as a result
of large Japanese by inflexible work policies have contributed to a growing two-tier labor market in Japan.
Government Bond This negatively affects productivity by keeping women, immigrants and older workers out
holdings[findings]
suggest that this of the labor force. The combination of more nonregular contracts and regular workers
risk will persistently prioritization of security over pay increases has contributed to low wage growth.
decline if Abenomics is
successful.
getabstract However, a middle ground exists in the two-tier labor market: Open-ended employment
contracts that provide escalating benefits and security as time goes on, modeled on similar
contracts in Spain and the Netherlands, could help Japan address its labor problems.

The government has offered tax incentives to companies that increase their workers pay,
and it has reversed its own public-sector wage cuts. Other structural reforms include policies
getabstract
Monetary policy that raise the pension age, an effort to increase married womens participation in the
depends not just on workplace and proposals for controlled immigration.
the current value of
the policy rate but on
public expectations of Arrow 3: Flexible Fiscal Policy
future settings of that The third arrow of Abenomics creates a flexible fiscal policy that shows financial markets
rate.
getabstract that the nation has a credible plan for tackling government finances. Abenomics includes
growth-friendly proposals to reform the protected agricultural sector, create legislation for
special economic zones and conduct further Trans-Pacific Partnership negotiations.

Japans total tax revenue is fairly low compared to that of other advanced countries, and
a change in emphasis from income taxes to consumption taxes, which are especially low,
is underway. Consumption taxes dont dampen either job creation or corporate investment
incentives.
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Japans growth
performance over Japans world-beating automotive and electronics sectors are known for their process
the past two decades innovation, but entrepreneurial risk taking and radical product innovation arent Japans
has been robust if
population aging is strong suits. Abenomics calls for addressing the undersized venture capital industry and
excluded. the nations relatively small foreign direct investment inflows. The government wants to
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restore credit discipline and to reduce the practice of keeping unprofitable businesses
alive, which impedes innovation. The state also plans to open domestic sectors to greater
competition. It also supports further financial and manufacturing integration with Japans
fast-growing Asian neighbors, including regional trade agreements.

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 Japanese savers are notoriously risk averse. They helped mop up the huge volume of low-
yielding Japanese government bonds, but the ultimate success of Abenomics depends partly
on encouraging enterprise investments with higher risks. This portfolio rebalancing effort
aims to pull the economy away from the stimulus spending and bond-buying patterns of
recent decades and toward a more conventional, self-sustaining private enterprise economy.
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Introducing a
single open-ended In January 2014, Japan launched a new stock index JPX Nikkei 400 composed of
[employment] contract native companies whose governance focuses on shareholder returns and profitability. The
woulddrastically
reduce firms marginal government underlined its commitment by investing part of its employee pension fund in
costs of converting the index. Officials are also seeking to introduce reforms that will raise the amount of risk
nonregular to regular
positions. capital investors provide by improving underdeveloped risk management tools.
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How Is Abenomics Going?
The announcement and start of Abenomics at the end of 2012 had a decisive effect on
Japans economy. The Nikkei equity index rose 80% between September 2012 and April
2013, with especially large gains for export-oriented firms. First-quarter 2013 GDP grew
4.1%, but the tightening labor market still didnt experience wage growth. Quantitative and
qualitative easing have had the desired effects of lowering bond yields, cutting the prices
of more risky investments, and reducing the prospect of further individual institution or
systemic credit issues in financial markets.
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Productivity growth However, export and investment growth have remained surprisingly flat. Banks have
has remained solid in
Japan. used their newfound financial space to accumulate reserves with the Bank of Japan rather
getabstract than increasing their lending to companies. The hoped-for move to a private investment-
and consumption-led recovery has proved elusive. A consumption tax increase from 5%
to 8% in April 2014 knocked the wind out of the recovery, leading to the October 2014
postponement of a second increase to 10%. A further jump to a 15% consumption tax
remains a future possibility. Meanwhile, inflation expectations have proven harder to turn
around but have improved slightly.

Quantitative easing hasnt affected the yen to the desired extent, but demand for exporting
more fuel from abroad in the wake of the March 2011 earthquake, as well as the calming
getabstract of the euro crisis that reduced safe-haven flows into yen assets, has helped on this account.
The yen is widely
considered a safe-haven
Recent estimates point to Japans staggering 240% debt-to-GDP ratio climbing still further
currencySince 2008, to 280% by 2030. This makes the interest rate payable on this debt a key factor in Japans
the yen appreciated growth and sustainability.
steadily against the
US dollar in effective
terms in the aftermath Japans economy has encountered and will continue to face some unique challenges, but
of various shocks.
getabstract its policy levers and progress may offer some important lessons for the rest of the world.
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About the Authors
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Dennis Botman and Stephan Danninger are economists with the International Monetary Fund. Jerald Schiff is an
adjunct professor at American University in Washington, DC.

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