The bold policies promised by Japan’s new government look ill-suited to reverse a relative decline that has turned a leading actor on the world economic stage into a bit-part player in less than a generation.
With Japan mired in its fourth recession since 2000, incoming Prime Minister Shinzo Abe campaigned on a platform of ‘unlimited’ monetary easing by the Bank of Japan (BOJ) as well as a splurge in public-works spending.
The yen has already started to weaken and could well decline further if the central bank succumbs to political pressure to set a formal inflation target. That would bring relief to Japanese exporters and, at the margin, provide a cyclical lift to growth.
“We’re already in a world with lots of excess liquidity in the system from the big central banks, but if the BOJ were to add to that then it would be another positive for risky assets. This is an additional tap that is, potentially at least, being turned on,” said Philip Poole, global head of investment strategy at HSBC Global Asset Management in London.
Yet if loose fiscal and monetary policy were a cure-all, Japan’s economy would not be in the sick ward in the first place.
The government is running a budget deficit of about 10 per cent of gross domestic product and its gross debt has risen from less than 68 per cent of GDP in 1990 to more than 235 per cent now.
And the Bank of Japan pioneered unconventional monetary policies a decade ago once it had reduced interest rates close to zero, introducing asset-purchase programs that have since been copied by other central banks, notably the U.S. Federal Reserve and the Bank of England.
Julian Jessop, chief international economist with Capital Economics, a London consultancy, said investors could be getting their hopes too high. After all, the BOJ has failed to reach its inflation ‘goal’ of 1 per cent, never mind the more ambitious ‘target’ of 2 per cent eyed by Mr. Abe.
Moreover, the Liberal Democratic Party, which Mr. Abe heads, was in government for much of the past two decades since Japan’s property and share-price bubble burst, crippling its banks and ushering in permanent low-level deflation.
“I don’t dismiss it entirely, but I’m a little bit sceptical that there will be a major sea change in policy,” Mr. Jessop said.
Tokyo’s policy response matters not only because Japan remains the world’s third-largest economy. Its experience is being closely watched by other countries that are also drowning in government debt, have already driven interest rates down to zero and will soon join Japan in having fast-ageing populations.
Growth in Japan’s working-age population peaked in the late 1980s, just before its asset bubble burst, and turned negative at the turn of the century.
Not surprisingly, Japan’s capital stock has mirrored the trend because businesses cannot justify making new investments to serve a shrinking pool of consumers.
With companies’ return on capital almost zero, monetary policy becomes as effective as pushing on a piece of string, according to Ryutaro Kono, an economist with BNP Paribas in Tokyo.
Indeed, even the existing capital stock is excessive in such an environment: net private investment has been negative in Japan since the mid-1990s as firms have written off old plant and equipment.
The slump in capital spending has freed up savings to help finance the government’s big budget deficit, but at some point the dearth of investment will push Japan’s trend growth rate, now no higher than 0.5 per cent, below zero.
That would depress tax revenues and touch off a long-feared fiscal meltdown, perhaps early next decade, Mr. Kono wrote in a recent paper.
All this makes Japan something of a laboratory experiment for economic and social policy.
According to U.N. projections, both the United States and the euro area are expected over the next 20 years to experience the same sort of decline in the share of their 15-64 age bracket - a drop of nearly 10 per cent - as Japan in the last 20 years.
Italy and Germany have particularly adverse demographic profiles.
“If Europe today accounts for just over 7 per cent of the world’s population, produces around 25 per cent of global GDP and has to finance 50 per cent of global social spending, then it’s obvious that it will have to work very hard to maintain its prosperity and way of life,” German Chancellor Angela Merkel told the Financial Times in an interview published on Monday.
On the face of it, Japan is a prime candidate for the combination of belt-tightening and deep-seated reform that Ms. Merkel tirelessly presses on the euro zone.
Nominal GDP is lower today than it was in 1992, greatly exacerbating the debt-to-GDP burden. Aggregate hours worked in Japan over the past 20 years have fallen by a whopping 15 per cent, whereas they increased in the United States and the euro area, Nathan Sheets with Citigroup in New York calculates.
Although the female labour participation rate in Japan has reached U.S. and European levels, the working-age population is projected by the government to drop another 7.7 million, or 9.4 per cent, this decade. Immigration to offset the decline is strictly controlled.
“Do you want to have a rising labour force or not? Japan has so far decided no, and that sets the determinant for growth, full stop,” said Jim O’Neill, chairman of Goldman Sachs Asset Management in London.
With Japan under no bond market pressure, Mr. O’Neill sees nothing to suggest that Mr. Abe will embark on the sort of difficult reforms to enhance productivity and growth that the likes of Ireland, Portugal and Spain are pushing through.
But he said Japan’s circumstances raised a broader question: Why should an already wealthy society risk its famed social harmony by subjecting itself to wrenching change just to maintain its lead over new aggressive competitors?
After all, Japan has continued to increase its per capita GDP over the past two decades - albeit by much less than the United States and the euro area - and its unemployment rate remains enviably low.
It might be quite rational, as long as markets keep co-operating, for Japan to stick with its “happy depression”, Mr. O’Neill concluded.
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