Abenomics
Student’s Name
Institutional Affiliation
Abstract
In the period between 1990 to 2012, Japan witnessed the most significant economic recession that took a tailspin on the stock and real estate market. According to Nobel Laureate, Paul Krugman, Japan’s recession was primarily due to a liquidity trap that has interfered with the bank’s ability to apply monetary policies that aid in regulating interest rates. However, empirical studies have shown that Japan’s problems stem from other sources such as the aging population problem, banking behavior, fiscal policy, liquidity trap, and transfers from central Government to the Local Government. There exist many resources that argue that the Japanese recession happened due to the growing vertical I.S. curve rather than the alleged liquidity trap. To date, massive loopholes still exist in the economy following the severe economic downturn that hit Japan in the period between 1990-2012. The recovery of the once modest economy has been set back by the March 2011 earthquakes and Tsunamis that struck Japan. With the country having the third-largest economy in the world, its economy is vulnerable to three main problems. Firstly the stagnant economic growth due to the structural problem in the 1990s is still deep-rooted in the system. However, critics forecast the possibility of the Abenomics strategy collapsing as the Government does not provide sufficient details of the progress of the initial steps to accomplishing the overall plan. After four years of single stimulus allocation and policy implementation, the country’s economy has moderately bloomed, inflation is below target, national’s debt and effects of structural reforms continue to prevail, and monetary easing remains a highly contentious issue. With the U.S. Federal Reserve continuously increasing their interest rates and abandon quantitative easing policies, it is uncertain what the future holds for the Japanese economy.
Keywords: Abenomics, Economic recession, Liquidity trap, monetary policy, Fiscal policy, Qualitative easing, Quantitative easing
Abenomics
Introduction
In the early 1990s, Japan experienced an economic slowdown that took a significant toll on the stock and the real estate market. The period leading to 2010, Japan suffered stagnant economic growth due to the weak economy that lasted for almost a decade. In the years 1995-2002, Japan’s annual average growth stood at 1.2% a relatively small compared to the G7 countries such as Canada with a gross index of 3.4%, the United Kingdom 2.7%, France 2.3%United States 3.2% and Germany 1.4%. Also, the countries lagged compared to less than half of all the other larger Organizations for Economic Co-operation and Development (OECD) countries such as the Republic of Korea 5.3%, Spain (3.3%), Australia 3.8%, Mexico 2.6%, and the rest of the Eurozone annual economic growth. Japan’s average yearly economic growth is also slightly lower than the OECD-wide average, which stands at 2.7%. Japan’s economic recession serves as a benchmark for other countries to study how low economic growth can affect the economy.
According to Nobel Laureate, Paul Krugman, Japan’s recession is primarily due to a liquidity trap that has interfered with the bank’s ability to apply monetary policies that aid in regulating interest rates. Empirical studies have shown that Japan’s problems stem from other sources. There exist many resources that argue that the Japan recession by the I.S. curve rather than the alleged liquidity trap. At the moment, there exists a wide range of reasons that influenced long-term stagnation, such as Japan’s aging population. With one of the highest life expectancy rates, the older adults in Japan make up a significant percentage of the community. As of now, Japan’s retirement age is 60 years old. The yearly turnover of this age bracket leaves the job industry grappling in a low workforce, which simultaneously causes small production. The number of older people is increasing while the younger generation is on the spiral decrease. The elderly consume less than the young people; therefore, this population difference causes reduced domestic consumption leading to slow economic growth. Other factors include the reshuffling of the centralized Government and commissioning of powers to the Local Government as well as the stringent banking measures labeled as Basel Capital requirements that curtailed banks from lending money to small startups business and SMEs. These rigorous measures halted Japanese innovation and technological advancements, which is a significant contributor to economic growth. This paper discusses the causes, consequences, and remedies of the most prolonged and severe economic recession in the history of Japan.
Banking Behavior
In the wake of 1980, Japanese banks made it mandatory for all banks to issue loans only to individuals with certified collateral properties or land. Immediately after issuing this directive, land prices started to decline, causing the banks to accumulate bad loan assets. happened due to the issue with the I.S curve.The vertical I.S curve caused the gradual increase of banking errors, which simultaneously lead to the closure of many banks, and the banking industry went into a tailspin in the period leading to 1991. To help resuscitate and recover the banks, the Deposit Insurance Corporation of Japan raised financial assistance to the affected banks. However, with the help of the DICJ, the failed banks took a decade to function correctly again. At the same, the issuance of the Basel Capital requirements greatly affected the monetary policies and measures in the banking sector. Basel 1 regulation stated that all banks should retain 8% capital regardless of the economic conditions. In effect, Japanese banks become reluctant to lend money to small startups and SMEs to avoid a shortage of capital. The banks also minimized the borrowing tendencies and capability to ensure retention of the 8% capital. It became increasingly difficult for startup businesses and SMEs to thrive, which are significant contributors to the Japanese economy as they could not borrow money from the banks. The financial and capital markets have a substantial impact on SMEs as they can provide security and contingencies in case of a failed launch.
Fiscal Policy
In 1990, to recover the economy, Prime Minister Miyazawa implemented the Fiscal policy. In his mandate, the Prime Minister aimed for the administration of the Public investment (Keynesian policies) to be adopted to boost the economy. However, the administration of the Keynesian policies did enforce a high growth as previously anticipated. The public policies facilitated the construction of roads and bridges that did not boost or aid in the recovery of the economy. New infrastructure investment had minimal impact on the gross national income as it was an ineffective method to revive the economy. Most of the public investment concentrated in rural areas that have less impact on the national economy compared to urban areas. Public investment in the agricultural sector is less effective compared to the bulk of public investment in the Industrial and service sector. The bulk allocation of public investment in the rural and agricultural centered regions projected unequal distribution of resources. It resulted in the multiplier if public investment drastic decline from an estimated 2.5 to about 1 in the last decade. A contextual review shows that public investments escalate budgetary deficits rather than bring about the economic recovery of Japan. As a result, the whole project had low simulative effects on the annual average economic growth in Japan. The misallocation of the public funds is evident in the yearly financial returns in terms of private and public performances in regards to boosting economic output
Ageing Population Problem
Japan has the highest life expectancy in the world. However, the retirement age is 60 years of age. Therefore the working population is slowly diminishing while the elderly population increases. Additionally, older adults consume relatively less than younger people causing a drastic decline in domestic consumption, which has ripple effects on the gross national income products. As a result, the aging population marked as the most significant cause of the severe economic recession in Japan.
Furthermore, the payment system in Japais based on seniority. Employees holding superior positions get more wages than those in lower ranks job categories. The seniority wage-based system curtails the employment of older people to fill vacant positions. Japenese Government stipulates that everyone above 60 years should retire regardless of the ability, skills, and social class. The dismissal of the elderly from stable jobs affected them mentally, socially, and even financially, and most of them ended up in social homes. As a result, the Government allocates one-third of the budget to social welfares to take care of the older adults causing the budget deficit to rise annually because these funds could have put into more optimal use to aid in the growth and recovery of the economy.
Transfer from the Central Government to the Local Government
The transfer of the authority from the central Government to the Local Government accounts for the second-largest government expense after social security in Japan. For the longest time, possible local governments heavily rely on the central Government transfers without making a minimum impact on growing the economy. For instance, in rural Japan, farmers solely depend on innovation and distribution systems and services provided by the local Government. The rigid and non- growing system failed to revitalize the system as well as the economies. Farmers lack the initiative and morale to develop and innovate to expand their agricultural production. The growing need to transfer funds from the central Government to the Local Government has curtailed access to education, research, and science, which only accounts for 5.6% of the total government expenditures. As a result, the imbalance has dramatically affected the economic growth across the country, and local governments should be financed by the private sectors to reduce high dependence and misappropriation of the central Government’s total expenditure account.
Liquidity Trap
Economists and financial analysts also argue that Japan’s; severe economic recession can be explained as a liquidity trap. Popular literature focuses on the monetary policies and ignores the structural issues which also play a role in the economic crunch in Japan, such as the vertical I.S. curve. The vertical I.S. curve shows an exceptional trend as even with the low-interest rates, the private sector did not bloom as expected. The industry experienced low return rates continuously despite the relatively slow technological advancements in the country. Even after the Central Bank reduced its short-term interests to zero, the Japanese economy was not able to recover as there was limited corporate restructuring. Financial analysts, Government advisors concentrated more on the monetary policies and failed to consider eradicating idle capacity and venturing into the new investment to recover the economy. The Government ignored the skyrocketing vertical I.S. curve that was drastically increasing due to current and previous economic conditions. These reasons include: when the real estate and the stock exchange market burst, companies invested heavily in excess capacity in various sectors to remain afloat, but the demand suddenly pommeled. Secondly, the high FDI Japan imposed on other Asian countries due to high appreciation of the yen as well as the high wage rates in Japan combined by the high annual average economic growth in other Asian countries because it soaring demand in those regions? Thirdly, as innovative and highly integrated technological companies pulled out investments from Japan, and the country experienced marginal productivity decline as only weak and unproductive companies were in operation. Lastly, the vertical I.S. curve came about because of the harsh economic conditions startups faced. The inability of the banks to lend to starts caused a dramatic decline in innovation and the eventual slowdown of the economy.
In the mid-1990s, the yen appreciated forcing major manufacturing companies to invest in other Asian countries. Also, the increase in the factors of production such as labor caused Japanese companies to move abroad which simultaneously negatively affected the domestic production in Japan (Naoyuki & Farhad, 2015)
Consequences
To date, massive loopholes still exist in the economy following the severe economic recession that hit Japan in the period between 1990 to 2012. The recovery of the once modest economy has been set back by the March 2011 earthquakes and Tsunamis that struck Japan. With the country having the third-largest economy in the world, its economy is still vulnerable to three main problems. Firstly the stagnant economic growth due to the structural problem in the 1990s is still deep-rooted in the system. Since the real estate and stock exchange bubble burst, the economy has been on a tailspin. Growth domestic production has been on a downward spiral. Compared to the USA and China, Japan’s GDP in 2012 is 18% higher in financial markets in 1991, much less than the G7 countries except for Italy. There are several reasons behind the weak economic growth that most parts marked the most prolonged economic recession in the history of Japan. These include: (i) the growing increase in the number of older people, with an estimated 40% decline in the work population by 2050. (ii) Rigid, uncompetitive sectors that have a high dependence on the central Government to the Local Government such as agriculture, energy, and healthcare. (iii) The division of the labor markets based on seniority such that regular workers had ample wages and generous rights. In contrast, nonregular workers get minimal benefits with fewer rights and short term contracts.
Deflation is another critical problem that Japan still fights to date. The failing prices have become a common phenomenon and have harmful effects on the economy. For the last two decades, deflation has become entrenched in the system. For instance, in Japan, consumers limit the consumption or purchase of certain products for a given time because the prices will drop; as a result, investors get discouraged investing in Japan and move abroad. in turn, negatively affects the country’s GDP growth. Addition deflation has caused an increased decline in the wage rate that impacts consumption spending. Furthermore, deflation increases real debt returns putting additional pressure on Japan’s massive deficit.
Lastly, the high level of public sector deficits still ails the country. A failed economy and continuous transfers of public funds to the local Government have increased the Gross national debt levels to 238% compared to U.K. 90% as of 2012. Year after year of public investment has led Japan to accumulated huge public sector debts. The Government implementation of continuous stimulus plans to recover the economy has not only failed but proliferated large deficits. On average, the general government deficit between 2009 and 2012 was 10% of the country’s GDP. The continuous accumulation of these massive deficits over a relatively long time has resulted in a sharp increase in the level of debt. The general Government gross debt has skyrocketed from 67% of the GDP in 1990 to and 2385 of the GDP 2012.
Despite the massive deficits, Japan faces minimal challenges while borrowing. Over the years, Japan has retained its borrowing power regardless of its unparalleled debts amongst stronger economies. Japan borrows at very low-interest rates. One of the significant reasons is home-based pension funds in most of the Japanese banks, which ensure that 90% of the funds remain in the country for a relatively long period. Also, Japan has low-interest rates due to the popular saving culture of the Japanese people. Therefore banks pull together large pools of savings in the local banks. Furthermore, deflation plays an integral role as it ensures the interest rates paid are far below the real value. Although Japan has had no crisis of market confidence, the long term fiscal sustainability has been criticized and questioned by many financial organizations and Capital financiers such as the OECD. In 2013 the economic survey of Japan stated that the unique equilibrium characterized by low-interest rates would not last for a long time as there will be a marked rise in interest rates that could potentially damage the banking system (Daniel, 2013).
To salvage the country from the grappling snares of destruction, Prime Minister Shinzo Abe has launched a three-pronged approach commonly known as Abenomics in 2013. Prime Minister Abe’s policies fall into three categories: Monetary policy, Fiscal policy, and the Economic Growth strategy. Mr. Abe structured these three policies to remedy the economy and made them a centerpiece of his term as the prime minister. The goal was to revive the economy by boosting domestic consumption and gross domestic product growth while raising inflation to 2%. Abe’s corporate restructuring policies aim to boost the country’s economic standing by increasing the competitive power, restructuring labor markets, and creating a conducive environment for trade partnerships.
With only four years in office, there has been an exceptional success; the country has experienced a systemic shift in economic growth indices. Under the monetary stimulus, the Bank of Japan has heavily invested in tackling deflation to boost economic growth in the country. In 2012 the BOJ implemented policies to cut down the interest rate to virtually zero. The strategy failed to peak as there was too much political pressure that did not consider the economic conditions. The following year the BOJ bolder policies to oversee monetary easing and set an inflation goal of 2%. Despite the heated debate and criticism of the viability of this policy, the Government has remained adamant that it is possible to achieve the target inflation soon. Furthermore, Abe appointed Haruhiko Kuroda as the governor of the BOJ to implement more aggressive measures to facilitate the achievement of the inflation target. Immediately after his appointment, he announced new standards that have been significant to end deflation. These measures include qualitative and quantitative easing to uplift the inflation to the set target within two years. The BOJ further announced the doubling of the quantitative easing, which will increase the monetary base from 138trillion yen in 2012 to 270 trillion yen by the end of 2014. As stated, this money will purchase Government bonds to keep the BOJ afloat. Moreover, the BOJ will double the average maturity of Government bonds purchase by 3 to 7 years. This part of the qualitative policy will help the bank venture into riskier investments directly or indirectly through lending loans to individuals, firms, or purchasing assets in Japan or abroad. The extended maturity period of the Government bonds will aid in increasing the long-term interest rates as the demand for these bonds skyrockets, which may inversely increase the demand for individual loans, which may, in return, boost economic growth. The critical function of these monetary policies was to end deflation and drive economic growth. These policies in the value of the yen could potentially depreciate, making Japanese goods cheaper to foreign markets, thereby increasing exports. On the other hand, this policy could damage the market confidence of Japan in the financial markets; gradually raise interest rates on government borrowing, thus affecting the banking system that depends on large deficits and government bonds.
Not long after taking office, Abe Government announced a fiscal stimulus package that comprised of over 10 trillion yen or 2.2% of the GDP made up of the three major elements. The first package consists of 37% supplemental funds channeled to the disaster, and relief prevention measures help in the reconstruction and rehabilitation of areas affected by the 2011 earthquake. The second package included implementing measures and ventures that encourage business investments. The final package consisted of social spending and money allocation to revive depressed areas in the economy. The Government projected that the stimulus would boost the GDP and adds 600,000 jobs in the country. It aimed to provide a temporary boost to the economy while developing and structuring a long term structural reform plan, which would take a relatively longer time than expected.
One of the dangers of this plan is that the temporary boost to the economy will accrue massive stock that, in relevance to the already existing public debt, is not healthy for the economy. Moving forward, the Government has acknowledged the magnitude of the fiscal challenges and sought to formulate measures to cushion Japan’s market confidence in the country’s long-term financial sustainability by developing a medium-term plan. In its initial plan, the Government had committed to reducing the primary deficit by half excluding the debt interest payment by 2015 and eradicate the debt by 2020.
To reduce the massive deficit, the Government has enacted the impending consumption tax from 5% to 8%. The rationale behind the tax rise is to provide additional revenues to supplement the eradication of the gross national debt. Despite the controversy surrounding this policy due to its remarkable failure in 1997, the Government implemented and allocated a 5trillion yen stimulus package to avoid a repeat of the previous performance. The stimulus covered the public works spending needed for the Olympic Games in Tokyo in 2020. However, there is much criticism from financiers and Government oversight that the tainted perception of the consumption tax portrays governments’ commitment to long-term fiscal sustainability.
The final and most crucial component of the Abenomics is the structural reforms. Although aggressive monetary and fiscal policies were essential to revive Japan’s economy, many believe the corporate restructuring is the solution to end the severe economic recession. Prime Minister Abe also shared in the same belief, and shortly after taking office announced the initial steps the Government would embark on to reverse the two decades of underperformance and achieve its mega ambitious growth strategy. According to Abe, the fundamental steps include; increasing the female workforce population in all industries, particularly mothers, by improving access and availability childcare in the workplaces as well as incorporating younger people in the job market. In Japan, a significant percentage of the working population are men as women often leave their jobs after having children and dedicate their time to nurturing and tending to their children. The cumulative effect results in lower participation of mothers in building the economy. Due to the rapidly aging population and diminishing workforce, the Government encouraged greater female participation in the Macroenteprises. One of the ways the Government achieved this is by providing flexibility and a sound childcare system that allows the mothers to return to works after giving birth, such as improving childcare facilities.
Additionally, this system had a positive effect on the birthrate as inadequate childcare may act as a deterrent to childbearing. Another fundamental step in structural reforms is the deregulation of specific sectors that are termed rigid and uncompetitive such as health, energy, and agriculture. The Government creates an incentive mechanism to abolish the existing central bank to local government distribution of transfers to reduce low rate returns. The Government opened up the sectors to private investors and venturing into entrepreneurship. For example, the Government legalized the sale of non-prescription drugs in Government and privately-owned chemists. Opening up this sector will attract private investors, thus creating a competitive environment as the industries producing high yields on return will gain the most transfers. Through this, the Government was able to allocate to other vital sectors in a more clearly defined manner to account for the spending and expenditure.
Future of Abenomics
However, critics forecast the possibility of the Abenomics strategy collapsing as the Government does not provide sufficient details of the progress of the initial steps to accomplishing the overall plan. For instance, restructuring the labor markets was not part of the strategy to re revive the economy at the time it was perceived as not an underlying issue. The Japanese workforce is sensitive to labor laws and required a lot of sensitization to fully understand the need and relevance for the restructure the benefits on an individual level as well as economic prospects. The ambitious growth strategy also included talks with significant economies such as the U.S. on setting up a free-trade for 11 countries near the Pacific Ocean. According to the Japanese Cabinet office, the free trade agreement would boost the Japanese GDP by 0.7% after a decade.
Since the inception of Abenomics in Japan, the country’s economic growth has undergone momentous growth, incremental GDP increase, and robust wage rate growth, and inflation been on a spiral. Late December 2017, inflation currently stands a 1 percent half of the set target in 2013. Growth has been gradual: Japan’s annual average economic growth bloomed and skyrocketed by 0.5 as forecasted by the annual economic survey of Japan, indicating three the prospects of a healthy economy for the first time in three decades. At the moment, the underlying factor driving the modest economic growth is the soaring global demand for its technological innovations, especially in high-tech electronics. The country’s investment in technological progress, particularly on robotics and labor-saving technology, has saved the country’s labor shortage problem due to the rapidly aging population. Aggressive monetary policies and deregulation of the job markets have also massively boosted the national economy.
However, policymakers and economists perceive consumer spending and wage growth significantly less. Politicians argue the monetary policies have adverse effects on the economy rather than positive. For instance, in 2017, household spending significantly dropped by 0.1 percent while the incomes fell by 0.2%. Additionally, the wages have been on a tailspin from 1997 shortly after the fixed asset bubble burst in 1997. According to policymakers, this is not a good representation of a growing economy. Following his reelection in 2017, Abe has vehemently pushed for companies to increase pay by 3%. Still, dominant companies have been defied the directive due to the potential loss of their competitive power and the gradual increase in the cost of production.
Recently many observers allude for implementation of bolder structural changes or paradigm demographic shift failure to which the Japanese economy will continue to promote. Some experts argue that sourcing workforce from neighboring countries would slowly boost the economy, but it remains a highly contentious matter. Meanwhile, the qualitative and qualitative part of the monetary policies as a temporary boost to the economy will have great input soon given the planned reelection of the BOJ Governor for another term in office.
On the other hand, critics argue monetary easing could contribute to another economic recession. In 2012 quantitative easing had failed to end deflation in Japan as the economy could not withstand the injection of newly created many due to the low workforce and private investors. As a result, monetary easing caused hyperinflation. Similarly, Abenomics is likely to replicate this same scenario in Japan, given the growing concern for Abe’s plan to end deflation. Next, the large deficit adding up to one quadrillion is highly likely to cause an economic crunch in the future. Monetary organizations such as the International Monetary Fund have vehemently warned Japan that these kind of accumulative debts are not healthy for the economy as well as the longer-term fiscal sustainability.
Also, the recent U.S. decision to withdraw from the Trans-Pacific Partnership will deter Abe’s plan to integrate a free market trade with the U.S. and 11 countries bordering the Pacific Ocean. Some experts say Trump’s decision to withdraw from the pact incapacitates Abe’s plan for economic reform. At the same time, the U.S. is seeking to set up a bilateral U.S. trade deal that will dismiss the Trans-Pacific partnership. The surfaces of this deal put pressure on the Abe to deliver lower tariffs and extend reforms not only in Agriculture but highly contentious matters such as high-tech, robotics, and machinery. As a result, Abe’s Government has declined any bilateral talks with the U. S Government. At the same time, Abe’s Government unverified negative interest rates have been a subject of controversy in the last decade, giving economists a run for their money. Some analysts worry that virtually zero policy projects more harm than good. In that, the negative rates discourage spending and borrowing but instead encourage hoarding, thus a contribution to the deep-rooted deflationary pressures. The increasingly high dependence on untested monetary tools may be the beginning of economic downfall in Japan. It is increasingly worrying to see a repeat on the public fund misappropriation of the 1990s (lost decade) with Abe’s current stimulus package plans. After four years of single stimulus allocation and policy implementation, the country’s economy has moderately bloomed, inflation is below target, national’s debt and effects of structural reforms continue to prevail, and monetary easing remains a highly contentious issue. With the U.S. Federal Reserve hiding the IMF advice to increase their interest rates and abandon quantitative easing policies continuously, it is uncertain what the future holds for the Japanese economy
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