How Inclusive is Abenomics?

In the last two years, Japan has embarked on an ambitious effort, the so-called Abenomics approach, to decisively get the economy out of deflation and revive growth. At the same time, policymakers and academics from all over the world are engaging in a global debate on inequality. This column presents research assessing the impact of Abenomics on inclusive growth, as measured by a metric which takes into account both growth and income distribution. The main policy implication of our analysis is that full implementation of structural reforms is necessary to foster growth as well as increase equality in Japan.

Japan is not immune from the increase in inequality that has been observed in advanced countries in recent years. Anecdotal evidence suggests that, among the Japanese population, concerns over income inequality have grown, and the previously widely held notion that "All Japanese are middle class" has become something belonging to the past. As seen in Figure 1, when measured using the Gini coefficient of market income (before fiscal redistribution), inequality in Japan has increased steadily over the last three decades. The latest available figure implies that income inequality in Japan, starting from the lowest among the G7 countries in the mid-1980s, has converged to nearly the G7 average of 0.50.

Figure: 1 Gini before Taxes and Transfers (Market Income)

Source: OECD

Against this background, the rest of this column discusses why inequality is important not only in its own right but also from a macroeconomic point of view, and presents an evaluation of Abenomics in terms of its inclusiveness.

In our view, concerns over inequality and inclusiveness of growth are driven not only by social and moral considerations, but also are directly relevant to macroeconomic outcomes and to the ultimate success of Abenomics, for at least two reasons.

The first reason is that if the perception that economic growth is not being shared fairly within the Japanese society becomes prevalent, this could erode support for much needed reforms, such as deregulation and further international trade integration, which are crucial to boost long-term potential growth, but which might imply short-term costs for some segments of the population.

The second reason is that in recent times, the consensus in the economic profession has been shifting from the past belief of a trade-off between economic growth and equality (e.g., Okun 1975) to a new view in which ensuring equality is seen as critical for sustainable growth. An example of this new conventional wisdom can be found in the work of Berg and Ostry (2011), who empirically document how greater equality can help sustain growth. According to several authors (e.g., Son and Kakwani 2003; Gramy and Assane 2006), equality also strengthens the poverty-reducing effect of growth.

In light of the above discussion, a recent International Monetary Fund (IMF) Working Paper (Aoyagi, Ganelli, and Murayama 2015) assesses the implications of Abenomics in terms of inclusive growth, using a panel of Japanese prefectural data over about 30 years. The dependent variable is the measure of inclusive growth developed by Anand et al. (2013), which can be interpreted as a measure of growth in average income "corrected" for the equity impact of such growth. The explanatory variables are proxies for the implementation of Abenomics reforms, which include reaching the 2% inflation target of the Bank of Japan (BoJ), labor market reforms aimed at reducing duality, increasing female labor participation, and further boosting labor supply in general.

Based on our regression results, Table 1 presents some scenario analysis summarizing the impact of Abenomics on our inclusive growth variable and its two sub-components (average income growth and equity change).The inclusive growth variable is calculated by taking the weighted average of the growth of per-capita income and the change in the index of inequality. The index of inequality takes the value of zero in the case of complete inequality (i.e., one person possesses the entire income) and one in the case of complete equality (i.e., everyone possesses the same income). In other words, our inclusive growth measure takes into account both average income growth and changes in income distribution.

• According to our analysis, moving toward the 2% BoJ inflation goal, one of the main objectives of Abenomics, would promote growth while having a negative impact on equality. The latter can be explained by the fact that the most vulnerable households cannot protect their real income against an increase in inflation.
• However, the overall impact of reaching the 2% inflation target on our inclusive growth measure is positive, because the "growth" effect of permanently getting out of deflation (which stimulates growth by changing expectations and raising incentives to consume and invest) more than offsets the negative impact of inflation on equality. Table 1 also shows that for working-age households, the negative equity effect is smaller, and the positive growth effect is stronger, compared to the all households sample.
• As shown in Table 1, reducing labor market duality (proxied as a scenario which brings the ratio of part-time to full-time job openings from its current level of 21% to the pre-bubble level of 5%) would improve inclusive growth by raising average income. This is consistent with the idea discussed in Aoyagi and Ganelli (2013) that Japan's excessive duality reduces productivity through a "training channel" as non-regular workers receive less training than regular ones, and an "effort channel," because non-regular workers tend to be less motivated and therefore are less productive than regular ones. Reducing duality therefore increases average income by raising productivity. As expected, such an effect is stronger when we include in the regression only working-age households. However, reducing duality implies a slight decrease in equality, because it prevents some workers who can only work part-time from being employed.
• Table 1 also presents the impact of increasing female labor force participation (FLFP) in Japan, which historically has hovered around 48% (more than 20 percentage points lower than male participation), by about five percentage points. As it can be seen, reaching this ambitious but feasible goal would boost our inclusive growth measure by 0.83 percentage points, by increasing both income growth and equality. The estimated effect is even stronger (1.13 percentage points) for the working-age household sample.
• Labor input, calculated as the number of workers multiplied by hours worked, has been in decline in Japan since 1979, reaching negative growth in the early 1990s. In our scenario analysis, we consider a case in which reforms aimed at increasing labor supply manage to shift the growth of labor input from negative to zero. Under this scenario, inclusive growth would be 0.42% higher, mostly due to average income growth, but also with equity slightly improving.

In summary, the results presented in Table 1 suggest that if only the first arrow is launched (i.e., if only the BoJ's inflation target is achieved), Abenomics would still achieve positive average income growth, but with some deterioration in income equality. The scenario analysis also shows that, as long as inflation reaches and stays at around 2%, our overall measure of inclusive growth improves, because the "growth" effect of inflation is stronger than its "inequality" effect. In the case in which inflation stays at around 2% and third arrow reforms (higher female labor participation, reducing duality, increasing labor input) are implemented, Abenomics increases average income growth while keeping inequality broadly unchanged (all household sample) or improving it (working-age household sample).

Furthermore, our regression results also show that there are non-linearities in the impact of inflation on growth. Due to a threshold effect, if monetary policy becomes overburdened because of a lack of structural reforms, resulting in runaway inflation above the BoJ's 2% target, overall inclusive growth (not only equality) will be reduced. Overall, our empirical results and scenario analysis support the argument that the best way for Abenomics to ensure gains in both growth and equity is to successfully launch the third arrow.

As stressed in the 2014 IMF Article IV Report on Japan, implementing structural reforms holds the key for faster growth in Japan and is vital to Abenomics' success. In this column, we have presented recent empirical research showing that fully launching the third arrow is equally important to foster income equality and inclusive growth.

Authors' note: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.