The Abenomics Referendum and Its Aftermath

Date December 18, 2014
Speaker Jacob SCHLESINGER(Senior Asia Economics Correspondent and Central Banks Editor, Asia, The Wall Street Journal)
Moderator YOSHIDA Yasuhiko (Consulting Fellow, RIETI / Deputy Director-General for International Projects Promotion, Bureau of Trade and Economic Cooperation, METI)


*This summary was compiled by RIETI editorial staff. It is not a direct transcript, or quotation, of the speaker.

Political uncertainty and instability



Political instability has been one of the constants in Japan, which has been very destructive to Japan's ability to deal with the many problems it has faced over the last quarter century.

When Prime Minister Shinzo Abe took office in December 2012, it was at first seen as just another turn in the revolving door of Japanese prime ministers. U.S. President Barack Obama had worked with five different Japanese prime ministers in his first four years in office, and he seemed to feel that investing in a relationship with someone who wouldn't be around for very long was not worthwhile. Now, the roles seem to have been reversed: Japan has a strong leader and the U.S. president has a variety of political weaknesses.

This is interesting not just in the context of recent Japanese political history but globally. Instability and uncertainty have affected advanced democracies around the world since the global financial crisis. In France, President Francois Hollande has a 12% approval rating. Political crises have erupted in Sweden and Greece, forcing leaders to call snap elections.

Abe's Election

There has been a lot of skepticism about the significance and validity of Abe's victory on December 14, 2014. Critics say it was an easy, unfair victory over a divided, historically weak opposition. The ruling Liberal Democratic Party and its Komeito coalition partner preserved their two-thirds super majority in the lower house of parliament in an election with voter turnout barely over 50%, the lowest since World War II. People weren't wild about Abe and didn't really have a choice among the opposition, and many people chose not to vote. Two days after the election, in a Kyodo News poll, Abe's approval rating still stood below 50%; and just one-fourth of Japanese people said they welcomed the election results. Just one-fourth said they felt that Abe's core policy, Abenomics, would actually improve things. Just one-third of voters after the election said they approved of Abe's security and defense policies, and more than half said they disapprove.

Much of the criticism and skepticism about the election is fair, but it is important not to lose sight of the fact that, for the first time in a very long time, a Japanese leader seems to have a hold on power for an extended period of time and can plan his policies into the future.

Abe has a very ambitious agenda, not just in economics but also in foreign policy and diplomacy. 2015 will be a fascinating year in terms of redefining Japan's role in the world. This includes U.S.-Japan relations, building relations with China, trying to improve relations with South Korea, whether Putin will visit Japan this year, etc. Abe's handling of the 70th anniversary of the end of World War II will also be an important challenge in 2015.

The Japanese economy and challenges for Abenomics

As we head into 2015, and as Abe starts his second term, the Japanese economy is not in very good shape. Abe won a landslide majority despite the fact that his centerpiece policy, Abenomics, seemed to be faltering. Right before the election it was reported that the Japanese economy had experienced two consecutive quarters of contraction and fell into a surprise recession. Three out of the last four quarters have seen negative growth. The performance under Abenomics hasn't looked considerably better compared with the years before Abe took office.

There's also the question of consumer confidence. The Bank of Japan (BOJ)'s quarterly survey of the public's attitude regarding their economic and financial circumstances published in September 2014 asked whether people were better off now than they were a year ago. Only 4.4% of people said that they were better off economically, a decline from the 4.6% who said so in March 2014. The number of people who said they were worse off grew steadily throughout 2014. In September 2014, nearly a majority of the people said that they were worse off than before.

On the other hand, some optimism exists that Japan will perform better economically in 2015. The big reason why Japan's economy stumbled in 2014 was the sales tax hike in April 2014, which did more and longer-lasting damage than expected. The delay of the next sales tax increase removes a possible dampening effect on the economy next year. The effects of the big stimulus from the BOJ announced at the end of October 2014 have yet to be fully felt. All of the pieces are in place for a positive 2015 for Japan's economy.

The consensus of more than 40 economists surveyed by the Japan Center for Economic Research is an expected rebound to better than 3% growth in the fourth quarter of 2014 after two quarters of negative growth. They also expect growth above 2% in the first quarter of 2015 and steady growth throughout 2015 and 2016.

What could go wrong when the consensus expects a recovery? The consensus, among both private and official forecasters, has been consistently overly optimistic about the effects of Abenomics.

The official forecasts from the BOJ's policy board illustrate that fact. Just over one year ago, in October 2013, the policymakers at the BOJ were expecting gross domestic product (GDP) growth of 1.5% for this fiscal year ending March 2015. They thought the economy would be strong enough to withstand the coming sales tax increase and recover from it. In later quarters, they lowered the forecast slightly but remained very optimistic. In July 2014, as data started coming in from after the sales tax increase went into effect, they lowered the forecast from 1.5% to 1%. As worsening data continued to come in, they lowered the forecast in October 2014 to 0.5% of GDP. A contraction is now expected for those 12 months of negative 0.5%.

There is considerable uncertainty about the underlying strength of Japan's economy. Honest forecasters would say they really don't know how much psychological and economic damage was caused by the sales tax hike, or how long it will last.

In the past few weeks, a number of worrisome measures of sentiment have emerged. Data measuring consumer confidence and the economy watcher's survey came out last week; both showed sentiment continuing to slide toward the end of the year. The BOJ's Tankan, a quarterly survey of the attitudes of major companies, showed that psychology is still quite fragile heading into the end of the year.

One useful framework for trying to assess the prospects for Japanese economic recovery is to use the model of BOJ Governor Haruhiko Kuroda. He likes to talk about "a virtuous cycle" in the Japanese economy; a self-sustaining, self-reinforcing period of growth. He envisions an economy that is not reliant on still more BOJ stimulus and public works spending but one in which companies invest more and raise wages, leading consumers to spend more and investors to invest more. Overall, it has not progressed as well as would have been desired when Abenomics started two years ago, but many things are actually going right.

Weighing the pluses and minuses of Abenomics

Three things have gone remarkably right under Abenomics. The BOJ's massive monetary easing immediately weakened the yen, which translated very quickly into higher profits for Japanese multinational companies as the value of their earnings on overseas operations suddenly increased. Many companies are now reporting record profits. This has translated into a remarkable doubling of the Japanese stock market since Abenomics was first proposed. There has also been an astounding improvement in the Japanese labor market. The unemployment rate, about 3.5%, is the lowest it's been since the mid-1990s. There is now well more than one job opening for each person seeking a job, the highest such ratio since the early 1990s. Many economists talk about the failure of Abenomics, but there are record profits, a stock market boom, and the lowest unemployment rate in a generation.

A better way of looking at it is as a partial success. The first part of the virtuous cycle has kicked in, but things are stuck somewhere else. The stock market boom isn't flowing so much through the economy, because only a relatively small portion of the population owns stock. Companies are earning record profits but are not spending that money and instead are sitting on a large amount of cash. Japanese companies chose not to spend during the period of stagnation and deflation largely because they were not optimistic about the future. The hope of Abenomics is that companies will become productive with their cash, but that hasn't really happened yet. Another problem is that the wealth has not spread to the average Japanese consumer. Workers' wages have actually decreased, when adjusted for inflation and the April 2014 consumption tax increase.

There is reason to hope that will change in 2015. In theory, in a tight labor market, companies raise wages to compete in hiring and retaining workers, and they spend money on equipment to find new efficiencies. In addition to hopes for the invisible hand of the market to do its thing, the prime minister is pressuring companies. Prime Minister Abe's first major meeting after the election was with Keidanren and the Rengo labor union, and he pressured them to agree to fairly big wage increases this year. In addition, new corporate governance policies are being put in place to try to force Japanese companies to do something productive with their cash.

Outlook for 2015

What does 2015 hold for the three arrows of Abenomics? The first and second arrows can only create so much growth for an economy whose growth potential has shrunk significantly over the last 20 years. According to the BOJ, in the late 1980s Japan had the potential to easily grow 4%, and now the "potential growth rate" is considerably below 1%. The only way to raise this to Abe's goal of 2% is the third arrow: restructuring and reform to increase productivity and the labor supply. Abe unveiled a list of policies he wants to put in place to get Japan closer to this goal, but he has not invested a lot of political capital in them.

U.S. policymakers want Prime Minister Abe to follow through on his promise to take on agricultural interests and complete the Trans-Pacific Partnership (TPP).

Another interesting question for 2015 is where the second arrow will be aimed: toward defeating deflation or curbing debt? I think that from the start there was a contradictory aspect to the second arrow. Part of it involves short-term fiscal stimulus to raise short-term growth, but it also includes a heavy element of trying to draw down Japan's debt via tax increases. Those are contradictory policies. In delaying the next tax hike, Prime Minister Abe was clearly shifting priorities on the second arrow and prioritizing anti-deflation policies ahead of debt reduction. He did clarify that this was a short-term tactical move and not a shift in strategy. He has insisted that debt reduction remains a top priority and that he wants to use his time in office to pursue that in a more serious way. One surprising thing about the tax hike delay announcement was that he also said that he would still stick to Japan's pledge to balance the budget by 2020.

Cabinet Office calculations show where Japan is right now and the path it seems to be on in terms of whether it can really balance its budget by 2020. Two scenarios are laid out: the "economic revival case" (optimistic) and the "reference case" (pessimistic/realistic) Even under the optimistic scenario, Japan will have a budget deficit of nearly 2% of GDP in 2020 and under the pessimistic/realistic scenario it will be 3% of GDP.

One way to close this gap over the next five years would be to make fairly sharp cuts in social security spending, but that would be politically difficult. Another would be raising the sales tax still further, to 20%. But given the difficulty of moving event to 10%, that also will be tough.

The election was billed as a referendum on Abenomics, and it was held in advance of a year in which some fairly significant economic decisions need to be made. Prime Minister Abe needs to choose in 2015 whether his own endurance as prime minister is itself the goal, or something more far-reaching. Thank you very much.


Q1. It seems that only the United States is presently showing solid recovery from the recession. What is the biggest difference between the Japanese and U.S. economies?


The U.S. economy is doing quite well and in some ways is the world's main growth engine. It may be said that the United States has a more flexible and dynamic economy than Japan. Some say that the United States sustains its economy in ways that Japan won't accept: whether it's a greater focus on shareholder returns or an open immigration policy that allows the population to keep growing. There are many reasons to be optimistic about the U.S. economy, and perhaps it is doing some things that should be copied, but there should also be a lot of caution about whether or not the United States is actually rising above the problems around the world.

Q2. Could you give us your outlook on the foreign policy challenges especially concerning Japan in relation to Korea and China?


That really is one of the big questions hanging over Japan right now. I would reiterate the history question. With China in particular, Prime Minister Abe seems now to be making some modest progress in improving ties, meeting with President Xi Jinping. But his handling of history matters as the world focuses on the 70th anniversary of the end of World War II can still complicate relations. Prime Minister Abe's visit to Yasukuni Shrine almost exactly a year ago was seen in China and South Korea—and in the United States—as a provocative act. There is a danger that if Prime Minister Abe makes a priority of attempting to revise the current prevailing view of wartime Japan, that will worsen relations with all three countries. There is a lot of skepticism in Japan about whether the concerns in China and South Korea are rooted in a sincere view of the war or whether they are using that as a tactic to keep Japan down. And there is some justification for that skepticism. But there is also little patience in the United States for Japan to keep trying to do things like revise the current globally accepted account of the comfort women, and a campaign to alter history risks undermining Japan's relations with the United States as well.

Q3. Some Japanese newspapers insist that the extraordinary easing of the BOJ should be stopped due to the side effects you mentioned. I don't think Mr. Kuroda will stop the easing next year, but if the BOJ were to change its course, what would the impact be on the market or the Japanese economy?


There is no question that Governor Kuroda will continue on the path he is on. The questions are whether he wants to go even further and whether he would be able to do so. If he were persuaded to pull back the reins, as far as what the impact would be, I think we are in uncharted territory on monetary policy worldwide but particularly in Japan. My first reaction is that you would have the opposite effect of the BOJ's rapid easing leading to a rapid decline in the yen and rise in the stocks—it would probably hurt the Japanese economy. One of the things that has kept interest rates low despite Japan's massive debt has been the BOJ's quantitative easing. Japan stated it plans to delay the tax increase, and Moody's downgraded Japan's sovereign debt rating. What usually happens in such a case is that interest rates rise as investors get nervous about the debt getting too big and unsustainable. In Japan, the exact opposite is happening. The 10-year Japanese government bond benchmark is now well below 0.4%, one of the lowest in the world. If the BOJ stopped buying those bonds, I think rates would move up very quickly and that in itself would cause tremendous economic damage.

Q4. What is the view from outside, mainly from the United States, about the weaker yen?


Usually when countries depreciate their currency, it causes significant criticism from other governments because the effect is that it essentially makes your goods cheaper in world markets; it's a way to export your way out of your problems. Japan's cheaper currency hasn't caused that kind of blowback this time in the way that it has previously, for a few reasons. The United States has concluded that it's in its own interest to have a stronger Japan, that Japan's weak economy is itself a problem for the alliance, not just for economic reasons but also for military and strategic reasons, and that if you are looking to have an Asian power to help counter the rise of China, the fact that Japan's economy continues to shrink while China's grows at 7% per year becomes a problem for the United States. The United States for a period of time is willing to tolerate Japan doing whatever it needs to get back on its feet. Another reason is that, in the classical model, when a country cheapens its currency, exports rise, but the mystery of Japan's economy in the last two years, and one reason why growth hasn't been stronger, is that exports have barely risen. Some people say it's just a matter of time before exports rise and others say there are structural changes in Japan's economy that mean they won't rise. Either way, as long as Japan is not threatening other countries with a massive increase in exports, the weaker yen is much less of a threat to other economies.

Q5. What is your recommendation on what the Japanese government should do about the third arrow?


The third arrow won't boost the economy immediately, but it can raise Japan's growth potential over time. Looking at it simply, there are two ways to raise the long-term growth potential: raise productivity or raise the labor force. An easy way to raise the labor force would be a much more open immigration policy, but that is a political and cultural choice and one that Japan has chosen not to adapt. There are many policies that can expand the labor force within Japan. The policies regarding so-called "womenomics" are fascinating. There is an incredibly educated, trained, and intelligent population, and a way of better tapping into those human resources to help raise the economy could be a revolutionary change for Japan.

Q6. What is your future projection for the U.S. economy in relation to security and foreign policy, considering events involving Russia and the Middle East?


Talking about the foreign policy challenges, it is a very scary time in the world. As for U.S. policy and the Middle East, not only is that area itself unpredictable but the time and attention that it draws from the United States makes it hard for the U.S. government to engage in challenges elsewhere including here in Japan and the rest of Asia. The United States is quite distracted from playing a role in Asia. On the other hand, big changes still can happen. Just today, we saw the remarkable news that the United States is normalizing relations with Cuba, which has huge potential to transform the region in tremendous ways.

Q7. I have a question regarding the third arrow. In Japan, revitalizing local economies is a major problem. The United States has many active local economies. Maybe in Japan, it is due to the aging society. Do you have any recommendations for that problem?


I do have some observations. Many local economies are struggling. On the other hand, places such as Tokyo are in some ways a model for aging societies, and to create a successful city with an aging population, the concentration of population actually makes a big difference in terms of your ability to offer those people a chance to live in their own homes but still have ready access to the things they might need. The danger of focusing too much on rural revitalization is that, in politics, rural revitalization policies often become excuses for pork barrel and inefficient public works spending, which, in a sense, was part of what got Japan's economy in trouble in the first place. How to revitalize local areas without creating inefficiencies is a delicate balance. It was announced yesterday that Japan, in only 11 months, had a record number of tourists enter the country, which is a hopeful sign. I think many regions have been very clever about marketing themselves to tourists. The core problem is a shrinking population.

Q8. Do you see any concern in the U.S. administration about the political course Abe is going to take in the coming years, in relation to China and South Korea or in terms of revising the constitution?


The United States is in a complicated position on this. It created Article 9 and the notion that Japan needed to be a pacifist nation, and then tried to reverse that as far back as the Korean War, encouraging Japan to build up a more active military. The United States has been very supportive of Prime Minister Abe's position on collective self-defense and would have, if anything, wanted him to go further. In those ways, I think the United States is happy that Japan has a prime minister who is willing to go down that path. The United States is also happy to have a Japanese prime minister who is willing to see the China challenge much in the same way that Washington sees it. The complexity comes regarding South Korea. The United States badly wants Japan and South Korea to get along as the two most countries for countering China's rise. One of the things that has struck me in my time here in Japan is how much that relationship has deteriorated.

Q9. You clearly indicated that the economic indicators are not so positive. How do you reconcile the election outcome with those indicators?


Part of it was just the logistics of the election. That's not a full explanation, though. People understand that it didn't take Japan two years to get into these problems, and it's not going to get out of them in two years. People are really tired of the political instability and are willing to give whoever is going to last a chance at least to see if it works. At some point, the indicators will have to turn up—more people will have to feel the benefits—or that patience will run out. It is remarkable to see the prime minister of a capitalist democracy calling in the heads of business and virtually ordering them to raise wages. If you see a significant increase in wages, presumably people will be more welcoming and accepting of Abenomics.

*This summary was compiled by RIETI Editorial staff.