Is Abenomics Firing at the Wrong Targets?


A long list of structural reforms have been identified for the “third arrow” of Japan’s Abenomics, from increasing women’s participation in the workforce to deregulating agriculture. But are they hitting the right targets?

Recent economic data has been mixed for the world’s third-biggest economy, despite the benefit of expansionary fiscal and monetary policies, the first two arrows of Abenomics. On Wednesday, the Bank of Japan’s “tankan” survey of business sentiment showed confidence among big manufacturers falling below economist expectations, while industrial production data for February, released on Monday, showed a bigger decline than forecast.

“A recovery in consumer spending has been slow after last April’s sales tax hike and exports aren’t that strong yet,” Taro Saito, director of economic research at NLI Research Institute, told Bloomberg News. “[The] figure is a reminder that it may be too early to be very optimistic about the economy.”

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Other recent data has also been weak, including zero consumer price inflation for February and the 11th straight monthly decline in household spending. The national economy expanded by an annualized 1.5 percent in the December quarter, emerging slowly from a technical recession in 2014.

Yet longer term, reviving Japan’s economic prospects in the face of a declining labor force and deflationary pressures will require enhancing productivity, which according to a McKinsey study now lags for labor as well as capital.

According to the consultancy, if Japan could double productivity growth, “with a sharp focus on increasing value added as well as reducing costs,” it could hike annual gross domestic product (GDP) growth to around 3 percent, increasing GDP by up to 30 percent above the current trajectory through to 2025, with a potential economic boost of $1.4 trillion.

McKinsey suggests firing a “fourth arrow” to accelerate labor and capital productivity growth, with measures such as fostering global integration, improving digitization, harnessing “big data,” restructuring industries, implementing merit-based pay and fostering both female talent and aging workers.

Should it do so, “Japan has a window of opportunity…to once again outpace the world in efficiency and quality, emerging as a global leader in fields such as advanced materials, 3D manufacturing, and the life sciences,” McKinsey said.

Fiscal, Monetary Fixes ‘Won’t Cut It’

Japan analyst Naomi Fink, chief executive of Europacifica Consulting, argues that stagnant “total factor productivity” (TFP) and unstable labor/capital shares of income are at the heart of the nation’s economic problems – and short-term fiscal and monetary adjustments simply “won’t cut it.”

According to Europacifica’s analysis, while Japan’s export-driven manufacturing sector has achieved “balanced” productivity growth, along with the information technology sector to a lesser extent, the services and non-IT sectors have fallen behind.

The worst performers in TFP growth from 1973 to 2008 included rice and wheat production, waste disposal, chemicals, electricity, real estate, coal, and petroleum products. By contrast, the best performers were in electronic data equipment, communications equipment, semiconductors, household electrical appliances, and electronic parts.

“The manufacturing sector is already efficient; it’s the services sector that needs to be improved,” Fink said.

“We see things like the privatization of Japan Post; that’s one small part, but the structure of the privatization isn’t such that the government cedes its exposure fully to market forces – it’s keeping a large portion and they don’t seem to be creating a level playing field. And that has implications for the insurance and financial sectors, in which productivity is exceptionally low.

“Also, I did some econometric studies on regulation and structural reform…and the striking result was that in non-manufacturing and services, when you decrease regulation it’s consistent with a rise in productivity. That’s not the case with manufacturing, where the coefficient is inverse.

“The long and short of it is if you start looking at special economic zones for manufacturing, they’re targeting many of the wrong industries, and they’re not putting enough emphasis on structural reform in the industries that really need it.”

According to Fink, the key to success is deregulating “low-productivity areas in the services sector,” while developing incentives for greater investment in non-IT and services sectors, as well as incentives for improved allocation of labor and female participation.

Risks abound “at almost every stage of policy” for Abenomics, including “unlikely but dangerous” tail risks of a blowout in inflation expectations and dumping of Japanese government bonds, to the “not so bad, but all too likely” risks of wages remaining stagnant, poor implementation of structural reforms and slow growth abroad.

Based on a “structural reform checklist,” Fink assigns the highest score of 86 percent to healthcare reform, followed by 57 percent for agriculture, technology innovation, and corporate governance changes and 43 percent for promotion of new start-ups.

But corporate tax reform and ‘Womenomics’ gain only 29 percent scores, followed by a lowly 14 percent for management of public funds, flexible working practices, and attracting overseas talent.

Overall, Fink gives Abenomics’ third arrow just a 40 percent probability of success, based on current performance.

“Is there evidence that the government grasps the underlying problem they are trying to solve? If the answer is ‘no’ then we cannot expect ‘Abenomics’ to succeed,” Fink warns.

Fortunately for Abe, with political incumbency until at least 2018 his administration still has time to improve its chances of success.

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