Can “Abenomics” Save Japan’s Economy?

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Can “Abenomics” Save Japan’s Economy?

On Sunday Japanese voters gave Shinzo Abe and the LDP a landslide win. Can he revive Japan’s growth prospects?

Shinzo Abe campaigned on taking Japan back to the future. Have the nation’s voters got what they wished for with the Liberal Democratic Party’s (LDP) stunning election victory on Sunday, delivering the 58-year-old his second stint as leader?

For the defeated Yoshihiko Noda of the Democratic Party of Japan (DPJ), the poll was a devastating electoral backlash against, among other things, his push to increase the consumption tax. Noda’s defeat is therefore reminiscent of the one that befell conservative Ryutaro Hashimoto in 1997.

In a landslide for the party which was ousted from power in 2009, the LDP and its likely coalition partner, New Komeito, are expected to win a combined 325 of the lower house’s 480 seats, providing the two-thirds “supermajority” needed to force legislation through both houses of the Diet.

For the DPJ, the election is likely to reduce the Party’s parliamentary seats to just 53, down from its previous 230 seats. Noda has resigned to take responsibility for the electoral pummeling. Meanwhile, a third force, the rightist Japan Restoration Party led by nationalist former Tokyo governor Shintaro Ishihara, secured 54 seats, only three less than the center-left DPJ.

Noda was forced to call an election as part of a deal with the opposition to get through a consumption tax hike, which will rise to 8 percent in April 2012 and 10 percent in October 2015.

The DPJ’s electoral prospects were also damaged by party infighting, its handling of the March 2011 disasters, foreign policy rows with Japan’s neighbors and an intransigent opposition-controlled upper house.

Abe will be installed next week as Japan’s seventh prime minister in six years, and the first LDP leader since its decades-long rule ended in 2009. He has vowed more government spending and monetary expansion to drag the economy out of its deflationary downturn.

Speaking after his election victory, Abe indicated that the economy would be his first priority in office.

“First and foremost we have to bring about an economic recovery and pull Japan out of deflation,” he said.

“We must strengthen our alliance with the U.S. and also improve relations with China, with a strong determination that there is no change in the fact that the Senkaku islands are our territory,” he added.

Abe also told local media on Monday he was reviving the Council on Economic and Fiscal Policy to facilitate communication with Bank of Japan (BOJ). It is widely believed he will seek to pressure BOJ into pursuing a more aggressive economic easing and allowing the inflation rate to double to 2 percent. In addition, the new leader said he was considering a “large-scale” extra budget for fiscal 2012, with a nominal economic growth target of 3 percent a year.

Koizumi Mark II?

Economist Jesper Koll, Japan Director of Research at JP Morgan, said Abe had the opportunity to “seize the moment” in his second stint in office. Abe’s previous term lasted less than a year, stepping down for health reasons in 2007 amid poor poll ratings after having succeeded free market reformer Junichiro Koizumi.

While there are clear differences in style and policy between Abe and the man he previously replaced, Koll said it could be second time lucky for the blue-blooded leader.

“Like no one since Koizumi, he’s clear cut, straightforward, and outspoken in formulating his policy goals and how to achieve them. First and foremost, the stated goal is to launch an all-out attack on deflation. Here, the [Bank of Japan] gets a mandate to deliver on a 2 percent inflation target, and to get there commit to indefinite base-money growth until that target is achieved,” he told The Diplomat.

“But it’s not just money policy. Abe also takes a clue from legendary LDP strongman Kakuei Tanaka – he wants to rebuild the Japanese archipelago and proposes a public works program worth 200 trillion yen [approximately US$2.4 trillion] over 10 years to rebuild public roads, reinforce against earthquakes and tsunami all public schools, hospitals and other buildings.

Credit rating agencies who warned Japan over its rising government debt — estimated to reach 245 percent of GDP in 2013 —  are likely to be concerned by Abe’s economic policy agenda. Already, Standard & Poor’s has stated it may lower its rating on Japan should it not carry out fiscal reforms, with Abe having previously indicated that the consumption tax hike was subject to economic conditions in 2013.

However, Koll said attack was the best form of defense when it came to tackling deflation.

“The key point here is that Abe actually wants to link the central bank and fiscal policy back together — Ministry of Finance [MOF] authorizes public works and infrastructure projects to create demand for credit and goods and services, while the central bank provides the immediate funding by buying the IOUs issued to get these projects off the ground,” he said, noting the similarity to the BOJ’s funding of Japan’s industrial growth of the 1930s.

“As an added bonus, Abe has just the man needed for the job – ex-MOF vice minister Eijiro Katsu is his stated choice to replace [BOJ Governor] Shirakawa when his term expires next April.

“Katsu is the mastermind of the recent tax-hike bills and disaster reconstruction spending. He is, in my personal view, fully committed to generating first-and-foremost a sharp pick-up in nominal GDP growth, as this is the absolute necessary condition to start long-term fiscal consolidation.”

‘Hot economics, cold politics’

Japan analyst Dr. Donna Weeks of the University of the Sunshine Coast said Abe’s return would mark the return of “hot economics, cold politics” for the nation and its key neighbors, China and South Korea.

“While there’s been friction between Japan and its neighbors politically, there’s a strong set of economic ties between the three countries [of Japan, China and South Korea],” she told The Diplomat.

“Abe has made it pretty clear that the economy is a priority over everything, so I suspect they’re going to try and do whatever they can to keep that trade continuing.”

However with Japan and China locked in a standoff over the Senkaku/Diayou Islands, Weeks said Abe could be forced to take a more nationalistic line due to the influence of hardliner former Tokyo Governor Ishihara in the Diet.

“Abe’s really going to have to keep Ishihara and his party reined in, because Ishihara has a strong support base and we could have this situation where Ishihara could try and manipulate and make things difficult, similar to Ichiro Ozawa in the DPJ,” she said.

Financial markets have already delivered their verdict on the change of power, with the yen weakening to a 20-month low against the dollar but the Nikkei Stock Average rising in the so-called “Abe trade.”

Can Abe overcome the obstacles and show the world’s third-biggest economy is capable of reviving itself? For many, it could be the last opportunity for Japan to kick-start growth before financial market realities bite.