Pacific Money

Japan 2019: Feast or Famine

Economist Jesper Koll on what to expect from Abenomics and Japan’s economy in 2019.

Anthony Fensom
Japan 2019: Feast or Famine

Jesper Koll

Japan is currently enjoying its longest economic expansion since World War II, with the lowest jobless rate in decades, record corporate profits and rising wages.

Yet the world’s third-largest economy is seen posting only around 1 percent gross domestic product (GDP) growth in 2019, amid sluggish inflation, high public debt, and headwinds including October’s planned consumption tax hike, the U.S.-China trade war, and a slowing global economy.

Pacific Money spoke to Tokyo-based economist, WisdomTree Japan’s Jesper Koll, on what to expect in the Year of the Pig, a year which will also see the imperial succession, upper house elections, and Japan’s hosting of the G20 summit meeting along with the Rugby World Cup.

Pacific Money: Japan’s consumption tax rate increases this October to 10 percent from 8 percent. Each of the last three times the rate has gone up, the economy has fallen into recession. What will prevent this happening in 2019?

Jesper Koll: That’s correct, it’s been three hikes for three recessions. [Prime Minister] Abe is very cognizant of that. Also remember it’s actually the first VAT hike that Abe has to take full responsibility for – the previous one was part of the agreement that got the democrats [Minshuto] out of power. He did actually postpone it once, and now he’s committed to it.

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But the bottom line is the budget for 2019 has almost the equivalent of the revenue raised from the VAT being spent on households. They’re making education free for preschoolers; they’re increasing transfers to households; there will be gift coupons.

There will still be economic volatility with people buying ahead and not buying afterwards, but I think the risk of recession because of the VAT hike is actually very low.

Looking at key risks for 2019, a survey of Japanese business leaders by The Yomiuri Shimbun pointed to the U.S.-China trade war as the top concern. Do you agree?

Japanese firms’ export dependency is very high. Overseas earnings average 61 percent of total earnings [of companies listed on Tokyo’s TOPIX] of which 25 percent is from the U.S., and 15 percent from China.

More important for Japan with the U.S.-China trade war is it has created an enormous amount of uncertainty among businesspeople. People need to build new factories, they need to add capacity in Asia, as Asia is growing.

Now business leaders are thinking, where do I build a new factory? Because of uncertainty over tariffs, a lot of Japanese and Asian companies have simply put their investment plans on hold.

On monetary policy, when can we expect a tightening from the Bank of Japan (BOJ)?

This is the most boring conversation… Five years ago I said it wouldn’t happen until after the 2020 [Tokyo] Olympics. [BOJ Governor] Kuroda is very clear – he said three months ago the risk has become asymmetric, with external factors pointing to downside risk. So for the BOJ, monetary policy is a most boring debate.

What people miss is that fiscal policy is much more complicated – it’s like making sausage, it’s a bloody and messy business. But there’s a lot of fiscal spending that is happening – they’ve just passed the highest budget ever. The borrowing requirements continue to go up – [gross public] debt is now at over 260 percent of GDP.

Is that debt level a concern?

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As an economist, you would say of course it’s a concern. Normally you would say with such a debt there’s a risk of a currency crisis… but the yen is not exactly in free-fall.

Looking at the debt [level] is not going to help me make money, either as a businessperson or as an investor in yen assets. The most interesting story, the most important one, is that Japan is the only country where a new middle class is rising, due to demographics.

A middle class rising? Can you explain that, given Japan’s shrinking population?

It’s simple demand and supply. The number of high school and university graduates is falling every year by about 50,000 kids. This means the value of those kids is going to be bid up. Average wages are rising by 2 to 2.5 percent, but starting salaries for university graduates are rising by almost 6 percent. You and I want to be reborn as a 23-year-old Japanese!

Now, that’s the interesting thing. As a businessperson, is the Japanese market a market of opportunity? The answer is absolutely yes. Because the purchasing power of the people is actually going up. The BOJ will never achieve its 2 percent inflation target – and that’s a good thing. Who wants 2 percent inflation? I want wages growth.

Remember that in Japan, about 40 percent of all prices are regulated by the government. And the government is ruthless in cutting regulated prices to keep purchasing power high, such as in the case of the telcos.

Six months ago they called in the CEOs of the telcos, showed them a chart and showed them that the Japanese price of a mobile phone contract is basically 40 percent higher than anywhere else in the world, go and cut it. And that’s awesome – that’s good government. Healthcare – same thing. For this year 2019, healthcare costs, pharmaceutical costs, are ordered to fall by 8.5 percent. As a person, that is awesome, especially the older generation.

Japan is now in its longest period of growth since World War II – how are you seeing the outlook?

Japan is not a high-growth economy – the run rate is about 1 to 1.25 percent, then you add or subtract almost a full percentage point based on the world economy. If the world economy is slowing from about 3.5 percent growth to 2.5 percent, Japan is going to bear some brunt of it. That’s why the best place to hide from a global recession is [by investing in] Japanese small and medium-sized companies.

Concerning Abenomics, how is it progressing with the third arrow of structural reforms?

The answer is there are aspects of structural reform that are working well. You’ve got this incredible increase in the female participation rate, so Womenomics, that part of structural reform is huge, as it goes into empowerment, the way companies are run and consumer behavior, so it’s a big impact.

Corporate governance too, when you look at share buybacks, dividends, that’s all working in ways that even five to six years ago you would have thought Japan would never do this.

The missing link I think is the corporate mindset… looking at only their small little world, the world of Mitsubishi or Sumitomo, rather than being more lateral thinkers and being more open, that still requires a lot of work.

The final point, a positive thing which the government is helping, is entrepreneurship. If you look at start-ups, venture capital, that ecosystem in Japan has gotten better. So for example they’ve given some tax incentives for angel investment – not huge, but at the margin it helps.

The Abe administration recently announced plans to increase immigration. How much is this going to help a declining population?

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Regarding immigration, the Japanese are very pragmatic. One in three working at convenience stores are now non-Japanese.

But the more interesting question is integrating non-Japanese opinions and leadership at the top level, at the board level, and there obviously Japanese companies are struggling. There are many aspects about the [former Nissan boss Carlos] Ghosn saga but this is obviously one of the elements.

The real issue to me is not whether there will be more construction workers… –that’s an interesting issue and the government is dealing with it – but will you ever see an Australian, German, American, or Chinese in the C-suite of one of the Fortune 50 Japanese companies.

Looking at Prime Minister Abe, he will be in power until at least 2021. What would you like him to achieve before then?

I think his legacy is going to be actually righting the Japan-China relationship. Last year they had the first bilateral summit in Beijing [under Abe]; this year there will be one, possibly two bilateral summits. There’s a lot more going on now between Japan and China. Ironically the implosion of the U.S. works in favor of that. My dream is that Abe persuades [Chinese President] Xi to join the TPP [Trans-Pacific Partnership].

For the TPP, the real issue is IP [intellectual property] and state-owned enterprises. In China, they’ve just announced a state entity to deal with IP. That’s huge. And to get into the TPP is very easy – you don’t have to do it now, just show a path [toward change]. So mark my words, if Trump gets re-elected, China will join the TPP.