The writer is chairman of Fulcrum Asset Management
The election of Yoshihide Suga as the new prime minister of Japan on 16 September has triggered many obituaries for “Abenomics”, which was launched dramatically by his predecessor in December, 2012. Japan is back on the radar screen of global macro investors, after a long period in the doldrums.
Key questions are whether Mr Suga will offer foreign investors new opportunities, and what lessons can be learnt from Abenomics by other countries that are well on the way to so-called “Japanification” — a combination of zero interest rates, low inflation, subdued output growth and very high public debt.
After decades in which western economists have lectured Japan about the “correct” approach to macroeconomic stimulus, it is ironic that the US and European economies have started to adopt the same characteristics. Convergence has occurred, but in an unexpected way.
Abenomics aimed to end deflationary pressures by its “three arrows”: ultra-easy monetary policy, flexible fiscal policy and reformist industrial policy.
Haruhiko Kuroda, Bank of Japan governor, certainly delivered on the first arrow. Aggressive quantitative easing reduced interest rates across the yield curve to almost zero by 2016. Short-term interest rates then went negative and yield-curve control was used to keep 10-year bond yields below 0.1 per cent. As a result, the BoJ’s holdings of government debt rose to 84 per cent of gross domestic product at the end of 2019, about 41 per cent of the level of public debt outstanding. This was a much larger dose of QE than in other major economies.
At first, the monetary arrow seemed to succeed. Inflation expectations rose towards the 2 per cent target, but this was mainly because the yen’s real effective exchange rate fell 30 per cent in the first two years, reversing decades of overvaluation. This devaluation, which increased import prices and boosted export competitiveness, was arguably Abenomics’ winning feature.
Foreign capital inflows into equities boosted the Nikkei 225 index by 120 per cent in the first 30 months of Shinzo Abe’s term, the best performance of the major stock markets. But since then, attempts at monetary stimulus have lost their force. Inflation has remained stubbornly below target, as wages resisted a tightening labour market. The Japanese equity market has traded broadly sideways, while US and European markets have strongly outperformed.
On the fiscal side, there was confusion about the exact meaning of “flexibility” in Mr Abe’s second arrow. Initially, budgetary policy was expansionary, supporting the thrust of monetary policy. But the Ministry of Finance had always been eager to control public debt by raising consumption taxes.
In 2014 and 2019, higher sales taxes slowed economic growth, though they also shifted the primary budget balance into surplus, while stabilising the public debt ratio. Contrary to some expectations, extraordinary levels of debt never led to a government financing crisis, but nor did fiscal policy fully support monetary policy in stimulating inflation.
Finally, structural reforms in industrial policy proved politically difficult.
According to the BoJ, potential GDP growth has been falling steadily since 2015, and has reached the worrying rate of 0.1 per cent year on year in the 2020 data. Adverse demographic trends account for much of this, but productivity growth has also slowed sharply.
A major achievement in the real economy has been the strong labour market. Unemployment halved in Mr Abe’s time, reaching 2.2 per cent before the virus shock in January.
Mr Suga inherits an economy that has made genuine progress under his predecessor. He now has 12 months in which to cement his position at the helm of the Liberal Democratic party, and win re-election. His strategy will accept the macroeconomic aspects of Abenomics, but add sensible emphasis on structural reforms, such as the restructuring of regional banks, and more competitive pricing in transformed digital markets.
Given the outstanding performance of Japan relative to other advanced economies in handling Covid-19, the outlook for 2021 looks encouraging. The yen and the Nikkei 225 have not gained much from this achievement but may now close the gap with Chinese and Korean assets.
In the longer term, a re-elected Mr Suga might face the same macroeconomic problems as other advanced economies, assuming secular stagnation deepens after the pandemic. However, in contrast to recent decades, Japan might be better prepared for the slow bicycle race of the 2020s than some other advanced economies.