Don't declare victory for Abenomics yet

With the yen's falling to below ¥100/$1 for the first time since 2009 and the Nikkei’s posting five-year highs, analysts have begun declaring victory for the Abe administration’s campaign against deflation and slow growth. Paul Krugman, the intellectual godfather of Abenomics, has not quite begun his victory dance yet, but he is optimistic that under President Kuroda Haruhiko the Bank of Japan has credibly signaled that it will continue monetary expansion until it reaches its 2% inflation target.

But it is far too early to draw conclusions about the success of Abenomics — given that deflation continues — and there remain a number of unanswered questions surrounding the Abe government’s economic program.

Ultimately, the success of an economic program must be measured not just in terms of corporate balance sheets, but also in the economic wellbeing of average citizens. If wages remain stagnant or if Japan experiences a jobless recovery, can Abenomics be declared a success? What will Abenomics mean for the Japanese worker? As a New York Times article by Hiroko Tabuchi and Graham Bowley suggests, it remains to be seen whether monetary stimulus will translate into wage hikes or higher employment — though the government is trying to encourage corporations to hire more workers and raise wages. It may also depend on whether the government is able to reverse the rise of Japan’s non-regular workforce, the short-term contract workers who enjoy few benefits, little to no job security, and virtually no opportunities for advancement. Non-regular workers comprise between a third and a half of the labor force, and as the government acknowledges, the non-regular sector constitutes a tremendous waste of human capital.

However, without a plan to overhaul the Japanese labor market, the danger exists that exhortations to raise wages will result in corporations’ raising wages for regular workers but maintaining or cutting low wages for non-regular workers, thereby deepening the inequality that exists between regular and non-regular workers. The Abe government and the LDP are not blind to this problem — last month, for example, LDP Vice President Komura Masahiko said (jp) that more had to be done to improve the status of non-regular workers and provide equal pay for equal work — but thus far it is not clear how the government plans to resolve it. (For more discussion of the problems in Japan's labor market, see here.)

The same goes for gender balance in the labor force. Noah Smith (a onetime guest blogger here) has identified how underutilized women are in the Japanese labor force, and expressed his hopes that the Abe government will act to increase female participation in the workforce. Abe has, to his credit, said the right things about gender equality.In his 19 April speech at the Japanese National Press Club (jp), Abe spoke of gender equality as not a social policy issue, but as a central piece of his growth strategy. The reality is, however, that we just don’t know what he will be able to do to change the role of women in the economy. Pretty much the only specific proposal Abe mentioned in his speech was the proposal to increase the number of women in corporate management positions, but that proposal affects a fairly small number of women. Abe is not the first politician to pledge to do something about gender inequality — for the past decade Japan has had a cabinet-level minister of state for gender equality — but we still don’t know what Abe will do to succeed where previous governments have failed.

Reforming the labor market is part of the so-called “third arrow” of the Abe program, the Abe government’s growth strategy. Once again, Abe’s rhetoric is at least encouraging — talk about public-private partnerships to move Japan from inefficient to high-value-added sectors — but until the government’s detailed plans are released in June, it is difficult to say anything conclusive about whether the Abe government will succeed at transforming Japan’s economy. It is worth noting that the Abe government is not the Koizumi government redux: whereas Koizumi talked of moving from the public sector to the private sector, in his speech last month Abe stressed the role of government in promoting growth in new sectors, industrial policy for the new century, with all the risks that come with efforts by government to pick winners. 

Abenomics (and the latest round of quantitative easing in the US) has raised fears of currency wars breaking out between Japan and its competitors. The effects of the BOJ’s stimulus program are already being felt outside of Japan. South Korea’s central bank has already moved to cut rates in light of the ongoing decline of the yen against the won, as did Australia’s central bank earlier this week. European exporters — especially Germany’s — are feeling the pain from the yen’s decline against the euro. Of course, no government will admit that a currency war is afoot, but if other governments engage in competitive devaluation with Japan the benefits to Japanese exporters from a weaker yen will be muted (if they aren’t already muted). Though the G7 finance ministers' meeting in the UK this weekend did not necessarily single out Japan for criticism, the fact that the meeting was held does suggest that Japan's policies are under close scrutiny abroad. 

There are also lingering questions about Japan’s fiscal situation. With the BOJ stepping in to buy government bonds, the Japanese government will continue to be able to borrow without having to worry about rising interest rates. But the risks of Japan’s ever-growing debt remain — and if the BOJ has in fact succeeded at convincing market actors that it is committed to raise inflation, there is the risk that it will be unable to control inflation once it has met its target, hastening the day when interest payments will rise and break the government’s budget. The government is in a race against time. It needs to trigger sustainable long-term growth that can raise tax revenue before interest rates rise. The Abe government has indicated if economic conditions are still sluggish, it will delay the consumption tax increase passed under the Noda government, thereby postponing a useful means of closing the government’s annual deficit of 10% of GDP.

Finally, the question of Japan’s demographics looms over the debate about Abenomics. Edward Hugh offers a sobering account of how demographics may forestall the Abe government’s program. Hugh basically asks whether Japan has experienced a prolonged balance-sheet recession and is in a liquidity trap, as argued by Krugman, Richard Koo, and others, or whether Japan’s persistent demand shortfall is the result of a “shrinking population trap.” Hugh is skeptical that either fiscal or monetary policy will fix Japan’s economy and that the government’s monetary policy experiment risks triggering capital flight as elderly Japanese investors seek higher returns elsewhere. Hugh’s post is lengthy and I cannot do it justice with a short summary, but it should be taken into account when deciding whether Abenomics has succeeded.

The point is that it is impossible to know whether Abenomics has succeeded until we actually see the whole program put into action. Generating inflation is, as the Abe government says, just one arrow in a comprehensive plan to rejuvenate Japan’s economy. Stock market gains and a weaker yen may be helpful indicators but they should not be mistaken for signs for change in the real economy. Similarly, promising rhetoric about reform is encouraging, but after decades during which many Japanese politicians have talked a lot about reform but failed to follow through, it seems that a “wait-and-see” attitude is still appropriate. 

Abe probably has about as favorable a political environment as a Japanese prime minister could ask for — dysfunctional opposition parties, few challengers within the LDP, and high public approval ratings — suggesting that he may well be able to follow through on his ambitious agenda. That being said, if Abe cannot reverse Japan's economic woes even with all of these factors working in his favor, I have to wonder if anyone can.

Will the DPJ weather the global rebalancing?

David Brooks's latest column in the New York Times calls for a restoration of "economic values" in the United States, with the aim of making "the U.S. again a producer economy, not a consumer economy." Brooks sees a decline in traditional values of restraint behind the rise of consumer spending to ever greater portions of GDP and the growing indebtedness of consumers. Whether or not the emergence of the US as a consumer economy is a function of declining values, greater restraint by US consumers is the flip side of Japanese consumers spending more of hoarded savings. After all, the growth of the US consumer economy was accompanied by global imbalances, massive current account surpluses by countries like Japan.

The question now is how to execute the transition to a more balanced relationship among the world's economies, including and especially in the relationship between the US and Japan. How can the US become relatively more predisposed to production and Japan relatively more predisposed to consumption (especially of imports from the US and elsewhere)? The FT's Wolfgang Münchau praises the G20 for at least recognizing the problem of imbalances. For his part Münchau rejects the notion that adjustment can happen automatically simply by US households changing their behavior — or rather, that it can happen, but the transition will be painful everywhere, as Japanese exporters, deprived of American consumption, have discovered over the past year. Instead he argues that each country will have to adjust in its own way:

The answer is that policy will have to be tailor-made to suit the specific circumstances of each country. China will probably not be able to reduce its excessive current account surplus without a revaluation of the renminbi. In Germany, the best overall macro-policy instrument would be a big tax cut to boost domestic demand. In the UK, restoration of balance will have to include heavy cuts in public spending, while Spain will also have to raise taxes, even in addition to last week's announcement of a rise in value-added tax.

And what of Japan?

The DPJ fully acknowledged during the campaign that the challenge facing the government is managing the transition from the postwar producer economy — divided between efficient exporters and inefficient domestic producers and service providers — to a more consumer-centered economy.

But less clear is how the Hatoyama government plans to contribute to the global rebalancing. After all, the government has few policy tools at its disposal. Interest rates cannot go any lower. The government's debt burden limits its ability to use public funds to make up for weak private consumption. The yen's exchange rate is one tool available to the government, but as Finance Minister Fujii Hirohisa's conflicting remarks suggest, there are political limits to how far the government can permit an undervalued yen to rise. After stating following a summit with US Treasury Secretary Timothy Geithner on the sidelines of the G20 summit in Pittsburgh last week that the government would not intervene to keep the yen down, Fujii subsequently softened his position, alluding to intervention should the dollar-yen exchange rate rise too rapidly.

Richard Posner's note upon reading John Maynard Keynes's General Theory of Employment, Interest, and Money for the first time — "How I Became a Keynesian" — makes for interesting reading in light of Japan's dilemma. Posner highlights Keynes's focus on consumption as the engine of growth in an economy — and how uncertainty can trigger hoarding. "People do not save just to be able to make a specific future expenditure; they may also be hedging against uncertainty," writes Posner. "And the third claim, related to the second, is that uncertainty — in the sense of a risk that, unlike the risk of losing at roulette, cannot be calculated — is a pervasive feature of the economic environment, particularly with respect to projects intended to satisfy future consumption." This passage strikes me as a particularly succinct description of the problem faced by the Japanese government since the bubble burst: how can the government dispel the ubiquitous sense of uncertainty on the part of Japan's aging consumers? LDP governments engaged in policies that took the outward form of Keynesianism — large-scale construction projects — without appreciating the essence of Keynes, that the goal ultimately was (and is) getting consumers secure enough to spend their own money again. For all the dams and bridges built by the government, the money probably would have been better spent rebuilding the social safety net, which would have in turn made the economy better capable of weathering the transition from the producer-centered dual economy.

In short, the DPJ-led government will attempt what should have been done a decade ago, except that now its fiscal policy options are constrained and the global economy is recovering from a monumental crisis. It will have less recourse to foreign demand to ease the pain of transition than the LDP had up until the global financial crisis. Ultimately the DPJ may be able to do little more than make the transformation marginally less painful, but, as Noah Smith wrote at this blog earlier this year, it will be painful nevertheless. The DPJ may be able to extend its time in office if it is able to deliver adequate social spending in its budgets, but admittedly the prospects for success are grim. The government may simply not have the tools at its disposal to overcome the thriftiness of the Japanese people in an age of uncertainty — but it could pay the political price for "inaction" anyway.

Dollars and yen(ts) (Noah Smith)

There's an interesting article in BusinessWeek asking whether Japan will intervene to push down the strengthening yen. The consensus seems to be that it will, even though such a policy is not necessarily optimal from an economic viewpoint, and may not in fact work. But a weak yen seems to still be an important part of Japan's industrial policy. Why?

While "classic" theory holds that currency intervention is always inefficient, a new school of thought holds that it's in fact very useful for developing countries. The reason, as Dani Rodrik explains, is that domestic exporters engage in "cost discovery" — holding down your currency gives your domestic companies the chance to find out what they're best at, which is good for long-term economic strength.

But Japan is manifestly not a developing country. And Japanese companies have by now had plenty of time to find out what they're good at. So at this point, an artificially weakened currency serves mainly to boost employment in Japan's export industries at the expense of (a) efficiency (what is Sanyo's core competency again?), (b) Japanese consumers, and (c) industries that serve the Japanese market.

Fine, you may say, that's a fair trade. After all, employment gets a boost. But does it? Employment levels are different from employment volatility, and exports are notoriously volatile (because terms of trade can change quickly). Even if a weak yen increases Japanese employment — which is far from obvious — it may actually make Japanese jobs less secure. A global downturn, or a rapid increase in terms of trade — both of which we are seeing now in Japan — can force companies to either default on their debts or fire workers. In the 90s, Japanese companies did the former; they are now doing the latter.

In other words, this is a pretty clear example where Japan's reflexive (and politically motivated) adherence to "developing country policies" has probably backfired. Just another way that reforming the country's sclerotic political system could yield real benefits for the economy and people of Japan.

— Noah Smith

Much ado about nothing in Essen

So the meeting of G7 finance minister and central bank presidents has concluded, and, despite grumbles from the Democratic US Congress and the EU's ECOFIN about the weakness of the Japanese yen, the final statement in Essen included nothing that directly referred to Japanese monetary policy.

Instead, the only country named directly in the paragraph on exchange rate policy is China, together with other developing countries:

We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange markets closely, and cooperate as appropriate. In emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur. (Statement available for download here)

So Japan has once again been granted a reprieve, with China remaining the favored scapegoat of developed countries feeling the crush of competition from the BRICs and the rest of the developing world. Perhaps the G7 balked at the potential consequences of a statement that might spark the rapid "unwinding" of the yen carry trade.

In any case, the yen remains weak, Japanese interest rates remain extremely low, and the G7 remains a body with questionable relevance in the rapidly changing international system.