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.

Vaarwel and au revoir to Belgium?

The FT's Gideon Rachman weighs in on the Belgian "crisis" in a piece called "For Nations, Small is Beautiful."

(I realize that this has little or nothing to do with Japan, a country Edwin Reischauer once suggested "may be the world’s most perfect nation-state," although with Okinawa as a prefecture, Japan is not nearly as perfect as the late ambassador would have it.)

In it, Rachman dispels some of the irrational fears that have marked responses in the outside world to the prospect of Belgium's splitting into two countries. Namely, that in the twenty-first century, the idea of agglomerating more and more land and people under one government is outdated, and, indeed, counterproductive.

But taking pride in the sheer size of your country is increasingly anachronistic.Traditionally it has been good to be a big country for two main reasons: prosperity and security. A big country meant a bigger market and so more trade and wealth creation. A large nation was also more powerful and less likely to be invaded.

But in the modern world, both these advantages seem to be diminishing.

Globalisation has opened up markets across the world. China and India are getting richer largely because they have access to the markets of the developed world, not because of the size of their domestic markets. Small countries can trade their way to success even more swiftly. Think of Singapore or Switzerland.

Small is also no longer synonymous with insecure.

In Europe, many minnows have enhanced their security by joining Nato. This is sometimes denounced as free-riding. Belgium or Luxembourg can afford to be small, secure and smug – because they are under the security umbrella, proffered by big and generous Uncle Sam.

But joining a collective security organisation is not an absolute necessity for a small country. Ireland and Switzerland are not members of Nato – and neither appears to be in imminent danger of invasion.

The fact is large countries are now less instinctively expansionist than they were in the days of empire. These days, invading and occupying small countries can be a massive pain in the neck – as the US has discovered in Iraq and Afghanistan.

Since the traditional disadvantages of being a tiddly country are disappearing, you are just left with the advantages.

As Beijing understands, at some point there are diminishing marginal returns for population size. At some point, an extra 100 million people who have to be fed, housed, clothed, and employed create more problems than the contributions they make in terms of taxes and productivity. Why else would the CCP have initiated the one-child policy? In terms of territory too, at some point the costs of policing a territory are more than the territory's returns for a government.

And the feasibility of small countries should finally mean the end of Europe's nationalities problem, in that every nation that desires autonomy can survive in its own national home. Scotland? Fine. Catalonia? Go ahead. As Rachman suggests, the existence of NATO and the European Union ensure the survival of small states in Europe. With a security guarantee from more powerful states, the security benefits derived from expansive territory and a large population are superfluous, while the EU's single market makes possible economies of scale that states once sought in large continental or overseas empires.

So should Belgium, the product of a political settlement among the great powers in 1831, break, I won't shed a tear, especially since the Walloons and the Flemings have been sleeping in separate beds, so to speak, for years. I'm sure both will be fine.

The larger idea here is that we should not be so wedded to the idea that the nation- and multi-national states that exist today will be around forever. The map will change; arrangements were the product of either political convenience or the contrivances of empires will break down, hopefully peacefully. This trend may prove to be one of the most significant of the century.

Change the LDP, change Japan — now more than ever

David Pilling, the FT's Japan correspondent, indirectly responds to a point I made earlier this week when discussing Matsuoka's suicide in an op-ed entitled "No way back to old Japan" (subscription required).

As the title suggests, he argues that Matsuoka's suicide actually marks the death throes of the old political system:

The postwar system that is now morphing into something new depended on fast growth to survive: the LDP shovelled tax money from the cities to the countryside via huge public works programmes. It reaped dividends in the form of votes from over-represented rural constituencies and "political donations" through grateful interest groups. That system is no longer viable, for the simple reason that the money has run out. The public works budget has been savaged in the past decade. The system of paying for roads and dams with post office savings is being wound down. Indeed, the post office itself, the world's jangliest piggy bank, is being privatised.

Gerald Curtis, a Japan expert at Columbia university, says that Japan is undergoing the third great change in its modern history. The first was the Meiji Restoration, when leaders ditched feudalism. The second was the postwar construction of a machine to deliver rapid economic growth. Professor Curtis calls the third phase a "20-year decade", a glacial but valley-carving response to domestic economic crisis and globalisation. That adjustment has meant the slow breakdown of convoy capitalism, reflected in the unwinding of cross shareholdings. It also heralds the abandonment of egalitarian income distribution. In politics, it means the end of elections by money-stuffed envelopes and the rise of prime ministerial power and accountability.

Interestingly, he also argues that Abe's emphasis on education and constitution revision are signs of change, rather than examples of how Abe is interested in anything but midwifing the creation of a new political system.

I wish it were so. I wish the old system were transforming before our eyes, the Abe Cabinet being the swansong of the old era. But I think the evidence to support Pilling's argument is thin.

Undoubtedly the money is running out. There's no way around that. Politicians like the late Mr. Matsuoka have a smaller pot to fight over — but how will that affect the system? Will pork-barrel politicians decide to become reformers when faced with difficulties in earmarking funds for their constituencies? Will the incumbency advantage actually fail them as the amount of money they send home shrinks? On the contrary, won't politicians simply compete that much more fiercely to earn their share of the shrinking pie?

As for the rise of the prime minister in the policy making system, the new power of the Kantei can and has been overstated; as Mulgan argues, what's happened is that the prime minister is now the third leg of a triangular policy making system, forced to contend with the LDP's policy making organs and the bureaucracy (who still collude with one another).

The implication in Pilling's argument is that the new political system is going to emerge organically, without any individual or party actively shaping its creation. But I disagree. I don't see how Japan's political system will transform into a system in which policy is made in service of public and national interests without an LDP president willing to impose discipline on party ranks, cut PARC down to size, sharply limit interaction between bureaucrats and Diet backbenchers, and centralize campaign funding in the party. Each of these steps would require the willingness to overcome fierce opposition from the LDP. Is there anything Abe has done that would lead someone to think that he will be the man to create a new political system?

What is likely to happen that even as the old system loses its potency, it will limp along in the absence of someone stepping forward to propose a replacement. The problem is that Japan cannot wait forever to reform. Its demographic sword of Damocles (hat tip: GLOCOM), together with the inexorable rise of China and India, mean that failure to act now to "rationalize" its political system will doom Japan to irrelevancy.

Demographics and political change

The Japan Times has a brief article about the Ministry of Internal Affairs and Communications' latest survey of Japan's population, conducted in October of last year.

The survey found that Japan's population held steady at roughly 127 million people, but there was considerable change in the populations of Japan's prefectures, a continuation of the shift of Japan's population away from sparsely populated, rural Japan to densely populated prefectures, particularly Tokyo and its surrounding prefectures.

If one looks at the top and bottom five prefectures in this survey, and looks at the relative numbers of LDP and DPJ candidates those prefectures send to the Diet, several things stand out.

First, the top five, with the latest growth figure (relative to the previous year), population and population density per square kilometer:

Aichi +.74 7,043,235 1,366

Tokyo +.66 12,059,237 5,514

Shiga +.61 1,342,811 334

Okinawa +.5 1,318,281 580

Kanagawa +.43 8,489,932 3,515

And the bottom (from fifth lowest growth rate to the worst):

Shimane -.77 761,499 114

Nagasaki -.83 1,516,536 371

Kochi -.86 813,980 115

Aomori -.98 1,475,635 154

Akita -1.02 1,189,215 102

In 2005, the top five growers elected a total of eighty-one LDP candidates -- between constituency and block elections -- and twenty-one DPJ candidates, comprising respectively 27% and 18% of each party's caucus in the Lower House. The bottom five elected twenty-one LDP candidates and five DPJ candiates, comprising approximately 7% and 4% of each party's caucus.

The greater weight of the densely populated, growing prefectures is by no means surprising -- but among the eighty-one LDP candidates elected in the top five in the 2005 landslide, forty-two of them were elected for the first time in either 2003 or 2005. They are, in short, Koizumi's children, beneficiaries of Koizumi's popularity throughout Japan, helping the LDP grow outside of its traditional rural base. (Note that in the shrinking bottom five, of the twenty-one LDP candidates elected in 2005, only five were running for the first or second time.)

So the question is, what will happen to the LDP in the next election, when LDP candidates first elected due to Koizumi's coattails face the voters again, this time with Abe instead of Koizumi at the head of the party? Will voters in growing prefectures be as eager to elect LDP candidates without a vigorous reformer at the helm of the party?

Another interesting question is at what point will the growing population disparities lead to pressure for a new round of redistricting (or even a new mechanism for redistricting).

These numbers do not suggest the LDP's doom; it is well placed, in the short term, to contest and win in urban Japan. But over the medium to long term, can the LDP shift its policy bias away from protecting rural constituencies to legislating towards the interest of urban workers and consumers? If Koizumi couldn't do it, is there anyone in the LDP who can?