TOKYO – It has been almost a year since Prime Minister Shinzo Abe launched his plan to lift Japan’s economy out of two decades of deflation and recession. How has “Abenomics” fared so far?
Answering this question requires breaking Abenomics down into its three components – massive monetary easing, expansionary fiscal policy, and a long-term growth strategy – which Abe, referring to the tale of Motonari Mori, a sixteenth-century daimyo (feudal lord), calls the “three arrows.” According to legend, Mori instructed each of his three sons to snap an arrow in half. After they had succeeded, he told them to tie three arrows together, and break the whole bundle at once; none was able to do it.
Like Mori’s three arrows, the three arrows of Abenomics are supposed to reinforce each other. But Mori’s arrows were bound together in parallel, whereas Abe’s policy arrows are connected through underlying structural relationships. While the first and second arrows aim to transform Japan’s actual growth path, the third operates on the economy’s potential growth path, which assumes the optimal use of all available resources and technologies.
Since Abenomics was launched, the “deflation gap” (the difference between actual and potential output) has dropped from roughly three percentage points to below 1.5. This implies that, while the first two arrows are helping to improve Japan’s actual growth path, the third arrow has yet to do much for potential growth.
In fact, since Abe’s first arrow took flight, Japan’s stock market has soared with it, recording an unprecedented 40% annual gain, while the yen has depreciated against the dollar by 20%, boosting Japanese firms’ export competitiveness. Moreover, credit growth has accelerated and asset prices have risen – trends that will encourage consumption by triggering the wealth effect (when people spend more because they feel richer). And monetary expansion is also having a positive impact on the labor market: the unemployment rate has fallen to 4%, and the job-to-applicant ratio is nearing parity.
With real GDP growth around 4% in the first half of the year (though it did fall below 2% in the third quarter), the first arrow has already hit the bull’s eye – a performance worthy of an A+.
The second arrow entails a sharp increase in short-term fiscal expenditure, especially investment in infrastructure projects. While those who, like me, adhere to the Mundell-Fleming framework (according to which fiscal stimulus will be offset by the resulting increase in capital inflows, currency appreciation, and reduced export competitiveness) do not stress the impact of flexible fiscal policy, Keynesians take it very seriously. On the assumption that faster growth will neutralize any threat to debt sustainability, the second arrow receives a B.
When the first and second arrows lift actual growth above potential growth, monetary expansion will no longer be able to produce substantial GDP or employment gains. That is when the third arrow, which aims to boost Japan’s potential growth through structural change (including increased private investment, technological innovation, improved trade links, and reformed corporate-tax policy), will become far more important.
Abe has set out the vision behind his long-term growth plan. “Japan is a country that challenges, that is open, and that innovates,” he says. But many of the details of his strategy remain uncertain.
Japan’s longtime approach to industrial policy, in which the Ministry of International Trade and Industry provided support and subsidies for selected industries, helping them to compete in world markets, is now obsolete (indeed, MITI’s role was taken over by the Ministry of Economy, Trade, and Industry in 2001). When Japanese firms operate at the frontier of industry, bureaucrats cannot choose the winners. Given this, the government’s role should be confined to areas where externalities exist, such as carbon-emissions reduction.
Unfortunately, a new, clearly defined approach to industrial policy is still missing. In fact, descriptions of some third-arrow projects seem to be based on little more than wishful thinking, with new technology or knowhow apparently expected simply to fall into Japan’s lap. A more effective approach would entail achievable, concrete goals like relaxing labor- and financial-market regulations, reducing corporate income taxes, liberalizing trade by joining the Trans-Pacific Partnership, and perhaps easing immigration policy.
The problem is that bureaucrats like the power that regulation affords them. Indeed, deregulation would require them to put their country’s long-term interests above their own short-term interests – a choice that they have so far resisted. To paraphrase John F. Kennedy, it is time for Japan’s leaders to ask not what their country can do for its government, but what the government can undo for its country.
In this context, the third arrow of Abenomics cannot yet be fairly assessed. While its impact has so far been lacking, it certainly cannot be deemed a failure, with Japan’s top leaders still working tirelessly to build the needed momentum. The most appropriate grade is therefore an “E” for effort. One hopes that it is an effort that proves adequate to overcome bureaucratic resistance to deregulation in the coming year.
With an A+, a B, and an “E,” Abenomics’s first-year report card reflects important progress, providing plenty of reason for enthusiasm. It even spells its originator’s name.