What is ‘Abenomics’? Three arrows in the quiver…
‘Abenomics’ is the general term used for the new policy introduced by Prime Minister Shinzo Abe to kick-start the Japanese economy. The market is currently focussing on the monetary side of ‘Abenomics’, and in truth it is also the most spectacular.
However, as we have pointed out, the underlying problems facing Japan are not only monetary in nature and do not only relate to deflation, although that is clearly a problem. Deflation is a symptom of the underlying illnesses, which among other things are an inefficient domestic economy lacking in true competition in many areas, demographic changes leading to a shrinking tax base and the prospect of increased future public expenditure, an insular and inflexible management style and mentality throughout most of corporate Japan, highly risk averse consumers, a cultural conservativeness which extends into financial decision making, and structural barriers to aggressive and much needed M&A (especially by foreign entities) particularly in domestic demand orientated sector of the economy. Deflation may not have been caused by these factors initially, but they make it very difficult for the economy to extract itself from a deflationary spiral, which is what Japan has been in for around two decades now, depending on the exact measure used. A dramatic change in direction is certainly needed urgently in order to avoid the Japanese government eventually defaulting on its debt, which is projected to stand at 250% of GDP in 2015 (resulting in roughly 30% of government tax revenue being spent just on interest payments).
Prime Minister Shinzo Abe has used the analogy of Three Arrows. Taken alone, each can be bent; Taken together, none can. This may sounds rather fanciful, but the underlying idea is valid. The three arrow are:
- MONETARY STIMULUS. Creating sustained inflation running at 2%, thus normalizing an economy that has been stuck in the grip of deflation for decades. (See our post here: https://nipponmarketblog.wordpress.com/2013/04/09/japan-initiates-bold-bid-to-end-years-of-tumbling-prices/)
- FISCAL STIMULUS. Increased government expenditure in areas like infrastructure. This has been attempted many times in the past, but mostly in badly thought out ways, often diluted by politics and to buy votes (especially in rural areas). It serves as a short term shot in the arm for headline GDP numbers, but they tend to have no long term effects on the economy. The only long term effect they have is to increase government debt.
- STRUCTURAL REFORM. This is the most important arrow, but also by far the most challenging. Japan is renowned for having one of the most isolated and hence inefficient and internationally uncompetitive domestic economies in the world. But the problems extend into the more export orientated sectors. Prime among these issues is the labour market. Generally speaking, Japanese companies consider their employees as a sort of extended family, and although life time employment guarantees no longer exists to the extent they used to, the labour market in Japan is still very inflexible. Importantly, this is not due to government regulation of lack thereof. It is simply decades-old corporate convention dictating how things work. The flip-side of this is that there is effectively nothing the government can do to change it. The government can only ask nicely, and it has already done so by requesting that companies increase summer bonuses this year. Another area of significant inefficiency and hence welfare loss for the economy is the legacy of the so-called ‘Convoy system’ employed in the 70’s and 80’s, when the largest companies such as Toyota would lead the way in the global market, and behind it would follow dozens if not hundreds of smaller companies, all supplying components to Toyota and effectively piggybacking onto its global sale successes. This system worked wonders when Japan was the leader in low cost, high volume manufacturing for the export markets, but in today’s economic reality where Japan is no longer the low cost manufacturing leader, and where product cycles are often much shorter requiring a much more flexible management style, many Japanese companies come up short. Visiting mid-cap manufacturing companies in Japan (especially in the electronic component sector), it is not unusual to encounter companies that maintain loss-making product lines out of a sense of responsibility to honour supply agreements with major companies that have historically been beneficial for the smaller component companies. This sort of thinking is almost unimaginable in the Anglo-Saxon corporate sector, but it is alive as (un)well in Japan. Needless to say, this represents a significant welfare loss for the economy as a whole.
The jury is still very much out on the last and most important ‘Abe Arrow’, but one suspect that the government might try to get the corporate sector onside through informal pressure, and drip-feed announcements to the public and to the market about coming initiatives in order to retain the image of credibility that the plan currently appears to enjoy among market participants. Actual meaningful change will undoubtedly be a long and slow process, especially in an inherently conservative and consensus-driven country like Japan, so of course the risk is that the market becomes disillusioned. Something that has happened a few times before.
A quick explanation of the monetary side of ‘Abenomics’ is explained by the FT’s David Pilling: