Japan and Abenomics

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Niraj Singh Mahraur's picture

Introduction

After being elected the prime minister of Japan in December 2012, Shinzo Abe in his first policy speech in January 2013 started off by admitting that Japan was in a state of crisis. The crisis not merely extended to the economy in the form of long term deflation, strengthening yen, slowdown in growth but also extended to diplomatic and social spheres. He saw declining academic achievement and the under participation of women in the labour force as major challenges. His economic policy response popularly labelled ‘abenomics’ is the three pronged strategy of aggressive monetary easing, flexible fiscal policy and structural reforms to encourage private sector investment. This essay presents an elementary theory of the relationship between the political leadership and financial markets and evaluates whether Abe’s claims came to pass in light of his policies.

Theory

We can imagine the head of the state and financial markets as two distinct entities with a complex set of direct and indirect associations involving other intermediate entities. In this representation the leader holds a set of threads which are powers granted to him by the institutional framework he operates in. These threads in turn influence the intermediate entities like the central bank, commercial activity, private firms, taxation and the society at large. Additionally he exercises some direct influence over the financial markets through the power of direct regulation. It is through these intermediate entities and direct regulatory powers the leader exercises an influence over the financial markets. The degree of influence a leader can possibly exercise over the financial markets thus depends on the set of powers the institutional framework empowers the leader with and the specific policy choices he makes while exercising those powers.

The head of the state is certainly not the sole influencer and many external factors like global economic and political phenomenon, non-state actors, and investor perceptions come into play. An empirical substantiation of this influence was observed in the American Precedential elections in 2004. Some flawed exit poll data that came out early on the Election Day, predicted a Bush defeat but the final count of votes had reversed that verdict. As the polls and election results were coming out a prediction market tracking the outcome operated and the financial markets continued to trade. Snowberg et al. looked at the movements in both these classes of markets and found that S&P 500 index closely tracked the probability of Bush winning the election. When the election results became clear and the probability of Bush winning moved from 30% to 95% the S&P 500 index rebounded, rising 1.5%. Other stock indices, bond yields and oil prices reflected similar dependencies. This paper provides strong support to the proposition that financial markets are unmistakably responsive to government transitions.

Abe’s election does not provide us with a conveniently flawed exit poll to extrapolate the above mentioned study on but an argument can be made on the basis of the similarities in the structure of the US and Japanese government and the powers of the Prime Minister of Japan and the President of the US. Although in the Presidential system of government the US President has a much lower degree of control over legislative action when compared to the Japanese Government; the executive functions in both systems of Governments significantly coincide to allow us to extrapolate Snowberg et al.’s findings to transitions in Japanese government as well.

Monetary and Fiscal Policy Decisions

Exercising his powers as the head of the executive, Abe promised closer cooperation between the Bank of Japan (BOJ) and the Government. In a joint statement with the ministry of finance on 22nd January 2013, BOJ set the price stability target at 2%. Following up on the agreed target the BOJ announced its ‘Quantitative and Qualitative Monetary Easing’ (QQE) plan on the 4th of April 2013 which entailed an increase to the monetary base of up to 60-70 trillion yen annually. Subsequently on 31st October 2014 an expansion of the QQE policy was announced and the pace of annual stimulus was increased to 80 trillion yen.

The Japanese economy has seen two years of aggressive growth of its monetary base and one must ask how has it affected the economy and financial markets?  BOJ in its statement issued on 21st January 2015 conveyed that the year-on-year rate of increase in the CPI is in the range of 0.5% to 1.0%. This number though still significantly behind the targeted rate of 2%, it is moving in the positive direction and is well above the negative figures of the previous decade.

Another consequence of the QQE has been devaluation of the yen, which was another objective that Abe had set out for Japan. The US dollar value of yen has risen from around ¥85 in December 2012 to ¥117 as of 24th January 2015.

This devaluation is not merely making Japanese goods and services competitive in the international market but also making production more feasible in Japan. Canon, Sharp and Daikin are some big names that have recently started to shift or increase production in Japan. Despite some positive news other significant factors like overall rising share of offshore production and Japan’s upstream position in the global supply chain have reduced the sensitivity of exports to fluctuations in the yen. Furthermore increasing energy and consumer electronics imports have further elevated the trade deficit. Abe’s policies have met their intermediate goal of devaluation of the currency but lack of significant structural reform has been widely blamed for slower than desired growth of GDP and Income.

In the area of fiscal policy Abe has some difficult choices to make. On one hand Japan’s public debt is higher than ever and on the other hand the need to spur domestic household and corporate expenditure requires the government to keep a light hand on taxes. One of the most significant changes in taxation in Abe’s time has been the hike in sales tax in April 2014. This hike as expected substantially affected the household expenditure growth rate in the subsequent months.

As a response to this, Abe has postponed the next scheduled hike in October 2015 by 18 months in order to allow household income to rise to sustain the higher taxes. Such policy decisions show that as a leader and chief decision maker he is consciously walking the tightrope balancing ‘fiscal consolidation’ with ‘economic revitalisation’.

Structural Reform

As the head of the executive and legislative branches of the government, implementing ambitious structural reform requires expenditure of significant political capital and is proving to be the most challenging for Abe. While the society remains averse to the idea of mass immigration Abe has sought to enrich the labour force by including more women in the workplace. As part of the draft budget for 2015, Abe has proposed utilising the revenues from consumption tax increase for a new child support system that will accelerate elimination of waiting lists for childcare services. Such investment will not only enable mothers to return to work but is also likely to tackle the long term problem population decline. Since Abe came to power the female labour force participation rate has increased by a percentage point to 49% but it still lags behind the world average and other high income countries.

 

Empowered by the majority in the National Diet, Abe has embarked upon a phased and ambitious plan of fully liberalizing electricity utility industry by 2020. Such structural reforms will contribute to increases in productivity and move the economy towards growth in the long run.

Conclusion

The numbers speak for themselves in this respect; since Abe was elected Nikkei has moved from around 9,500 in December 2012 to above 17,000 in January 2015.

A definitive answer to the question of to what extent have Abe’s policies contributed to this rise is difficult to conceive but significant credit is undoubtedly owed. The consumption tax hike in April 2014 has taken the economy’s growth rate into negative figures but most economists expect a modest recovery in 2015.

Apart from substantive policy changes and structural reform the leader has a great degree of symbolic significance to the financial markets. Perceptions and investor sentiments play a huge role in driving movements and a leader who has a specific plan and is dedicated to it is positively viewed by investors. Certainty and stability in the government drives investment in an economy. Julio and Yook after observing investment expenditure data across 248 national elections in 48 countries including Japan had found support for the hypothesis that political uncertainty leads firms to reduce investment expenditures until the electoral uncertainty is resolved. Abe’s government commands a majority in both houses of the parliament and his re-election in December 2014 has reaffirmed the electorate’s and investor’s confidence in his ability to marshal the economy and the financial markets towards growth in the long run.

References: 

Research Papers

"Partisan Impacts on the Economy: Evidence from Prediction Markets and Close Elections"

Author(s): Erik Snowberg, Justin Wolfers and Eric Zitzewitz

Source: The Quarterly Journal of Economics, Vol. 122, No. 2 (May, 2007), pp. 807-829

"Political Uncertainty and Corporate Investment Cycles"

Author(s): BRANDON JULIO and YOUNGSUK YOOK

Source: THE JOURNAL OF FINANCE • VOL. LXVII, NO. 1 • FEBRUARY 2012


Reports

IMF Country Report No. 14/236: JAPAN 2014 ARTICLE IV CONSULTATION.

IMF Country Report No. 13/253: JAPAN 2013 ARTICLE IV CONSULTATION

(http://www.imf.org/external/country/JPN/index.htm)

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Policy Speech by Prime Minister Shinzo Abe to the 183rd Session of the Diet

http://japan.kantei.go.jp/96_abe/statement/201301/28syosin_e.html

 

Joint Statement of the Government and the Bank of Japan on Overcoming Deflation and Achieving Sustainable Economic Growth

January 22, 2013, Cabinet Office Ministry of Finance, Bank of Japan  

https://www.boj.or.jp/en/announcements/release_2013/k130122c.pdf

 

Introduction of the "Quantitative and Qualitative Monetary Easing" 

April 4, 2013, Bank of Japan

https://www.boj.or.jp/en/announcements/release_2013/k130404a.pdf

 

Expansion of the Quantitative and Qualitative Monetary Easing 

October 31, 2014, Bank of Japan

https://www.boj.or.jp/en/announcements/release_2014/k141031a.pdf

 

Statement on Monetary Policy 

January 21, 2015, Bank of Japan

https://www.boj.or.jp/en/announcements/release_2015/k150121a.pdf

 

Weak Yen Rekindles Hope for ‘Made in Japan’

Jan 18, 2015, Wall Street Journal

http://www.wsj.com/articles/weak-yen-rekindles-hope-for-made-in-japan-1421618401

 

Survey Report on Overseas Business Operations by Japanese Manufacturing Companies Results of the JBIC FY2014 

Survey: - Outlook for Japanese Foreign Direct Investment (26th Annual Survey)- November 2014 

Research Division, Policy and Strategy Office for Financial Operations Japan Bank for International Cooperation

https://www.jbic.go.jp/wp-content/uploads/press_en/2014/11/32994/20141128English1.pdf

 

Summary of the Latest Month on Family Income and Expenditure Survey

November 2014, Statistics Bureau of Japan

http://www.stat.go.jp/english/data/kakei/156.htm

 

Highlights of the Draft Budget for FY2015

http://www.mof.go.jp/english/budget/budget/fy2015/01.pdf

 

Electricity System Reform

November 13 2013, Ministry of Economy, Trade and Industry

http://www.meti.go.jp/english/policy/energy_environment/electricity_system_reform/index.html