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Reinventing Growth

Article - October 12, 2016

Challenged on multiple fronts, the rising sun empire is working to reinvent itself–driven by a leader who wants to prove his country’s economic resilience and robust capacities even in these trickiest of circumstances

After a 20 year-long economic recession punctuated by the Fukushima nuclear disaster five years ago, the world’s third largest economy may seem merely striving for survival to the unfamiliar observer. That lackluster ambition however is not in the nature of Prime Minister Shinzo Abe, who has much brighter plans for his country, and aims for nothing less than an economic renaissance, a reinforced role in the global order and a newborn diplomatic and military assertiveness.

Some foundations have already been laid. Since becoming Prime Minister in 2012, Mr. Abe has stamped his name in the country’s renowned path for economic revival: ‘Abenomics’, which is based upon three “arrows”–fiscal stimulus, monetary easing and structural reforms–that are backed by a 10.3 trillion yen ($102 billion) fiscal stimulus.

Based on that ammunition, Japan has recorded its lowest jobless rate in two decades (3.2%), secured record corporate profits and achieved its longest sequence of year-on-year nominal GDP growth in two decades. An upbeat mood is starting to emerge in a country that is still haunted by the Fukushima trauma.  

That renewed optimism surely played a role in the ruling LDP coalition’s landslide win in the upper house elections held in July. The victory gave Mr. Abe a two-thirds majority in both chambers, providing the government unprecedented room for maneuver that is in turn translating into increasingly ambitious economic reforms.

The electorate’s support has also given Mr. Abe the confidence to adopt a sort of bullish rhetoric that was unheard of during Japan’s long years of lassitude: “With an even stronger political base, we can and must push forward our economic and diplomatic policies even more aggressively. That’s the way to respond to the mandate the public gave us in this upper house election,” the Prime Minister declared following his reelection.

This optimism, however, could be jeopardized by a plethora of threats. The most serious one is deflation, a seemingly chronic Japanese disease that continues to dent the country’s economic resurgence. Consumer prices dropped for the fifth month in a row in July and recorded the biggest annual fall in more than three years. Core inflation still remains well below the 2% target, meaning that Japan’s fiscal and monetary policies need to be rethought.

Both the International Monetary Fund (IMF) and the World Bank expect the country’s economy to expand by only 0.5% in 2016–hardly an undisputed sign that Japan is back from the cold. Indeed, its nominal GDP was roughly the same in 2015 as it was 20 years earlier, while America’s, by comparison, grew by 134% in the same period.

Consumption and internal demand must be the driving forces that correct deflation and put the economy in a more secure footing, as investors have been quick to point out. “We definitely need to see a revival of private consumption; that’s the source of weakness for Japan’s economy,” said Tomo Kinoshita, chief market economist at Nomura Securities in Tokyo.

It is time for Abenomics 2.0, a reflationary push that points toward a very clear direction: increasing consumption. Mr. Abe knows that Japan cannot rely on an unstable international scenario to improve his country’s fortunes, but has to generate impetus from within. “Britain voted to exit the European Union and emerging economies are showing signs of deflation, therefore Japan must boost domestic demand,” the Prime Minister stated in July.

The ruling coalition has a comfortable parliamentary majority to forge ahead with a fresh Abenomics therapy, and it has not taken long before unveiling its firepower. In July, the government signed a large new fiscal-stimulus package worth 28 trillion yen ($278 billion), or 6% of GDP. Mr. Abe has also announced major investments in transport and tourism infrastructure, including in the country’s signature Shinkansen bullet trains, and promised to speed up the reconstruction of the areas hit by the Fukushima disaster.

However, the stimulus must be coupled with market-friendly reforms. Sadayuki Sakakibara, Chairman of the Japan Business Federation, clearly stresses, “The top priority is ending deflation and revitalizing the economy. To accomplish this, it’s essential that the government expand personal consumption and investment, and promote deregulation.”

Mr. Abe is already considering structural reforms such as easing smaller companies’ access to funding, attracting more foreign workers into the country, and enabling firms to hire and fire more easily. The government also seems ready to boost women’s participation in the labor market, a long-due move that would require confronting atavisms that are still a feature of Japanese society.

It remains to be seen whether those measures can spur Japan’s economy in the long term – yet there are already indications to show that, if ambitiously pursued and complemented with the aforementioned reforms, the country could leave the intensive care unit for good.

The Japanese stimulus-based approach to economic reanimation should give other major economies food for thought. Specifically, in Europe, where the austerity doctrine has failed to boost growth and reduce unemployment to any remotely acceptable level, and where governments should pay attention to Mr. Abe’s recipe for growth, even when it still must stand the test of time.

There are hints that a re-empowered Japan is rising, even if the IMF has already warned Tokyo that the reformist drive must continue unabated, and has sent a formidable to-do list to the country. Encouraging wage hikes, reducing the gap between regular and non-regular workers, easing fiscal and monetary policies, boosting labor supply and increasing productivity are just a few examples of the homework that is yet to be done. In short, Abenomics must “double down”, according to David Lipton, IMF’s First Deputy Managing Director.

Economic revival is expected to unleash other ambitions. It is no secret that the Abe administration wants Japan to play a more substantive geostrategic role, mitigate its overreliance on U.S. military assistance, and become a counterweight to China in the Asia-Pacific region.

Japan’s post-war constitutional constraints, which forbid the country from using force to settle international disputes, increasingly look like an uncomfortable straitjacket, and Mr. Abe has vowed to take it off. The Prime Minister has called for a debate on rewriting the country’s pacifist constitution and using his supermajority to revise Article 9, which states that the Japanese Army has an exclusively self-defensive role.

Even if any amendments required approval in a referendum, the traditional sanctity of Article 9 is now under question. This has been enough to unsettle China, which rightly sees its arch-rival maneuvering as a response to Beijing’s territorial claims in the region, and is wary that an emboldened Japan could hinder its triumphal march across the Pacific.