When Shinzo Abe took office as Japan’s prime minister two years ago, he spoke of “three arrows” of reform – structural, fiscal and monetary – that would enable the Land of the Rising Sun to finally hit the bull’s eye of decent growth, something it had failed to achieve for two decades.
But it would appear that one of those arrows has left the bow and pierced Japan’s own foot.
Data yesterday showed that the country’s GDP unexpectedly contracted at an annualised rate of 1.6 per cent in the third quarter of the year, following a massive 7.3 per cent annualised drop in the second quarter. As the first chart shows, that puts the country back in a technical recession again. And it leaves “Abenomics” in a state of crisis.
Professor Koichi Hamada, one of Mr Abe’s close advisers, described yesterday’s numbers as a “body blow”. The stock market instantly sold off, with the Nikkei down by 3 per cent.
Blame for the return to recession has almost universally fallen on the decision by Mr Abe’s administration to hike the country’s sales tax earlier this year, which, as many predicted at the time, has hammered consumer confidence and aborted the recovery.
The arrow that has misfired was fiscal reform. Mr Abe put up the sales tax from 5 per cent to 8 per cent in April, in an attempt to put Japan’s public finances on a sounder footing and to slash the country’s large fiscal deficit, which is running at around 7 per cent of GDP.
The broader aim was to persuade the international bond markets that Japan was prepared to take serious measures to rein in its vastly swollen national debt pile, which is equivalent to more than 245 per cent of the country’s annual output. The gamble was that the economy would be able to ride out the shock higher sales taxes would inflict on consumption levels, and that Japan could have fiscal tightening and growth simultaneously.
It now looks as though the gamble has failed. Household consumption fell off a cliff in the second quarter of the year, declining by 5.2 per cent on an annual basis, and only eked out a 1.5 per cent annualised increase in the third quarter. The Japanese consumer has taken flight, leaving domestic demand deflated.
Abenomics’ other two arrows – structural reforms and monetary easing – have not inflicted such grave self-harm. But they have not hit the target either. Structural reforms to the sclerotic Japanese labour and services markets have yet to make any discernible impact on activity or expectations of higher future incomes. The drive to open up the workplace to women has yielded few tangible results. “The government has begun the legislative process on a range of measures, including opening up the health sector, allowing the employment of foreign housemaids in some areas and shaking up corporate governance, but there seems to be little urgency,” said Rob Wood of Berenberg Bank.
The most successful of the trio of Abenomics’ arrows has certainly been monetary policy. The Bank of Japan has said it will do whatever it takes to raise consumer price inflation to 2 per cent by 2015, ending years of enervating deflation.
To that end, the central bank has been buying up government bonds and all manner of other assets as well – including exchange-traded investment funds. Its balance sheet has shot up, as the second chart shows, rising by 50 per cent in two years. That stimulus has pushed up consumer price inflation from minus 0.9 per cent in February 2013 to 2.2 per cent in September.
And as a handy side effect, the easing has pushed down the value of the yen against the dollar, helping Japan’s exporters. The yen has dropped almost 50 per cent against the dollar in the past two years, from $78 to $116.
But domestic price growth expectations have been subsiding in recent months. And nominal GDP growth, which is the key metric when it comes to the sustainability of Japan’s public finances, is running below official plans according to yesterday’s data. NGDP actually fell by 3 per cent on an annualised basis in the third quarter.
The Bank of Japan’s governor, Haruhiko Kuroda, was sufficiently alarmed by the signs of slippage last month that he pushed through another increase in the target for the central bank’s balance sheet expansion. That was a close run thing though. Mr Kuroda only squeezed the expansion through the Bank’s nine-man board by a five to four margin.
Yet other changes will almost certainly have to be made if Abenomics is to survive. Mr Abe is widely expected to delay another hike in the tax to 10 per cent that was due next October until 2017, in order to give consumers a break. There is talk of a snap election in December to renew the political mandate for the administration’s economic therapy.
Analysts think that Mr Abe would win such a vote. But the experts also expected the country to avoid another recession. The fate of the boldest economic reform that Japan has seen in two decades hangs by a thread. More self-inflicted wounds could well be fatal.
A female problem: still outstanding
One of Shinzo Abe’s priorities when it comes to structural reform of the Japanese economy has been to encourage more women into the workforce. Female participation is 63 per cent – in the US it is 67 per cent, and 70 per cent in the UK. Analysts at Goldman Sachs have estimated that raising the Japanese female participation rate to the same level as that of men would add eight million jobs and increase GDP by as much as 15 per cent.
Mr Abe has allowed private companies to provide childcare, in order to increase provision and bring down costs. He has also set a target of getting women in 30 per cent of “leadership positions” by 2020. But business has not been keen. And attitudes from women themselves are also an obstacle. In 2012 half of women said they preferred to stay at home, up from 40 per cent a decade earlier. Mr Abe placed five women in his 18-strong cabinet in September – but three were part of a conservative political group which opposes gender equality.