Does Abenomics deserve a mandate?
It’s been two years since Japanese Prime Minister Shinzo Abe implemented his first array of stimulus policy, dubbed ‘Abenomics’, in an attempt to pull Japan out of a seemingly chronic economic stagnation. He has also recently called an election in an attempt to give himself a new mandate, and although he is expected to win comfortably, it is still worth deciphering how his economic policy has fared thus far.
It should not be underestimated how unusual the whole concept was to begin with. Shinzo Abe came into office and announced that he was about to go on a Keynesian binge in a world where most political leaders saw Keynes as useful only in emergency like situations that marked late 2008, not as a blueprint for long-term economic prosperity. The fact that it was less than two years after the GFC that countries, especially in Europe, not only reversed their Keynesian stance but actively pursued austerity, shows just how mistrusted the ideas of the Brit are.
When Abe came into office, the Japanese economy was saddled with an amazingly large debt to GDP ratio of over 200%, stagnant growth, and deflation. This is a hole that can be almost impossible to escape from and one that has left Japanese policy makers for dead over the years. The aim of Abenomics was to approach this problem from three fronts; monetary, fiscal and structural (the ‘three arrows’) in order to reduce the debt burden, accelerate growth, and perhaps most importantly, escape deflation.
Two of the three arrows, fiscal and monetary policy, were enacted almost immediately as Abe set about implementing a fiscal stimulus of 10.3 trillion yen, as well as raising the annual inflation target to 2%, which was to be achieved through a quantitative easing program similar to the one adopted by the Federal Reserve in the US.
Initially, what was hoped for, occurred, as growth surged almost as fast as Abe’s approval rating. After persistent deflation, Japan saw inflation at and above the targeted 2% rate. This was coupled with a massive depreciation of the yen, which has surprisingly had little improvement on the trade deficit. In fact, it has actually worsened since the implementation of Abenomics.
However, the positive results of this Keynesian diet were short lived as in April of this year, Abe decided to go through with his increase in the consumption tax from 5% to 8%. The reasoning was that massive stimulus in the short-term had to be offset somewhat by a healthy dose of austerity to ensure that the economy didn’t spiral out of control in the medium-term. Of course concerns about the deficit and the debt were supposedly sufficient reasons for undertaking this policy, and of course the rise in the consumption tax was supposed to take care of it all.
And of course it was a disaster.
Almost immediately after the consumption tax hike was implemented, the economy contracted sharply. Real GDP fell an astonishing 6.8% (at annualised rates) in the second quarter of 2014, which was the largest drop since the Tohoku tsunami hit in 2011 when it fell 6.9%.
Safe to say you know your economic policy is misguided when it’s 0.1% more helpful than a tsunami.
However, Abe wasn’t done yet in attempting to undo all his good work. Despite the disastrous impact of the initial rise in the consumption tax rate, he was intent on holding firm on his promise to increase it to 10% by October next year.
The reasoning was, as with all austerity policy, that confidence would be boosted (somehow) and that this would stop debt spiralling out of control (again, somehow).
It should be noted that Japan itself has had this problem before. No more than 17 years ago, in 1997, Japan was in the middle of an economic crisis when it raised its consumption tax by 2%, which lead it into a deflationary trap. It’s amazing how strong economic amnesia can take hold on policy-makers within one generation.
Thankfully, Abe announced recently that he would push back the date of the consumption tax hike, which depending what line you believe, was either due to poor economic data or a conversation with Paul Krugman. Seeing as the poor economic data has been a more consistent presence in Japan than Paul Krugman, one could argue that his arguments may have had the greater impact.
However, it shouldn’t have taken all of this. As well as the results being clear, so is the economic logic. Firstly, for debt to be serviced, there needs to be revenue generated in the economy, which doesn’t occur when growth is stagnating, as the last two decades in Japan aptly illustrate. Secondly, inflation itself actually has a positive effect on debt as it erodes its value. Put simply, deflation is amazingly destructive to just about every economic indicator worth mentioning and thus must be avoided at all costs.
Abenomics in its original form wasn’t perfect, but it was a class above the austerian version. If Abe makes it clear that he is willing to revert back to this original form, as his delay in the consumption tax suggests, then a new mandate is what he deserves and what Japan needs.