Blu Putnam: Abenomics Likely to Disappoint

 

A spotlight shines very brightly on Japan at the moment – and especially on Prime Minister Abe – not unexpected of course when an economic policy bears your name.  Abenomics was sold to the electorate in December 2012 partly on hope and partly on a willingness to give change a chance based on the frustrations of the past two decades.

There is a burning desire in Japan to regain some of the past economic glory and to attain annual real GDP growth rates above 2 percent and possibly higher.  Unfortunately, it may happen and here is why.

Over the long-run, the arithmetic of real GDP growth argues that economies grow either when their labor force grows, or with expanded capital investments so that labor productivity grows.

Japan is challenged on both counts.

Japan’s labor force is not growing.  If the structural reforms in the third arrow can increase the participation of women in the labor force or increase immigration, this could help growth.  But aside from some small gains in the health care sector, this seems unlikely.

Raising labor productivity is also difficult.  It is not at all clear that large new capital investments would raise average labor productivity much at all given the diminishing returns for an already highly modernized and mature economy.

And it gets more difficult.

Neither Bank of Japan asset purchases or fiscal stimulus encourage capital spending by corporations who are driven by future profit objectives based on potential higher sales, mostly abroad, on low interest rates or tax incentives at home.  Tax incentives may work to increase earnings, but not to increase capital investments that do not necessarily appear to make good business sense anyway for companies focused on global growth.

Another way to look at the challenges to Abenomics is to realize that its initial logic was flawed.  The plan was to increase domestic consumption by breaking the back of deflationary expectations, so that domestic consumers would fear price rises and want to spend more.

The main reason Japan’s consumers spend less than they once did decades ago, however, is that they are much older now.  Japan’s average age is in the mid-40s, well above the U.S. (upper-30s) and most other mature countries.  Older consumers just do not buy the latest fashion or a new car with the frequency of much younger consumers.

And then, even if consumers actually spent more, would they spend it on domestically produced goods or imports?

Given the Japanese economy’s needs for imported food and energy, increases in domestic demand may well simply raise imports – not the answer the government is seeking, but the one it may get.

Thus, quantitative easing is not working to increase lending or consumption, just to put more government debt on the balance sheet of the BoJ and less on the balance sheet of banks and pension funds.  Rearranging the deck chairs for who owns the government debt does not create domestic demand or investment activity.

Fiscal policy turned austere when the national sales tax was allowed to go into effect in April 2014, and that may happen with the next scheduled rise, too. Competitive and structural market reforms have been few and far between, with only some limited success in health care and agriculture. Moreover, the timeline for long-term reforms is measured in decades, not years.

If this analysis is correct, then one economic scenario gaining probability is that real GDP growth will not be robust in 2014, imported inflation from the lagged depreciation of the yen will soon run its course, and the next sales tax increase will complicate the prospects. This leads to the possibility that Prime Minister Abe will push for a further depreciation of the yen, which at the least might raise yen-denominated equity prices even if higher real GDP growth rates remain elusive.

Bluford (Blu) Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. He is responsible for leading economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact. Prior to joining CME Group, Putnam gained more than 35 years of experience in the financial services industry with concentrations in central banking, investment research and portfolio management. He has authored five books on international finance.

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