Abenomics set to fade in rear-view mirror

The Liberal Democratic Party (LDP) elected Fumio Kishida as its new president on September 29. On October 4, Kishida will be appointed prime minister by the Diet and form a cabinet.

The new government’s economic policies will hopefully increase the Japanese economy’s growth potential through a growth strategy while maintaining financial market stability. Doing so is the foremost key to raising the public’s standard of living.

Economic policy during the premiership of Shinzo Abe, Japan’s longest-serving postwar prime minister, was overly dependent on monetary easing and fiscal expansion, respectively the first and second “arrows” of Abenomics. These two arrows may have been detrimental to both financial market stability and the economy’s growth potential.

Meanwhile, Abenomics’ third arrow, structural reforms coupled with a national growth strategy, proved insufficiently effective, with the economy’s potential growth rate and labor productivity growth rate both trending downward throughout Abe’s tenure. A decline in the potential growth rate is prone to trigger a vicious cycle where companies turn cautious vis-à-vis capex, leading to a further decline in the potential growth rate. A declining labor productivity growth rate exacerbates concerns of a downshift in real wage growth, dampening consumers’ expectations of a rising standard of living.

Under Abe’s successor, Yoshihide Suga, economic policy was a continuation of Abenomics, albeit with the previously neglected structural reforms targeted more narrowly at specific sectors. Unfortunately, however, the Suga Government ended up being overwhelmed in dealing with the pandemic. Suga was forced to step down barely a year into his tenure without accomplishing much of his economic agenda.

I expect the Kishida Government to normalize fiscal and monetary policy and endeavor to maintain financial market stability while pursuing a primary mission of boosting the economy’s growth potential by forging ahead with the structural forms and growth strategies neglected by the Abe and Suga Governments. In this respect, the Kishida Government may be worthy of some degree of optimism. Abe’s imprint on Japanese economic policy should fade further.

Virtuous cycle of growth and income distribution

Of the four candidates who vied for the LDP presidency this time, Kishida seems to place the most priority on economic policy. He called his economic policy platform “a new Japanese-style capitalism” and “a pivot away from neoliberalism.” He blames neoliberal deregulatory and structural-reform policies for spawning wealth inequality and aims to reduce inequality through a virtuous cycle of growth and redistribution.

Concerns about inequality have rapidly escalated globally since the 2008 Lehman crisis. In Japan, however, income inequality appears to have generally attenuated in the wake of a post-GFC economic recovery that was the longest in Japan’s history. Japan places more priority on growing its economic pie than on dividing the pie more fairly. Between growth and income distribution, the former takes precedence. I hope the Kishida Government focuses on boosting Japan’s long-declining potential growth rate as an economic-policy priority.

On a relatively short-term basis, however, income redistribution policies may be needed as one element of pandemic relief. The pandemic has benefitted some companies while devastating others. In the labor force as well, some workers are earning more during the pandemic while others have lost income. Such disparities are one respect in which the pandemic differs greatly from a typical recession.

Policies that redistribute income from the haves to the have-nots in both the corporate and household sectors are an urgent imperative. Such redistribution is closely related to the issue of how to fund pandemic relief spending. I hope the new government starts to discuss non-debt funding sources for pandemic relief as soon as possible. If it instead allows JGB issuance to continue growing, the resultant incremental debt could be a drag on private demand and further reduce the economy’s growth potential going forward.

Despite advocating a supplemental budget, Kishida is a fiscal hawk at heart

While campaigning for LDP president, Kishida emphasized the need for a supplemental budget to fund tens of trillions of yen of spending to shore up the economy. Although he did not delve into specifics on this spending’s composition, he has talked about pandemic control policies and compensation for the economic burdens they impose.

Of pandemic-related appropriations in the FY20 budget, over ¥30 trillion of unspent funding was carried over to the FY21 budget. Swiftly pumping this money into the economy should be the new government’s top economic priority initially. As a next step, the government would be well advised to draw up a supplemental budget that reduces previously budgeted non-essential spending and newly appropriates more funding to essential programs.

This new spending should be earmarked predominantly for pandemic relief for companies and individuals. The current system for distributing pandemic relief funds to companies has a major shortcoming in that the assistance is not available to all sectors impacted by the pandemic. The government should consider reinstating cash benefits to help businesses stay afloat without restricting eligibility to designated sectors.

Conventional economic stimulus, by contrast, is largely ineffective and should be a low priority. The next supplemental budget therefore need not be large. I sincerely hope the new government avoids policies that exacerbate Japan’s fiscal challenges through unproductive overspending.

Although Kishida is emphasizing the need for a supplemental budget, he is not a fiscal expansionist. He has long preached the importance of fiscal discipline. Even when Kishida was campaigning to win the LDP presidency back in September 2020, fiscal consolidation was one of three core planks of his economic policy platform.

While Kishida’s advocacy of fiscal expansion in this year’s LDP presidential election campaign stands out in stark contrast to his previous platform, it seems to be limited to the relatively short-term objective of navigating the pandemic. Kishida’s 2021 policy platform also includes a commitment to fiscal consolidation in the aim of economic normalization, signaling that Kishida remains a fiscal hawk. Although economic stimulus may be strategically necessary to win the upcoming Lower House election, Kishida is expected to reassert his long-standing commitment to fiscal consolidation after the election. I certainly hope he does, given fiscal discipline’s importance to economic and financial market stability.

More monetary policy latitude for BOJ?

Under the Kishida Government, political pressure on the BOJ is likely to abate, affording the BOJ more freedom to conduct monetary policy as it sees fit. While campaigning for the LDP presidency, Kishida did not say anything notable about monetary policy. His silence implies that monetary policy does not figure prominently in his economic policy plans. Government policy has not been heavily dependent on monetary accommodation since relatively early in former PM Abe’s tenure. The Kishida Government may, however, urge the BOJ to explore CBDC (central bank digital currency) issuance.

The BOJ will not immediately change its policy stance under the new government but after Governor Kuroda steps down in April 2023, it is likely to cautiously pursue policy normalization. In particular, appointment of a BOJ insider to succeed Kuroda in April 2023 would likely expedite the subsequent normalization process and should help mitigate the side effects of long-term unconventional monetary accommodation.

While BOJ policy normalization may give rise to short-term headwinds like yen appreciation, it should contribute to financial market stability from a longer-term perspective.
Incidentally, the probability of a BOJ insider being appointed governor was low during Abe’s premiership because Abe feared the BOJ would revert to its historically cautious attitude toward monetary easing.

Kishida’s growth strategy

Kishida has said he intends to pivot away from Japan’s neoliberal policy path dating back to the reformist premiership of Junichiro Koizumi. Kishida seems to have bought into opposition parties’ old criticism that Koizumi’s reforms widened inequalities. In a nod to Abenomics’ three arrows, Kishida has pledged to maintain a three-pronged economic policy framework comprising bold monetary policy, agile fiscal policy and a national growth strategy. His framework may seem to be a continuation of Abenomics, except Kishida has omitted structural reform from the third prong. Kishida equates structural reform with neoliberal policies that he deems undesirable because they worsen inequalities.

The term “structural reform” itself, however, is actually quite vague. It encompasses any policy that engenders constructive structural change in the economy. Some such reforms, mainly regulatory and competition policies that intensify competition in markets, may exacerbate inequalities. One such competition policy is PM Suga’s moral suasion to induce wireless telecom carriers to lower their pricing on mobile plans.

In contrast, policies that support Japanese leading-edge technologies, promote internationalization and/or boost productivity broadly benefit the public at large. Policies that facilitate or otherwise promote digitalization likewise increase economic efficiency. Such policies are normally included under the rubric of structural reform.

Kishida’s policy agenda in fact features many specific policies that would typically be classified as structural reforms, including a new ¥10 trillion fund to promote science, technology and innovation; increased R&D tax incentives and investment tax credits for leading-edge technologies like semiconductors, AI, quantum computing and biotech; promotion of digitalization in the financial sector, most notably in the form of a digital yen; facilitation of investment in new clean energy sources; extension of 5G and other digital infrastructure to rural areas ("digital garden city state" concept); and rectification of economic overconcentration in Tokyo.

To send a message on reducing inequality, Kishida presented an anti-structural-reform image but he is actually very much in favor of broadly defined structural reform as the term is commonly used. Indeed, he can arguably be characterized in essence as a structural reformist.

Combine three structural reforms with pandemic relief measures

Ideally, the new government should take advantage of conditions created by the pandemic to forge ahead with structural reforms in parallel with anti-pandemic policies. It will hopefully avoid getting so bogged down in dealing with the pandemic that it makes no progress on structural reform or growth strategy. From such a perspective, I would like to see the new government pursue the following three structural reforms in particular amid the pandemic.

The first is promotion of private-sector digitalization. One digitalization initiative that should increase economic efficiency is migration to a cashless ecosystem through issuance of a highly reliable CBDC. With the public currently wary of the risk of COVID transmission through use of physical currency, now is an opportune time to implement such a policy. This initiative should be accompanied by promotion of big data (e.g., payment history) utilization also.

The second reform is rectification of economic overconcentration in Tokyo. People and companies continue to relocate from Tokyo to outlying regions against a backdrop of widespread teleworking and concern about COVID contagion risk. If this trend enables greater utilization of land, infrastructure and human resources in nonurban areas, it could end up boosting the Japanese economy’s overall efficiency. One key lever to rebalance the economy away from Tokyo is to relocate government ministries and agencies to other regions to induce households and companies to follow suit.

The third reform, one on which the Suga Government failed to follow through, is improvement in productivity in the SME sector and/or service sectors such as food services, retailing and travel. These sectors have been hardest-hit by the pandemic. They also suffer from low productivity by international standards. By capitalizing on the pandemic as an opportunity to promote reform of these sectors through such means as business makeovers and M&A, the government could boost the economy’s overall efficiency.

Of these reforms, CBDC issuance and rectification of economic overconcentration in Tokyo are included in Kishida’s policy platform, a fact that bodes promisingly for progress on these fronts.

In sum, it is highly advisable for the incoming Kishida Government to address low productivity, the Japanese economy’s biggest problem, through structural reforms and a growth strategy to be implemented in parallel with pandemic relief measures. Additionally, I have high hopes that the new government will cast aside the Abenomics playbook of overdependence on monetary and fiscal policy in favor of macro policies more conducive to financial market stability.

• Takahide Kiuchi
  

  Executive Economist