Just weeks after taking office in December 2012, Japanese Prime Minister Shinzo Abe, who had also led the country from 2006 to 2007, announced plans for a new suite of policies geared toward jolting the stagnating economy out of its deflationary malaise. Japan, having fought deflation for more than two decades, remains mired in weak growth despite repeated attempts to revitalize the economy.
Abe’s three-pronged approach, dubbed "Abenomics," combines fiscal expansion, monetary easing, and structural reform. The immediate goal is to boost domestic demand and gross domestic product (GDP) growth while raising inflation to 2 percent. In the longer term, Abe’s structural policies aim to improve the country’s prospects by increasing competition, reforming labor markets, and cementing trade partnerships.
So far, the success of these "three arrows" is unclear. Despite massive government stimulus, Japan fell back into recession in the second quarter of 2014. Inflation initially inched upwards but is now falling on the back of plunging global oil prices, and the country may again face deflation in 2015. Concerns over ballooning debt remain, and many doubt that Abe can muster the political will for difficult structural reforms—some of which remain deeply unpopular among certain industries—even after his coalition’s strong showing in early elections called in December 2014.
What is Abenomics?
Abenomics refers to an aggressive set of monetary and fiscal policies, combined with structural reforms, geared toward pulling Japan out of its decades-long deflationary slump. Fiscal stimulus began with economic recovery measures totaling 20.2 trillion yen ($210 billion), of which 10.3 trillion ($116 billion) was direct government spending. The Bank of Japan (BOJ) simultaneously pursued an unorthodox injection of liquity into the economy, a policy known as quantitative easing, seeking to push inflation to 2 percent to spur spending. Finally, structural reform—including slashing business regulations, liberalizing the labor market, cutting corporate taxes, and increasing workforce diversity—aims to revive Japan’s long-term competitiveness.
Quantitative easing (QE), the BOJ’s unprecedented asset purchase program, is at the heart of Abenomics. "It's a gigantic experiment in monetary policy," says the Wall Street Journal’s Greg Ip. Under Governor Haruhiko Kuroda, the BOJ undertook an initial round of QE that doubled its balance sheet in an attempt to send inflation to 2 percent. With that expansion of the balance sheet achieved, but inflation still low, the bank has moved into a second, open-ended phase of QE in which it will buy up government debt until the 2 percent inflation target is achieved.
The scale of the purchases is unmatched anywhere in the world: the value of the assets held by the BOJ reached 57 percent of GDP in 2014—more than twice the size of the U.S. Federal Reserve’s holdings, which stand at 25 percent of GDP, and the European Central Bank’s assets, which have fallen to 20 percent of GDP.
Despite years of near-zero interest rates, Japan has suffered chronic deflation over the two decades since the bursting of its real estate bubble in the late 1980s.
In the fiscal realm, Abe ordered a hefty stimulus package focused on critical infrastructure projects, such as building bridges, tunnels, and earthquake-resistant roads. About a third of the package, Japan's second-largest ever, was earmarked to stimulate private investment. A separate 5.5 trillion yen boost followed in April 2014, and in the immediate aftermath of the December 2014 elections, Abe pushed another spending package worth 3.5 trillion yen.
Even while pursuing spending policies that have ballooned government debt, Abe has attempted to reduce the deficit by raising taxes, a move that some say has worked at cross-purposes to the rest of the program. An increase in the national consumption tax, from 5 to 10 percent, had been passed by the previous government and supported by Abe’s party while they were in the opposition. The first increase, to 8 percent, in April 2014, futher depressed consumer spending and likely was the cause of recession. As a result, the next planned bump up to 10 percent was postponed until 2017. While good for short-term growth, this decision arguably undermines the long-term fiscal sustainability goals of the original plan.
What are the prospects for structural reform?
Beyond these short-term monetary and fiscal policies, the success of Abe’s plans ultimately rely on the “third arrow,” structural reform. In June 2014, Abe announced a broad reform package, including corporate tax cuts, agriculture liberalization, and initiatives to overhaul regulation of the energy, environment, and health-care sectors. Proposed changes include a shift in the investment strategy of government pension funds andtax incentives to increase career opportunities for women.
Labor reform will be critical, as Japan’s demographics portend a troubling future. The working-age Japanese population contracted by 6 percent over the past decade. Initiatives to counter this trend include encouraging greater female participation in the workforce and revamping labor-market rules that keep nearly 40 percent of the workforce in low-paid, temporary positions.
“Demographics are at the heart of Japan’s economic challenge,” says CFR Senior Fellow Sheila Smith. “Many of [Abe’s] reforms call for significant adjustments in the norms of Japanese society. It’s a huge agenda and there is no one silver bullet,” she says.
Even though Abe’s coalition has held a resounding parliamentary majority for over two years, there has been little concrete progress on structural reform, leading many observers to question the government’s commitment. Complicating matters, a growing scandal over political donations has already cost Abe several of his top allies.
However, Abe’s emphatic win in snap elections in December 2014 may give him more time to take on entrenched interests and implement politically sensitive measures. In early February, for instance, the government reached a breakthrough agreement to limit the power of the national agriculture cooperative, JA-Zenchu. The cooperative has long used its control over local farmers and its political heft to oppose the modernization of Japan’s moribund farming industry.
Beyond these short-term monetary and fiscal policies, the success of Abe’s plans ultimately rely on the “third arrow” of structural reform.
Progress on agriculture, in turn, boosts the prospects for another high-profile plank of Abenomics, the Trans-Pacific Partnership (TPP) (PDF), a regional free trade agreement being negotiated among the United States and eleven other Pacific Rim countries. Though Japan accounted for 14 percent, or $146 billion, of U.S. goods traded with TPP partners in 2012, the agriculture industry has lobbied against the deal, objecting to the removal of high tariffs and other protective measures. Some health-care providers have also complained that Japan's national health insurance system could be adversely affected if Japanese citizens are forced to buy foreign-produced pharmaceuticals and medical devices.
Still, Abe has insisted that Japan needs to take advantage of its "last chance" to remain an economic power in Asia. "I see a positive convergence between the domestic efforts, the economic strategy, and what's been going on in the trade front," said Mireya Solís, a senior fellow at the Brookings Institution’s Center for East Asia Policy Studies. "But this is just the tip of the iceberg. There are many different hurdles."
Will Abenomics reinvigorate Japan's economy?
There isn't much that's technically new about Abenomics. Despite years of near-zero interest rates, Japan has suffered chronic deflation over the two decades since the bursting of its real estate bubble in the late 1980s. Over that period, the Japanese government has spent trillions of dollars in various bids to lift the economy, in the process accumulating the largest public debt in the developed world.
Abe hopes his extraordinary monetary policy will change this dynamic, starting with bringing down exchange rates and giving exports a major boost. Indeed, the yen has fallen a dramatic 50 percent against the dollar since the end of 2012, leading to a 2.7 percent rise in exports in the final quarter of 2014. The resulting rise in corporate earnings should result in higher wages, policymakers reason, thus increasing consumption and boosting markets. The Nikkei index has steadily risen to an eight-year high in 2015.
In most areas, however, the results have been underwhelming. Despite optimistic projections, Japan fell into a triple-dip recession after two quarters of negative GDP growth in 2014. And while the economy did return to growth by the end of the year, March revisions showed that GDP expanded by just 1.5 percent in the fourth quarter—less than the 2.2 percent originally recorded, and far below the 3.8 percent that economists had predicted. The same numbers showed that consumer spending, weighed down by stagnating wages, increased by a weak 0.5 percent. At the same time, the central aim of the BOJ’s monetary policy—to reach 2 percent inflation—faltered as inflation continued to decelerate to just 0.5 percent in early 2015. Compounding the problem, a weaker yen has driven up the price of imports, which has also dampened consumer demand. Falling global oil prices have made “reflating” the economy even harder, leading some economists to foresee a return of outright deflation in 2015.
BOJ asset buying accelerated in October 2014, but the space for further monetary action is limited. By February 2015, Kuroda ruled out further short-term easing over concerns that the sharp fall of the yen was hurting consumers.
Thus, most observers agree that deeper structural changes are needed. Without greater consumer demand based on increased wages—which have fallen 9 percent in real terms since 1997—or improvements in underlying productivity and competitiveness, the Japanese economy will continue to struggle in the long-term.
What are the risks?
Critics argue that Abenomics brings major risks. Some think monetary easing could spur hyperinflation, while the opposite view holds that Abe's plan may do too little to reverse deeply entrenched deflation. There is also worry that Japan's national debt, which at over one quadrillion yen ($8.62 trillion) is more than twice its GDP, will become unsustainable if interest rates rise. Investors, anticipating inflation, could put a scare in the bond market by selling out of fear that their investments will lose value in real terms.
The vast majority of Japan's debt is held domestically and at low interest rates, unlike Greece or other troubled eurozone member states. However, Japan’s aging demographics and shrinking population mean that the country may eventually need to look abroad for financing, where demand for yields will be higher.
Those who remember the unfinished public projects that littered Japan's countryside during the "lost decade" also worry that Abe's debt-financed stimulus may be wasted, adding to the debt load without boosting output. "In a country where pork-barrel projects have been rampant, infrastructure projects that seek to cater to the needs of construction companies have been a very common fact of political life," says Solís. Today, however, construction companies are having a hard time finding workers, yet another sign that Japan’s old ways of tending to the economy are out of date.
Finally, there is a risk that these fiscal and monetary efforts could give the government an excuse to postpone structural reforms, as the IMF has warned. "Without additional reforms Japan risks falling back into lower growth and deflation, a further deterioration in the fiscal situation, and an overreliance on monetary stimulus with negative consequences for the region,” its 2014 regional outlook report said.
What does this mean for the global economy?
Abe's policies are already being felt in the international arena. Exporters like Germany and China have sounded warnings about a global currency war, or competitive devaluation, in which countries vie to weaken their currencies and thus gain an advantage for their exports. Tokyo’s recent disputes with Beijing over the Diaoyu/Senkaku islands in the East China Sea have spilled over into their economic relationship, and the yen's drop has only escalated the discord. Abe’s hawkish reputation, and his push to amend Japan’s pacifist constitution, has led some to see the TPP trade push as a way to contain Beijing.
But Solís objects to that view, saying that she expects Abe’s pragmatic side to prevail. "There's been this desire to not add fuel to the fire, and to have stable relations with China," she said. "I think everybody understands what tragic consequences could arise from using a very nationalist rhetoric that would be quite self-defeating."
"Almost the entire rich world is stuck in a zero-interest-rate liquidity trap situation, and I think everybody is haunted by the possibility that there's no way out of it. If Japan shows a way out of that, it will be very encouraging." —Greg Ip, Wall Street Journal
At the same time, U.S.-Japan relations have been strengthened by progress on the TPP, one of Abe’s biggest campaign pledges and a centerpiece of Washington's Asia pivot. "Obama and Abe successfully shifted the focus of the U.S.-Japan agenda to our mutual economic interests," explains CFR’s Smith. "The U.S. needs deeper economic ties with Asia, and cooperation on TPP is a part of that."
Finally, the outcome of Japan’s experiment holds implications for other economies, including the eurozone, that are also struggling with deflation and low growth. "It provides hope, by the way, for other countries," says Ip. "Almost the entire rich world is stuck in a zero-interest-rate liquidity trap situation, and I think everybody is haunted by the possibility that there's no way out of it. If Japan shows a way out of that, it will be very encouraging."
This Economist Intelligence Unit report outlines some of Abe's policies and evaluates their potential efficacy.
This August 2013 IMF country report [PDF] discusses Japan's hopes for economic recovery.
The IMF’s 2014 Regional Economic Outlook for the Asia-Pacific analyzes the risks and opportunities facing Japan.
The Congressional Research Service [PDF] discusses the major elements of the Trans-Pacific Partnership.
The Daiwa Institute of Research Group presents a multifaceted examination of the economic policies of the Abe administration in this report [PDF].
BOJ Governor Haruhiko Kuroda discusses the challenges of overcoming deflation and Japan's economic policy in this CFR meeting.
In this Foreign Affairs essay, Richard Katz critiques the implementation of Abenomics.
Martin Feldstein argues against Abenomics in this January 2013 Project Syndicate op-ed.
This April 2013 Economist article appraises Abenomics.