Japan, having fought deflation for more than two decades, remains mired in weak growth despite repeated attempts to revitalize its economy. 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 to jolt Japan's stagnating economy out of its deflationary malaise.
Abe’s three-pronged approach, dubbed "Abenomics," combines fiscal expansion, monetary easing, and structural reform. Its immediate goal is to boost domestic demand and gross domestic product (GDP) growth while raising inflation to 2 percent. Abe’s structural policies aim to improve the country’s prospects by increasing competition, reforming labor markets, and cementing trade partnerships.
The fate of Abenomics is not yet clear. Despite massive government stimulus, growth is tepid and inflation has continued to fall on the back of plunging global oil prices. Concerns over ballooning debt remain; many doubt that Abe can muster the political will to implement difficult structural reforms, some of which remain deeply unpopular; and a major trade deal could face a difficult passage in parliament.
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. These are the policy's "three arrows."
Fiscal stimulus began in 2013 with economic recovery measures totaling 20.2 trillion yen ($210 billion), of which 10.3 trillion ($116 billion) was direct government spending. Abe's hefty stimulus package, Japan's second-largest ever, focused on building critical-infrastructure projects, such as bridges, tunnels, and earthquake-resistant roads. A separate 5.5 trillion yen boost followed in April 2014, and after the December 2014 elections, Abe pushed another spending package, worth 3.5 trillion yen.
The second arrow, unorthodox monetary policy—especially the Bank of Japan's (BOJ) 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. The BOJ has simultaneously injected liquidity into the economy (a policy known as quantitative easing, or QE) and, for the first time, pushed some interest rates into negative territory.
Under BOJ Governor Haruhiko Kuroda, the bank undertook an initial round of QE in 2013 that doubled its balance sheet. But with inflation continuing to stagnate at well below 1 percent, the bank has moved into a second, open-ended phase of QE consisting of $660 billion in yearly asset purchases that Kuroda says will continue 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 has exceeded 70 percent of GDP, while the U.S. Federal Reserve's and European Central Bank's assets, by contrast, both stand below 25 percent of their respective GDPs.
With Japan's economy remaining weak, in January 2016 Kuroda made the unexpected decision of introducing negative interest rates in a fresh bid to spur lending and investment. The BOJ joins the ECB, Denmark, Sweden, and Switzerland as the only central banks to push some rates below the "zero bound."
Finally, a long-delayed program of structural reform—including slashing business regulations, liberalizing the labor market and agricultural sector, cutting corporate taxes, and increasing workforce diversity—aims to revive Japan's competitiveness.
What are the prospects for structural reform?
Many analysts argue that the success of Abe's plans ultimately rely on this 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. His proposals include a shift in the investment strategy of government pension funds and tax incentives to increase career opportunities for women.
Japan’s demographics portend a troubling future. The working-age Japanese population contracted by 6 percent over the past decade, and Japan could lose more than a third of its population over the next fifty years. In September 2015, Abe announced an "Abenomics 2.0" platform that centers on raising the birth rate and expanding social security. He also created a new cabinet position, held by Katsunobu Kato, devoted to reversing Japan's demographic decline.
"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.
The working-age Japanese population contracted by 6 percent over the past decade, and Japan could lose more than a third of its population over the next fifty years.
Though Abe's coalition has held a resounding parliamentary majority for more than three years, progress has come slowly. After Abe’s emphatic win in December 2014 elections, however, he reached a breakthrough agreement to limit the power of the national agriculture cooperative, JA-Zenchu. The cooperative has long used its political heft to oppose the modernization of Japan’s moribund farming industry.
This progress on agriculture reform gave a critical boost to the Trans-Pacific Partnership (TPP), a regional free trade agreement Japan recently concluded with the United States and eleven other Pacific Rim countries. Japan's agricultural industry has lobbied against the deal, objecting to the removal of high tariffs and other protective measures. Health-care providers and other sectors have also complained of the deal's potentially adverse affects.
But for Abe, the TPP is an opportunity to lock in domestic economic reforms, and he has insisted that Japan needs to take advantage of this "last chance" to remain an economic power in Asia. Abenomics represents "a positive convergence between the domestic efforts, the economic strategy, and what's been going on in the trade front," says Mireya Solís, a senior fellow in the Brookings Center for East Asia Policy Studies.
Will Abenomics reinvigorate Japan's economy?
There isn't much that's technically new about Abenomics. Japan has suffered chronic deflation since the bursting of its real estate bubble in the late 1980s. In the years since, the Japanese government has implemented years of near-zero, and now below zero, interest rates. It has also spent trillions of dollars attempting 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. But export growth has been tepid, and Japan's Nikkei index has been volatile.
Indeed, a weaker yen is a double-edged sword, given that it can drive up the price of imports, which can dampen consumer demand and lead to reduced spending. At the same time, plunging global oil prices, which have fallen from more than $100 a barrel in 2014 to around $30 a barrel in 2016, have added to Japan's deflation woes. With cheap oil and a stagnant world economy both likely to continue for the foreseeable future, "reflating" Japan's economy will be even harder.
Despite optimistic projections, Japan fell into a triple-dip recession after two quarters of negative GDP growth in 2014. Since Abe took power in 2012, the economy has grown just 2.4 percent, barely returning to its 2008 size. As the Financial Times columnist Martin Wolf has pointed out, Japan's labor force performs well, with growing productivity and just 3.1 percent unemployment, but the country will find it difficult to sustain any sort of growth with its rapidly shrinking population.
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 a major demographic shift, the Japanese economy will continue to struggle.
What are the risks?
Critics argue that Abenomics brings major risks. Some think monetary easing could spur hyperinflation, while others hold that Abe's plan may do too little to reverse deeply entrenched deflation. There is also worry about Japan's national debt, which, at over one quadrillion yen ($11 trillion), has surpassed 245 percent of its GDP. The International Monetary Fund (IMF) has repeatedly warned (PDF) that these debt levels are unsustainable.
That's why Abe has attempted to reduce the deficit by raising taxes, a move that some say has worked at crosspurposes with the rest of the program. A 2014 increase in the national consumption tax from 5 to 8 percent futher depressed consumer spending and likely caused a renewed recession. As a result, the next planned bump, up to 10 percent, was postponed until 2017. While good for immediate growth, this decision arguably undermines the goal of fiscal sustainability.
At the same time, negative interest rates, a relatively untested monetary tool, give many economists pause. The BOJ was split five to four on the decision over worries that the policy could damage the banking system. Negative rates might not actually encourage spending, but rather, the hoarding of cash, thus adding to deflationary pressures.
Negative interest rates, a relatively untested monetary tool, give many economists pause.
Those who remember the unfinished public works—massive and often unnecessary road and bridge construction projects—that littered Japan's countryside during the "lost decade" of the 1990s also worry that Abe's stimulus may add 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.
Complicating matters, scandals have cost Abe several of his top allies. In 2015 his agriculture minister, Koya Nishikawa, was forced to step down, and in January 2016 an even bigger blow came as Economy Minister Akira Amari resigned amid bribery allegations. Amari had shepherded TPP negotiations to completion, and his departure comes as the trade deal faces a tough fight for passage in the Japanese parliament.
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," the Fund's 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 to 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, along with his push to amend Japan's pacifist constitution, has led some to see his 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."
The outcome of Japan's experiment also holds implications for other economies, including the eurozone, that are also struggling with deflation and low growth. "It provides hope 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.