Japan, having fought deflation for more than two decades, has repeatedly pursued government interventions in the hope of revitalizing its economy. Entering the fifth year of his latest turn in office, Japanese Prime Minister Shinzo Abe continues to follow a suite of policies aimed at jolting 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 expanding trade partnerships.
However, major challeges remain. Despite massive government stimulus, growth is tepid, inflation is below target, concerns over ballooning debt remain, and difficult structural reforms have languished. The election of President Donald J. Trump, meanwhile, has disrupted Abe’s efforts to cement a regional trade deal and placed the U.S.-Japan relationship under renewed strain.
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. Through 2016, with Japan’s recovery still sputtering, Abe’s budget continued the near-record levels of deficit spending.
- 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 stagnating below 1 percent into 2017, 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." The BOJ’s negative rates, as well as its asset purchases, have continued into 2017, causing some economists to warn that these low rates damage the banking system and can lead to speculative bubbles.
- 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 relies on structural reform. In June 2014, Abe announced a broad reform package, including corporate tax cuts, agriculture liberalization, labor market reform, and initiatives to overhaul regulation of the energy, environment, and health-care sectors.
Though Abe’s coalition has held a strong parliamentary majority for more than four 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.
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.
Labor market reforms have focused on Abe’s so-called “womenomics” plan to raise the female employment rate from 68 percent to 73 percent by 2020. The government has required corporations to increase the appointment of women to management positions. The original goal was to have women fill a third of senior business positions by 2020; that has since been scaled back to 15 percent. The government argues that raising women’s wages and status in the labor market will also increase fertility rates, pointing to countries like Sweden and Denmark that have both higher female employment and higher fertility.
Abe has also promised broader labor reforms to break down Japan’s two-tier employment system, in which a persistent class of temporary workers are shut out of the regular workforce. So far, however, his labor policy has focused on reducing the culture of overwork that has led to a rise in depression and suicides.
What will be the impact of the U.S. withdrawal from the Trans-Pacific Partnership?
This progress on agriculture reform was central to Abe’s push to complete the Trans-Pacific Partnership (TPP), a regional free trade agreement with the United States and eleven other Pacific Rim countries. Japan’s agricultural industry in particular lobbied against the deal, objecting to the removal of high tariffs and other protective measures.
With President Trump rejecting the TPP, however, some analysts say that Abe’s economic reform efforts will be complicated. With Trump reportedly seeking a bilateral U.S.-Japan trade deal in lieu of the TPP, negotiations could put pressure on Abe to deliver even deeper tariff cuts and more extensive reforms. What the Trump administration will ultimately seek from a new deal is ultimately uncertain.
Can Abenomics reinvigorate Japan’s economy?
Since Abe took power in 2012, robust GDP growth, wage growth, and inflation have all proved elusive. The economy fell into recession in 2014, and while it returned to growth above 1 percent in 2015 and 2016, consumer prices continue to fall. Low unemployment of just over 3 percent and pressure from the government on Japanese corporate leaders have helped wages begin to rise, but that growth is slowing.
Japan’s economic woes are nothing new. The country 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 hoped his extraordinary monetary policy would 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.
However, 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 fell from more than $100 a barrel in 2014 to a low of under $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.
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 recession. As a result, the next planned bump, up to 10 percent, has been continuously postponed, first to 2017 and then to 2019. 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. Some worry that negative rates might not actually encourage spending, but rather, the hoarding of cash, thus adding to deflationary pressures.
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.
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.
What does this mean for the global economy?
Abe’s policies have been 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.
The election of President Trump, who brings a new vision of global trade and economic policy oriented away from the multilateral negotiations favored by President Obama, has complicated Abe’s options. Some experts have argued that Trump’s rejection of the TPP and his criticism of Japanese trade practices could unsettle the U.S.-Japan alliance, a relationship that Abe has called “the cornerstone of Japanese foreign policy.” Trump has also heavily criticized what he calls Japan’s currency manipulation, accusing Abenomics of “playing the devaluation market”—a charge which Abe strenuously denied.
Ultimately, 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 the Wall Street Journal’s 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."