Friday, 18 April 2014

Assessing Abenomics

Japan has been such a perplexing country in terms of its economy for the past two decades. A country riven by a slow, government-driven recovery has tried everything: from massive monetary stimuli which has kept interest rates really low for the entire period, to massive fiscal stimuli which resulted in a >230% of Japanese debt to GDP (which is ok apparently since the majority of this debt is held by domestic entities - or is it?). It's hard to think of any country going through the same painful experience. Up until today that is. It seems that a similar scenario awaits the UK and Europe - stagnant economies at least for a decade if not longer, with rising debt levels and low productivity. 

However 20 years of no growth (the two lost decades) have finally taken its tolls and the idea was to replace them with something new and yet untried, so to speak. Abenomics, the set of economic policy measures applied by Japanese PM Shinzo Abe, appears to be just what the country needed - a mix of everything: fiscal stimuli, monetary stimuli and a long-term pledge for reforms. 

The three pillars of Abenomics; monetary easing, expansionary fiscal policy and a long-term growth strategy are designed to reinforce each other (he refers to them as the "three arrows", according to a 16th century tale from Japan where breaking one arrow in half is easy, but tying all three together and breaking them at the same time is impossible). So apparently that was the problem - these policies weren't being done simultaneously, which is why each of them has failed individually. 

Source: Richard Koo
Except this isn't really true. Bank of Japan (BOJ) has been performing easy monetary policy ever since the bubble burst in 1990, which has been steadily accompanied by higher government spending throughout the same period (to substitute for the lack of private spending) (see the graphs). By the ineffectiveness of these policies it was obvious that Japan was NOT and AD shock, but much more likely a deep structural (AS) shock, which is exactly why Japan cannot be characterized by any of the standard macroeconomic models (and why soon enough the same will apply to Europe as well).
Source: Richard Koo
However, perhaps the "third arrow" was missing all this time since there was never any real pledge to do long-run reforms. Perhaps that's why the stimuli failed? 

Was it successful?

The initial effects were surprisingly good. Since the start of the policies, the stock market soared (40% annual gain), the yen has depreciated which boosted exports (yes currency depreciation only works if you have massive production, i.e. if you have stuff to export), credit growth rebounded, asset prices started rising, consumption recovered, while the unemployment rate dropped down to 4%. Real GDP growth rebounded in the first half of 2013, even though it dropped back to low levels in the next quarter and has been gradually declining ever since. So the short-term effects have been really good. The question is for how long did they last?
Quarterly economic growth rates in Japan for 2013.
Source: Kunio Okina, WSJ
After such great initial results the critics have focused on Japanese potential output and the long-run set of policies that need to be introduced to overshoot that goal. Koichi Hamada, one of Abe's advisers, praises the short-term effects of the first two arrows, but is worried over the increasing role of government in picking industry winners. This is where Abe needs to be much more effective according to Hamada: "A more effective approach would entail achievable, concrete goals like relaxing labor- and financial-market regulations, reducing corporate income taxes, liberalizing trade by joining the Trans-Pacific Partnership, and perhaps easing immigration policy." He resents the power held by Japanese bureaucrats, which makes them very inefficient and wasteful. Which is no surprise as they've gotten used to this with two decades of failed fiscal stimuli, particularly at the local level

There were the negative effects as well. The current account deficit has reached a historical high, since Japan's economy is dependent on imports (food, oil, natural resources) and a depreciating yen has increased their prices. Despite the initial upsurge of GDP growth, it was really low in the final quarter, and on the yearly level it stood only at 0.7% (the expected was a 1% annual growth rate). This all comes before an increase of the sales tax from 5% to 8% which is expected to again hit consumption. Furthermore since real wages are still falling, don't expect any positive increases of consumption any time soon, despite the expected growth in employment. In addition, the debt levels are unsustainable and are still rising. This is another issue the government needs to quickly begin to address, as such high debt levels are certainly constraining economic growth

Source: Kunio Okina, WSJ
Finally, an interesting argument comes from Edward Hugh's blog, where he claims that Japan's economy is actually near its potential, as opposed to what many economists seem to think. Many are using the argument that not only Japan, but also the US, UK and Europe, are currently all operating far below their potential output. But what if this isn't true? What if all these economies are simply now facing a lower output path, a sort of a new, low equilibrium? I've made this argument many times in the cases of US and Europe, and it seems to be the correct portrayal of Japan as well. After all, they are all characterized by similar structural issues and were facing the same problems after a huge bubble burst - they falsely described an AS shock as an AD shock, which has led to a number of ineffective fiscal and monetary policy solutions. 

This is exactly why Japan doesn't fit the pattern of any macro model and why any conventional macroeconomic policy won't work there. Abe has made a nice try, but Japan is way too exposed for a short-term stimuli to be of any significant effect even for a single year. Abenomics is still using only the first two arrows, and yet again they are being broken. 

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