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Japanese ‘Abenomics’: The Overlooked Third Arrow of Shinzo Abe’s Reforms

The surprise announcement of Japanese Prime Minister Shinzo Abe’s resignation in August has renewed an international debate over the efficacy of Abe’s massive economic reforms. Abe, who resigned due to health issues, was the longest-tenured prime minister in Japanese history, having held office since 2012. Reflecting on his flagship economic program, dubbed ‘Abenomics,’ it is clear that this well-intentioned platform has not done enough in the way of structurally reshaping the world’s third-largest economy. Abe’s successor, Yoshihide Suga, has already vowed to continue following the economic philosophy that Abe spearheaded. If the Japanese economy is to achieve genuine, sustainable economic growth moving forward, Suga must enact structural reforms geared toward improving productivity and deregulating businesses.

The long-term legacy of Abenomics remains an open question. After a prolonged period of slow growth and high deflation stemming from the devastating collapse of Japan’s real estate bubble in the 1990s – referred to as ‘The Lost Decade’ – Abe sought to execute a three-pronged approach toward economic restoration from 2012 onward. His agenda consisted of the “three arrows”: flexible fiscal policy, monetary expansion, and structural economic reform. While the first two arrows yielded promising, if not resoundingly successful, results, Abe failed to balance these enormous reforms with the third arrow of structural reform. This oversight has only been compounded by the global economic decline and market volatility brought about by the Covid-19 pandemic.

"By masking Japan’s deep-seated economic issues with hefty spending, as Lacalle points out, Abe focused his attention on the wrong places during his eight-year run and allowed Japan’s glaring labor and structural vulnerabilities to become even more pronounced."

First, the context of Abe’s fiscal and monetary policy overhauls is crucial in understanding his misguided neglect of the third arrow and why, moving forward, structural reform is imperative. The monetary policy of Abenomics aimed to spur rapid growth by drastically cutting central bank interest rates in order to incentivize borrowing and spending, even introducing negative interest rates in 2016 to dig Japan out of the deflationary hole it had been stuck in leading up to 2012. In tandem with quantitative easing, Abe adjusted the country’s fiscal policy to augment government spending and thereby undermine deflation. For instance, Abe’s sweeping fiscal stimulus package in 2013 included ¥10.3 trillion (equivalent to $116 billion) in direct government spending, with large-scale budgetary expenditures continuing in subsequent years. While these growth-oriented policies had their benefits, Japan was never able to consistently hit its target annual rate of two percent under Abe. Nonetheless, considering that the national economy had reached a staggering peak deflation rate of almost 1.4 percent in 2009, Abe’s ability to cultivate a net positive inflation rate (averaging over 0.8 percent between 2013 and 2019) has rendered his fiscal and monetary reforms at least marginally successful.

Where Abenomics has truly fallen short is in the execution – or, more aptly, nonexecution – of its structural pillar, which Abe largely ignored in favor of the aforementioned fiscal and monetary pillars. This failure to address the urgent, labor-related obstacles plaguing Japan is heavily to blame for the ultimately unextraordinary results that Abenomics has produced. As economist Daniel Lacalle puts it, Japan tried “to disguise structural problems with high levels of debt and high levels of government spending.” Lacalle adds that, because the program effectively abandoned the structural reform arrow, Abenomics “has hurt growth, it has hurt productivity growth, and more importantly, it has massively hurt the real wages for workers.”

By masking Japan’s deep-seated economic issues with hefty spending, as Lacalle points out, Abe focused his attention on the wrong places during his eight-year run and allowed Japan’s glaring labor and structural vulnerabilities to become even more pronounced. For one, Japanese labor productivity trails that of many fellow economic powers, as the country’s GDP per hour worked stood at roughly $45.40 in 2018, about 21 percent less than the average productivity level of Organization for Economic Cooperation and Development (OECD) members. This disparity is in large part attributable to a distinct characteristic of modern Japanese society that Abenomics has not sufficiently tackled: its aging population. In 2017, Japan had the oldest population in the world, with a third of its populace at or over the age of 60. This trend is not projected to falter anytime soon, as estimates suggest that up to 42 percent of Japan’s population will be 60 years old or older by 2050. Japan’s demographic troubles have decreased the size of its labor force and strained its vital factors of production, contributing to the drop in national productivity.

In addition to low productivity, “regulatory hurdles for businesses remain high… and Japan’s international competitiveness has receded.” Despite corporate governance initiatives and related reforms designed to attract foreign investment in Japanese companies, this overarching objective has not been attained. In fact, the International Institute for Management Development ranked Japan just 34th in its 2020 world competitiveness rankings, down four spots from last year and seven spots since Abe took office in 2012. Meanwhile, in spite of Abe’s promises to improve Japan’s standing in the “Ease of Doing Business” rankings, published by the World Bank, Japan clocked in at just 29th this year, nine spots lower than in the 2012 report. This indicates that onerous regulations are holding back Japanese firms and investment opportunities, hampering the greater economy in the process. Evidently, conducting business and securing investment in Japanese-based enterprises has only become more difficult under Abe, signaling that structural work has to be done to alleviate some of these prevailing corporate regulations and roadblocks.

With low productivity and waning competitiveness on the international stage, it is no wonder that Abenomics has done no favors for real wages or overall growth in Japan. As for the former, despite wage increases across the majority of the developed world dating back to the 1990s, Japan’s average real wages have stayed relatively stagnant at under $40,000 over this extended time frame, compared to real wages of nearly $49,000 for the OECD as a whole in 2019.

Wage growth centrally relies on broad economic growth, which necessitates a revived structural focus on areas like productivity and corporate competitiveness. According to data courtesy of the Bank of Japan itself, the country’s potential growth rate has progressively worsened during the Abenomics experiment, shrinking from about one percent in 2014 to barely more than zero percent today. Needless to say, Covid-19 has disrupted economies worldwide, but the unprecedented GDP drop that Japan suffered in the second quarter of this year should serve as an especially salient reminder that, now more than ever, the third arrow of Abenomics is a necessary means of recovery and growth. Because labor and private investment are key drivers of economic growth, the prospect of vast economic advancement in Japan – particularly in the wake of the pandemic – is mere fantasy if these innately structural factors remain overlooked.

Whether it comes in the form of technological developments to facilitate productivity gains, strengthened social programs to boost labor force participation, greater relaxation of corporate regulations to generate private investment, or other strategies, Prime Minister Suga needs to implement major structural reforms. Indeed, the International Monetary Fund (IMF) recently recommended several possible avenues of structural improvement. On top of the previously identified need to bolster investment in Japan, which would require further deregulation and trade liberalization on the part of Suga’s administration, the IMF pinpointed critical labor-market reforms that the new prime minister should consider. Ideally, these wage- and productivity-minded reforms would target less advantaged members of the Japanese labor force, including older workers, foreign workers, and women; specifically, reforms such as the elimination of mandatory retirement ages at Japanese companies and the provision of more accessible childcare services would encourage higher labor force participation among these groups.

The IMF approximates that, through strong implementation of these types of policies, Japan can counteract up to 60 percent of the economic stagnation that its aging, dwindling population is expected to cause moving forward. This maximal progress can only occur, however, if Prime Minister Suga initiates a “fully credible” rollout of structural reforms, meaning that private-sector actors must be assured that Suga will follow through on said reforms. If the rollout is fully credible, businesses and the general public alike will expect wages and investment returns to increase, so they will be more likely to spend money and, in turn, stimulate the domestic inflation and growth that Abenomics has long tried to engender. For this reason, Suga must confidently, aggressively advance structural reforms moving forward. It is only through an established focus on this vital third arrow that Abenomics can accomplish its far-reaching goals for an improved Japan.

Photo: Image via Flickr (Anthony Quintano)

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