Abenomics

This post will look at Japan's recent economic performance under the policy of Abenomics. Policy recommendations are made at the end.

Japan's Prime Minster, Shinzo Abe

In 2012 Japan's prime minister, Shinzo Abe, ushered in a new set of economic policies which have been termed Abenomics. The policy involves "three arrows": fiscal policy, monetary policy and structural reform.

For further in depth analysis and details on Abenomics please read: Abenomics and the Japanese Economy.

Japan's recent performance

The latest GDP print is disappointing; Japan's economy shrank 1,6% (annualised) in the last quarter. Exports where down 16.5% (annualised) highlighting the flaws the export reliant model. When global growth or export markets slow, the export economy suffers.¹

Private consumption fell 3% (annualised), which is significant given Japan's economy is 60% consumption. The falling Yen added to problems for the Japanese consumer with food prices rising.¹

The large drop in growth seen in 2014 (see above chart) was the result of an increase in the consumption tax from 5% to 8%. 

Is Abenomics a success?

The rise in the consumption tax hurt consumer spending at at time the economy didn't need it. The result was a recession in late 2014 (two quarters of negative economic growth). Increasing government spending while increasing taxes is like having one foot on the accelerator and the other on the brake. The government must focus on generating growth today and address fiscal sustainability in a few years or expect the jittery economic growth to continue.

Raising domestic demand is paramount and the government should not only cancel future consumption tax increases but also reverse the previous increase. Additionally, the government could lower taxes for low-income earners to increase disposable income. It must be noted that Japan's income tax is very progressive.

Relying on a currency devaluation to boost exports is a less effective tool to boost growth. Firstly, the gains are marginal given the increasingly global supply chain. Secondly, it acts as a consumption tax on imports which reduces household real incomes. As mentioned above, rising food costs have become a problem for Japan.

The demographic challenge Japan faces must be addressed either through higher birth rates or net migration and getting more women into the workforce. This is one of the major aims of the structural reforms proposed under Abenomics.

Conclusion

The failure of Abenomics is political (not economic) with the deficit hawks continually demanding policies to reduce the deficit when the exact opposite is needed to propel Japan out of its protracted economic malaise. The more difficult task will be establishing the structural reforms which challenge the politically strong vested interests. If Japan can overcome these hurdles, they will be the shining example of an economy that escaped the debt deflation global epidemic.

References

1. Warnock, E. and Obe, M. (2015). Japan’s Economy Shrinks in Second Quarter. [online] WSJ. Available at: http://www.wsj.com/articles/japans-economy-shrinks-annualized-1-6-in-second-quarter-1439769883 [Accessed 23 Aug. 2015].

We Want a Stronger Currency!

I wanted to write a timely article on the effects of a strong currency. We are currently seeing the Australian Dollar (AUD) rise to lifetime record highs against the Euro as problems in the Eurozone continue to fester and investors look for perceived safe haven economies to park their money. The Australian economy is a very attractive location for capital because of its stable developed economy, stable political system, relatively low government debt and is generally business friendly.

Safe haven status takes years to attain but can be lost in few months. The most recent currency to lose some of their safe haven credibility is Switzerland, which pegged its currency to the Euro and now has to print unlimited amounts of Swiss Francs (CHF) to maintain the currency peg. Since the Eurozone fears lead people to buy CHFs, the Swiss are forced to increase their money supply to meet demand, which will eventually cause prices to rise as those newly created CHFs leak into the wider economy.

The economic pundits will tell you that the high AUD or CHF is hurting domestic industries and jobs are being lost. This fails to recognise that the fundamental goal for an economy is not to have more jobs but to increase productivity. Maybe every Swiss person could have worked for 35hrs a week instead of 40hrs a week since their purchasing power is increasing in EUR terms. That’s obviously a good thing and helps them achieve a higher standard of living by making their lives easier and more enjoyable to live.

The Swiss government fell for the myth that a weak currency stimulates exports. But what they continually forget to mention is the reduced cost of imports that benefits EVERYONE in Switzerland. There will be changes that will occur in an economy with a strong currency including job losses since marginally productive exporters will face greater competition through cheaper imports. Some businesses will close down but others will become more productive. The business that closes down will result in job losses but does that mean the newly unemployed will never work again? OF COURSE NOT! There is always a productive use for labour in an economy and as long as wages and labour regulations are flexible, the unemployed will find work elsewhere within the economy. Maybe new employment opportunities will come from a growing business reliant on imports that have seen demand rise as their products are now cheaper. The net result is an increase in the overall productivity of the economy and is an example of Schumpeter’s creative destruction, where the resources from a non-productive business are reallocated to a more productive business.

The other point touched on before was that a stronger currency will benefit everyone since they can buy goods from the rest of the world cheaply. Exporters may see stiffer competition but they too will see costs decline if they import supplies or raw materials from foreign businesses.

The Australian economy is a great example of an economy that has thrived despite seeing a rising currency. This does not mean the economy is completely healthy because households continue to have high debt levels due to large mortgages and we are likely to see the property market continue its slow decline. Australia is also heavily exposed to Asia and if there is a slow down or financial crisis our economy could be slammed. But things continue to function and we have not seen our economy die as a result of the strong Australian dollar. Next time you see the Aussie dollar make a new high, don’t frown, fist pump the air and shout YOU BEAUTY!