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].

Economics and Politics

Source: Lena Groeger

One of the most important fields to emerge in the past three decades is the field of cognitive and behavioural bias. Countless experiments prove that we are all heavily biased decision makers and not the rational homo economicus purported by academic theories. Because economics is not a natural science like physics, conducting experiments to prove theories is not possible. Despite this, economists have tried to use maths (see econometrics) to prove various theories. The problem with constructing mathematical models is the reliance on assumptions and because there are so many moving parts in the economy, even a complex model will be inaccurate.

The lack of clear evidence results in multiple theories that are difficult to disprove. Usually supporters of a particular economic theory will find it magically aligns with their political bias. Obviously this is no surprise because confirmation bias is one of the most common biases we all exhibit.

For economics to really become practical and more scientific, biases must be eradicated when conducting economic analysis. When biases are mitigated, you don't get flawed predictions like "QE will result in hyperinflation" or "the budget sequester will cause the economy to go into recession."

For economics to be scientific and void of bias, it must be apolitical. I can only hope that one day economics will be apolitical. What will this day look like? It will occur when the vast majority of the economists agree on theories and predictions.

This is exactly why I support Money Realism because it tries to keep the politics out of economics. Cullen explains this in his summary of MR eliminating politics from economics:

"We probably can’t completely eliminate politics from economics, but MR is based on attempting to understand the monetary system and the economy at its operational level as opposed to focusing on providing policy solutions like so many other economic schools.   So we focus on things that are verifiable. For instance, how certain institutions are structured in specific monetary systems, how modern banking works, etc.  It’s all based on the view that a superior understanding of the money system comes from building an understanding of how the monetary “machine” works from the ground up.

We try, as best we can, not to provide prescriptive ideas and instead try to provide a set of understandings so that users of MR’s understandings can then decide on their own how best to implement policy.  We are not Keynesians, Monetarists, Austrians or any specific school at all.  MR is simply a set of understandings designed to describe the money system. 

Economics tends to focus on how certain policies can solve problems.  I believe economists should adhere to a Da Vinci method.  That is, when Da Vinci studied the human body he did not focus so much on how to fix the body, but how it worked.  Economists focus too much time trying to fix the economy and not enough time building a set of principles that define how it works.  If more economists adhered to a Da Vinci method I think better solutions would necessarily arrive. 

This is the primary strength of MR.  We don’t treat economics like it’s a religion.  Instead, we treat it like an evolving and changing science that requires flexibility and an open-minded approach.   As far as I know, there are few if any approaches to economics that provide this sort of approach."

Examples of biased economists

Some prominent economists that come to mind are Paul Krugman who has a blog titled "Conscience of a liberal". Just in case you did not know which political ideology he subscribes to. It is also clear that the Nobel Prize winner in economics, still does not understand how the banking system works when he claims that banks are not lending out reserves!:

"Banks are holding almost $2.7 trillion in excess reserves — funds they could lend out, but choose instead to leave idle."

Another biased economist that comes to mind is Stephen Koukoulas who frequently lambasts conservative politicians. He was an advisor to the former Prime Minister and leader of the Australian Labor party, Julia Gillard. Unfortunately his otherwise good economic analysis is tainted by his political bias.

On the other side of the political divide there are people like Peter Schiff and Robert Murphy from the Austrian school and a whole host of neoclassical economists like Arthur Laffer who will preach the virtues of a free market and that more government action will lead to adverse outcomes.

I would suggest you ignore the above economists who closely align themselves with one side of politics. Look out for those who are objective and apolitical, which is important in almost any field that relies on discovering knowledge.

But what about my political ideology? If I had to describe my own political bias then it would be Libertarian. Unfortunately, identifying with a particular ideology leads to many biases that result in a distorted view of reality. Thus I will now address eradicating political bias from your identity.

The most important reason to get rid of politics from your identity

The simple answer is politics makes you stupid. How you ask? When we adopt a political ideology as part of our identity, we perceive value from having correct beliefs. But what happens when these beliefs are wrong? You start to question your own self-worth and become reluctant to change these beliefs/identity, which makes "changing your identity a psychologically brutal process." 

"The most important psychological imperative most of us have in a given day is protecting our idea of who we are and our relationships with the people we trust and love." These quotes are from the article by Ezra Klein - How politics makes us stupid, which is highly recommended reading. This is the reason I am abandoning my Libertarian beliefs or any political belief/ideology for that matter. I don't want to be stupid and I guess you don't want to be either!