For more than two decades Japan’s economy has been in a state of stagnation. Like many other developed countries, Japan has been stuck at a zero nominal interest rate. Prices have fallen since the late 1990s, while the average level of growth between 1993 and 2012 was a meager .8 percent. This stagnation came after a prolonged period of rapid growth, which began following WWII and continued up until the 1970s. At that time, warning signs that the economy was slowing began to appear. In December 2012, Prime Minister Shinzo Abe announced that new measures would be taken to combat deflation and the stagnation of Japan’s GDP. The policies that were adopted with the aim of jolting the economy into growth is called Abenomics.

Abenomics is comprised of three different parts that, in theory, when introduced together, would lead to Japan’s recovery. The three parts are fiscal expansion, monetary easing, and structural reform. Today, three years later, the question is whether or not Abenomics has been successful.

There are several underlying factors that contributed to Japan’s slowed rate of growth and the subsequent implementation of Abenomics. The first is that, by the 1970s and 1980s, Japan was catching up with more advanced economies. There were less importable technologies that were able to sustain previous levels of rapid growth. Another leading factor was the collapse of the fixed exchange rate in 1973. This meant that Japan could no longer rely on an undervalued currency to bolster its exports.

Arguably, slow growth is damning because  of the long-lasting deflation with which Japan has been simultaneously battling. Japan first experienced problems with deflation in the early 1990s. Scholars have pointed to several reasons why Japan initially experienced deflation, and why, unlike other OECD countries, it has been so persistent. Starting in the late 1980s, and continuing to 1991, Japan experienced an asset bubble in which real estate and stock market prices became enormously inflated. By 1990, the Nikkei index had fallen to fifty percent of its peak, while asset prices began to fall in 1991. Many economists point to the bursting of the asset bubble as the primary cause that started Japan’s fight with deflation. The asset shock however, cannot explain persistent downward inflationary pressure for the past two decades. Many attribute the failure to combat negative demographic trends, through  economic policy as a possible explanation of why deflation has been prevalent for so long. The increase in life expectancy in Japan puts greater downward pressure on the natural real interest rate, as well as growth and savings.

 As a whole, Japan’s population is aging as life expectancy increases, and at the same time fewer children are being born: the population peaked in 2008 at just over 128 million people. Since then, every year it has been falling at a rate of 0.2 percent. The working age population (16-54 years old), however, has fallen at a steeper rate of 1.5 percent. This means that there has been a nine percent total decrease since 2000 in the labor force. On the other hand, the fraction of citizens over the age of 65 has risen from 17 to 23 percent since 2000 (compared to 12 to 14 percent for the U.S.).

 Abenomics attempts to combat the challenges that these changes have created within Japan. The short term goal of Abenomics is to boost domestic demand and GDP, along with raising the inflation rate and holding it at two percent. In the long run, Japan would like to see both increased competition and reformed labor markets, with a view to ensuring sustained growth in GDP. These long term changes would be part of the structural reforms promoted by Abenomics.

 The monetary easing aspect of Abenomics is addressed by The Bank of Japan (BOJ), the central bank. The BOJ has openly committed itself to increasing inflation to a target level of 2% (up from roughly 1%). This will be done by engaging in asset purchases and doubling Japan’s monetary base.  By doing so the central bank would also devalue the yen, which would theoretically give a boost to exports. Other currencies would be able to buy more Japanese manufactured products which would hopefully translate into increased investments.

 The second part of Abenomics revolves around fiscal stimulus. The aim is to increase economic growth through increased government expenditure and public work investments. In the first year after Abenomics was introduced, Japan increased its public works budget by more than 10 billion US dollars. The Japanese government has taken an approach to where fiscal policy can be flexible in the coming years depending on the state of the economy despite its 200 percent of GDP debt.

 If Abenomics is to be successful, perhaps its most important aspect is structural reforms. Successful structural reforms would lead to positive long term change. Labor reform, one of the proposed reforms, is crucial for the country’s recovery. The troubling demographic trends that have cause so many problems in the past few decades in Japan show no signs of disappearing. Japan’s population has contracted by six percent over the past decade and the working population to an even greater extent. To counter these trends, initiatives are being introduced with Abenomics that encourage greater female participation, along with changing market rules that keeps a large portion of the working population in low-paying jobs. Additional planned structural reforms include limiting the level of protection farmers receive and utility deregulation..

 Three years after Abenomics was introduced, critics and proponents alike are looking to see if there are any merits behind the actions being taken. When examining the Japanese economy, there are several elements that have changed. However, others such as deflation have not been affected to the degree was hoped.
First off, the yen has fallen 50% against the dollar. This has led to a 2.7 percent increase in exports in the final quarter of 2014. Along with exports rising slightly, the stock market has risen by a large sum in the years following the new policies seen by the Nikkei index which reached an eight year peak in 2015. On the other hand, the real interest rates have fallen mainly due to the increase in expected inflation. Despite these positive changes, thus far the overall results have been modest at best. Japan experienced two quarters of negative GDP (once again) in 2014 and only a 1.5 percent increase in the fourth quarter. This was significantly below the 3.8 percent predicted growth economists had thought would be seen in 2014.

 Negative inflation, which has been a huge problem for Japan for over two decades, was a primary target for Abenomics. With the introduction of Abenomics came the promise to raise the level of inflation to two percent by any means necessary. However, to date, the two percent mark has not been reached. In early 2015, inflation fell to 0.5 percent. Part of the problem is that the goal of two percent is not credible. The BOJ has failed to be credible in the past, which has the effect of keeping inflation low. Another reason for the failure of the two percent target can be blamed on the political realm. A large portion of the elderly population have their pensions indexed to CPI. Furthermore, the Japanese hold over half their wealth in bank deposits and currency (compared to less than fifteen percent in the US). Inflation imposes huge losses to those that are retired. The older generation would feel the effects of higher inflation while not being compensated with improvements in the labor market.

 One anomaly that has occurred is that, while one of the biggest advantages of the devaluation of a country’s currency is that the goods become very inexpensive to foreigners, Japan has not benefited as much as one would have expected. While exports have risen, as mentioned, growth in the export sector has been minimal. This smaller increase may relate to the fact that many of the exports and imports are inelastic to changes in the exchange rate.

 Thus far, while the results of the implementation of Abenomics have been anything but promising, there are additional risks that critics point to. As noted above, one of the primary goals of the BOJ is monetary easing which many believe could lead to hyperinflation. Furthermore, Japan’s debt now exceeds 200 percent of GDP. If interest rates were to rise, that level of debt would become unsustainable. While most of Japan’s debt is held domestically, in the coming years Japan may have to look abroad for their financing. However, when Japan does so, it may not be able to get the extremely low interest rates it is currently are accustomed to obtaining.

 The question of whether or not the policies undertaken by Abenomics have resulted in limiting deflation and spurring growth within the Japanese economy are important for other countries. While the results of Abenomics are clearly most important for Japan, other developed nations are also watching closely to see what the outcomes will be. Many other nations in Europe and the Americas will be experiencing similar trends, namely aging populations, rising pension burdens and slowed GDP growth in the coming decades.

 It’s clear that, to date, Abenomics has not been as successful as its proponents had hoped. While some continue to believe that its policies and changes will work, there has not been clear evidence such a positive scenario is guaranteed. Without a doubt, the third part of Abenomics (structural reform) must be the focus in coming years. Drastic changes, many of which may be difficult, are necessary if Japan is to recover from decades of poor growth and a lifeless economy.

All views expressed in this article are those held by the author alone.  This writing is copyright of the author and Lake Forest Letters.  Please do not quote or cite without permission of S. Aneeqa Aqeel or the author.  Comments are welcome! Please use the form below.

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