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As Abe leaves, Japan assesses the state of the economy

By GlobalCapital
18 Sep 2020

What impact has Covid-19 had on Japan? The answer is complicated. No major economy has done so well at containing the spread of the virus — or so badly at limiting the economic fall-out. William Pesek reports.

Shinzo Abe could have been forgiven for expecting 2020 to be his crowning glory. Abe’s premiership was heading into its eighth year, a sharp break from the political merry go-round that preceded him, when the country had five prime ministers in five years. He would bask in the glow of the Tokyo Olympics, just as his grandfather did as premier in 1964. He would rewrite the pacifist postwar constitution, a career-long goal. He might even — finally — get the economy under control.

The pandemic ruined Abe’s swansong of a year, delaying the Olympics, hurting the economy and putting any talk of constitutional changes on hold. On August 28, he announced his resignation, citing health reasons. 

JapanHe did not leave on a high note. In the months before Abe quit, his cabinet’s approval rating sank into the low 30’s — the danger zone for any Japanese government.

On the surface, Japan seems a striking success as regards Covid-19, with fewer than 75,000 cases and just under 1,400 deaths. Churning below, however, is widespread anger about Tokyo’s poor testing and contact tracing capacity. Abe is widely seen as having, like diplomatic ally Donald Trump, prioritised the stock market over public health, while protecting the Tokyo Olympics, already delayed to July 2021.

The bigger problem, though, has been a cratering economy for which Abe has had no answer. Japan’s stumble began well before Tokyo confirmed its first coronavirus infection — with a terribly timed hike in consumption taxes to 10% on October 1 last year. That sent gross domestic product plunging 7.3% in the October-December quarter.

Now, as the pandemic fallout ravages the world’s third-biggest economy, the deflationary forces Abe pledged to eradicate since 2012 are returning. And with them, a question that until recently seemed inconceivable: Is Japan on course for yet another 10 years of flatlining growth and falling prices?

‘Lost decade’

“The implications of Abe having presided over yet another ‘lost decade’ will be felt not only by Japan, but by the entire region,” says Michael Heazle, a professor in Kyoto University’s department of foreign studies. 

This was hardly the conventional wisdom when Abe bowed out. He won widespread plaudits for his attempt to resuscitate Japan’s moribund economy. But the speed with which Japan’s economy toppled, at an annualized rate of 27.8% between April and June, suggests the longest expansion since the 1980s was shallower than believed. Although stocks had a great run — the Nikkei 225 Average more than doubled on Abe’s watch — the virtuous cycle of surging living standards never materialised.

“Without a sufficient rise in wages, the benefits of Abenomics were not shared by households, and thus failed to stimulate domestic demand,” says Shigeto Nagai, head of Japan economics at Oxford Economics. “Abenomics did not stop the secular stagnation in household incomes.”

To understand the magnitude of the challenge facing the new prime minister Yoshihide Suga, it’s important to recognise how Japan got here.

In December 2011, Abe came to office — with chief cabinet secretary Suga at his side — promising to fire three arrows at chronic deflation: monetary loosening, fiscal pump priming and structural reform. In reality, though, the government only truly got one aloft. 

Beginning in March 2013, Abe’s hand-picked Bank of Japan governor, Haruhiko Kuroda, deployed what analysts upgraded to a “bazooka”. That set the BoJ on a path to hoard half of all outstanding government bonds and gorge on stocks via exchange traded funds. By late 2018, the central bank’s balance sheet was equivalent to the nation’s $5tr of annual output.

The fiscal shot was less successful. First came a 2014 hike in the consumption tax to 8% from 5%, which resulted in a mild recession. Next was last year’s step to 10%. The deregulatory reform arrow, though, remained largely in the quiver.

“The structural reforms with the most potential to lift productivity growth have not been addressed,” says Tom Learmouth, who covers the Japanese economy for Capital Economics, an economic research company. Abe did put some upgrades on the scoreboard: promoting better corporate governance, increasing the share of women, seniors, and foreigners in the labour force.

Most of these tweaks, though, were of the low-hanging fruit variety. The last eight years saw virtually no progress in taking on Tokyo’s notoriously change-adverse bureaucracy. Coronavirus reports are still largely arriving at ministries via fax machine.

There’s great pressure on the new government to “reform Japan’s complex and undigitised admin systems that drag on productivity. Such reforms have the potential to lift trend growth,” Learmouth says.

Tough task

The first challenge for post-Covid Japan is to address the causes of its malaise, not just treat the symptoms. Since 2001, when the BoJ began experimenting with quantitative easing, Tokyo has been engaged in the latter.

In 2012, Tokyo set out to change the ‘deflationary mindset’ with a supply-side show of force. To encourage Japan’s 126m people that the next 10 years would be more vibrant than the last, officials previewed plans to loosen labour markets, cut red tape, empower women, shift tax incentives from big exporters to start-ups and internationalise corporate practices.

Yet Abe, like myriad predecessors, saw the magnitude of the task and backed away. The heavy lifting was instead done by the central bank, which begun an aggressive easing of monetary policy.

The pandemic, however, leaves Tokyo with less fiscal and monetary space to support growth. Before Japan confirmed its first Covid-19 cases in January, its national debt burden was by far the biggest among industrialised nations — approaching 250% of GDP.

In June, just after Tokyo announced a $2.2tr coronavirus rescue package, the ratings agencies fired shots across the ruling Liberal Democratic Party’s bow. First came S&P Global Ratings, which cut the outlook on Japan’s sovereign rating from positive to stable, reminding the government it ended 2019 already $12tr in debt. In July, Fitch revised its long-term outlook on Japan to negative from stable, while a decision from Moody’s is still pending after it completed its review of Japan in July. 

JapanHopes that Japan can avoid further debt growth hinge in part on it avoiding a second wave of Covid infections.

Another hope is that big trading partners the US, China and Europe will stabilise to provide demand for Japanese cars, electronics, apparel and other exports.

Economists also worry that the monetary policy side of the ledger is largely tapped out. The BoJ’s massive purchases of government bonds is warping trading dynamics and making it hard to price corporate and asset-backed debt. Since 2018, there have been several days when not one public debt issue traded in Japan’s secondary market.

Covid-19 will leave Japan worse off in a number of other areas. Even before the pandemic, Japan had fallen nine places on the World Bank’s ease-of-doing business survey — 29th in 2020 from 20th in 2012. As Tokyo scrambles to support growth, little is afoot in policy circles to raise Japan’s competitive game.

Japan’s women are also bearing the brunt of job losses this year. A July 20 study from Massachusetts Institute of Technology and University of Tokyo showed that losses to female incomes have greatly outpaced those of men.

“Female workers fare worse than males and their negative welfare effects are three times as large as those of male workers,” wrote Shinnosuke Kikuchi at MIT and the University of Tokyo’s Sagiri Kitao and Minamo Mikoshiba.

The disparity undermines Abe’s claims to be making Japan’s other half “shine”. Women’s labour participation increased markedly in recent years to a record 71%. Yet most female workers are relegated to ‘non-regular’ jobs with less security, pay and benefits. These gigs, about two-thirds of which go to women, have been the first to disappear amid the pandemic.

Japan’s nascent tourism industry might never be the same. This was supposed to be the year when Japan welcomed a record 40m visitors. Many were expected to come for the Tokyo Summer Olympics, which are now postponed to July 2021.

Japan’s demographic troubles also could be exacerbated by the coronavirus. At the end of 2019, the 65-and-over age bracket hit a record 28.41% of the population. In the same year, the number of new-born babies dropped below 900,000 for the first time. In 2019, Japan’s fertility rate was 1.36 per woman, the lowest in 12 years.

That leaves the nation with the biggest debt burden with a shrinking workforce at the same time as social-security outlays on pensions and medical care are increasing. What’s more, health experts worry that concerns about current household finances and future earnings will dissuade families from having more kids.

“This is an emergency,” says Masaji Matsuyama, who from 2017 to 2018 was the cabinet minister charged with increasing Japan’s birth rate. He notes that some private sector surveys suggest the number of births might even drop below 700,000 next year “due to the coronavirus' influence”. 

Since the pandemic hit, Japanese consumer prices have flatlined. In July, for example, prices were zero — a far cry from the 2% target. Concerns about consumer prices falling back into the red are putting upward pressure on the yen, which is in turn increasing headwinds for Japan’s exporters as 2021 approaches.

It’s not all doom and gloom. In fact, silver linings abound when one looks at what the pandemic has forced Japan Inc to grapple with. One is more flexible work schedules that Japan’s notoriously rigid corporate culture had not even considered at the start of 2020.

Working from home is shaking up Japanese companies in unpredictable ways. In July, Japan’s Cabinet Office found that at least 34.6% of workers in Japan have experienced working remotely. In Tokyo’s 23 wards, the figure reaches 55.5%. It might be hard to return to the old days of insisting all employees be physically in offices.

Equally extraordinary, 145-year-old Toshiba Corp is mulling a four-day working week, for both office and factory workers. Corporate icons Hitachi, Fujitsu and Mitsubishi Electric Corp have ambitious plans to increase the scope of teleworking programs. Meetings via Zoom, Skype, BlueJeans and other video conferencing platforms quickly became the norm.

“What corporations do at this critical juncture will have significant influence on the future course of Japan, not only economically but socially,” says Yoko Ishikura, professor emeritus at Hitotsubashi University.

JapanGrowing pains abound, of course. The vast majority of Japanese companies, Ishikura says, have an “inadequate technological infrastructure” and a “lack of digitised data” to expand telecommuting on a broad basis. Among OECD members, Ishikura notes, Japan is ranked “very low” in the area of digital infrastructure resources and skill.

Looking ahead to 2021, Japanese companies plan to invest about 16% in information technology to keep up with the digitalization wave.

Equally important is taking on Japan Inc’s fierce devotion to an analogue, paper-based office culture heavy with fax machines, face-to-face meetings and business card exchanges.

The new government should invest more money and political capital raising Tokyo’s technology game with an ambitious digital strategy. “Covid-19 has forced change upon us,” Ishikura notes. “Now is the time for organisations as well as individuals to make up their mind and commit to transforming their ways. The strategic window of opportunity will close very soon.”

Japan’s ability to adapt to a fast-changing year will say much about risks of another lost decade. It’s worth noting that Japan’s GDP is now back to the same levels as in 2010. That, along with a dearth of inflation and generalised wage gains, means Japan’s reform push in recent years “has been a flop,” says Jeff Kingston, head of Asia studies at Temple University’s Tokyo campus.

The key, says analyst Scott Seaman, director for Asia at Eurasia Group, is for Suga’s government to “tackle this ‘third arrow’ of Abenomics more energetically than Abe did”.  

That means getting serious about building economic muscle so that Japan creates more jobs from the ground up, not just protecting big firms at the top of the economic food chain. It means reducing the bureaucracy, which costs Japan a thriving startup scene that disrupts the economy.

The next government could put teeth on the corporate governance reforms Abe rolled out in 2014 so that scandals like the one afflicting Nissan Motor are relegated to the past.

Though laudable, says Brian Kelly, managing partner at Asian Century Quest, “like so many such efforts over the decades there is little enforcement and virtually no penalties for non-compliance”. 

Even so, those upgrades, which include giving shareholders a bigger voice, were partly what drew Warren Buffett to place a $6.2bn bet on five Japanese trading houses in September: Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo. Suga’s team could work to harness this “Buffett effect”. 

The new government could also craft a more creative and pro-growth energy policy that prioritises new innovation over nuclear reactors. Japan’s long, fabled history of innovation in the battery space, for example, made Panasonic Corp one of Elon Musk’s first phone calls when the Tesla founder opened his initial $5bn Gigafactory in the Nevada desert. Observers hope Japan’s new leadership leans into such partnerships.

Better geopolitical relations in Asia also should be a major priority, says Miyeon Oh, director of the Scowcroft Center for Strategy and Security’s Asia Security Initiative.

“New Japanese leadership, combined with the outcome of the US presidential election, could be a game changer for geopolitics in Northeast Asia,” says Oh.

Japan played a critical role in keeping the Trans-Pacific Partnership alive after US president Trump pulled out of the multi-nation pact. 

“How the new prime minister is going to continue Japan’s multilateral engagement will have a significant impact on the changing global economic architecture with accelerated transition to the digital economy caused by the pandemic crisis,” says Oh.

The bottom line, though, is that Covid-19 has only heightened the need for economic reform in Japan. Suga has a tough task ahead.

By GlobalCapital
18 Sep 2020