Today’s commentary
Abenomics is one of the most aggressive economic experiments we have witnessed in the post-Marshall Plan developed world. The questions is whether the massive stimulus campaign can work when politically there will always be discomfort with the large deficits at the heart of the campaign. Deficit reduction is now coming online via tax increases. Below are some threads on what is happening in Japan as this occurs.
When 2013 began, I was bullish on Japan. I predicted Japan would outperform all other developed economies and it did both in terms of growth and in terms of its equities markets. A lot of this is simply a currency effect and the result of deficit spending adding to the bottom line of private companies. What is happening in Japan in terms of the political alignment between the central bank and the federal government is the end game for all severe economic crises. The state issues fiat money and the central bank is the state’s agent. Despite the fiction of central bank independence, the reality is that these two agents will always align in exigent circumstances, rather than allowing the state to fail. This is what we saw in the US in World War 2 for example. And this is what we are also seeing in the US and in Europe despite the ECB’s alleged independence. The Japanese are just further into the crisis process.
The real question in Japan is whether this policy alignment can morph into something that doesn’t require as much deficit spending and money printing to lift the economy out of its torpor. And to date, I haven’t seen anything on that front.
My argument in December was that Abenomics and the consolidated balance sheet approach was simply the end result of Shinzo’s nationalism given the economic woes of Japan. There’s no real re-thinking of long-term policy – and so I remain sceptical about the eventual success of Abenomics.
Right now, growth is good enough that Japan believes yet again that it can cut the deficit without it having long-lasting consequences on the real economy. The Japanese think that Abenomics has done enough to end deflation and re-start growth that the economy can make it on its own now. Without wage growth, however, the risk is that Abenomics fails and we end up back in the same trap – only with a higher public debt figure. That’s when I believe wealth confiscation would become a real possibility.
But here is what is happening now in Japan.
According to the Financial Times, machinery orders have just hit a five-year high. That’s bullish because it could mean more business investment to counteract the coming sales tax:
Japanese companies are gearing up for significant new investments in domestic factories, distribution networks and other infrastructure this year, government data suggested on Thursday, in a shift that would bolster the country’s Abenomics-driven expansion.
Orders of new machinery by businesses, considered a leading indicator of overall capital investment, surged to a five-year high in November, rising 9.3 per cent to Y882.6bn. The year-on-year increase, which handily beat analysts’ expectations, was the second in two months and the fifth biggest on record.
What we want to see then from a cyclical perspective is deficit-led growth fuelling capital investment and wage and job gains that power the cyclical upturn forward and lay the seeds of a secular turn in Japan’s deflationary stagnation. For this to work, wage growth is key because higher inflation is not going to spur sustainable growth unless wages rise too. And right now there are a number of factors working against wage growth.
Back in July, FT Alphaville had a good piece on the labour market reform situation. This was the key takeaway:
A large swathe of Japan’s economy, he explained, could be described as “corporatist welfare” — in which legacy jobs are rewarded through familial connections, there is little threat of hostile takeovers, unprofitable and unproductive companies are kept alive via tight relationships with banks (which in turn are backstopped by the government), and certain industries are protected by non-tariff barriers.
A politician who tries to interfere with these processes might be setting the stage for a higher potential growth rate later on, but the immediate price for the increased dynamism would be large displacements and a loss of economic security.
Without rehashing too much of the issue, a reasonable extension of the points made above is that getting the first two arrows right — raising inflation expectations and providing appropriate fiscal stimulus — are key to successfully enacting the third. Without expectations of a stronger economy to cushion the near-term fall of those who would be displaced, structural reforms are unlikely to get very far before there is a huge political backlash.
Now, what Abe is trying to do is to get employers to raise wages as labour market reforms go into effect in order to cushion the blow of removing “corporatist welfare”. He wrote a piece about this with this key line that I see as a veiled threat to corporations in Japan:
Needless to say, wage levels ought to be determined solely by management and workers. But it is equally true that the emerging consensus among the government, business leaders, and trade unions already has led a growing number of companies to promise significantly higher wages and bonuses.
Translation: Japanese companies, raise wages on your own or expect government and unions to force you to do so.
So far so good. Two arrows of Abenomics, monetary and fiscal policy, have been aggressive and yielded the desire results in terms of growth and asset price inflation. The third arrow of labour market reform has been outlined in vague terms but we await more specifics because wage growth needs to come online first before reforms. And the most recent figures show wages rising for the first time in 18 months.
Nonetheless, wage growth alone cannot keep up the economy. Japan is no longer and export powerhouse. The trade balance is weakening, not just because of energy imports but also because the Japanese are shipping jobs over to China and elsewhere in Asia. That means job growth will be anemic going forward, offsetting wage gains. And the aging workforce in Japan makes this lack of job opportunity for new entrants into the employment market even more stark.
The problem is then that Japan needs an increase in nominal GDP that comes from both wage and employment growth that is commensurate with declining government deficits and debt to GDP. Otherwise, politically, the pressure will always be to move to tax increases in order to lower deficits and debt when the economy is in a cyclical upswing. Nothing Japan has done thus far convinces me that we are going to get sustained nominal GDP growth from private sector agents that would permit the government to lower its deficit and lower the governments debt as a percentage of output on a sustained basis. Therefore, I anticipate that the government debt issue will continue to be a politcal problem irrespective of Japan’s status as a sovereign currency issuer with an aligned central bank.
My view here then is that it is likely that Abenomics will fail during the next cyclical recession because of poor nominal GDP growth. The large increase in deficits during that recession will force a political decision onto government about the government debt. The Japanese will begin to ponder whether it should start to employ wealth taxes to reduce the deficit. And in lieu of a wealth tax, even a politically-motivated default is possible. By the time the next recession occurs, government debt to GDP will be 250% of GDP and all options will be on the table.
This is where the US and Europe are headed unless they solve the job and wage problem. Indebted developed economies cannot reduce debt and deficits sustainably without job and wage growth. Europe, with its lack of fiscal space is more likely to consider wealth taxes and sovereign defaults in the medium term than the US. The United States has a long way to go on this front but the eurozone is not far behind Japan because of the institutional setup of the eurozone.