Overcoming debt, deflation, and demographics was never going to be an easy challenge for “Abenomics.” Yet as Japanese Prime Minister Shinzo Abe celebrated becoming the nation’s third-longest serving postwar leader, positive signs have emerged in the world’s third-largest economy, despite long-term headwinds.
On May 28, the Liberal Democratic Party (LDP) leader overtook his reformist predecessor Junichiro Koizumi, with his 1,981 days (including his previous stint in office) lagging only Shigeru Yoshida at 2,616 and Eisaka Sato at 2,798 days.
Commenting on Abe’s leadership style compared to Koizumi, Chief Cabinet Secretary Yoshihide Suga said: “Koizumi pressed forward while confronting opposition, but Prime Minister Abe builds consensus within the party through explanation.”
Economic revitalization, the creation of a more “vibrant” society and security against North Korea and other threats were cited as the most pressing issues.
However, Suga noted, “The most important thing is not how long an administration lasts, but what it has done.”
“It’s the Economy, Stupid”
As former U.S. President Bill Clinton’s famous campaign slogan said, “It’s the economy, stupid.” Fortunately for the Abe administration, growing signs are emerging that it is achieving progress on its Abenomics program, comprising fiscal and monetary stimulus with pro-growth reform policies, albeit far more slowly than demanded by critics.
“Three years since Abenomics was introduced, we are now at an inflection point for inflation,” Nikko Asset Management’s (Nikko AM’s) Japan equity team said in a May 2017 research note.
“There is no denying that Prime Minister Shinzo Abe and Bank of Japan Governor Haruhiko Kuroda have taken unprecedented measures to turn Japan’s economy around. These measures have led to the third-longest economic recovery – 53 months to date – in the postwar era.”
The growth record was marked on May 18, with Cabinet Office data showing the Japanese economy expanded at an annualized pace of 2.2 percent in the first quarter, easily beating consensus estimates of 1.7 percent to notch its fifth straight quarterly rise.
The gain in gross domestic product (GDP) was helped by strong exports, which grew by 2.1 percent quarter-on-quarter, while private consumption expanded by 0.4 percent and corporate capital spending by 0.2 percent.
The last time the economy enjoyed such an extended winning run was under Koizumi in 2005-06, when it expanded for six straight quarters.
“From a policymaker’s perspective, it does not get much better than this: Japan’s economy is entering a more balanced growth phase and the rate of growth is above-potential, but not too fast to warrant changes in monetary policy,” said Tokyo-based economist Jesper Koll, head of WisdomTree Japan.
Meanwhile, more positive signs for the sought-after “virtuous cycle” of expanding profits, wages, and consumption have also emerged.
Corporate Japan enjoyed record profits for fiscal 2016 despite the headwinds from a strong yen. According to a Nikkei survey, listed companies’ net profit grew by 18 percent, its first increase in two years, with trading houses rebounding from their previous resources losses and communications businesses benefiting from the smartphone boom.
Further gains in both revenues and profits are expected for the current fiscal year, with automakers seen gaining from a softer currency and trading houses enjoying rising commodities prices, the financial daily said.
Increased corporate profits have fueled rising corporate capital expenditures (capex), with capex expected to expand by 13.6 percent in fiscal 2017, a separate survey found. After dropping in the previous fiscal year, the U-turn in the year to March 31 has been driven by the fastest growth in domestic investment since the global financial crisis.
Japanese exports also posted their fifth straight monthly gain in April, amid a firming global recovery, despite worries over the Trump administration’s protectionist policies. In the same month, the nation’s core consumer price index posted its fourth straight monthly rise, increasing by 0.3 percent.
Japan’s net external assets also grew by nearly 3 percent in 2016 to reach 349 trillion yen ($3.1 trillion), the first rise in two years, with the nation maintaining its position as the world’s largest creditor nation for the 26th straight year.
And crucially for Japan’s households, whose spending accounts for 60 percent of GDP, wages are posting their fastest growth in decades. According to Morgan Stanley, wages growth will accelerate to 2.8 percent by the end of 2018, with higher hourly earnings canceling out reduced working hours and slower employment growth.
With wages rising, inflation will be “the last piece of the jigsaw puzzle to fall into place,” Morgan Stanley’s Jonathan Garner told Bloomberg News.
A broad gauge of employee compensation posted a 2.2 percent rise in 2016, following two years of around 2 percent gains, in the strongest growth seen since the 1990s, even while hourly pay rates have yet to respond.
With the unemployment rate at a 23-year low of 2.8 percent in April and the job-to-applicant ratio at 1.48, the highest since 1974, the prospects for further wage rises are rising amid an increasingly acute worker shortage. A record-high 97.6 percent of new university graduates secured jobs as of the April 1 start of the 2017 fiscal year, a government survey found, in another indication of the strong labor demand.
While “non-regular” jobs, mainly filled by women, reached 37.5 percent of the labor force in 2016, Nikko AM argues a growing number of firms are hiring full-time employees to secure staff, resulting in higher wages.
It points to parcel delivery firm Yamato Transportation, which has been forced to hike prices for the first time in 27 years on the back of additional labor costs and rising delivery demand from e-commerce.
Yet despite the sustained recovery, Nikko AM noted the slow change in the behavior of Japanese households and corporations, which collectively hold around $11 trillion in cash and deposits, an all-time high. While corporations have been driven to increase investment on the back of changes in corporate governance and international acquisitions, “there are still few clear signs of a corresponding change among households.”
The Tokyo-based firm argues that worries about future sources of income, including wages, have been key to consumer behavior, but the tighter labor market and resulting wages growth could force a change.
“What is interesting in Japan is that, empirically, there appears to be an inflection point around 3 percent unemployment from which inflation starts to pick up. This leads us to believe that the final push toward wage hikes and inflation is finally here,” it said.
“As the labor market tightens further, we are likely to see more wage hikes. As a result, we should finally start to see households spend more as their concerns regarding future income ease. This in turn should result in inflation picking up, kicking off a virtuous cycle.”
Nikko AM said inflation would “pick up gradually in the second half of 2017,” helping spur higher expectations of inflation, as sought by BOJ Governor Haruhiko Kuroda.
Adding to the positive trends, the Nikkei Stock Average of Tokyo stocks has finally scaled the 20,000 line. As of June 5, the benchmark index was showing a one-year return of 23.5 percent, having risen by 5.5 percent in 2017.
Adding to the positive momentum has been a tourism boom, with a record 24 million overseas visitors arriving in 2016, well ahead of the government’s target of 20 million by 2020, the year of the Tokyo Olympics. The Abe administration is now targeting 40 million inbound tourists by 2020 and 60 million by 2030.
Structural Headwinds
Yet while the short-term indicators are improving, structural headwinds continue to crimp the nation’s potential growth rate, including a declining population.
In 2016, the number of births dropped below 1 million for the first time since records began in 1899, with the total fertility rate slipping to 1.44. While the number of newborns totaled 976,979 in 2016, the number of deaths reached a postwar high of 1,307,765, with deaths outpacing births for the 10th straight year.
Since peaking at 128 million, Japan’s population has shrunk by nearly a million in the five years through to 2015, and could fall to as few as 80 million by 2060, demographers warn. A declining labor force will place an increased burden on workers and government to fund an already strained pension and healthcare system, adding to a growing government debt burden, with net government debt currently at around 126 percent of GDP.
While publicly opposed to mass immigration, Japan has quietly opened the door to foreign workers, which in 2016 surpassed a record 1 million. Yet while Tokyo has encouraged more women and elderly workers, the nation still faces its worst labor crunch since 1991, at the end of the bubble economy.
“The labor shortage is getting serious,” Abe told business leaders. “To overcome it, we need to improve productivity.”
One solution to the labor shortage is the deployment of robots and artificial intelligence, which the government expects to save 5.7 million jobs through to 2031, along with the growth in female employment and an extended retirement age.
Yet as nations across the developed world have found in recent years, raising productivity is far more difficult than relying upon an ever-growing population.
In a 2016 report, the International Monetary Fund urged a range of measures for Japan, including reducing “labor market duality” and using “comply or explain” policies with profitable companies to force wage hikes; closing the pay gap between regular and non-regular workers; increasing the supply of childcare facilities; and enhanced corporate governance reforms, among other measures.
Deregulation, including through the full implementation and expansion of the Trans-Pacific Partnership trade deal, are also seen contributing to potential productivity gains, the IMF said.
The Abe administration points to its structural reforms in agriculture, energy and healthcare, along with initiatives to encourage start-ups and cut corporate taxes. Although childcare remains an issue, the number of women workers has increased by about 1.5 million from 2012 to 2016.
Yet inflation remains stubbornly below the Bank of Japan’s 2 percent target, with other economists calling for reforms to social insurance to help “ease future concerns.”
“The hard work that still needs to be done is to assure people in their 20s and 30s that indeed, their pensions and healthcare system is actually sound and safe,” WisdomTree’s Koll said. He said workers’ compensation had risen by around 12 trillion yen since 2012, but consumption had only increased by 4 trillion yen, suggesting that workers are saving rather than spending in fear of their future financial needs.
However, time is still on Abe’s side. The center-right leader is set to remain in power at least until late 2018, and potentially even after the Tokyo Olympics, as the economy nears the government’s nominal GDP target of 600 trillion yen and a final escape from the post-bubble deflation.
“There’s been far more success for the overall Abenomics agenda than generally recognized,” Morgan Stanley’s Garner told Bloomberg News.
Amid a skeptical populace, 2017 could well mark a turning point for Abenomics, even if the plaudits are hard to find.