The Pandemic Depression
The Global Economy Will Never Be the Same
Japanese Prime Minister Shinzo Abe faces a major economic challenge. Pay increases have disappointed; consumer sentiment remains poor; equity markets have continued to tumble; and the yen has risen to the highest level against the dollar in nearly 18 months, putting a dent in corporate profits. Forecasters have predicted that GDP data from the first quarter of 2016, which will be released on May 18, will show that Japan's economy has barely avoided a second consecutive quarter of contraction. All these signs suggest that Abenomics, the prime minister’s policy program for sustainable growth, is close to failure.
In a bid to rescue Abenomics, Abe appears to be considering a U-turn in which Tokyo would abandon fiscal consolidation in favor of fiscal stimulus aimed at spurring near-term growth. In practice, that might entail offering a stimulus package as large as 10 trillion yen (around $94 billion) and holding off from introducing the two percent consumption tax increase that many observers believe is essential to putting Japan’s finances on a sustainable path—and which Abe has already put off once.
Voters won’t be too angry if Abe goes back on his word as long as doing so advances policies they favor.
Such a policy would effectively require the Abe government to abandon its long-standing commitment to balancing the Japanese budget by 2020. But Abe has few other options. It is clear that monetary policy alone cannot trigger the growth Japan needs: Bank of Japan Governor Haruhiko Kuroda has maintained the bank’s annual 80 trillion yen ($750 billion) of government bond purchases this year and even introduced a negative interest rate in January 2016, but growth has been anemic, and thanks to falling energy prices, inflation has dissipated. The bank’s choice at its April 27–28 meeting to leave monetary policy unchanged suggests that it is running out of room to maneuver. Nor does currency devaluation seem to be on the table. The Abe administration has resisted the temptation to intervene in foreign exchange markets so far, in large part because doing so might trigger a currency war and would complicate Japan’s relations with the United States, which fears that intervention could damage the already grim prospects for the ratification of the Trans-Pacific Partnership by the U.S. Congress. (U.S. officials, including Treasury Secretary Jack Lew, have warned the Japanese government against such intervention.)
That leaves fiscal policy and structural reform as Abe’s last resorts. The idea is that more fiscal stimulus could offset the impact of a stronger yen in the near term and buy the administration more time to introduce reforms to raise Japan’s potential growth rate. But a fiscal U-turn will take deft political maneuvering on Abe’s part—and he will still face opposition from entrenched interests that have slowed down the pace of reform thus far.
The problem is that when Abe announced in November 2014 that he was postponing the consumption tax hike that had been scheduled for October 2015, he also promised that he would not delay it again, no matter the circumstances. In fact, he even agreed to drop the condition that he could make a choice about the tax hike based on prevailing economic conditions. “The April 2017 increase,” he said at the time, “will be carried out without fail, without any provisos for decisions based on the economic climate.” Building on that promise, in a medium-term fiscal plan approved in June 2015, the Abe government renewed its commitment to halve its primary fiscal deficit relative to 2010 by 2015 and to eliminate the fiscal deficit entirely by 2020. Since the start of 2016, Abe has repeatedly told lawmakers that it would take a natural disaster or a “Lehman-type” global shock to lead him to reverse course, implicitly reiterating that commitment.
The fiscal plan that the Japanese government produced in 2015, however, did not make clear how the government would achieve deficit cuts, since it did not mandate major reductions in social security spending or put a hard limit on spending increases. Instead, Japanese policymakers believed, monetary easing, a weak yen, structural reforms, and changes to industrial policy would drive growth. That approach has not succeeded: as Abe’s predecessors also discovered, attempting to strike a balance between economic growth and fiscal consolidation can result in neither goal being achieved. And so it appears that Abe will have to go back on his word.
With the International Monetary Fund and prominent economists arguing that fiscal stimulus is necessary to combat slow global growth (a case the Nobel laureates Paul Krugman and Joseph Stiglitz made directly to Abe in March), the prime minister should at least be able to argue that a major shift in economic policy rests on sound principles (he will likely make a similar case for fiscal stimulus when Japan hosts a G-7 meeting later this month). What is more, the April earthquakes in southwestern Kumamoto prefecture, which killed as many as 48 people and forced tens of thousands to evacuate, may have strengthened the case for fiscal stimulus. The disaster has already forced the government to scrap much of its legislative agenda for the current parliamentary session and prioritize a recovery budget that could include as much as one trillion yen (around $9.4 billion) in spending on temporary housing, infrastructure repair, and relief for the victims.
Fiscal policy and structural reform are Abe’s last resorts.
Fiscal hawks in Abe’s Liberal Democratic Party and in its coalition partner Komeito, who have long pushed consumption tax increases as the key to fiscal reconstruction, have had little to say in response to the argument that Abe should put off the tax hike again. Some lawmakers have argued that delaying the tax increase would weaken public confidence in the social security system, which consumption tax revenues are intended to support; others have claimed that a fiscal U-turn could scare off investors or that economic conditions are not so bad as to warrant a delay or a large stimulus package. But those arguments are thin: because government bond yields are negative out to ten years and nearly 40 percent of all outstanding government debt is held by the Bank of Japan, it is now harder to argue that Japan could follow Greece into a sovereign debt crisis than it was when the consumption tax plan was originally approved in 2012. Nevertheless, to keep the peace within the ruling coalition, Abe has to take these counterpoints seriously, making a convincing case to lawmakers for delaying the consumption tax as the only sensible choice, even if it requires abandoning earlier promises. To do otherwise would leave him vulnerable to charges that his leadership is recklessly spendthrift.
The global economy's uncertain outlook, the soaring yen, and the devastation in Kumamoto will surely help Abe overcome these objections. Polls showing that the public overwhelmingly favors delaying the tax hike will help, too (on May 1, a poll published by the Nihon Keizai Shimbun, a financial daily,suggested that 66 percent of Japanese oppose raising the consumption tax). It is therefore likely that Abe will be able to win support for delaying the tax hike and introducing a new round of fiscal stimulus. But if his government is unable to use fiscal stimulus effectively—pursuing, as the economist Richard Katz has argued, the “right kind” of fiscal stimulus that “[increases] spending on the kind of public works that actually help the economy long-term while providing short-term stimulus”—and take the opportunity provided by the stimulus to promote structural reforms, particularly to labor market practices that have inhibited opportunities for advancement for many Japanese, Abe will only increase the debt that he and his successors will have to manage. It is far from certain that fiscal stimulus will succeed: even if the administration funds worthy projects, labor shortages could still limit the impact of a new round of fiscal stimulus.
Some observers are already penning the obituaries for Abe’s economic program. But it is too soon to declare his experiments failures. As long as the Japanese public continues to believe that Abe is the only leader capable of tackling Japan’s economic challenges, he will still be able to govern; as of May 1, his approval rating was around 53 percent, according to the Nihon Keizai Shimbun. Voters won’t be too angry if Abe goes back on his word as long as doing so advances policies they favor. The prime minister is therefore likely to survive this summer’s upper house elections unscathed. But if a rebooted Abenomics still fails to revive Japan’s economy, public support for Abe, which has been relatively steady for three years, may begin to wane.