Prime Minister Shinzo Abe has vastly outspent his predecessors in order to revive the Japanese economy. But is more of the same really the solution for Japan’s economy? Will Abe’s economic policies – Abenomics – lead Japan into a new golden age, or leave the economy stranded by the roadside?
With the Eurozone edging closer to deflation (falling consumer prices), attention is turning towards Japan. The country has long endured deflation and made various attempts to find a cure. In its boldest attempt yet, the government is now using massive spending to spark momentum in the economy. For economists, this is an economic experiment of gigantic budget. For the Japanese people, this is their economy’s make-or-break moment, which might define their lives for decades to come.
Once the economic awe of the world, the past two decades have been rough on Japan. Growth has been slow, and real wage increases have been modest. Ending deflation has by many been seen as a key step in breaking this gloomy circle. However, during this time, deflation has gotten the best of Japanese politicians. Their primary weapons – governmental spending and monetary easing – has, at best, managed to keep deflation at bay. Furthermore, this has been achieved at a high cost, since the governmental debt has soared dangerously.
Nonetheless, when Shinzo Abe ran for prime minister in 2012, his platform was clear. Deflation ends now. He vowed to undertake the measures necessary for ridding his country of its economic plague, however drastic they might be. His primary weapons were still governmental spending and monetary easing, but more of it. In a way, this development was spectacular: the highest spending government in the developed world was going to step up its spending pace even further. The idea was to kick start the economy into substantial, self-generating growth, not unlike the thoughts of the New Deal in the 1930s. But could saving the world’s third largest economy really be that simple?
Naturally, this course of action was not without its critics. Previous attempts at stimulating the economy through governmental spending had in 2009 left Japan with an enormous public debt of 183% of GDP, the highest of any developed country in the world. To put this into perspective, Greece needed international bailouts to avoid national bankruptcy already when public debt reached 147% in 2010. Could the Japanese government really afford such spending? Furthermore, if Japan had already tried this solution unsuccessfully in the past, could more of the same really be the solution?
Despite the criticism, Abe got Japan’s central bank to play along. Through an ambitious bond-buying scheme, the Bank of Japan increased their purchases of governmental bonds rapidly, thereby financing the governmental spending through the printing press. While the Federal Reserve received worldwide attention for their quantitative easing in the US, Bank of Japan was outspending them vastly in relative terms.
At first, the Japanese economy behaved nicely. The GDP grew and so did the inflation. However, after two years, consumer prices once again started falling. Was Abe’s remedy outdated and unable to rid Japan of deflation, or was the problem simply that spending still was not high enough? Abe remained convinced of the latter.
What happened next showed how serious his first commitment to revive the economy at all costs had been. In 2014, Abe dissolved the Japanese parliament and called a snap election. Doing so, he hoped to obtain a strong mandate to push through with his reforms, most importantly the ambitious economic package. The move was bold, but paid off. The new election was a personal success for Abe, as his party capitalized on a struggling opposition and retained almost all parliamentary seats, despite lower public approval ratings for the government.
With a renewed mandate for Abenomics, Shinzo Abe continued to push through with its “three arrows”; fiscal stimulation, monetary easing and structural reform. Shortly after the election, he announced a new 29 billion US dollar stimulus package and Bank of Japan shocked market expectations by a huge increase in its bond-buying. Furthermore, a scheduled rise of the sales tax – crucial in raising government revenue, but damaging to economic stimulation – was postponed until 2017.
This is where we are today. Shinzo Abe remains both in power and committed to fighting deflation. Abenomics is being pushed through at full force. However, there are signs that it is still not working. The economic growth remains modest at best, real wages keep falling and the pace of inflation is dangerously close to zero.
In the end, the battle is not just against deflation, but also against time. With a soaring debt (227% of GDP in 2014), the government can only afford to stimulate the economy for so long. Eventually, the government will have to limit its commitments in order to curb its debt. If the Japanese economy has not reached a sufficient, self-generating growth before that, the risk of a devastating recession is high.
The Japanese economy appears to have reached its make-or-break point. Two questions need an answer: do Abe’s economic policies work and, if so, can they reach their goal before it’s too late? The coming years will bring the answers. Should Abenomics fail, not only will the government have lost time, but debt levels will have increased so much that future governments may be forced into crippling austerity.
Can more of the same really be sufficient to steer a modern economy towards success? Japan and the rest of the world eagerly awaits the answer, as this high stake experiment unfolds.