Today we’ll be looking at the economic policies that Abe Shinzo has stated he will follow since becoming Prime Minister of Japan on December 16th. I’m going to talk about 3 things:
1. A brief introduction to Abe Shinzo
2. His proposed economic policy
3. The possible economic and political consequences of such a policy
Abe Shinzo: the basics
•Abe Shinzo became Prime Minister on December 16th. His Liberal Democratic Party (LDP) won a majority of seats in the lower house, and with its coalition partner the New Komeito (the political arm of Buddhist organisation Soga Gakkai), won more than two thirds of all seats in parliament – this allows it to overrule the upper house to force through bills should it want to.
•However, this does not mean Abe has a mandate to govern. His party won 3 million fewer party votes (the electoral system is such that citizens vote for either a party or a certain candidate) than it did in 2009, when it was thrashed by the now-in-opposition Democratic Party of Japan (DPJ). However voter turnout was so low that this was enough for a convincing victory. This represents a rejection of the DPJ, not a mandate for the LDP
•In addition, Abe’s credibility is damaged because he made such a poor stab of this job last time. Between September 2006 and September 2007, he served as Prime Minister; a year that was marked by gaffes, scandal, and a series of ministerial resignations. He resigned in some disgrace and the public do not generally remember him fondly. Thus, the bounce that a new government’s popularity generally enjoys is likely to be quite small this time round.
What does Abe plan to do about the economy now he’s in power?
To combat the deflating economy, he will;
•Raise the inflation target to 3%, even though the current 1% looks out of Japan’s reach. To do this, he will ask the BOJ to underwrite construction bonds (bonds whose expenditure does not have to be written off during the same fiscal year, not necessarily on construction).
•Drive interest rates below zero (inflation and interest rates are inversely proportional – as interest rates drop, people borrow more, then spend more, creating inflation)
•This easy money would weaken the yen, making Japanese exports competitive again, give a bounce to the stock market and return Japan to levels of inflation commensurate with other major developed markets.
This all sounds great. Are there any economic problems with this strategy?
Unfortunately the old maxim is true – a little knowledge is a dangerous thing, especially where Shinzo Abe and economics are concerned. The economic problems of the strategy are manifold;
•The current BOJ head is strongly opposed to the idea. Masaaki Shirakawa called the idea foolish – however the election for the post of BOJ governor is up for re-election in March, and Abe no doubt hopes to get someone more amenable to his plan in the job – Kazumasa Iwata possibly, with fellow supporter Yasuhisa Shiozaki for the Ministry of Finance portfolio? However, even with his two thirds majority in the Lower House of the Japanese parliament, Abe cannot force through the appointment of his favoured candidate – the upper house will still need to approve whoever he puts forward.
•Under current law the plan is illegal. The BOJ cannot currently directly underwrite bonds issued by government; they can only purchase them on the secondary market. No major developed economy allows its central bank to do so. Abe has gone as far as suggesting restricting the independence of the BOJ, which it won in 1998, to push through such a change
•Japan has the largest public debt in the industrialised world at more than twice GDP. As inflation increases so must bond yields, but Japan depends on its sub 1% yields to carry out the normal economic functions of government. Increasing inflation to 3% would push JGB yields unacceptably high, and borrowing would become much more difficult for the government. It should be noted that even at the height of the bubble in the late 1980’s, Japan’s inflation never rose above 3%.
•As Governor Shirakawa has pointed out more forcefully than he points out most things, negative interest rates would be disastrous for the smooth functioning of the money market and render the BOJ impotent in providing liquidity. In an unusually forthright retort to the Abe plan, he said ‘There is no case of a central bank in an advanced country undertaking a negative rate policy.’
•While the yen would weaken under these circumstances helping exporters, Abe should remember that a strong yen is not all bad – it certainly helps Japan pay for all the oil and LNG (liquefied natural gas) it needs to import just to keep the lights on.
•Abe does not understand the genie he is letting out of the bottle. Such excessive monetary easing would lead to speculation in currency and money markets which he would be powerless to control.
•Deflation is a symptom, not a cause of a poor economy. Japan needs much wider fiscal reform to increase demand from all sides – less insularity and more flexible labour markets might be a good place to start.
Oh dear…what about political issues?
Slightly less of them, but by no means are they insignificant
•Abe’s policy recalls the ‘bad old days’ of the LDP, when pork barrel spending from central government kept rural MPs in power, but left Japan with costly white elephants like the Yanba Dam, Joetsu Shinkansen and Ibaraki Airport (which currently has a grand total of two scheduled daily flights – for comparison, Heathrow has over 1300)
•These policies provide easy pickings for political opponents, and when he is elected you can be sure the DPJ will not stay silent – they will oppose him at every turn, making it very hard to continue the work of government.
•The US is also unlikely to approve, mostly because it will make it much harder to be firm with China about currency manipulation when its closest security partner in Asia is doing much the same thing.
•Abe has also stated on record that he will take a firmer line with China and will resume visits to the controversial Yasukuni Shrine, which enshrines Japan’s war dead – this is likely to ratchet up tensions with China that have caused Japanese exports to China to fall and trade flows between the two nations to shrink.
In conclusion, Abe’s plans for the central bank are undemocratic, imprudent and likely to lead Japan back over the recessionary cliff rather than pull it away. As the saying goes, to a man with a hammer every problem looks like a nail. Abe’s hammer is monetary easing, and he seems to think that it can cure all problems. For Japan’s sake, I hope he picks up an Economics 101 textbook soon and realises that hijacking his central bank is not a good idea. While it seems likely that his proposals will be watered down by the strength of opinion against them, the LDP manifesto for this election is still likely to pledge an inflation target of at least 2%.