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Abe’s ‘third arrow’ of structural reform being deflected by vested interests

by Ayako Mie

Staff Writer

So far, so good. This is exactly how the global community and the Japanese public felt about Prime Minister Shinzo Abe’s deflation-busting economic program dubbed “Abenomics” — until a few months ago.

Two of the three “arrows” in his quiver — the fiscal spending and radical quantitative easing — have hit the mark by pumping up stock prices and weakening the yen against the dollar, handing a lifeline to the export-oriented economy as he tries to stoke 2 percent inflation. The improving economic outlook greatly raised expectations for Abe’s third arrow — growth-oriented structural reforms.

Since taking office, Abe has been busy touting reform to spur private investment. The growth-focused bills he is trying to pass in the extraordinary Diet session, however, are less substantial than the global community was expecting because Abe is taking on special interest groups that are opposed to deregulation.

“The third arrow is still in the quiver, if there is any,” said Mana Nakazora, chief credit analyst at BNP Paribas in Tokyo. “The government has introduced what they can manage, but it was not ambitious enough to bring about some ground-breaking reforms that could completely change the landscape in Japan.”

Under a bill for strengthening industrial competitiveness, for example, the government will compile a three-year plan to bring capital investment back to ¥70 trillion, the level it was at before the 2008 financial crisis, and help restructure certain industries. Pushing this goal gives the government more initiative to expedite restructuring and mergers and acquisitions in certain industries.

The government hopes the bill will spur innovation and streamline the market. But some experts warn they could give the government more control over which areas to let thrive and which to streamline, stifling competition.

“The government should not interfere too much,” said Nakazora. “It is natural that underperforming companies are eliminated. But (in reality,) the government has helped to keep deficit-bearing companies in place.”

While the government is promoting the bill as a breakthrough, the actual incentives for innovation and investment remain relatively small, experts said.

Aiming to spur investment, the government is introducing a system that will help companies foresee to what extent their new business will conflict with regulations before the projects begin.

For example, a health care company could be accused of violating the private information protection law by analyzing a potential customer’s medical expenses. Under the new bill, the government will tell companies what information they can use without infringing on the law, facilitating the creation of new health care businesses.

The bill also aims to offer more tax breaks for capital spending or for streamlining underperforming businesses.

Under the current system, spinning off heavily indebted businesses increases taxable income, which the government thinks prevents the ditching of loss-making segments. The new system will instead allow companies to log as much as 70 percent of the costs of the spinoff process as losses, allowing them to shave tax payments.

Other tax reduction incentives include an exemption of 5 percent on capital investments, as long as the investment is expected to increase production by 1 percent per year.

Yet tax breaks are unlikely to encourage companies to spend the estimated ¥220 trillion in cash they have stashed away. Some 70 percent of Japan’s companies do not pay taxes because they do not generate any profit.

Critics also say that domestic companies are unlikely to invest domestically because they are opting to shift overseas, where demand is stronger and wages are often considerably lower.

“The reason why capital investment has not seen much advance is that emerging countries are being industrialized while domestic profits have been declining,” said Yukio Noguchi, economist and professor emeritus at Hitotsubashi University. “Corporate tax breaks will not counter this trend.”

The biggest reason why Abe’s government has not been able to effect bold reforms is because of strong opposition from vested interests, especially in the agriculture, health care and labor sectors.

In its most recent example of backpedaling, Abe’s government failed to completely deregulate online sales of over-the-counter medicines because it was staunchly opposed by the pharmacists lobby.

Despite the Supreme Court’s decision in January that a Health, Labor and Welfare Ministry ordinance banning online sales was illegal, 28 products accounting for 0.2 percent of all OTC drugs — including the lucrative hair loss remedy RiUP — cannot be sold online because of consumer safety concerns.

“The regulation exists to protect the benefits of specific industries,” said billionaire Hiroshi Mikitani, CEO of Rakuten. The online shopping mall owns Kenko.com, a company that sued the ministry over the ordinance.

Abe handpicked the outspoken Mikitani to be part of his government’s Industrial Competitiveness Council to fight the interest group. But Mikitani is likely to resign and has threatened to sue the government for not bringing about comprehensive deregulation.

Abe was also forced to compromise on his special economic zones bill, another key piece of his structural reform plan, after encountering fierce resistance from the farming sector and labor unions.

“Although there are several sectors, including heavily protected ones, where we made progress, there are many obstacles to (deregulation),” said Heizo Takenaka, a former economic and fiscal policy minister who serves on the council, in a statement it released last month.

The Keio University professor, trained at Harvard, was also state minister in charge of postal privatization under former Prime Minister Junichiro Koizumi, who shifted Japan’s growth strategy from traditional fiscal spending on wasteful public works to deregulation, notably privatization of the gigantic postal system.

Another setback for Abe was not being able to push for companies to own farmland, which needs to happen to enhance the competitiveness of Japanese agriculture. One of the world’s most protected farming industries is being tested by Japan’s attempt to join the free trade pact known as the Trans-Pacific Partnership.

Law prohibits companies from owning farmland to prevent them from using the land for purposes other than farming. Yet, companies will not be able to aggressively invest in farming over the long term if they have to return it whenever the landlords ask.

Meanwhile, what disappointed foreign investors the most was the watered-down changes he is seeking for the labor sector.

Abe found, for example, that he could not push for an exemption on overtime limits for white-collar workers or ease the rules for firing them because they were severely opposed by the labor ministry and labor unions.

Domestic labor laws effectively guarantee life-time employment by making it difficult to fire full-time workers without a legitimate reason or without giving them more than 30 days’ notice.

While reasonable on one level, these rules have become a costly burden for some Japanese companies and a hindrance to foreign firms hoping to enter the Japanese market. These rules also have led to companies hiring more vulnerable contract or non-regular workers, who don’t receive the usual benefits, especially after Koizumi enabled certain industries to easily hire more of them.

Yet some experts say hastily deregulating the labor market might undermine Abenomics in the long run, since its success requires that Abe remain popular in the long run as well.

“When wages are flat, I think this proposal will be very difficult to move if it involves plans where people can potentially lose jobs,” said Scott Seaman, senior Asia analyst at Washington, D.C.-based Eurasia Group. “A lot of full time workers are not productive and receive benefits not in line with their value. But if you move too quickly on that, people will say Abenomics is only benefiting the companies, but not normal Japanese.”

Seaman also warned that Japan will not be able to attract foreign investment unless it offers comprehensive deregulation nationwide, rather than limiting it to special economic zones. Abe says the special zones will attract more foreign investment, something he wants in the runoff to the 2020 Olympics.

Economists agree that what is really needed are more drastic reforms to enhance labor diversity by bringing in more foreigners of all levels to sustain production in a country where the population is projected to plummet to about 90 million by 2050, from 127 million at present.

“In order for Japan to have economic growth, we have to increase productivity,” said Nakazora of BNP Paribas. “We need to change the structure in production by bringing in more foreign workers, even though Japan is averse to opening its doors to non-Japanese (for jobs).”

Japan is opting instead to lure highly skilled workers, via the special economic zones, as well as qualified non-Japanese interested in alleviating its shortage of doctors and nurses.

Yet a plan to bring in and train nurses and caregivers from the Philippines and Indonesia through an economic partnership agreement has proved mostly unsuccessful, given that it requires high proficiency in Japanese.

And the plan to attract highly skilled people is being under-utilized as it attaches somewhat ambitious requirements, such as a minimum annual compensation level of ¥10 million.

While many see Abe’s growth strategies as too little, too late, he appears to be making headway in some areas.

For example, the government has been voicing preparations to terminate output and price controls for rice production by curtailing all paddy-reduction subsidies by 2018 — a crucial step toward opening the nation’s heavily protected farm sector.

But challenges remain because any structural reforms will take more than five or six years to achieve. Unless Japan can keep a strong and stable leadership team in place after Abe, vested interests will have time to fight back.

“The Japan Post reform under Koizumi was put on a long-term track to gradually privatize over time. But as soon as Koizumi left it got rolled back,” said Seaman. “The danger is what happens after Abe leaves, because the vested interests have enough time to derail all those reforms.”