Why Abe’s third arrow flopped

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The ruling Liberal Democratic Party scored a resounding victory in the Lower House election last December by successfully pursuing its strategy of taking the Democratic Party of Japan, the top opposition party, to task for failing to implement effective economic policies while in power for three years and three months from September 2009 to December 2012.

It may not be fair to blame the DPJ for causing protracted deflation because the Japanese economy plunged into downward price spirals in the late 1990s — about 10 years before the party assumed the reins of government. Still it is an undeniable fact that the DPJ manifesto was devoid of a policy to end the deflationary trend.

If the DPJ is a party of liberalism as it says, it should have pursued such programs as elevating irregular workers to the status of full-time employees, taking positive measures to improve the social security system, and making all phases of education free of charge. In order to finance those schemes, the party should have made income tax rates more progressive, raised the rates of taxes imposed on inheritance and assets, and taken other aggressive steps to help the economically weak and to redress the disparity between the rich and the poor.

Through these measures, the DPJ should have pursued truly liberal policies of redistributing wealth from the rich to poorer people who possess a high propensity to consume, which in turn would shore up household spending and thus would ultimately enable the Japanese economy to grow. Indeed, French economist Thomas Piketty, famous for his book “Capital in the Twenty First Century,” has stated that one of the necessary conditions for rectifying disparities is a high economic growth rate.

A deflationary economy means a situation in which prices continue to fall. Initially, the causes of deflation in Japan were identified with growing imports of low-priced goods from China and other East Asian countries and with the so-called reverse imports of goods manufactured by Japanese companies that had shifted their production facilities abroad.

Today, however, it would be more appropriate to attribute the deflation to a stagnant demand in the domestic market and to stagnation in technological innovation.

One of the principal factors that led the Japanese economy to deflation was the saturation of the markets for automobiles and virtually all other durable consumer goods, which happened to come simultaneously with the bursting of Japan’s economic bubble in 1991. Products that have penetrated into the domestic market during the past quarter of a century have been limited to digital items like cell phones, digital cameras, laptop computers and tablets.

Automobiles have a powerful economic ripple effect on a wide range of related industries, with their growing sales enriching such sectors as materials, oil, construction, non-life insurance, retail and tourism. But the same is not true of digital products because their ripple effect is extremely limited.

In addition, during the past five years, Japanese manufacturers of fast selling smartphones and tablets as well as of photovoltaic panels and other environment-related goods have lost much of their global competitiveness in relative terms and, as a result, demand has shifted to items being imported from the United States, South Korea, Taiwan and China.

The weakening competitiveness of Japanese-made digital products is testified to by the fact that the volumes of their exports have not been growing despite the weakening of the yen currency by a large margin, which was brought about by “Abenomics,” the economic policies promoted by Prime Minister Shinzo Abe.

Moreover, the expanded use of smartphones and tablets have slowed down spending by consumers on books, magazines, newspapers, cameras, postal services, fax machines, radios and TVs.

And as Internet shopping becomes popular, fewer and fewer customers visit large outlets for books and home electric appliances and retail stores of goods other than fresh foods, forcing these businesses to reduce the salaries of their employees.

A broader use of information and communication technology (ICT) by companies leads to big cuts in the number of their employees. ICT equipment not only replaces blue-collar workers but is also free from errors originating from fatigue. It performs its duties speedily and accurately, and has flawless supervisory capabilities. In the long run, ICT instruments will cost the company less than hiring workers as they perform much more efficiently than unskilled laborers.

There is nothing that will stop the current trend of ICT equipment and robots replacing manual workers and the need for unskilled workers will become much smaller, making it inevitable for the rate of unemployment to go up despite the dwindling number of people in the productive age bracket. The anticipated lowering of the cost of ICT machines, moreover, would apply a downward pressure on wages.

The digital revolution, which started around the turn of the century, has defied expectations that it would boost the domestic demand. Instead, it has had a negative effect of depressing personal spending except on digital products.

As more and more ICT equipment begins to be used by companies, especially in the service sector, many employment opportunities will be lost for unskilled workers. In this sense, the digital revolution, which has gathered strength since the late 1990s, has undeniably become a hidden cause of Japan’s protracted deflation.

The deflationary economy cannot be blamed on either the DPJ or former Prime Minister Junichiro Koizumi, who pushed for structural reform while he headed the government from April 2001 to September 2006.

Rather it is the logical consequence of the saturation of the markets for conventional durable consumer goods and of innovation achieved in the ICT-related field. And therein appears to lie the reason why Abe’s strategy of achieving growth through private-sector investments, which constitutes the “third arrow” of Abenomics, has misfired so far.

A former professor of economics Takamitsu Sawa is president of Shiga University.

  • Richard Solomon

    It seems to me that Abe has not really tried to implement any so called ‘structural reforms.’. He has talked of doing this but so far has taken little, if any, actual concrete steps via tax reform, tax incentives for businesses to increase wages, or fiscal stimulus to encourage more demand. If the current deflation is due to the ITC-related issues which this article describes, what are the solutions? Or does the author suggest that it is a hopeless situation?

  • A.J. Sutter

    While I agree with Sawa-sensei’s main point that the DPJ shouldn’t be blamed for the economy, his commentary misses the mark in several respects:

    1. Piketty doesn’t say exactly that a high economic growth rate is necessary. He says that a high difference between the rate of growth ‘g’ and the rate of return on capital ‘r’ is necessary. He also points out that some actions to raise g will also raise r.

    2. Piketty also says that there are two ways to raise g: one component comes from increasing the labor pool, through increasing the population. This reduces inequality because estates are divided among a greater number of heirs. Another way is to increase productivity; he assumes that profits will be shared with workers. I agree with Sawa-sensei that we are seeing that this latter approach doesn’t work so well in Japan: productivity increases are reducing payrolls, not increasing paychecks. As for increasing the population, we must also find a way to provide (i) the parental generation with good jobs and the time and means for raising children, and then (ii) more good jobs for the children. No policies are really forthcoming toward those ends.

    3. One can imagine ways of increasing g that could exacerbate inequality. E.g., consumer spending isn’t the only factor: Japan could boost its GDP by becoming a vendor of robot-manufactured weapons, luxury goods, and useless transport systems (such as the maglev train between Tokyo and Nagoya, an already well-served trunk line that will be a giant showroom for overseas sales of maglev projects). That’s clearly not science fiction anymore. So high rates of growth aren’t sufficient for reducing inequality anyway.

    4. And what is a high rate of growth, anyway? Piketty says that actually 1% per annum is quite a lot. According the Conference Board Total Economy Database, Japan’s real average GDP was 0.9% for 1997-2006. It was 0.2 during 2007-2012, the financial crisis period when, e.g., the UK averaged 0.0. And in 2012 and 2013 it beat the EU, having growth > 1% (albeit partly due to bounce-back from the 2011 tsunami tragedy). From a global perspective, Japan’s problems (if low rates of GDP growth are truly problems) may be less atypical than are presented here.

    5. The Abe Administration’s “third arrow” isn’t even aimed so much at growth as at the stock market. The financial economy has very little to do with the real economy of Japan anymore. The marquee names in the economy do most of their manufacturing and their selling overseas. The weak yen helps to inflate their repatriated profits when stated in dollars and, until the other day, euro. Growth of the domestic Japanese economy wasn’t necessary for their record profits. The ECB’s recent QE announcement shows that this sort of fiscal management can’t achieve the results for the domestic Japanese economy that economists claim it can: no one central bank can completely manage its currency anymore. So arrow #1 may be broken, too.

    6. Sawa-sensei is probably correct that automation is now at the point where it’s making society more unequal, turning what had just been fears during the 1960s (when this possibility was widely discussed) a reality. But in addition to abandoning the vapid euphemism “structural reforms,” which conceals more than it explains, he should be more upfront about those reforms’ role in making things worse: one of the reasons automation has been displacing workers has been the labor law reforms wrought during the Koizumi years. Maybe Koizumi shouldn’t be let off the hook after all.