Commentary / Japan

An economic policy agenda for the Reiwa Era

by Jesper Koll

On May 1, the new Reiwa Era will start. Throughout modern history, the Imperial eras have always proved a better demarcation of developments in society, in the economy and in the nation at large than other measures of time.

The recurring and predictable rhythms of the calendar or fiscal years may define public budget cycles and private profit swings, but the true mega-trends and national mood are captured best in the Imperial eras: the Meiji modernization boom; the Taisho drift from liberalism to populism to militarism; the postwar Showa rush to rebuild, to catch-up and to surge all the way up to the climax of “Japan as number one”; and the now-passing Heisei Era starting off with the biggest economic bubble bust in history, forcing decades of deflation, deleveraging and delusion. Japanese history will always be written in reference to the Imperial era baselines.

But what about the future? In my view, the new era has the potential to redefine Japan and its role in the world in a very positive way. During the Heisei Era, Japan was for many decades “the sick man of the world.” Now at the start of Reiwa, Japan has got what it takes to become a true global leader. If, as I suspect, the following five fundamental policy challenges are addressed in the early years of Reiwa, Japan will impress by positive example and become the envy of global policy makers.

1) Freeze the consumption tax.

Five months after the start of Reiwa, the consumption tax rate will rise from 8 percent to 10 percent. The big problem with the consumption tax is not so much the short-term volatility it forces on domestic demand, but the more structural damage it causes by fueling consumers’ fears that there will be even greater tax hikes in the future. Already, some pundits claim that the consumption tax must rise to 20-25 percent to fix Japan’s problems. Utter nonsense of course, but I have yet to meet a Japanese who does not expect taxes to go up more and, as a result, save more and consume less. A bold decision by Prime Minister Shinzo Abe and his team would be to announce a moratorium on future tax hikes.

If the ruling Liberal Democratic Party commits to a freezing of the consumption tax at 10 percent, consumer savings behavior and spending patterns are bound to change fundamentally for the better. Fear of future tax hikes is a huge negative force pushing up precautionary savings balances and depressing domestic consumption. There is plenty of research confirming that a consumption tax level above a certain point becomes increasingly ineffective as an added revenue source, while forcing unnecessary cuts in people’s purchasing power. A freeze in the consumption tax at 10 percent would go a long way to boost consumer confidence.

2) Cut entitlements by introducing means testing.

To assure fiscal sustainability, focus on specific and targeted expenditure cutbacks instead of tax hikes. Japan’s immense system of entitlements for social security, pensions and public medical services is the single biggest drag on public finances. Combine entitlements with the rapid aging of the population and you get a runaway fiscal deficit, projected to rise by almost 2 percent of gross domestic product every four to five years.

The solution is entitlement cuts that are based on the financial health of the consumer. So out-of-pocket expenses for medical or care-giving public services should go up progressively: The higher one’s net financial assets, the more he or she should pay out of pocket. For example, if your net financial assets are more than ¥15 million, and you no longer have a mortgage, your out-of-pocket pay goes up to 90 percent or 100 percent (from the current maximum of 30 percent).

Of course, this is a tricky policy because where exactly should you draw the line? But in an aging society where a growing proportion of people no longer earn employment income and live on their pensions, taxation will have to focus more on assets and net worth. True political leadership is required to devise a new system that is fair and efficient. The good news is that the younger generation of politicians is not afraid to think out of the box and experiment with means-testing. Politically it should prove quite popular as such policy adds a strong focus on fairness and can serve to solve the gap between the rich and poor. Abe already pointed in this direction when he declared at the World Economic Forum meeting in Davos this year that he wants to be a “gap buster.”

3) Set the global best standard for data governance by defining data as common social capital.

On the global stage, Japan is in pole position to define and set the best practice global standard for data governance. Tensions over data and data governance are increasingly at the core of new friction between the superpowers: the United States, China and Europe. Simply put, in the U.S. data is owned by companies, in Europe by the individual, and in China by the state. The result of these fundamentally different governance ownership structures is a de-facto breakdown of using data across the globe for a common good.

For example, it is not possible to get a global data set on diabetes or cancer records — even though everyone agrees that the bigger and the more diverse the data set, the greater the chances of true improvements in diagnosis and cure. The lack of globally agreed data governance means that data is not the new oil of the global economy — the moment it crosses borders, data turns into sand.

Of course, the issues here are complex. Some data should be proprietary and for-profit only, but other data should be common social capital and freely accessible. Shouldn’t traffic flow data be a public good, not a private one owned by one company? Or health data if properly anonymized? And yes, data privacy standards are in urgent need of harmonization across the globe.

This is no easy task, but much of the current hype around the coming golden age depends on the free flow of data across countries and around the globe. No trust in data means no Fourth Industrial Revolution, no Society 5.0, no big AI, no machine learning and no singularity. Japan has both the credibility and the diplomatic and legal expertise to actually mediate and lead a much needed global data governance standard. The good news is that Ministry of Economy, Trade and Industry and the World Economic Forum recently joined forces and set up a new center in Tokyo tasked to lead the design of a much needed global data governance standard.

4) Free the Bank of Japan from its stock market assets.

The BOJ owns almost 6 percent of the Japanese equity market through its exchange-traded fund-buying program. While justifiable as an emergency measure to help overcome deflation, the central bank’s de-facto nationalization of equity capital has become counterproductive for many reasons. The biggest one is that nobody can conceive a smooth exit — if the BOJ starts selling, surely the market will crash. Who is there to buy the BOJ equity overhang? There is only one answer — Japanese savers in general, the older generation in particular (the over 65-year-olds own more than 70 percent of the net financial assets).

To get an elderly saver to swap from bank deposits to risky exchange-traded funds will require a real incentive carrot — an inheritance tax. If the BOJ and the Finance Ministry can cooperate and devise a scheme where any individual who buys ETFs directly from the BOJ will have these ETFs exempt from their inheritance tax, I am certain the central bank could clean up its balance sheet within a couple of weeks. The net result would be a reprivatization of Japanese equities, a healthier corporate ownership profile, as well as a better risk-return profile for household sector balance sheets. Most importantly, it would free the BOJ and Japan from the criticism of manipulating the stock market and imposing more and more state-owned governance on free market investors and savers.

5) Create a “startup nation Japan” ecosystem for entrepreneurs.

Last but not least, a focus on domestic growth. Nothing creates growth as powerful and sustainably as a strong entrepreneurial culture. More than 70 percent of net new job creation comes from young startup companies. Today, Japan has barely one entrepreneur for every three in Germany, and in both the U.S. and Israel there are twice as many entrepreneurs as there are in Japan (adjusted for population). This is why productivity and prosperity growth is higher there than in Japan. Through special economic zones, deregulation and social policies that allow failure and encourage trial-and-error, there is much that can be done to build a better and exemplary ecosystem for entrepreneurs here in Japan.

All said, the Reiwa Era is poised to become a great one for Japan. There will be cyclical ups and downs, of course. But if the ruling elite stays focused on leading by example, Japan is poised to redefine itself as a true global leader in the Reiwa Era. Tax stability, means-tested entitlement cuts, a data governance blueprint for the world, capital markets freed from government intervention, and a new national movement from salaryman to entrepreneur — Reiwa could well become Japan’s next golden age.

Based in Tokyo, Jesper Koll is WisdomTree’s senior adviser and ex-CEO (Japan). He is ranked as a top Japan strategist/economist. www.wisdomtree.com/blog.

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