Author: Yuri Okina, Japan Research Institute

More than five years have passed since Prime Minister Shinzo Abe came to power at the end of 2012. Between then and now, Japan has seen steady economic growth and its unemployment Rate fall by nearly half. Yet inflation remains low at 0.7 per cent and the ratio of outstanding debt to GDP has increased to 18 per cent. The potential growth rate — an estimate of how fast the economy would grow if it ran at full capacity — has barely moved.

The Abe administration’s economic Policy had three initial pillars, known as the first ‘three arrows’ of Abenomics. The first was bold monetary policy, which saw the introduction of a two per cent inflation target and a program of quantitative and qualitative easing, or QQE. The second — flexible fiscal policy — meant large-scale increases in public spending. The third pillar — a growth strategy to stimulate private investment — equated to a range of measures including regulatory reform, corporate governance reform and the reduction of corporate taxes.

The first three arrows were skewed towards monetary policy. Haruhiko Kuroda announced the policy on his appointment as Governor of the Bank of Japan (BoJ) in April 2013, attempting to realise a two per cent inflation target in two years through radical QQE — including the annual purchase of Japanese government bonds totaling 50 trillion yen (US$452 billion) per year.

Initially, the new monetary policy produced lower interest rates as well as a weaker yen. These results promoted the purchase of Japanese stocks by overseas investors, boosting stock prices and improving the profitability of Japanese companies.

Still, monetary policy failed to boost inflation, and the BoJ had no choice but to pursue further easing. In 2016, the BoJ introduced a negative short-term interest rate and a yield curve control policy that pegged the long-term interest rate close to zero. Yet even after five years of aggressive monetary easing, the inflation rate remains below one per cent and a variety of negative side effects have been generated.

With the decline in loan interest rates among regional banks, more than half have recorded deficits. The pegging of long-term interest rates around zero led to a lack of market warnings as debt grew. Considering Japan’s worsening fiscal trend, an exit from QQE is an increasingly difficult prospect.

In 2015, Abe was re-elected as president of the ruling Liberal Democratic Party (LDP) and positioned the next three years as the second stage of Abenomics. Taking up the slogan, ‘a society in which all 100 million people can be active’, Abe announced the ‘new three arrows’ of Abenomics.

These new three arrows are: a strong economy that creates hope, support for child raising that fosters dreams and social security that gives citizens a sense of reassurance. In concrete terms, the policy package continues to prioritise growth but also seeks to halt the decline in Japan’s birthrate and create a society that promotes women’s involvement in the workforce. The aim is a society in which no woman needs to leave the workforce to provide nursing care to a member of her family.

The major elements set forth in the new three arrows’ growth strategy are essential initiatives for Japan — including reform of working styles, fostering human resources and supporting cutting-edge innovation in the digital arena.

The reform of corporate governance is a particularly praiseworthy initiative. A Corporate Governance Code has been formulated. Listed companies in Japan have begun to seriously consider an orientation that would see them enhancing their governance functions while introducing diverse perspectives — for example, through the appointment of external directors — in order to increase their return on equity.

Since the most important policy issue for Japan is higher productivity, rapid implementation of supply-side reforms is urgently needed. Abenomics has not, so far, produced an increase in productivity. A policy of promoting digital innovation has been set out, but greater reform speed is essential against the background of intensifying international competition. There was initial progress in easing regulation in fields such as agriculture and medicine, with holders of vested interests such as Japan’s Agricultural Cooperatives kept in check in part thanks to the LDP’s landslide victory. More recently, however, these initiatives appear to have stalled.

With Japan’s extremely high outstanding debt-to-GDP ratio, further fiscal restructuring is inevitable, even with the increase in consumption tax scheduled for 2019. Of particular importance will be controlling increases in social security expenditure in a super-aging society. Social security-related expenses accounted for 55 per cent of general expenditure in the 2018 budget, 33 trillion yen (US$298 billion) in total.

Increasing Japan’s healthy life expectancy and the efficiency of medical care provision through better coordination of medical data are priorities. In addition, it will be essential to control medical and nursing care-related public expenditure in diverse areas, while maintaining health insurance for all citizens. Eliminating the anxiety about their future that Japanese citizens are experiencing will benefit the growth of Japan’s economy and its society.

Yuri Okina is Chairperson of the Japan Research Institute.

This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Peak Japan’.