Satyajit Das: Shinzo Abe’s ‘three arrows’ will fall short of the target once again

Activity is easily mistaken for achievement. The frantic exertions of the government of Shinzo Abe, who took office as prime minister for the second time in December last year, has prompted optimism, notably among foreign observers, that Japan can achieve a reversal of its economic drift. Recent growth figures are cited as “proof” of the success of policies which have just been announced but which were not in place during the relevant period.

Under Mr Abe, Japan has initiated an ambitious “three arrows” economic recovery plan, christened “Abe-nomics”.

The first arrow is a ¥10.3trn (£67bn) fiscal stimulus programme to increase public spending. The second is a further easing of monetary policy to boost demand, investment and inflation to 2 per cent. The third is structural reforms, to raise incomes and improve Japan’s industrial competitiveness and productivity. Japan’s total factor productivity in the manufacturing, non-manufacturing and agricultural sectors is the same as in 1991.

The programme is designed to increase growth, income, spending and inflation, as well as reduce the value of the yen to boost Japan’s exports. The hope is that it creates a self-sustaining cycle of rising prices, rising wages and increasing economic activity.

The policies have all been tried before, with limited success.

The government’s spending programme follows 15 stimulus packages between 1990 and 2008. Based on previous experience, it may provide a short-lived boost to economic activity but it will not create a sustainable recovery in demand.

Investment will be mainly in non-tradable, non-competitive sectors such as public infrastructure and construction, which frequently adds to over-capacity and earns poor returns.

Japan has maintained a zero interest rate policy for more than 15 years and implemented several rounds of quantitative easing. The new plan will assist the Japanese government to finance its spending. It may also help devalue the yen and pump up asset prices. But given that short-term rates were near zero and 10-year rates around 0.50 per cent before the announcement of the plan, the effect of monetary initiatives on economic activity is likely to be less significant.

Structural reform requires deregulation of inefficient sectors of the economy, opening them up to domestic and foreign competition. Reform is needed of taxation, trade policy, labour markets, environmental laws, energy policy, healthcare and services, as well as population and immigration. But many “reforms” are vague statements of objectives. Many of the ideas are old and have been tried before, unsuccessfully. The required changes are also politically and culturally difficult.

Reform of agriculture would require reducing or eliminating agricultural subsidies and tariffs as well as anti-import restrictions on rice and dairy products. It would require changes in land laws that limit the size of farm plots. But attempts at serious reform put the government in conflict with its own supporters and financiers, such as the farm lobby.

The chances of Mr Abe’s programme succeeding are limited. The failure of the charismatic and popular former PM Junichiro Koizumi’s ambitious policies in the early 2000s shows the difficulty of implementing even modest reform in Japan. To paraphrase baseball coach Yogi Berra, the current government’s programmes may be a case of déjà vu, once again.

Commentators, especially foreigners, have praised the initiatives. The Japanese stock market has risen around 70 per cent since late 2012, with foreign buying a significant factor. The yen fell against the US dollar from around ¥80 to ¥100, a decline of around 25 per cent. Japan government bond (JGB) interest rates fell initially, anticipating Bank of Japan buying.

But in May 2013, its financial market began to experience increased volatility. The stock market fell by more than 15 per cent, with daily price moves of 3 to 7 per cent. JGB interest rates increased sharply, from around 0.50 per cent to 0.90 per cent. The yen remained weak. Financial market volatility was sharply higher.

The reversals reflect closer scrutiny of the programme’s inherent contradictions.

The Bloomberg columnist William Pesek summed up the increasing doubt: “This faith that Japan is just one huge spending package away from bliss is becoming more detrimental with each passing year and credit downgrade. Abe-nomics really is more religion than reality.”

Satyajit Das is a former banker and the author of “Extreme Money” and “Traders, Guns & Money”.