Japan’s Last Best Hope

Courtesy of CSIS

Courtesy of CSIS

By Eric Ramoutar

During the Meiji period in Japan, the economy and social structures in Japan made the rapid, but necessary, shift from the feudal to the modern. Infrastructure was developed, schools were built, and industry sprang up across the country.  The Meiji officially concluded in 1912, and just more than 100 years later, it seems like Japan is once again in need of a revolution.

Plagued by decades of insufficient economic growth, Japan has cycled through leader after leader without finding a solution that has stuck. Shinzo Abe, the Japanese Prime Minister, is doing his best Emperor Meiji impersonation, attempting to find innovative solutions to break out of this frustrating rut. But if Abe is going to be successful, he either needs to do more, or he needs some help. 

A New Way Forward

Abenomics (as Abe’s economic policy is often called) has three pillars: government stimulus, loose monetary policy, and structural reforms. All of those seem like reasonable steps to restore the vibrancy that Japan has lacked for the last two decades. The first leg is supposed to spur growth though increased demand and consumer spending, the second is designed to give Japanese companies easier access to capital, and the third is intended to make Japanese firms more competitive globally.

Despite the apparent sensibility in Abe’s policies, Japan is still in a dismal economic state. In fact, since the financial crisis in 2008, Japan has fallen into recession three times and current Japanese private investment is down about 9% since 2008. Surely, some of Japan’s troubles can be written off as remnants of the financial crisis, and Japan was unexpectedly set back by the Fukushima Daiichi nuclear disaster in 2011 (a year in which growth was -0.5%), but there still appears to be something holding Japan back. Even as Abenomics starts to take hold of the Japanese market, there is something lurking beneath the surface that is not being addressed by Abe’s prescription.

When Caution Becomes Destructive

It turns out that the underlying problem in the Japanese economy doesn’t have anything to do with Abe’s policies, but rather with the companies that he is trying to jumpstart. In particular, Japanese companies are sitting on unprecedented amounts of cash; cash that, while on the sidelines, is utterly useless. The Economist noted that Japanese firms are currently holding $2.1 trillion on the sidelines, which constitutes a massive 44% of their GDP. In comparison, American firms are only holding about 11% in cash. In all other developed economies, private investment is the engine of growth, buttressed by government stimulus and monetary policy. Without robust private investment, the prospects of Japanese growth are dim. What’s more is that these companies are not just opting out of potentially risky investments, but are keeping the cash out of the hands of their shareholders. Although not ideal, if Japanese firms were to redistribute this cash through dividends, consumers could recycle those gains into the market and boost growth from the demand side. The same Economist article pointed out that if Japan and South Korea, who is experiencing a similar issue, were to spend just half of their reserves either through private investment or corporate dividends, global GDP could see as much as a 2% boost. For an international economy whose current outlook is gloomy at best, 2% could do a lot of good.

Presumably, Japanese companies would be among those who would gain from robust global growth, so why are they so reluctant to grease the wheels? The answer speaks to the unique psyche of Japanese corporate executives. In the post World War II period, Japan experienced astounding prosperity, but in the early 1990s speculation, unreasonably rapid economic activity, and excessively loose monetary policy caused the Japanese asset price bubble to burst. Very quickly, Japanese firms saw their stock prices plummet, their bottom lines shrink, and their access to capital disappear. Moreover, government solutions to Japan’s crisis proved fairly futile. Japan’s Central Bank attempted to stem the tide by injecting money into banks to lower the interest rate and increase lending, but interest rates were already so low that the stimulus had pretty much no impact.

The next two decades have become to be known as Japan’s “lost decade,” a period with anemic growth, declining wages, and little, if any, inflation. The experience of the late 1980s and early 1990s have stained the perspective of Japanese executives, making them extraordinarily risk-averse. Most prefer to sacrifice some growth in order to avoid the prospect of another asset bubble, even if that fear is fairly unreasonable. In countries that haven’t had the unenviable experience of living through such a profound crash, profit-seeking risk tends to be the dominant corporate boardrooms. But in Japan, it is just the opposite.

Once Again, It’s Up to Abe

So it seems that Abenomics might have a real chance at succeeding if only Japanese firms would do their part. Unfortunately, waiting for two decades of crippling prudence to subside isn’t much of an plan, and the onus is on Shinzo Abe to make sure that Japanese firms capitalize on his aggressive economic policy.

A stone’s throw away, South Korea is dealing with a similar problem by trying to incentivize investment through taxes on excess profits. Even if that policy is effective at getting cash off of the sidelines, it is an overreaction that doesn’t allow for corporate caution when that caution is appropriate.

A better idea would be to extend Japanese firms the carrot instead of threatening the stick. If Abe were to introduce tax incentives for corporate investment into the structural reforms leg of his three-fold strategy for economic renewal, there would an extra reason to mobilize some of this cash. Japanese bosses might then be presented with a potential payoffs on investments that are simply too good to pass up. In the end, though, this hyper-prudence is a function of culture and generation, of an elite class that was scarred once by runaway activity and that has no desire to undergo a similar period ever again. Even if it can be counterproductive, their fear is understandable.

A scheme of tax incentives and new regulations may not be enough to tear down two decades worth of cultural barriers, but if Japan is to be the engine of growth in Asia again, Shinzo Abe must try.

 




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