Those examining the Japanese economy and its prospects are in many ways the frontiersmen of macroeconomics.
That is partly because anyone looking at that market realises many of the traditional remedies applied in other economies have failed to work. They range from a Keynesian fiscal stimulus addressing a shortage of demand, monetarism – which seeks to manage the economy through the manipulation of the money supply – and more conventional supply-side economics, which aims to stimulate demand by addressing how goods and services get to market.
The urgency of the work of those on the frontier comes from the fact that many of the characteristics that shape the Japanese economy are now looming over the horizon for much of the rest of the developed world.
No simple solution
The traditional Keynesian view is that persistently low economic growth is the result of an absence of demand in the economy, and so the correct response is for the government to inject cash into the system to stimulate demand.
The problem Japan has with such a strategy is its ageing population. Older people have less inclination to spend, something economists call a lower marginal propensity to consume, so a stimulus that pushes cash into the economy is less effective for such segments of society as they are likely to simply save more money.
Keynesian economics is usually most effective when unemployment is high, as the extra demand injected into the economy generates jobs, and as unemployed people receive wages they can then spend more, generating more demand.
But Japan’s ageing population means its number of retirees is very high and the unemployment rate is low. So a Keynesian stimulus has less of an effect than would be expected to be the case in a more typical economy.
Monetarist economic theory works on the basis of Say’s Law, which states that supply will always find the appropriate level of demand.
As a result, advocates of this theory take the view that the correct response to persistently low economic growth is to increase the supply and velocity of money in the economy. This theorises, therefore, that if interest rates are low, money becomes so cheap that consumers and businesses will want to buy it (that is, borrow money), and the resultant extra spending generates extra demand.
It is partly this reasoning that has led Japan to adopt exceptionally low interest rates and quantitative easing. But as older people are more likely to be in the decumulation rather than the accumulation phase, they are less likely to borrow at cheap interest rates to invest in future growth – or to consume more, as mentioned above. And businesses have little faith in the prospects for economic growth, whatever the risk-free rate.
Because a sizeable proportion of the country’s population is in the drawdown phase, measures that generate economic growth are likely to be less popular than those designed to restrict inflation. This can also limit the government’s ability to deploy Keynesian or monetarist policies, both of which are commonly deemed to be inflationary.
Low interest rates also mean that those who are approaching retirement may find their pension pot is not worth as much as expected. As a result they increase their savings levels, producing precisely the opposite impact intended by rate setters.
Supply-side economic measures typically include labour market and corporate governance reforms. The aim is to free up demand in the economy by making it easier for new entrants to join an industry, and force prices downwards.
A particular feature of the Japanese economy is the relatively low level of immigration into the country. This makes the ageing population more of an issue, as does the Japanese tradition of comparatively few women working outside of the home.
Assessing Abenomics
The latest Japanese answer to the range of problems described above is the so-called ‘Abenomics’ programme, which seeks to combine elements of all of the above measures into one policy. That is where the uncharted waters come in. Typically, economists huddle into either Keynesian or monetarist camps; the idea the policies could be used in tandem is viewed as a heresy.
In the decade since the financial crisis, both the UK and US governments pursued the monetarist solution of slashing interest rates and introducing quantitative easing, while simultaneously – in the UK’s case in particular – cutting back on government spending.
The idea for Japan is that its set of reforms would increase both growth and inflation. Yet the latter is currently way below the 2 per cent target, at 0.8 per cent.
David Jane, a multi-asset manager at Miton, says Keynesian and monetarist programmes are easy to introduce as they effectively involve giving the population free money in one guise or another. The problem, he says, is that such stimulative actions can only ever be effective if structural change also takes place. But politicians rarely want to make those changes as they are not popular with the population as a whole.
Andrew Milligan, economist and chief strategist at Standard Life Aberdeen, says structural reforms, particularly those that make it easier to emigrate to Japan and for women to enter the workforce, are happening. But he also suggests that, unlike the other two ‘arrows’ of growth, the government can’t make a fuss about these reforms for fear of a political backlash.
The short-term benefits of more migrant workers are that the number of people of working age rises, meaning the proportion of the population in the accumulation phase also increases, making the various stimulus measures more likely to be effective.
One reason many western countries have grown at a faster rate than Japan in the past has been the increase in the working age populations caused by immigration. As political currents in the US, the UK and many parts of the eurozone point to politicians attaining power with a mandate to curb this, the risk is that the rest of the world moves in the direction of Japan.
The fastest pace of quarterly growth achieved in Japan in the past three years is just 0.8 per cent. There have been three quarters in those three years where GDP has shrunk, and the consensus estimate is that the final quarter of 2018 will also have recorded negative GDP growth. Despite the many travails of the UK economy over the same three-year period, growth has often been higher in the UK and has not been negative for a single quarter in that time. Over the past decade, Japanese GDP growth has only risen by more than 2 per cent in a quarter on one occasion.
Reasons to be cheerful
Mr Milligan notes that Japan is becoming a world leader in robotics technology. That is important, because the other way economies can grow structurally, apart from through an expansion of the working age population, is via technological innovation.
The potential for some Japanese technology companies to grow at a faster pace than either their own economy or the rest of the world may reassure the swathes of investors who have long been sceptical of allocating to the country.
Andrew Herberts, head of private client investing at wealth manager Thomas Miller Investment, sums up the dashed hopes of those who have bet on Japan in the past, saying: “I have only been in the markets for 20 years, how could I have made money from Japan yet?”
Simon Edelsten, who runs the Mid Wynd Investment Trust, has 11 per cent invested in Japan. He says improvements achieved in corporate governance have made the country a more attractive market. But he concedes the next step may require the government to permit more Japanese companies to be taken over, as a way to drive up the long-term productivity of the economy.
David Thorpe is investment reporter at FTAdviser.com
