Japan, the irresistible enigma
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A year before Narendra Modi began his campaign as prime ministerial candidate in the general election, his friend Shinzo Abe had fought and won a landslide victory in the national election in Japan. He had already served as PM back in 2006, when he became the youngest post-war PM in Japan, and even his comeback in 2012 was unprecedented. Modi’s campaign harshly attacked the high double-digit inflation of the United Progressive Alliance government. He promised voters that he would bring down inflation sharply. By contrast, Abe promised his voters that he would raise inflation! His goal was to achieve inflation of at least 2%, if not higher. Japan has had deflation in 10 of the past 25 years. Deflationary spirals can be self-fulfilling, as consumers postpone purchases in anticipation of lower prices, and their collective postponement depresses demand, leading to further price cuts and discounts. Now, the Modi-Abe friendship is legendary. Both are keen to upgrade the India-Japan strategic and economic relationship to a more robust and tighter embrace. Alas, there is no trade possible in “inflation”, else India would have happily exported it to Japan!
The Japanese economy seems like a macroeconomist’s unsolvable Sudoku. It is not shrinking nor is it growing. Japan is in stagnation, but in a benign way. For the past 25 years, its nominal gross domestic product (GDP) is more or less constant at 500 trillion yen. Since there were periods of deflation, it meant that real GDP has often grown faster than nominal GDP.
There have been repeated and unsuccessful attempts at stoking growth with fiscal stimulus. As a result, the debt-to-GDP ratio at 240% is now the highest in the world. The annual structural deficit is 5% of GDP. Despite the glut of government bonds, the yields on these remain very low.
Since fiscal measures weren’t effective, the Bank of Japan (BoJ) has tried monetary stimulus too. For the past three years, the BoJ has been pursuing its own quantitative easing, with annual purchases of 80 trillion yen of government bonds. That target may go up to 100 trillion in the future. Despite this massive pumping of money, inflation has barely moved, and is nowhere near the 2% goal. One consequence of the asset purchases is that the central bank now owns more than one-third of all government bonds. If the pace of purchases continues, the BoJ will end up stocking two-third of all the bonds in the next four years. As per the calculations of The Economist, by 2026, at a pace of 100 trillion per year, the BoJ will end up owning all the outstanding debt of the government. This January, the BoJ entered the negative interest rate policy regime and the yields on 10-year bonds are now negative. Long-duration bonds yields are close to zero.
Abe’s strategy is called the three arrows of Abenomics—fiscal, monetary and structural. None seem to be working. Last year, in a bid to cut the fiscal deficit, his regime increased the national sales tax from 5% to 8%. That led to a recession. Hence, further increases in consumption tax have been postponed by two years.
The current plight of Japan with zero growth, and ineffective monetary and fiscal policy is now new. It seems like an impossible puzzle. The great macroeconomist Rüdiger Dornbusch once commented that maybe Japan should just impose capital controls. This suggestion during the heyday of the Washington Consensus was radical, if not downright heretical. Even with these textbook maladies and seemingly unsolvable macro problems, consider these features of the Japanese economy.
Firstly, despite the high debt-to-GDP ratio, it is mostly owned domestically.
Secondly, since the population is shrinking, the per capita GDP is actually rising, even with zero nominal growth. With deflation, the real growth is positive anyway. This puts into question whether the threshold to define recession in an ageing society like Japan should be minus 1% or 2% growth rather than just below zero. Thirdly, the female participation in the workforce is the lowest among Organisation for Economic Co-operation and Development (OECD) countries. If that increases, then GDP and productivity are likely to get a boost.
Japan is still the third largest economy in the world, and a leader in renewable energy, clean technologies, nuclear power (at least until Fukushima happened), high-speed transportation and automobiles. It gets the highest rainfall among all OECD countries, which speaks about its green cover. Its energy and carbon intensity has been falling. Its life expectancy at 84 years is possibly the highest in the world. Japanese students routinely score much higher than OECD peers in international tests, especially in maths and science. This speaks of the quality of education in Japan. Finally, in a world with ageing population, slow growing labour force, slowing productivity, labour displacing innovations like driverless cars and 3D printing, the goal of 4% or even 2% growth may be a chimera for an economy like Japan. That is not to say the stagnation is a good thing. But zero growth with zero inflation and a shrinking population may not be that bad either. As for India-Japan ties, there is tremendous complementarity. On the Japanese side are huge pension liabilities, the need to generate higher returns, and large pool of patient capital. This is a perfect complement for long gestation, capital-hungry infrastructure projects of India. Added to this is the strong chemistry between the prime ministers.
Ajit Ranade is chief economist at Aditya Birla Group.
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