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Staying the course of Abenomics

May 15th, 2014 | Posts By Devalier | Filed in: General, Interface Times

The S&P's Chief Global Economist


Yesterday I listened to Paul Sheard, Chief Global Economist and Head of Global Economics and Research for Standard & Poor’s Rating Services comment on the progress of Abenomics thus far. He was speaking at a professional luncheon at the Foreign Correspondents Club of Japan.

Sheard has a long working relationship with Japan, having previously worked as Global Chief Economist and Head of Economic Research at Nomura Securities, a position he earlier held at Lehman Brothers, where he was also Lehman’s Asia Chief Economist.

Sheard framed Abenomics not as 3 arrows but rather as two policy pillars, one pillar aggressive monetary policy coordinated with fiscal policy and the other pillar supply-side structural reform to spur economic growth. Sheard considered Abenomics as “conventional” in concept of orthodox economics but in a Japanese context a sharp break from previous BOJ policy.

He referenced economic statistics that are striking to describe Japan’s two-decade battle with deflation. From an all-time high of 112.70 Index Points in the 4th quarter of 1994, Japan’s GDP deflator fell to a record low of 89.60 in the 1st quarter of 2013, before increasing to 92.70 in the 4th quarter. Since its peak in the 4th quarter of 1997, Japan’s nominal GDP has been -8%, compared with an increase in nominal GDP of 96% in the US. Four factors severely aggravated Japan economic results: the 2008 financial crisis, Fukushima disaster, yen strengthening to 75, and Eurozone debt crisis.

Regarding the first policy pillar (or 1st and 2nd arrows) of Abenomics, Sheard gave the Abe government (including the Kuroda-led BOJ) good marks.  He considered Kuroda’s policy shift a revolutionary shift in thinking, with the resolute message of “Yes, we can, yes we will” end deflation.

Is Abenomics working? The reflation objective is going well, with nominal GDP growth spurred by public investment up 18%. Public sentiment is good. But victory is not yet secure. The BOJ is on the right track but the handicap of deflation, so long embedded in the economic fabric, is not easy to overcome. And there is not yet strong evidence that Japan corporates are convinced of the enduring benefit of Abenomics.

Regarding the second policy pillar (or 3rd arrow), results so far are less impressive. Growth can come from 3 sources: increased labor, increased capital, and increased productivity though innovation and greater efficiency. With Japan’s population projected to decrease from 128 million in 2010 to 100 million by 2048 and 68 million by 2060 (fertility rate of 1.41 (2012) vs. 2.07 needed to maintain the population steady), Abe must increase the labor participation rate through measures designed to increase female workers and enlightened immigration policy, a holistic approach.

Sheard was firm in his belief that the Abe government should stay the course on monetary policy, even doubling down on monetary expansion. He steered away from making quarterly forecasts of GDP, indicating that S&P emphasizes a longer-term view, but did recognize both a widely expected strong 1st quarter result and a downturn in the 2nd quarter influenced by the impact of the consumer tax increase. Just released: Japan’s 1st quarter GDP rose 5.9%, the best showing in 2 1/2 years.

Staying the course is Japan’s best bet for ending deflation and achieving economic growth.  Abe has an unusual window of opportunity—the turnover of prime ministers in recent Japanese history is frightening (8 in the 21st century). We should give him an ample chance to prove that his policy works.

All the best,

Warren J. Devalier

©2014 Warren J. Devalier

A worthwhile bet?

May 8th, 2014 | Posts By Devalier | Filed in: General

The bold and the traditional conjoin


At 35.65% Japan has a higher taxation rate than any other country in the world, except the United States (40%) and United Arab Emirates (55%). The corporate tax rate in China is 25%, Japan’s largest trading partner (total trade 1.62X Japan’s trade with the US). South Korea’s corporate tax rate is 24.2%, Taiwan’s 17%, Australia’s 30%, Thailand’s 20%.

Most of these trading partners have reduced their corporate tax rates over the last 10 years, and as part of the Abe government’s growth strategy, Japan will likely propose lowering its corporate tax rate from 35.65% to 20% next month. This reduction is intended to encourage companies to increase capital investment in Japan. Also being considered are tax breaks to stimulate greater investment in start-ups.

It remains to be seen whether the corporate tax reduction under consideration will substantially boost Japanese corporate investment in Japan. Other factors driving Japanese investment are wage costs and the strategic objective to expand markets overseas to offset the impact of a declining domestic population. In general, the preference would consistently be to manufacture in Japan assuming that the overall investment climate, including the wage cost factor, is favorable.

Large Japanese companies don’t really need the cash flow benefits of tax reduction. They  are awash with cash. “Japan, Inc” is sitting on a cash pile the size of the total Brazil economy.

The Abe government is betting that the tax cuts will pay for themselves—that the initial decrease in tax revenue will be offset by greater corporate investment and profits, bringing in greater tax revenue.

This is a big bet, as the initial effect has to be offset elsewhere. Increased Japanese government bond financing? Japan’s public debt as a percentage of GDP (214%) is the highest in the world, higher than Zimbabwe(202%), Greece(161%), Portugal(129%). Even if held domestically, this is leverage to the hilt and at some point is unsustainable.

If corporate taxes in Japan are reduced to bring the level competitively in line with other countries, the government should offset that loss in revenue by getting a lid on the wasteful spending on projects that placate cozy vested interests.

Tax breaks to encourage start-ups make sense but the criteria should be well-thought out. Simply throwing money at any harebrained scheme squanders public resources. Incentives to angel investors might be effective since those investors have skin in the game, as do venture capitalists.

All the best,

Warren J. Devalier

©2014 Warren J. Devalier