Is Japan’s ‘Revival’ For Real?

There’s been a lot of bullish sentiment towards Japan lately, as reflected by the Nikkei index’s 70% gain over the past six months – the index now stands above 15,000, at its highest level in 5¼ years. Much of this is thanks to Prime Minister Shinzo Abe’s efforts to revive the economy via his ‘three arrows’ of extreme quantitative easing (QE), fiscal stimulus, and an as-yet-unveiled new growth strategy. Abe is clearly a man with a mission, and I don’t recall Japan having such a seemingly determined leader since the early days of Junichiro Koizumi, a reformer who served as prime minister in 2001-2006.

But is this optimism justified? Regular readers of this blog will recall that I have generally sounded a pessimistic note about Japan, having warned that the country is at risk of a ‘lost eternity’. More recently, I have warned that Abe’s combination of extreme QE and fiscal stimulus could accelerate Japan’s debt crisis. I still hold these views.

What If We Are Wrong About Abe?

Nonetheless, I must also recognise the possibility that Abe might in fact succeed in reviving Japan. By ‘revive’, I mean putting the Japanese economy onto a sustainable growth path that allows for a reduction in the budget deficit and debt burden, and causes it to regain some of the ‘edge’ that it has lost to countries such as South Korea and China.

Abe’s sense of mission is encouraging. It is better that Japan has a leader who at least tries to shake it out of its slumber than one who does nothing, or very little. (Some could argue that a do-nothing approach is better than accelerating the inevitable bust.) The fact that Abe is Japan’s first prime minister since the late 1940s to be given a second stint in the job suggests that he could have more staying power than before; i.e. he may have learned the mistakes of his previous premiership.

There is also the possibility that Abe may be able to channel his nationalism towards a new agenda for economic reform. In general, there are two kinds of economic nationalism. One is parochial and protectionist, designed to keep the economy (of any country, not just Japan) relatively closed to foreign competition and to preserve the country’s business culture (and thus its broader culture and social system). This model is tied to vested interest groups.

But there is also a second kind of economic nationalism, one that recognises that in order to revive Japan’s economy and make the country strong, a broad restructuring is needed that will transform its business model via the adoption of foreign ideas and practices. In the late 19th century, Japan’s leaders adopted this policy for the purposes of strengthening the country against possible Western colonialism. In the early 21st century, China, not the West, is Japan’s most formidable rival.

Shinzo Abe is a strong nationalist, and wants to make Japan militarily powerful. The question is, which economic model will his nationalism embrace? In his first period as premier (2006-2007), Abe favoured the first kind. However, Abe’s apparent desire to take Japan into the Trans-Pacific Partnership (TPP) free-trade grouping suggests that he could indeed be a reformer this time. Nonetheless, no-one should underestimate the strength of Japan’s vested interest groups.

July’s Upper House Election Is Key

Abe is due to unveil a new economic growth strategy (his ‘third arrow’) in June, and investors are hoping that he will outline reforms to a variety of sectors, including agriculture, healthcare, utilities, and the labour market, amongst others. Then, in July, Japan will hold elections to its Upper House, where Abe’s Liberal Democratic Party (LDP) lacks a majority. If the LDP wins a majority, which is a distinct possibility given Abe’s overwhelming popularity, he would be Japan’s strongest prime minister in many years and should have a solid hand with which to carry out economic reform.

There is, however, a danger that once he secures an Upper House majority, Abe could lose interest in bold economic reforms and instead focus on issues closer to his heart, such as amending Japan’s constitution to reduce constraints on the use of its Self Defense Forces (SDF). Recall that one of the reasons Abe lost popularity during his first stint as prime minister in 2006-2007 was because he championed ‘patriotic’ and defence-related matters at a time when voters were more concerned about ‘bread and butter’ issues. If Abe backtracks on his commitment to reforms or Japan’s inclusion in the TPP, then investors could lose faith in Japan once again.

There is also a possibility that excessive focus on defence issues on the part of Abe could worsen relations with China and South Korea, which oppose Japanese rearmament and deeply resent Tokyo’s relatively unapologetic attitude to its Imperial past.  

Possible Game-Changers

Regardless of the Upper House elections and the durability of Abe himself, there are several possible game-changers for the Japanese economy over the long term.

The first is a colossal debt crisis. Naturally, this would be viewed extremely negatively. However, it is quite possible that such a visible systemic failure could serve as the trigger for genuinely radical reform, as was the case in South Korea after its 1997-1998 financial crisis. Some have argued that Japan’s ‘lost decade’, and even the 2011 triple disaster, were not painful enough to galvanise the country into reform. On a positive note, Japan, like South Korea, probably has the social cohesion to rally behind reform, rather than slip into Greece-style mass unrest.

The second is a new resource bonanza. Japan has actively been researching ways to develop its considerable reserves of offshore methane hydrates, a topic my colleagues in BMI‘s Oil and Gas team has been tracking closely. If this proves successful, then this could be a substantial boost for Japan’s economy, which imports most of its energy. Japan could also tap rare earth metals from its sea bed. These are in high demand for a variety of hi-tech goods, and the world’s major economies are keen to break China’s virtual monopoly (97%) on its production.

The third would be a new immigration strategy, which the LDP proposed in 2008, but quietly dropped later. It is my contention that immigration is the real key to Japan’s revival – the country needs newcomers to top up and rejuvenate its population, and introduce new ideas and ways of thinking. However, Japan remains resistant to immigration for fear that it would change the culture. In any case, immigration is not a panacea, and Japan still needs to implement some of the above-mentioned reforms.

A fourth possibility is the rise of a new political force, if the LDP stumbles once again. This could include the Japan Restoration Party (JRP) of former Tokyo governor Shintaro Ishihara and Osaka mayor Toru Hashimoto, possibly in cooperation with other parties. (Sadly both men have made some highly inflammatory comments, which have been condemned in China and South Korea.) Although the JRP has lost some of its momentum since its establishment in 2012, it is now the third-biggest party in parliament and could even move to second place. However, it is unclear if the party’s highly nationalistic leaders can deliver reform.   

No Easy Path To Recovery

Overall, Japan’s road to revival will be bumpy. As the population ages, its society will probably be less disposed towards change. In addition, Japanese prime ministers come and go with alarming speed, and it is not clear if any of Abe’s putative successors would continue ‘Abenomics’.

Much is at stake. The coming years will determine if Japan regains its lost edge and remains among the world’s most important economies, or slips further down the rankings of global powers.