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3 out of 5 Arrows: Japan’s Abenomics

by John Brian Shannon | April 29, 2016

If the fundamentals of an economy are sound, any conceivable shock to an economy will eventually dissipate and normal economic flows will resume. (Every economist knows this)

Unfortunately for Prime Minister Shinzo Abe of Japan he inherited an economy where the fundamentals were unsound, and more than one economic parameter was out of alignment. Which is a different way of saying the Japanese economy was going to fail on his watch or during the next Prime Minister’s watch.

The Fukushima-Daiichi meltdown and the subsequent closure of Japan’s nuclear power plants massively shocked Japan’s economy. Some 29 percent of Japan’s electricity was produced by those (cheap to operate) nuclear power plants. Many of the country’s n-plants are now undergoing decommissioning or remain offline.

Mr. Abe’s Three Arrow policies were necessary, timely, and for what they are, effective. In retrospect, there was no other way for Japan to proceed. The country’s economy would have imploded had the Prime Minister not acted so appropriately.

When Prime Minister Shinzo Abe took office in December 2012, he announced a strategy – comprising three “arrows” – to overcome the economy’s combination of slow growth and low inflation: [1] very easy monetary policy, [2] a short-term fiscal stimulus, and [3] structural reforms to labor and product markets. But the government’s economic policies (so-called Abenomics) have not fixed Japan’s problems and are unlikely to do so in the future.” — Professor Martin Feldstein writing in Project Syndicate

However, I suspect that even Shinzo Abe knew it would take more than Three Arrows to reset Japan’s economy. But they were a great start to putting Japan’s economic fundamentals where they need to be.

It will take two more ‘Arrows’ to return Japan to a balanced state — ‘the steady state’ where a fundamentally sound economy can withstand moderate economic shocks.

Mt Fuji from Yokohama, Japan. Image courtesy of comeonoutjapan com

Mt Fuji from Yokohama, Japan. Image courtesy of comeonoutjapan.com

Arrow #4 must surely be an inheritance tax of some significance. Japan’s diminishing population pyramid means that domestic demand will continue to taper. An inheritance tax can help to counter that loss in government revenue.

With falling tax revenue due to a shrinking population, the government needs money to operate — providing the same infrastructure, but to a shrinking population. In Japan’s case an inheritance tax of 25%-50% will allow the government to maintain services in the face of falling income tax and other tax revenues due to a rapidly declining population.

Understanding Population Structure in Japan.

Understanding the Population Structure in Japan 1960-2060.

Arrow #5 must be raising corporate taxes. If voters are expected to shoulder a higher tax burden then corporations must also pay their fair share. If that means that dividends for wealthy investors are a few cents lower, well, that’s just too bad.

Voters will not accept the twin assault of higher inheritance taxes and the (proposed) Value Added Tax increase from 8% to 10%. That will only result in widespread public disaffection and PM Shinzo Abe being voted out of office after doing so much good work.

By raising inheritance taxes and corporate taxes, the government could hit zero-deficit within 3 years.

At that point the Japanese economy will return to a ‘steady state’ where it can flourish as a fully functioning economy.

Although I’m a fan of massive stimulus; At the early onset of economic downturns, massive government intervention works well, but by continuing to massively stimulate an economy for more than 5 years, we reach a point of diminishing returns in the 6th or 7th year.

That is why, in order for government intervention to be most effective, it must be massive, it must be early, and it must continue for 5 years or less. (Less is better)

Other economic levers must also be applied. We can’t expect stimulus alone to solve the fundamental problems with the economy.

If an economy hasn’t got it’s fundamentals in order, massive stimulus only warps the equation — but in fairness — it gives the country’s leaders five years to get those fundamentals in order.

Therefore, my prescription for Japan’s ailing economy is ‘take two more arrows and aim for zero deficit within 3 years.’

Prime Minister Shinzo Abe has the credibility and the political energy to get it done. Leaving it for the next Japanese Prime Minister isn’t an option.

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