The recent volatility in Japanese financial markets has seen Abenomics come in for much (unwarranted) criticism. In turn, this has seen much greater scrutiny of the “third arrow” of Abenomics – the structural reform agenda. Ahead of this Friday’s Cabinet meeting to rubber-stamp his growth strategy, Shinzo Abe’s latest structural-reform speech delivered last Wednesday proved a disappointment for many. As with his previous two speeches on structural reform, the speech was full of noble high-level objectives (see table below) but with detailed and substantive measures thin on the ground.
For many observers, the sketchiness of the policy proposals, together with a seemingly relaxed timetable for legislating new measures lacked the necessary ambition. Indeed, many potentially powerful measures – not least initiatives to see workers more easily reallocated from mature businesses to new growth sectors, presumably by making it easier to make permanent employees redundant – were left particularly vague.
But we are not writing off the third arrow just yet. Those disappointed by Abe’s speech simply had unrealistic expectations. Rather than missing its target, as many suggest, the third arrow has yet to be even unleashed. Sensitive reforms were never likely to be explicitly spelled out before July’s Upper House elections. And for the reforms to be ultimately effective, a strong Upper House majority, easing their passage, will be more important than a detailed strategy document now.
Indeed, successful examples from other major economies demonstrate how ambitious structural reforms, which ultimately pay dividends in terms of stronger competitiveness and GDP growth, are rarely announced and implemented swiftly without policymakers first having developed a consensus for change and carefully sequencing the relevant measures. Perhaps most notably, the key German reforms implemented by the Schroeder government a decade ago, which helped to transform that economy from Europe’s sick-man to the rejuvenated export machine it is today, took several years to design and implement. It took about two and a half years following the establishment of an independent committee to design new measures before the most celebrated policy – the so-called ‘Hartz IV’ welfare reform – was implemented, in January 2005. And even then, at the time many critics suggested that the policies were too timid. Yet the reforms have subsequently been credited with the dramatic improvement in the functioning of the German labour market over the past decade or so.
We would not dare yet suggest that Abe will be as successful as Schroeder. In any case, it is simply too soon to judge. And Germany’s challenges a decade ago were very different to those currently facing Japan. But the German experience provides grounds for both patience and cautious optimism. So, while more detail about the third arrow should be provided this coming Friday, we are not expecting (nor looking for) a fully articulated plan.
But we do believe that Abe has a broadly coherent framework that is capable of making more of Japan’s potential economic output. Ultimately, the reforms need to both get more people working and make those in work more productive. By increasing the share of women aged 25-44 who work he can help to reduce the impact of adverse demographics on the labour force. And through increased openness to trade and foreign investment – not least via participation in free trade agreements – and deregulation, where most observers would agree there is plenty of low-hanging fruit, there is also scope to boost labour productivity.
The precise impact of Abe’s reforms on Japanese potential growth will, of course, depend on the detail. But recent studies (e.g. from the Peterson Institute or University of Tokyo) illustrate how participation in the Trans-Pacific Partnership (TPP) trade agreement – a key part of the third arrow – could provide a significant boost to Japanese growth over coming years. Similarly, the OECD has illustrated how, by adopting industrial country structural policy norms consistent with Abe’s framework, Japan could well achieve annual average real GDP growth well in excess of 1% towards the end of this decade. If so, given Japan’s shrinking population, and provided the 2% inflation target can be met, the 3% annual average growth in per capita income that Abe’s third arrow is aiming for could well be within reach.
Abe's 'third arrow': Selected key targetsSource: Kantei, Nikkei and Reuters
Chris Scicluna, Head of Economic Research