Japan hit a snag with the 0.6% economic contraction in the first quarter. The question is whether it is just a hiccup or a troubling end to the best run of growth since the 1980s.
Most pundits say it is a blip. Asia's second-biggest economy, they argue, is on a roll amid heady global growth and buoyant corporate profits. But Prime Minister Shinzo Abe's team should not downplay the risk that this slowdown is for real.
Credit where it is due: Abe's weak yen and moves to tighten corporate governance since 2012 refilled Japan Inc.'s coffers. That positioned Japan to harness the best synchronized recovery the global economy has enjoyed in years. But now, U.S. President Donald Trump's trade war risks clipping Tokyo's wings.
The bigger-than-expected annualized first-quarter setback may be the latest clue. It interrupts the longest expansion -- nine quarters -- since the 1986-1989 period. Business spending declined, while private consumption walked in place. Equally worrisome, growth in the fourth quarter was revised to just 0.6%, well below the earlier 1.6% figure. In March, meantime, exports rose just 2.1%, less than half what economists hoped.
Growth could indeed return in the April-June quarter. Still, we need to take stock of why Japan is so vulnerable: Abenomics, nearly six years on, has not addressed Japan's biggest headwinds. Despite majorities in both houses of parliament and, until recently, decent approval ratings, Abe's government did little to ease labor regulations, boost productivity or rekindle innovation. It made negligible headway on streamlining the process of starting new businesses, offering tax incentives to entrepreneurs or cutting bureaucracy.
Abenomics has not catalyzed a wave of inbound foreign-direct investment, encouraged a mergers and acquisitions surge or done enough to empower activist investors. It has not enticed risk-takers like SoftBank's Masayoshi Son to deploy more capital at home. Nor has it resulted in a series of high-level promotions for female executives.
The problem, as this column has argued before, is too much quantitative easing and fiscal excess, not enough structural change. The Bank of Japan drove interest rates below zero, cornered the bond and stock markets and is still only about halfway to the 2% inflation target. Despite promises to control the world's biggest debt burden, Japan's IOU's hit a record 1,087 trillion yen, or nearly $10 trillion, last fiscal year -- an increase equivalent to Hungary's gross domestic product.
Epic stimulus has neither reignited Japan's animal spirits nor gotten executives to boost wages markedly. Trump's trade tariffs, meantime, come at the worst possible moment. This, after all, is the year the virtuous cycle of big salary increases was supposed to arrive. Uncertainty emanating from Washington could make CEOs less inclined to share the wealth.
Abe's dwindling political capital is not helping confidence. He failed to ram disruptive change through parliament when his support rates were in the 70% range. They are now in the 30s, limiting his latitude. The prime minister is struggling through two controversies. One involves the 2016 sale of public land at an 86% discount to a school company with ties to Abe's wife. The other: Abe's bromance with a Trump White House acting against Tokyo's interests on issues from trade to climate to North Korea. Tokyo is out of the loop as his friend Trump rewards North Korean leader Kim Jong Un with a planned summit next month.
Turns out, Abenomics did not have three "arrows," as originally advertised, but two. Shot No. 1 came from the BOJ in 2013. The second: construction ahead of the 2020 Tokyo Olympics. The third and most important -- a deregulatory big bang -- remains largely in the quiver. Abe wagered that the first two arrows would hit the reflation target convincingly, making the third unnecessary.
That, after all, worked for Abe's Liberal Democratic Party before. Abe gambled that all Japan needed was bigger stimulus doses to prod executives to share trillions of dollars of cash with workers. Executives called his bluff. They are withholding big raises until Abe comes through with his supply-side revolution to take on an ascendant China.
After falling 0.2% in 2017, inflation-adjusted "real" wages were essentially flat in February and March -- rising 0.8% one month, falling as much in the other. A 2.5% jobless rate is not boosting incomes -- and will not without bold structural upgrades. Add in trade headwinds driven by Abe's pal in the White House and optimism about 2019 wages is in question, too. It hardly helps wage-earners to increase consumption that Tokyo plans to hike sales taxes next year from 8% to 10%.
The problem is a lack of audacity. Even Abenomics' biggest wins require asterisks. It is grand, for example, that female labor participation is approaching a record 70%, less so that women now account for about two-thirds of "non-regular" jobs that pay less and offer fewer benefits.
Abe, for example, has yet to entrust a woman with a pivotal cabinet role -- finance, foreign affairs or chief secretary. For all the chatter about making women "shine," Japan has fallen 16 rungs in the World Economic Forum's annual gender-empowerment index to an all-time low of 114th on Abe's watch. Japan ranks behind Saudi Arabia in the number of female lawmakers.
Nor have moves to increase return on equity sufficiently chastened Japan Inc. Quality-control scandals at Kobe Steel, Mitsubishi Materials, Subaru and others are tarnishing Japan's global image. Regional lender Suruga Bank is now on the hot seat for allegedly falsifying documents related to property investments.
In 2014, Abe implemented a U.K.-like stewardship code to give shareholders a bigger voice. It has resulted in few headline-grabbing battles between investors and boards. Abe prodded corporate boards to feature two outside directors. Yet having two did not stop Toshiba from fiddling with its numbers. The electrical group was hit in 2015 by an accounting scandal which involved its executives inflating profits by $1.2 billion over seven years.
Abe called on CEOs to fatten paychecks. They shrugged, stopping corporate windfalls from trickling down. Bottom line, these are nice policies to have, but too voluntary and toothless to raise national competitiveness or wages in the long run.
Only time will tell if the economy is taking a break or skirting renewed recession. There should be no mystery, though, about the causes of Japan's underperformance -- and how Abenomics could turn things around.
William Pesek is a Tokyo-based journalist and author of "Japanization: What the world can learn from Japan`s lost decades." He is a former columnist for Bloomberg and Barron's.