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Politics

Abe’s missing ‘third arrow’ brought into focus by leadership vote

Economy remains key to prime minister's political agenda

Japan's Prime Minister Shinzo Abe has promised more investment in young people if re-elected as party leader on Thursday.    © Kyodo

TOKYO -- With Japanese Prime Minister Shinzo Abe widely expected to be re-elected as leader of the Liberal Democratic Party on Thursday, attention has already started to turn to his policy goals for the next three years, in particular if and how he will implement the third element of his signature revitalization program.

In recent weeks, Abe has repeatedly spoken of his long-held goal of revising Japan's pacifist constitution as a policy priority.

For many, however, this is an unnecessary diversion. "Investors would prefer Abe not to get distracted by constitutional revision" and stay focused on the economy, said Tobias Harris, Japan analyst at New York-based risk consultancy Teneo Intelligence.

Some are still holding out hope for Abenomics, as the program is known, despite the fact that the government's 2% inflation target appears increasingly unattainable.

"Where is the third arrow?" asked Jesper Koll, CEO of WisdomTree Japan, a U.S. investment company, in reference to Abe's promise of deregulation and other economic reforms that the market has been crying out for to revitalize Japan's stagnant economy. The first two arrows of Abenomics were aggressive monetary easing and fiscal spending.

Japan's economy has grown annually by an average 1.3% in the past six years. During his leadership campaign, Abe has signaled an intention to invest more in young people, with ideas such as free preschool education and help with college tuition.

He has also promised to smooth the way for foreigners to enter Japanese workplaces to help cope with the country's chronic labor shortage. "It is necessary to create a system that brings in a broad range foreign workers with a certain level of skills and expertise," Abe said in an interview this month.

Koll, however, pointed to a need for more efforts to foster startups, or "the next generation of superstars."

Policies to support entrepreneurship have been implemented under Abe's tenure, but they have failed to produce a dramatic increase in the number of new companies.

On CB Insights' list of 260 "unicorns," or startups worth at least $1 billion, 121 are based in the U.S., 76 in China and just one in Japan.

Tellingly, Japan's biggest companies now look overseas for an environment in which they can innovate. MUFG Bank is undertaking a blockchain project in Singapore, while Toyota conducts research and development in Silicon Valley.

Koll cites Japan's conservative business culture as the biggest obstacle, while Teneo's Harris argues that more substantive labor market reforms are what is missing.

Fostering domestic growth will be crucial amid global uncertainty.

Japan has so far not been targeted directly by U.S. President Donald Trump's isolationist trade policies, although tariffs of up to 25% on imported cars and car parts have reportedly been considered. If imposed, such levies would have a devastating effect on Japan's auto industry -- Toyota Motor's profits, for example, would fall by one-third.

For the most part, the global economic environment has been favorable to the Abe government, but that could also change as U.S. expansion enters its 10th year. Any slowdown could put the U.S. Federal Reserve's monetary tightening campaign on hold and trigger an appreciation of the yen against the dollar, hurting Japanese exports.

"The Abe government has been very lucky with the U.S. economy staying strong" in the last six years, said Sota Kato, a professor of political science at the International University of Japan and a former senior official at the Ministry of Economy, Trade and Industry.

"The Abe government has used a strong economy to maintain popular support, which has provided him with political capital to push forward with his national security agenda," he said. "If the economy doesn't grow, his whole business model stops working."

One way to hedge the risk of trade tensions with the U.S. is to strengthen economic ties with China.

The two countries have had tense relationship in recent years, which Abe has sought to put on a positive trajectory.

"I met with Chinese leader Xi Jinping in Vladivostok and agreed to prepare for a summit in China. The two countries are moving steadily toward a new level of relationship," Abe stressed on Sunday.

The move comes as Japan's automakers increase investment in China to offset uncertainties in the U.S. market. If successful, a rapprochement with Beijing would be seen as a major achievement.

The two countries also agreed to work together on infrastructure development projects in third countries.

WisdomeTree's Koll predicts that better relations with Beijing could lead to Japan participating in the China-led Asian Infrastructure Investment Bank, joint development of high speed railway projects and combined investment in North Korea.

On the domestic front, Abe said he is committed to a promised increase of the sales tax to 10% from 8%, scheduled to take place in October 2019. The hike is designed to cover the social security deficit and provide new funding for child-rearing assistance.

However, Abe has already postponed the move twice, in 2015 and 2017, and some think it could be delayed a third time.

"He is unlikely to push through an economic measure that puts popular support at risk," Kato said.

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