TOKYO -- Outside Masahisa Noda's secondhand shop in Tokyo's Asakusa district are racks of bargain items, on sale at 30% off; on the glass door is a sign offering a 5% rebate for cashless payments. Inside, surrounded by kimonos and obis stacked neatly on shelves, Noda is gloomy about the future. A hike in the consumption tax last fall hit his sales hard, and he sees little prospect of a recovery.
"People buy a kimono as a small luxury. It's not an essential item," he said. "A tax increase of just 2% can still make people postpone purchases. Sales started slowing even before the higher tax kicked in. People had already become defensive. They tried to avoid unnecessary spending."
The tax rise, from 8% to 10%, came into effect in October. Its impact on consumer spending was far greater than economists had forecast. Consumption dropped 11%, and the economy shrank by an annualized 6.3% in the final quarter of 2019. Any hopes of a quick rebound were then dashed by the outbreak of the new coronavirus, which abruptly cut off tourist arrivals from China.
Asakusa is a popular tourist destination, and foreigners account for 10% to 20% of sales at Noda's store. Chinese visitors have now almost entirely stopped coming, and even locals are staying away. "Japanese people now avoid visiting Asakusa, because it's popular with tourists," he said. "They fear they will catch the virus if they come here."
The consumer slump, falling demand in China and the impact of the virus could push Japan back into technical recession -- defined as two consecutive quarters of economic contraction -- for the second time since Prime Minister Shinzo Abe took office in 2012. Back then, he promised to "break down any and all walls looming ahead of the Japanese economy, and map out a new trajectory for growth."
His strategy, dubbed "Abenomics," was supposed to jolt the moribund economy back to life using three "arrows" -- aggressive monetary policy, fiscal flexibility and major socioeconomic reforms to make corporate Japan more entrepreneurial and efficient. Automation, along with labor and immigration reforms, would help to take the pressure off the overstretched workforce; financial technology would streamline business; and a huge influx of foreign tourists -- toward a target of 40 million per year by 2020 -- would bring a new source of income.
While monetary stimulus did force down the yen, and the government did spend -- and borrow -- enormously on fiscal stimulus, small traders like Noda did not feel the benefits. The tourism boom barely offset falling domestic spending.
"When [Abe] was elected as prime minister in 2012, it gave me hopes that things might improve the next year," Noda said. "But my hopes have shrunk like a balloon losing air."
Abenomics' more profound reforms are still a work in progress. External pressures are mounting, and Abe's time and political space seem to be running out.
"It is very clear that we are, right now, crash-testing Abenomics," said Jesper Koll, economist and senior adviser for the U.S. asset manager WisdomTree. "Quite frankly, we don't know how resilient the system is going to be."
The Matsuya department store is right in the heart of Ginza, Tokyo's high-end retail district. Next to the Louis Vuitton building and across the street from Apple, Chanel and Cartier stores, it has become a place of pilgrimage for wealthier Chinese tourists, who often travel with an extra empty suitcase so that they can stock up on luxury goods -- cosmetics, apparel, bags, pearls and watches -- at Matsuya and its neighbors. Foreign tourists make up a quarter of the store's sales, according to Shimpei Kono, Matsuya's sales planning manager.
Like many retail businesses, Matsuya had braced for the sales tax rise. The store had a surge of business in September, as consumers made large purchases before the hike. Sales rose 18% on the year, before plummeting 20% in October, pushed down by not only higher prices but also the impact of Typhoon Hagibis, which barreled through Tokyo and Yokohama during the three-day weekend of Oct. 12 to 14. A 10% drop in the Chinese currency against the yen was another factor.
Year-on-year sales were down 0.8% in November, and 1.5% in December. Business picked up in January and early February, however.
"Sales were especially strong toward Valentine's Day, as the store attracted many female customers in their 20s, 30s and 40s," Kono said. "It made me expect a full recovery."
Indeed, the Abe government's decision to go ahead with the tax hike in October was a show of confidence that the economy could withstand the blow.
The prime minister took power in the aftermath of the financial crisis, amid a deep slump and after several recessions. There seemed to be no clear route out of the stagnation: Corporations were hoarding cash, and a "lost generation" of people in their 30s and 40s, who had missed the opportunity to secure lifetime jobs during the country's boom, seemed doomed to remain underemployed.
Successive governments had found themselves without the political and fiscal leeway to address the country's long-term challenges. Labor shortages, rising welfare liabilities and falling consumption from a declining population are already pressing issues, and will only get worse. The International Monetary Fund forecasts that Japan's gross domestic product is on track to fall by a quarter in the next 40 years due to a spiraling demographic decline.
"When you lose 500,000 customers per year, you will have a very hard time to have consumer spending be an engine for your country's growth," said Michael Thomas Cucek, assistant professor of Japanese politics at Temple University's Japan campus. "This was always on the horizon."
With the economy in the mire, necessary long-term measures, including raising taxes to meet the inevitable increase in health care and pension liabilities from the aging population, had proved all but impossible. Attempts to raise the sales tax were particularly politically toxic. The IMF says that Japan needs to increase the tax to 15% by 2030, and 20% by 2050, but it took two decades to get the public to accept even a modest 5% rate. Attempts to raise it further have brought down governments.
Abenomics promised to break the cycle of short-termism. Huge stimulus packages, starting with 13 trillion yen (then $117 billion) in 2013, would reflate the economy and give space for structural reforms. Bringing more women and more migrants into the workforce would ease labor shortages. Labor reform would make the workforce more competitive and push up wages. With government support, companies would embrace technology, particularly in payments, where a continued dependence on cash was seen as holding the economy back.
For a while, it seemed to be working. For the first time in decades there was a swagger to the Japanese economy. In 2013, the Nikkei Stock Average jumped 57%. Although growth was still not stellar, hiring increased.
"You have young people with a very positive outlook about their lives, due to the extremely massive hiring that has been possible under both the [fiscal] stimulus and loose monetary policy," Cucek said. "This generation is very upbeat."
But even as the early Abenomics surge fizzled out, the government kept spending. Gross public debt has risen to nearly 240% of GDP after successive stimulus packages. Despite the kick-starts to growth, reform has been slower than the government hoped.
Real wage increases have been limited. Companies have continued to add to their cash reserves rather than investing. Japanese businesses and consumers have stoically refused to move to cashless payments. The country's electronic payment ratio -- the proportion of household transactions that are made using digital methods -- is just 20%, compared to 69% in the U.K. and 96% in South Korea. Realpolitik meant that some of the harder reforms were delayed. The tax hike was postponed twice.
"It would have been better had the Abe administration started difficult reforms earlier," said Naoki Takayama, assistant professor of economics at Tokyo's Hitotsubashi University and a former government official responsible for national income accounts. "It's been presiding over one of the longest expansions in postwar history. But no boom lasts forever. If the government thought the upturn would last for 10 years, that would mean they were imprudent."
The government knew that hiking the consumption tax would hold back growth, so it prepared countermeasures, including a 5% rebate for cashless payments and tax breaks on purchases of cars and homes. Analysts predicted the impact would be in the range of 3.5% to 4%. The true size of the hit was a surprise.
"They couldn't delay the consumption tax hike again, because that would be an admission that Abenomics has failed," said Tobias Harris, senior vice president at U.S. consultancy Teneo. "[Abe's argument was] that the economy is strong enough to withstand a small tax hike, and that this would be fine this time. ... In reality, it has shed a light on how little [the economy] has fundamentally changed since 2013. Exactly the thing that they wanted to avoid has happened."
The biggest surprise in the October-to-December numbers, though, was how much business investment had fallen as well as consumption -- down by 14%.
The reasons for that are partly external. Hitachi Construction Machinery, a major producer of excavators and other heavy equipment, should have been well-positioned to take advantage of a construction boom in Japan, as well as an export market buoyed by China's huge Belt and Road infrastructure initiative.
However, the company had to suspend production in Japan for almost three weeks between October and November after one of its suppliers in Nagano was flooded during Typhoon Hagibis, a spokesperson told Nikkei. Exports were also hit by a slowdown in China, as the country wrestled with the fallout of the trade war with the U.S. In January, Hitachi Construction Machinery reported a 30% drop in sales in China between April and December, but predicted that the decline would narrow to 20% for the January-March period.
That was before the coronavirus outbreak, which has blindsided many businesses. In February, over 50 companies warned that they will downgrade their earnings forecasts, or will see significant sales drops, according to credit research specialist Tokyo Shoko Research. More are likely to follow.
Hitachi Construction Machinery was preparing for the release of a mini-excavator for the Chinese market when it was hit by another supply chain shock. The coronavirus outbreak has forced the closure of its assembly plant in Hefei, in Anhui Province, west of Shanghai, as workers were ordered by the provincial government to stay home as part of a campaign to stop the spread of the virus.
At the Matsuya store in Ginza, shop attendants now wear masks, something they were not allowed to do before for fear it would degrade service by hiding their faces and muffling their voices. Fewer customers are around to notice the difference: Purchases by foreigners at the department store have halved, and even locals are staying away.
Many worry that the coronavirus will wipe out the possibility of a post-tax hike recovery. "I am concerned that people might stop going out, which would have knock-on effects on private consumption," said Shuichi Sato, an official at Kanagawa Toyota Motor Sales, a Yokohama-based operator of car dealerships.
Retail is suffering, exporters to China are suffering, but it is the tourism sector that has borne the brunt of the virus's impact.
Hiroyuki Ikeda, the manager of Tokyo-based Tabata Oji Hotel, is fed up with phone calls from tour operators, who are invariably ringing to cancel group bookings from mainland China. Nearly 80% of the Tabata Oji's bookings are ordinarily from Chinese parties, but since January, Beijing has barred organized tour groups from leaving the country to curb the outbreak.
"All bookings from them for March have been canceled," Ikeda said. The hotel has begun offering a 20% online discount to attract guests. Although there are still reservations in the books for April, if the coronavirus is not under control by then, the peak cherry blossom season could be a bust. "It is a loss of millions of yen per month," Ikeda sighed.
The hotel usually has three or four cleaners to take care of its 48 rooms, but Ikeda now asks only one person per day to come to work. "I have no other measures to deal with this situation," he said.
Boosting foreign tourist numbers has been an obsession of the Abe government, which set huge targets -- 40 million by 2020, when Tokyo hosts the Summer Olympics, and 60 million by 2030. By that point, the government hopes international tourists' spending will hit 15 trillion yen ($135 billion) per year.
More than 31 million people did come to Japan in 2019, around half from China and South Korea. A 25% increase in 2020 was already ambitious, particularly as a diplomatic spat with Seoul has pushed down arrivals from South Korea.
The coronavirus makes hitting the 40 million target all but impossible. January figures showed a slight monthly decline of 1.1%, but that does not account for the escalation of the outbreak. February's numbers are likely to be much worse. The Kawaguchiko area at the foot of Mount Fuji, known for its iconic lake, has seen a sharp decline in the number of foreign travelers. They normally account for half of total visitors, while Chinese alone account for a little less than 20%.
"The area as a whole is seeing a 20% to 30% decrease in bookings, and some hotels are even down by half," said one official from the Fujikawaguchiko Tourism Federation. Thais are also starting to cancel their bookings, after the government in Bangkok issued an advisory warning against travel to Japan. Thailand is the sixth-largest source of visitors to Japan.
In Kyoto, which in recent years has struggled with tourist overcrowding, a group of businesspeople launched an advertising campaign showing some of the city's most famous sites deserted, using the Twitter hashtag #nopeople. On the northern island of Hokkaido, at a snow festival which last year drew nearly 2.8 million visitors, traffic was down by a third.
Companies that positioned themselves to take advantage of the tourism boom now have their backs against a wall.
Laox, a major electronics retail chain, runs more than 30 duty-free stores across Japan, including four in Kyushu that specifically cater to cruise ship customers. Each time a ship docked, staff from nearby stores would be mobilized to serve the several thousand customers who would flood into the stores to buy rice cookers, microwaves, shavers and hair dryers. Today the shops are open, but hardly anyone is browsing the aisles.
Laox plans to temporarily shutter its flagship store in Shinjuku, Tokyo, and may consider a permanent closure if the outbreak drags on.
"We are working on the basis that tourists won't return till the second half of the year," said Yosuke Abe, head of Laox's finance division. "It's hard to tell when China will lift its ban on group tourism. And if the ban is lifted, it is not clear if people would buy a holiday package. They are out of work right now, and financially strained. If they come to Japan, it's not clear whether they would spend the way they did before."
Critics say that the coronavirus has highlighted a tourism policy overdependent on foreign travelers, and on China in particular. According to the Japan Tourism Agency, Japanese overnight tourists spent 15.8 trillion yen in 2018, more than three times that of visitors from overseas.
"If the government takes special care for Chinese tourists and neglects Japanese travelers, we have to say that is a failure of [its] economic policy," said Hideo Shioya, director of the Japan Travel Bureau Foundation, a Tokyo-based research institute that specializes in tourism.
The biggest looming risk for the tourism sector is the Olympics, due to start in July. Hotels have invested heavily in increasing their capacity to meet an expected jump in demand. Research by property group CBRE, released in June 2019, shows the number of new rooms planned to open between 2019 and 2021 in Japan's nine largest cities increased from nearly 30,000 to 80,000 over the previous year.
"Even though the number of rooms is already becoming oversupplied, they are still increasing," said Takeshi Kitamura, director at Japan Hotel Appraisal, a real estate appraiser dedicated to hotels. "People believe in the boost from the Olympics and in an increase in international conventions for the post-Olympic period. If the sporting event is canceled due to the coronavirus, industry players will be stunned."
A cancellation is unlikely, but a big reduction in numbers would take the gloss off an event that was supposed to be a showcase for Abenomics and Japan. Analysts were already concerned about a post-Olympics hangover, as the impact of capital investments wears off.
"You wish you had started with a boom then a bust," said WisdomTree's Koll. "That's the story everybody wanted to write about with the Olympics. Boom and bust. Now it's the other way around. First the bust, [then] it will be a recovery. ... The question is the strength of the rebound. How strong it will be?"
In December, the Abe government signed off on a 13.2 trillion yen stimulus package to try to mitigate the impact of the supertyphoon and falling demand in China. The money was earmarked for disaster readiness projects, road infrastructure, support for small businesses and agriculture and the rollout of fifth-generation mobile phone networks. It is supposed to be matched by another 13 trillion yen of private investment.
Some analysts think a further supplementary budget could be prepared to cushion the blow from the coronavirus. More stimulus could keep the economy moving, but it would do little to push forward Abenomics' more ambitious -- and perhaps more important -- components. The success of the grand experiment has been in question for years, but the external shock of the outbreak has increased speculation that Abenomics, and Abe himself, may finally have run out of road.
"Third-arrow structural reforms will have to be put on hold for now. The economy is in a downturn. This is not time for painful reforms. It is not politically feasible, anyway. The room for policy maneuvering is extremely limited for the Abe government right now," Hitotsubashi University's Takayama said. "What Abe can do is to ... create space for new initiatives for the next government."