Jan. 11 marked the first anniversary of the Emergency Economic Measures for the Revitalization of the Japanese Economy. This important Cabinet Office document spelled out the so-called three arrows of Abenomics -- "bold" monetary policy, "flexible" fiscal policy and a "new" growth strategy for Japan. Together, these three arrows were intended to extricate the Japanese economy from decades of stagnation.
First-year reviews of Prime Minister Shinzo Abe's emergency measures are arriving almost daily from leading commentators. Abe's economic adviser, professor Koichi Hamada, has graded monetary policy an A, fiscal policy a B, and the growth strategy an E for effort, spelling out the prime minister's name. The conclusion is that Abenomics has been a mixed success at best.
According to the International Monetary Fund, the rate of consumer price inflation in Japan will achieve Abe's announced goal of 2%. This counts as a solid A for the Bank of Japan's quantitative and qualitative easing, initiated under BOJ Gov. Haruhiko Kuroda. Under Kuroda's leadership, the BOJ has belatedly responded to the U.S. Federal Reserve's unconventional monetary policies, which are just now ending.
The IMF's authoritative Fiscal Monitor predicts the Japanese government's cyclically adjusted primary balance, the IMF's preferred indicator of fiscal sustainability, will improve from -9.5% of gross domestic product in 2013 to -6.8% in 2014. This would leave Japan far short of a sustainable fiscal policy of around -3%, even with the legislated increase in the consumption tax that will take place on April 1, 2014.
This moderately pessimistic view of Japan's fiscal policy does not take into account the cabinet decision of Dec. 5 -- Economic Measures for Realization of a Positive Cycle -- further relaxing fiscal policy. This added flexibility in anticipation of the consumption tax increase will be insufficient to achieve Abe's 2% growth target. Flexible fiscal policy deserves a B.
Overlooked and misunderstood
Japan's new growth strategy, the third arrow of Abenomics, has befuddled most commentators. The April 2 cabinet decision to reform the electricity industry has been overlooked in many discussions of monetary and fiscal policy. Electricity generation would be separated from electricity transmission and distribution. This well-conceived strategy is long overdue, but poses daunting challenges.
The most important short-run objective for electricity policy is to recertify Japan's nuclear power capacity and bring it back into production. Nuclear accounts for almost 20% of generating capacity and has been idle since shortly after the Fukushima nuclear accident in 2011. Japan has had to rely more heavily on fossil fuels and has given up long-cherished commitments to reducing greenhouse gas emissions.
Perhaps more important, substantially increased imports of fossil fuels have derailed efforts to increase Japan's international competitiveness while maintaining a positive current-account balance. Toyota has become more profitable, but export volumes will peak in 2014 and then begin to decline, according to the IMF. This will frustrate Abe's objective of stimulating private investment.
Reform of the electricity industry is a high priority in Abenomics.
Beyond reactivating the nuclear generating plants, the Japanese electricity industry faces the challenge of creating an integrated national grid. This would knit eastern and western Japan into a single national market and produce the efficiencies needed to reduce Japan's sky-high electricity rates. Lower rates would raise living standards and increase industrial competitiveness.
Reform of the electricity industry deserves the high priority it has been given in Abenomics. However, this will be a task for the next decade, not the next year. Beginning with the politically unpopular recertification of the idled nuclear capacity, the reforms will continue with creation of a national grid, and will strive for the long-term goal of separating electricity production from transmission and distribution.
The second key initiative in Japan's long-term growth strategy is Prime Minister Abe's decision to apply to join negotiations for the Trans-Pacific Partnership in March. The TPP is potentially a far-reaching trade agreement including Japan, the U.S. and 10 other countries in Asia and North America. Japan was invited to join the negotiations in April and began to participate formally in July.
The original objective of the TPP negotiators was to complete an initial agreement by the end of the 2013 calendar year, but this schedule has been moved back. In the meantime, the prime minister has announced that subsidies to reduce rice production will be eliminated by 2018. A new scheme to consolidate rice farms and cut costs of production has also been announced, and both measures will increase Japan's agricultural competitiveness.
Trade agreements are essential for creating investment opportunities for Japanese businesses outside Japan. These agreements also attract foreign direct investment into Japan to provide a more competitive business environment. However, the task that lies ahead is to resume Japan's long march toward opening the economy to the full benefits of globalization, a process interrupted by a series of economic crises stretching back to the 1970s.
The elimination of subsidies for reducing rice production is expected to increase Japan's agricultural competitiveness.
Heizo Takenaka, an academic member of Abe's Industrial Competitiveness Council and a key adviser to former Prime Minister Junichiro Koizumi, has called for acceleration of the initiative to establish Chinese-style "national strategic special zones." These would reduce corporate tax rates and relax labor- and product-market regulations in major centers like Tokyo and Osaka.
While specific economic policies in the special zones remain to be determined, the policy package would presumably spread to other areas, following the Chinese pattern. Ultimately, deregulation would take place all over Japan, breaking the "rock-solid" barriers to competitive labor and market products. These have accumulated over the decades since Japan regained sovereignty in the 1950s.
Taken as a whole, the growth strategy of the Abe government is an impressive achievement, deserving a much higher grade than professor Hamada's "E for effort." However, each of the initiatives will require a decade or more to come to fruition. This central fact is not captured by the rhetorical device of three arrows that has guided the communication strategy of the Abe cabinet.
Less rhetoric, more realism
The third arrow of Abenomics is ambitious, but has inspired growing skepticism by economic commentators. The prime minister's rhetoric has deflected attention from the long-term goals of his growth strategy. Monetary and fiscal policies are capable of producing quick results (and short-term disappointments), but a successful growth strategy requires, above all, staying power.
Growth strategies must first be formulated at a relatively abstract level, providing general direction but devoid of specifics. The second stage is to identify issues that are ripe for action, sometimes after decades of academic discussion and political debate. The third stage is to enact detailed measures or at least an approach for testing the alternatives, like special strategic zones.
After specific policies have been formulated, they must be transferred to a capable bureaucracy for implementation. This is where Japan will excel. Implementation also requires careful monitoring. This can provide the basis for regular progress reports to involve the public, which is essential for generating political support for additional measures as they are required.
Under the scenario I have outlined, monetary and fiscal policies will not disappear from the agenda. These policies play a critical supporting role in managing the government's response to unanticipated shocks, like changes in the international environment faced by the Japanese economy. This idea is well captured by the story of Mori Motonari* and the three arrows. However, the larger lesson of Motonari's successful leadership of the Mori clan is the essential role of his mastery of long-term strategy.
Prime Minister Abe's leadership has been impressive, but his new growth strategy remains a work in progress. For example, creating a flexible labor market to take advantage of Japan's superbly educated workforce, including a rapidly growing cadre of highly educated women, will take decades, not years. This will be the real test of Abenomics, along with overcoming the protectionism that has mired Japanese trade and service industries in inefficiency.
The time has come to put the three arrows of Abenomics back into their quiver.
Dale W. Jorgenson is a professor at Harvard University.
*Mori Motonari(1497-1571) was a daimyo in feudal Japan. He is famous for a legend in which he showed his three sons how it is difficult to bend three arrows at one time and told them to unite.
