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Japan is firing its financial arrows at the wrong target

Abe should aim at raising wages, not prices, to boost economic growth

| Japan
Bank of Japan Gov. Haruhiko Kuroda speaks to Prime Minister Shinzo Abe at a House of Representatives Budget Committee meeting.

The debate over Haruhiko Kuroda getting a second term as Bank of Japan governor is close to pointless.

Prime Minister Shinzo Abe will almost certainly reappoint Kuroda when the BOJ head's term ends in April, since Kuroda's epic monetary easing has been the most successful arrow in the quiver of Abenomics. The yen is down 32%, corporate profits are thriving and the Nikkei Stock Average is breaking records again.

Abe's fiscal dart fell way short of its target, thanks to counterproductive increases in Japan's sales tax in 2014 and 2015. The third and most important shaft -- structural reform -- has yet to be convincingly even nocked to the string. That is why the longest economic growth run since 2006 and the tightest labor market in two decades are not boosting wages or getting the BOJ close to its 2% inflation goal.

So, the simplest choice for Abe is to keep shooting his monetary arrow and to keep his chief archer in place. But what if that means that his entire effort is aimed at the wrong target?

Deflation, remember, is a symptom of Japan's multidecade malaise, not the underlying cause. Kuroda's predecessor, Masaaki Shirakawa, warned as much before Abe showed him the door in March 2013. Shirakawa argued, correctly, that weak prices were products of a fast-aging population and a dearth of confidence in the future, not the amount of yen in the financial system.

Enter Kuroda, promising to reverse the "deflationary mindset" impeding pricing power. Fifty-five months on, the 2% mantra may be backfiring and entrenching the very mindset Kuroda sought to change. Fears of imminent inflation, in other words, are adding to anxieties of a 127 million-person nation that has not seen a hefty raise in decades. Perhaps it is time Abenomics aimed at 2% wage gains instead.

Real wages did in fact rise in August, but that negligible 0.1% gain was the first in eight months. It is a reflection of Tokyo's failure to modernize labor markets, tweak taxes and encourage greater innovation and productivity to give companies greater confidence to fatten paychecks. But it is also a product of treating the symptoms of deflation rather than the causes and a lack of policy audacity.

Tokyo could start with a concerted jawboning effort. One of a central banker's most important tools is "open mouth operations," whereby officials influence the collective psychology of traders and investors. Kuroda tried this approach in trying to persuade Japanese households to spend, and failed. He and Abe should go the other way: a tag team proclaiming 2018 the year when employers make Japanese incomes great again.

Abe could jump-start things by raising the pitifully low minimum wage. Making 822 yen ($7.21) per hour does not leave much disposable income to buy Nintendo's latest gaming console, Sony's newest smartphone, Issey Miyake's fall clothing line or Toyota's next-generation mini car. Japan Inc. would rebel, but the end justifies the means if households sensed higher wages were coming.

The prime minister's team should ignore giant business lobbies and prod trade unions to raise their sights. For a third straight year, for example, the Japanese Trade Union Confederation, or Rengo, is asking for a roughly 2% base pay raise. It will not get that, of course. It is disturbing, though, that some member unions worry Rengo is already setting its sights too high. On Oct. 19, Rengo President Rikio Kozu said it is time to "bring back the notion that wages should rise." Your move, sir.

The ruling Liberal Democratic Party should penalize companies hoarding some $2.7 trillion of cash reserves that would be better used boosting wages or investing in increased innovation. Or, if Abe's party wants to protect its pro-business bona fides, why not offer tax breaks for companies distributing some of their wealth? With President Donald Trump promising lower U.S. corporate taxes, the LDP is under pressure to lower Japan's rate of around 32%. Rewarding wage-boosting chieftains seems a wise approach.

Cry for help

Next, Kuroda could ask lawmakers to impose tax penalties on banks gorging on Japanese government bonds. JGBs have long been the main financial asset held by pension funds, insurance companies, the postal-savings system, government-run institutions, universities and, sadly for the BOJ, banks. Under Abenomics, bank lending has doubled to 3% year-on-year, but that is underwhelming considering the BOJ's epic quantitative-easing scheme. If banks were incentivized to lend more, the BOJ might enjoy the multiplier effect needed to broaden Japan's recovery. To whom would banks lend if nobody in the private sector wants to borrow?

Labor reforms, a vital part of Abe's third arrow, are desperately needed, too. A July 21 report from Kuroda's team on the topic reads like a cry for help. A system built on seniority-based raises and promotions discourages job-hopping, restraining wages. So does an institutionalized preference for security over risking companies' ire by demanding a raise based on merit. Regulatory rigidities incentivize companies to hire temporary staff over permanent employees with lower pay, fewer benefits and zero bargaining power.

Abe's new $17.5 billion plan to promote "revolutions in productivity and human resources development" is pointless if Tokyo does not address the rigidities holding incomes back. Corporate mindsets, for example, could do with less bureaucracy -- fewer meetings, reduced paperwork, less micromanagement, limits on overtime.

To date, Abenomics has been a bet on BOJ cash launching a virtuous cycle: rising profits, stocks and inflation catalyzing new job creation and higher wages. That might have worked in an textbook economy, sealed from outside forces and impervious to long-term shift such as demographic and technological change. But it does not work in a world reshaped by China and in a country where aging is sucking the energy out of the population. Just firing money arrows will not work.

William Pesek is a Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He has written for Bloomberg and Barron's.

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