Japan's Economy, Abenomics, and Impact on U.S. Economy
7 Reason's Japan's Economy Is Stuck
Japan's economy produced $5.4 trillion in 2017, as measured by purchasing power parity. That makes it the world's fifth largest economy after China, the European Union, the United States, and India. But it's not on pace to catch up because it only grew 1.5%.
Japan has 127 million people. Its gross domestic product per capita is $42,700 or 41st in the world. That makes its standard of living lower than the United States or the EU. But it's higher than its Asian competitors, China, and South Korea.
Japan's largest exports are automobiles and parts, steel products, and semiconductors. As the world moves toward electric vehicles to combat climate change, it will hurt Japan's economy. Electric vehicles use one-third fewer parts than in gas-powered vehicles.
To meet these challenges, Japan’s government wants manufacturers to stop building conventional cars by 2050. China, the world’s biggest car market, already has a goal of 1 in 5 vehicles running on batteries by 2025.
Japan's main imports are oil and liquified natural gas. It's trying to reduce these imports by increasing its use of renewable energy. It's also restarting nuclear plants that were shut down after the Fukushima nuclear disaster.
What's Wrong with Japan's Economy?
Japan relies on its central bank to prop up its economy. Like the United States, government spending is around 20% of the country's gross domestic product. But Japan can't finance this through taxes because that would slow growth even more.
Instead, the Bank of Japan buys government debt. It's similar to the U.S. quantitative easing program but it's ongoing. The Federal Reserve ended its QE purchased in 2015. Japan's central bank bought $3 trillion in government bonds or about half the total. That's less than the Federal Reserve's ownership of $4 trillion worth of U.S. Treasurys. But the U.S. central bank owns just 23%.
To spur growth, the Bank of Japan keeps interest rates low. Its discount rate is just 0.3%. It promises that rates will remain low. People expect low rates and falling prices. That expectation guarantees deflation. In 2017, prices only rose by 0.5%. That's the highest level in years. In 2015, prices fell 0.1%.
The expectation means that every time prices rise, consumers stop buying. They just wait for prices to drop again. Businesses can't raise prices or hire new workers. Employees don't get raises, so they just keep saving. Just look at Japan to see why a little inflation is a good thing.
The Bank wants to keep the value of the yen low. But the yen carry trade keeps raising it. Even when the dollar's value soared 15% in 2014, it didn't increase the price of imports. A lower yen normally increases the price of imported commodities, triggering inflation. But plummeting oil prices kept prices low. That made deflation worse.
The government and the central bank are trying to stimulate growth through expansionary fiscal and monetary policy. But you can't push a string. As a result, Japan has fallen into a classic liquidity trap.
Seven Characteristics of Japan's Economy
The following seven factors hinder Japan's growth. The country's leaders must address these challenges to restore growth.
1. Keiretsu is the structured interdependent relationships between manufacturers, suppliers, and distributors. This allows the manufacturer monopoly-like power to control the supply chain. It also reduces the impact of free market forces. New, innovative entrepreneurs can't compete with the low-cost keiretsu. It also discourages foreign direct investment. Non-Japanese companies can't compete with the advantages given by keiretsu.
2. Guaranteed lifetime employment meant companies hired college graduates who stayed until retirement. Around 25 million workers, aged 45 to 65, benefit from the system. Most have outdated skills and are just cruising until retirement. That burdens corporate competitiveness and profitability by artificially raising wages for these workers. The recession made that strategy unprofitable. By 2014, only 8.8% of Japanese companies continued to offer it. But its influence remains.
3. Japan's aging population means less demand to drive growth. Older families don't buy new houses, cars, and other consumer products as much as younger ones do. And the government must pay out more retirement benefits than it receives in income taxes from workers. It doesn't help that the population is also shrinking. By 2065, Japan will have 30% fewer people than it did in 2015. The country does not welcome immigrants. An influx of younger families would boost the economy. Instead, Japanese companies must rely on temporary workers from nearby South Asian countries.
They send their wages back to their home countries, exporting Japan's growth.
4. The yen carry trade keeps is a result of Japan's low interest rates. Investors borrow money in low-cost yen and invest it in assets denominated in higher-paying currencies, such as the U.S. dollar. That keeps the value of the yen higher than the Bank would like. It hurts exports and prevents inflation.
5. Japan's massive debt-to-GDP ratio means Japan owes more than twice as much as it produces annually. The biggest owner of its debt is the Bank of Japan. That has allowed the country to keep spending without worrying about higher interest rates demanded by skittish lenders. But it also means government spending doesn't boost the economy
6. Japan briefly became the largest holder of U.S. debt in 2015 and again in 2017. Japan does this to keep the yen low relative to the dollar to improve its exports.
7. Japan is the world’s largest net food importer. The country has just one-third as much arable land per person as China.
The Problem Started with Japan's Lost Decade
In January 1990, Japan's stock market crashed. Property values fell 87%. The Bank of Japan fought back. It lowered the interest rate from 6% to 0.5% by 1995. It didn't revive the economy because people had borrowed too much to buy real estate during the bubble. They took advantage of low rates to refinance old debt. They didn't borrow to buy more.
The government tried fiscal policy. It spent on highways and other infrastructure. That created the high debt-to-GDP ratio.
By 2005, companies had repaired their balance sheets. In 2007, Japan's economy started to improve. It was up 2.1% in 2007 and 3.2% in Q1 2008. This led many to believe it had finally grown out of its 20-year slump.
The 2008 financial crisis sent GDP growth plummeting 12.9% in the fourth quarter. It was the worst decline since the 1974 recession. Japan's economic collapse was a shock, since Q3 growth was only down 0.1%, following a decrease of 2.4% in Q2 2008. The severe downturn was a result of slumping exports in consumer electronics and auto sales. That sector was 16% of Japan's economy. It had been a driving force behind the country's economic revival from 2002 to 2008.
The Tsunami and Fukushima Disaster Didn't Help
On March 11, 2011, Japan suffered a 9.0 magnitude earthquake. It created a 100-foot tsunami that flooded the Fukushima nuclear power plant disaster. It occurred just as Japan's economy was emerging from the Great Recession. In 2010, GDP increased by a healthy 3%. That was the fastest growth in 20 years.
Japan lost much of its electricity generation when it shut down almost all its nuclear power plants after the earthquake. The economy shrank 0.5% in 2011 as manufacturing slowed due to the crisis.
Japan adopted more stringent regulations, under which it is reactivating at least 30 reactors that pass. Its energy plan is to have 22% nuclear, 24% renewables, and 26% coal by 2030.
How Abenomics Tried and Failed to Correct It
On December 26, 2012, Shinzo Abe became Japan's Prime Minister for the second time. His first term was from 2006 to 2007. He won in 2012 by promising economic reform to shake the country out of its 20-year slump.
"Abenomics" has three principal components, called the "three arrows."
First, Abe instructed the Bank of Japan to initiate expansive monetary policies through quantitative easing. That lowered the value of the yen from $0.013 in 2012 to $0.0083 by May 2013. That's expressed in terms of the value of the dollar, which rose from 76.88 yen to 120.18 yen. But by 2019, the yen strengthened against the dollar. One dollar could only purchase 110.5 Japanese yen.
Making the yen cheaper should have increased exports. Their prices drop in dollar terms, making them more competitively priced. But Japanese companies didn't increase exports as expected. Some companies didn't lower their foreign prices. They pocketed the profits instead. Others had already outsourced factories to lower-cost areas, so the devaluation didn't help. Still others weren't helped because they had moved production into their markets. For example, Toyota made 2 million vehicles in the United States in 2017.
The devaluation hurt Japanese businesses that rely on imports. Their costs rose. It also hurt consumers, who had to pay more for imports.
Second, Abe launched expansive fiscal policy. He increased infrastructure spending. He promised to offset the rise in Japan's 235% debt-to-GDP ratio with a 10% consumer tax in 2014. It backfired when it briefly returned the economy to recession.
Third, Abe promised structural reforms. He promised to modernize Japan's agricultural industry. He said he would reduce tariffs and expand plot sizes. That put him against the powerful rice lobby. But in 2015, the Central Union of Agricultural Cooperatives, also called JA-Zenchu, agreed to reduce its power over farmers. That allowed the government to promote more efficient production methods.
Japan was the first country to ratify the Comprehensive and Progressive Agreement for Trans-Pacific Partnership. The massive trade deal includes 10 other Asian countries. They signed it after President Donald Trump pulled the United States out of the agreement.
How Japan Affects the U.S. Economy
On July 17, 2018, the EU signed a trade agreement with Japan. It reduces or ends tariffs on almost all goods. It's the world's largest bilateral trade agreement, covering $152 billion in goods. It will come into force in 2019 after ratification. The deal will hurt U.S. auto and agricultural exporters.
The Bank of Japan had been the largest foreign holder of U.S. debt until China replaced it in 2008. Both Japan and China do this to control the value of their currencies relative to the dollar. They must keep their exports competitively priced. But this strategy drove Japan's debt to 182% of total GDP output even before Abenomics.
A low yen made Japan's auto industry very competitive. That was one reason that Toyota became the No. 1 automaker in the world in 2007. But if Japan's central bank decides that a low yen isn't boosting growth and oil prices rise, then it may let the yen strengthen to reduce inflation. It would purchase fewer Treasury bonds. That would allow yields to rise and boost U.S. interest rates.
Japan's aging population gives it a dependency ratio of 65. It has 65 dependents for every 100 working-age persons. The U.S. ratio is 51, but it also has an aging natural-born population. Its ratio is lower because it allows immigration. But President Donald Trump's immigration policies threaten to slow that growth. Without immigration, the U.S. economy could fall into a slump similar to Japan's.
The Bottom Line
Although it’s the fifth largest economy in the world, Japan has been suffering from deflation and slow growth since the 1990s. Shinzo Abe’s “Abenomics” failed to correct low prices, expensive imports, and a high debt-to-GDP ratio.
But a devalued yen has made the nation a top manufacturer and exporters of automobiles, machinery and equipment, steel products, and electronics. To spur exports and earn more, Japan keeps its yen low relative to the U.S. dollar. Japan signed huge trade agreements like the TPP and a bilateral one with the EU. These agreements do not include the United States. As such, these may soon pose serious competition to the U.S. agricultural and manufacturing sectors.
The drive to extend their global market share comes from Japan’s burgeoning debt and a declining population of a taxable, working age group. Both pose considerable economic challenges. Public debt and U.S. Treasurys comprise most of this debt.