Japan Needs to Restructure its Tax System as the Nation Struggles to Restore Economic Growth

Japan has fallen back into a ‘technical’ recession after recording its 2^nd successive quarter of negative growth. Japanese GDP fell by 0.4% (or an annualised rate of -1.6%) in the 3rd-quarter of 2014. Reuters had forecast economic growth of 0.5% (or annualised growth of 2.1%). Quarterly figures are misleading in the context of the sales tax hike, as it’s probable that people brought forward expenses in the 2^nd quarter (contraction of -1.83%, or annualised rate of 7.3%). Based on statistical evidence, private households are not responding to the stimulus, with private consumption, representing 60% of economic activity, rising just 0.4%.

Equity markets understandably took the contraction badly, with the Nikkei-225 falling 3% (517pts) to 16,973pts in response to the news. This follows a strong recovery in the Japanese market since the BOJ revealed an expanded stimulus program. The Yen was also weaker by 0.85%, falling to 115.58 Yen against the USD, taking the Yen to a 7-year high.

Clearly there was a lack of confidence by Japanese business leaders and consumers in the sustainability of the Japanese recovery. This poor result can be attributed to:

1. A lack of substantive reform
2. The increase in the sales tax rate from 5% to 8% in April 2014.
3. The subdued growth in exports – apart from the one-off ‘yen-depreciation’ gains
4. The interim nature of the data. There is still corporate ‘capital items’ to be reported which will marginally improve the revised numbers, yet the final figure will still look bad.[i]
5. The government’s attempt to “flog a dead horse” by attempting to use stimulus to boost inflation. It is ludicrous because he is not pursuing the right monetary settings to achieve that goal.

The policy is poorly conceived for a number of reasons. The principle objective is to rebalance the public sector budget and to revitalise the economy. If they can revitalise the economy, then this will go a long way towards removing budgetary pressures. The problem is that:

1. Executive Japanese governments are renown for cowardice. They simply don’t have the ‘braze balls’ to pursue policies that will impact the Japanese people.
2. Japan's government simply does not have the courage to cut spending on public works that have sustained a substantial amount of domestic demands, even if it has been hugely inefficient and raised the public debt to ridiculous levels. The good news is that most of this debt is being carried by the Japanese people, so it is easy for the Japanese government to simply raise taxes or inflation to recapitalise the economy.
3. Japanese households are struggling to save given their lack of financial literacy, as well as the poor return on traditional ‘bonds’. The greater folly is that the Japanese government has abused pensioner savings by investing in domestic infrastructure, which has offered investors and the economy a sub-optimal benefit. Few other nations want to invest in government bonds that return a paltry yield of just 0.4%; least of all when the currency is being rapidly debased. The low-medium income Japanese investor is a sucker for it.
4. The Japanese distribution of income is very tight so a great many families are struggling on low incomes. The implication is that a lot of households are vulnerable to a rise in sales taxes. The last rise from 5% to 8% occurred in April 2014, and a further rise to 10% is scheduled for Oct 2015.
5. Given the slack economy, many commentators are expecting the Japanese government to defer the last tax increase until 2017. The problem however is that Abe is attempting to place the burden on the households, and that is just outrageous when you consider the wage restraint imposed upon the economy. The government should be taxing capital, with the ultimately intent to boosting the return on capital, as well as stimulating consumption. That would be particularly sensible strategy given that is where the asset appreciation is. The most sensible way to achieve this might be by ending 'centralised government'. Rather than central governments dispersing funds to prefectural and city governments, it would probably make more sense to bestow a greater responsibility upon local government to carry administrative burdens. 

The rationale for taxing consumers is to stimulate business activity, however this is a ludicrous idea when:

1. External markets are subdued
2. Wage growth is subdued because the reform initiative has been mute

Domestic costs need to fall and the best approach is not to raise consumption taxes, but to reduce the burden on the Japanese people. This can be done by:

1. Boosting immigration, and Abe is certainly looking at that, whilst concurrently scaling up the nationalistic rhetoric.
2. Speeding up the pace of political and industry reform that promise to cut the costs of living and to add dynamism to the economy. We have electricity privatisation in 2015, however more is required.
3. Cutting spending so that the consumer has greater discretion to optimise their own spending. It cannot rely on stronger external trade in the current context.
4. Speeding up privatisation so that capital can be more efficiently employed
5. Tax reform that shifts the burden of the state from the consumer to the holders of capital

The corporate sector, given its exposure to weaker yen were able to contribute in terms of ‘record profits’, however this is not real growth. The problem of course is that Japan cannot look to the external account to boost Japan because of the weak global economy.

There is a propensity for economic commentators to not understand inflation. The Bank of Japan's (BOJ) has a ludicrous goal of 2% inflation. You cannot blow out money supply by a massive 40% and persist in wondering why there is no inflation. They look at inflation as a simple ‘demand phenomenon’, so when they look at inflation and see no inflation, they think ‘the economy needs more pump-priming’. The reality however is that the ‘pump priming’ is boosting asset prices (i.e. asset inflation), not the ‘cost of living’ inflation that affects workers. There is a good reason why this is the case and it is the immense ‘oversupply’ of unskilled labour in the global marketplace, and Japan is no exception. Only among the higher skilled workers is there a rise in incomes.

We clearly see evidence of asset inflation with the Nikkei off its 7.5 year high of 17,500pts. In the case of Japan, the asset inflation is largely confined to the equity market and inner-city property markets, which offer the most tangible exposure to assets in a depopulating market. The property market does however offer substantive opportunity for future gains if there is evidence of economic reforms that auger well for real income growth. In the short term, the property market is destined to be constrained by:

1. Negative growth in real income
2. Slack employment growth
3. Low consumer and business confidence
4. Negative population growth

The only positive aspect is that despite ‘negative’ overall population growth, there is still migration of people to the cities. Rather than people going to the city centres, a great many of these youthful Japanese are turning to the outer areas of Tokyo, which are far cheaper.

The rationale for an election is simply because Abe’s opponents are divided and weak. It would be opportune to call an election whilst that remains the case, but why now? There is no reason why he can’t defer the sales tax, but there is an imperative that he is seen to be carrying through with his reform mandate. There is every possibility that Abe will look to other measures like immigration to boost the economy. Expect the influx of tourists to help placate Japanese fears of increased immigration.

[i] Comment by Yoshito Sakakibara, Executive Director - Investment Research, JP Morgan; “Japan's economy contracts in third quarter” by Li Anne Wong, CNBC.com, website, 17^th Nov 2014.

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide
Profit from mining with Global Mining Investing eBook

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Land price rise highlights the reform initiative - but more required

One gets the sense that Abe is causing a lot of angst in Japan. The positive side is that he is appealing to all interests, whether its nationalists, conservatives, and even liberals. He is causing a lot of controversy and derision for his policies as a result; but might in the process he win favour for simply 'doing something' big. Its early days, but Abe is doing a number of important things:
1. Constitutional change - We are hearing 'noises' from liberals (mostly lawyers), but aren't indolent Japanese citizens destined to simply trust him to take them on the right path. We might wonder if the provisions sought are the end of the story, or a precursor for more power. From a collectivist government, that cannot be a good thing, even if the threat posed is not Abe, but a latter leader. But then maybe those constitutional protections were never what we wanted or expected. NZ seeks no less protected than any other nation 'with a constitution'.
2. Tax increases - Not something to celebrate but at least the government is addressing the fiscal imbalance. Does a reform program need more spending or less? I would argue more private spending and less government spending, but that is not going to occur until the private sector sees real progress, so he could be forgiven for spending.
3. Immigration - Recently we have seen the Abe administration open the nation to Asian tourists, as well as the adoption of a new class of visa. i.e. Gaijin ('foreigners') under the proposal, if they have good jobs, stable incomes, needed skills, are destined to be offered permanent residency in Japan. This is surely a measure to improve population demographics. i.e. Aging population, rural depopulation.
4. Child protection - After decades of inaction, there are signs that Japan is finally entering the fold for the protection of children caught up in international marriages.
5. Stimulus - This is perhaps the less impressive move, though it was a brazen some compared to the historic legacy. I would argue that it did not achieve anything, however you could argue that it did boost economic activity in a period of transformation. But its not really happened yet. Perhaps it was only meant to 'encourage people', so the real action would be favourably received.
6. Higher land prices - Land prices had bottomed in 2006, however they have been lacklustre of late, but more recently still, they show signs of improvement. Signs of inflation are not enough though, the government will need to do more to post real wages as well. It has encouraged businesses to do so, but to no avail yet. Consider however some reforms.
7. Trade reform: Japan has been an enthusiastic supporter of tariff reductions. Until recently, it was reluctant to cut tariffs on rice, however concessions have been made, and policies have been adopted to reform agriculture in the nation.

In my book 'Japan Foreclosed Property', I discuss how in the last few hundred years that Japan has been moved by both external and internal events to undergo enormous transformation that raised the nation to prosperity. i.e. After Admiral Perry's entry and during the Meiji Period. The latter are just some of the measures. More important than the 'number', is the nature of them. They are pretty drastic steps for Japan. Westerners benefiting from these reforms, particularly the opportunity to live in Japan, would do well to consider how they might benefit from their 'distinctive cultural differences' in a nation which is pretty homogeneous in its thinking. After all, this is why Abe is trying to break Japan out of its comfort zone. Its happened before, and it seems to be happening again. We have patiently been waiting for it!

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide
Profit from mining with Global Mining Investing eBook

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Strong economic growth in the Philippines

The Philippines has just reported a healthy annualised growth rate of 7.7%, highlighting the enormous appeal of the country as an investment destination. You might be interested in our property report - listed below. There are several appealing facets to the nation:
1. Better economic management
2. Prospect of settling disputes with Muslims in Mindanao
3. Falling interest rates
4. Strong remittances from abroad
5. Strong Business Process Outsourcing
6. Proximity to Asia
7. English speaking, law and customs

The old problems of poor infrastructure are rapidly being curtailed. The low-grade cultural experience as a reuslt of 'enfranchisement' of malls is a problem that should be erased in time as incomes and urbanisation rates rise rapidly.

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide
Profit from mining with Global Mining Investing eBook

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

The upside in Japanese property

A student of Japanese history cannot help but be impressed by how this country has turned itself around in the past. These periods of growth tend to be proceeded by protracted periods of stagnation, whether because of war or economic malaise. These situations include the post-WWII recovery and the Meiji Era expansion. One might be inclined to ask - if Japan has a hope of recovery - where can be expect such a recovery to come from. Clearly if such circumstances are to prevail it will be because of a 'cultural revolution'. Not the false promise of a collectivist revolution as in China, but a capitalist revolution. It is easy to conjure up explanations as to how that might happen. For example:

1. Women's liberation: Japan has yet to really feel the impact of the women's liberation movement that struck the West. In the West it was radical women who drove it, and the government who pragmatically recognised the benefits of taxing more household members. Today most women are proud to call themselves housewives. We might however see different values taught in schools and on TV educational programs in coming years.

2. Immigration: Most Western governments who have abused their debt-financing capacity (NB: I think all of them now since Australia and China pragmatically joined the club) have recognised the power of immigration to boost internal demand during periods of recession. We have all seen the levels of consumption in developing countries like Vietnam. Take one of those destitute Asians however and put them in the West, and suddenly you have a booming economy. In the last 3 years, Australian immigration numbers have jumped from 140,000 to 300,000 per annum. Rest assured that other countries are doing the same way, because its easy stimulus for the government, and who would not want more taxpayers to fund unsustainable debts. Might we expect the same in Japan? This would require change in Japanese values or 'tolerances to change'.

3. Central administration: Revolution anyone? I will be writing a lot more about this in future, but another basis for change is likely to be political transformation. Personally, I don't expect Japan to be a leader in political theory, but they do make great followers when they see how things can work. If any country shifted from a centrally-administered political administration, i.e. national & local assemblies referred as 'democracy', we would see a huge increase in productivity. For some of you, you will jump to the 'false dichotomy' of totalitarianism as the only alternative. But in fact there are other approaches to government. This is beyond the scope of this topic, but the impact would be significant.

4. Parenting & values: Advances in parenting and general personal values could also have a profound impact on Japanese people, particularly the youth. Such changes could also herald a huge improvement in the innovativeness of Japanese people.

5. Population growth: You might wonder if women might be encouraged to have more children. I think any such campaign is less likely to be effective without a deep-seated change in values.

Japan is already a hardworking nation of people, so I do not see much progress possible in terms of effort, but rather values which could culminate in favorable changes to how those people work. There are huge advances to to be made if people recognise and understand the opportunities. So do they? I don't it. Like I say...it will start somewhere else. Maybe the USA? And how long before Japan realises the personal relevance?

So long as Japan remains a collectivist country, the challenge of change is likely to depend upon external factors. We might expect this to be:

1. Debt crisis

2. Political stagnation

3. Charismatic leader

The fact is that the Japanese have not suffered enough that they are willing to change. That will change over the next two decades as power shifts to younger people. There will come a time when an appealing politician eventually emerges.

This is likely I think to result a dictatorial regime, though it is unlikely to embrace militaristic ambitions or persecution of foreigners. Yet few nationalistic regimes do when they start out. I actually don't expect a regime which needs to rely upon external markets for trade and 'population growth' to entertain such persecution of minorities. More probable is radical reform. In the context of Japan it is going to be concrete, sweeping and probably economically-focused.

NZ Property Guide Philippine Real Estate GuideForeclosed Japan GuideAuthorAndrew SheldonApplied Critical Thinking | www.SheldonThinks.com

Japan's debt - is it a crisis?

Japan periodically attracts a lot of attention for all the wrong reasons. There is no question that Japan has a large debt. The question though is just how serious the 'crisis' is. I would suggest the problem is serious, by there are authors who envisage a dire crisis. Such authors conjure up a dire scenario where Japan is left with the sole inevitable need to raise interest rates, and that this will of course force up interest rates around the world. Think again.

Almost all of Japanese indebtedness is to the Japanese people. The implications are several:

1. Japan can simply raise taxes to reduce debt. This is not attractive when you are trying to encourage spending, but its not impossible when you have little choice. The GST seems to be the most popular choice, but I would not be surprises to see a land tax.

2. Japan can reduce public spending to reduce its debt obligations. This is not easy for a social democratic party, however its an option, particularly if its an efficiency drive.

3. Japan can print money to repay debts. This is easy because all the debt is Japanese, so no forex implications.

4. Japan can boost immigration. This is not a popular policy, but in some point in the future, people might accept it. I doubt it, but it remains an option. The reason is because, unlike the rest of the world which accepts immigration as an easy way to artificially stimulate domestic economic activity, Japan does it the 'real way'. Don't give the Australian govt kudos for strong economic growth when the population is growing at 2% because they doubled immigration numbers.

5. Japan can keep working harder. I really don't believe Japanese employment numbers. In any respect, a great many people in the economy are under-employed, or under-utilised. This is particularly the case with women, who remain boxed in glass ceilings, if not padded cells. There is however a huge challenges retaining these people to make them productive. I think mothering is perhaps the most likely option. :) Some of them seem pretty useless. Its hard to believe the 'real workers' can work longer hours, so I guess its more outsourcing low-value labour to China and working more efficiently. Less drinking for them, which means more for me. Sorry I'm not there!

Personally, I suspect they will do all of these to some extent.

NZ Property Guide Philippine Real Estate GuideForeclosed Japan GuideAuthorAndrew SheldonApplied Critical Thinking | www.SheldonThinks.com

Outlook for Japan could be promising

Reading the following article, you might want to consider the merits of buying property in Japan. Property markets in Japan have been overheated for some time. Japan in contrast is relatively undervalued. The question is how long will it remain in this condition. An election is due for March 2010. The question Japanese people will be asking after an annualised 15% contraction in the economy in the Mar-09 quarter, is whether they should continue their support for the Liberal Democratic Party (LDP). The LDP have enjoyed the support of the people for 5 decades - with the exception of a brief hiatus of 9 months. Most of this period corresponded to the Cold War alliance with the US.

With the Japanese economy locked in a 20 year slump, and the export slump in 2008, might the people consider a change? History suggests they are unlikely to change parties. However the long standing bear market suggests the problem is linked to the LDP and not to any particular administration.
The positives side is that the Japanese investors hold "$15 trillion in financial assets", mostly bonds and bank deposits, and "only 3.5% of it in the stockmarket". The positive is that Japanese investors have been sheltered from the economic collapse to a larger extent. The bad news is that they have had 20 years of poor returns, and their equity has shrunk significantly as a proportion of global assets, and more importantly, relative to the number of taxpayers, due to an aging population and zero population growth.
With the Japanese being the most patient slaves in the world to political mismanagement, you might ask how tolerant are they expected to be. The recovery will create a phenomenal investment opportunity because those bank deposits will find their way into the stockmarket. Clearly fund managers are waiting for a sign of political change. Unfortunately the shift in assets itself is likely to delay any shift since markets tend to over-expect prompting politicians to under-deliver.
Interestingly in the Mar-09 quarter, Japanese investors were net buyers of stocks for the first time since 1991. Already the Japanese trade surplus has collapsed. It is only a matter of time before the Japanese yen collapses as well for the following reasons:
1. The savers are not getting any younger - the percentage of retirees is increasing
2. Any recovery is likely to boost spending as well as exports. In the past only the export sector was strong. In the 'future' the domestic economy will need to be reformed, which will result in the broader based economic recovery we have not seen since the 1980s.

You might then wonder what are the implications for investors in Japan, with a falling yen on the horizon, and greater economic rigor. The problem of course is that this is a leap of faith. Japan may not recover for some time. Generally it takes an economic emergency to drive reform. In the case of Japan it might take a charismatic leader who can unit LDP party factions. There is little sign of a voter defection. Instead we are seeing a defection by LDP members into external groups. Surely this will lead to some less entrenched factional outcomes. Herein lies the potential for surprise.

A collapse in the currency is of course not good for investors, though I would expect such a collapse to be quick because broad based consumption and foreign investment (China, etc) will be more important than export surpluses. Clearly the country will need to address its lack of population growth, and such a change could be an important element of reform and recovery, and clearly good for the property market. I would however expect an increase in property taxes since the huge debt needs to be funded. The other question remains the outlook for interest rates. They will most certainly increase, but will they match the foreign increases as we look forward towards higher inflation.

Clearly Japanese stocks make a lot of sense as well. A weaker yen will provide greater stimulus to exporters. These exporters will benefit from retained earnings from offshore assets, as well as greater profitability from retained Japanese plant. Some Japanese stocks also offer excellent exposure to China.

------------------------------------
Andrew Sheldon www.sheldonthinks.com