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.

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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!

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Is the DPJ doomed? Not just yet.

I get the sense that Japan is looking at another substantive shift in its political game; though nothing transformational to be sure, at least not at this point. Some 9 members of the Democratic Party of Japan (DPJ) have resigned as a result of the party's decision to increase the GST (consumption tax) to 10%.

I totally agree with their position. There is no question that the Japanese government needs to raise taxes to pay off its 'internal' debts, but taxing consumption is not the way to proceed. It ought to be taxing assets - most particularly land. Probably the best approach would be to totally cut off funding for the provincial governments and allow them to raise local government rates. This would offer some form of competitive pressure, as well as make these governments independently accountable.

It looks like we might be looking at a 'no confidence' motion in the Japanese PM, and thus a new election...unless a new political leader emerges. I'd say we might be looking at a return to the alternate party.

It must however be acknowledged that this could be considered 'posturing' by local party members trying to save face in their local electorates. i.e. Essentially such posturing entails playing musical chairs or erecting Chinese walls, where you resign from one party, set up another, and pretty well function as an pseudo-independent faction. How long can this go on? Well, musical chairs can go on for a long time if you keep changing political candidates at every election. Good luck with that game!

See the latest news at Japan Times.

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

Political transformation could aid property in Japan

The spectre of a political revolution in Japan might occur sooner than you think. Political crises have always been a strong factor driving reform. Most often change occurs because of crises. Things get to a point when something has to give. Maybe it was the national debt – currently in excess of 200% of GDP. Yes, I know, its owed to Japanese people, but it either has to be paid by taxation, immigrants or currency debasement.

In recent times, we have also pointed to the prospect of political change driving political reform. We see evidence that this is already happening.

Osaka Governor Toru Hashimoto has established a new party One Osaka comprising 82 candidates, among them 40 former LDP members, who will contest the local elections next spring 2011. The Japan Times is comparing the development with the “Meiji Restoration's abolition of the feudal clan system and the establishment of the prefectural system”, and rightly so. It conveys a mass realignment of political interests.

The Osaka LDP chapter has taken steps to expel the 40 LDP members from the party in a bid to stem the tide of party defections. The reality is that any sign of popularity for this party is going to result in even more defections. We might ask however – is Hashimoto such an inspiring leader? What can he do if he becomes PM, given that his supporters might comprise the old members of the LDP? Isn’t it just the same? Perhaps the difference will be the amalgamation of all pro-reform members in the parliament. So what will unite them other than rhetoric? Is there any basis for consensus? It’s hard to say. But change can’t hurt. We will have to watch to see whether there are further defections on a national-scale. Already there is talk of a coalition between Hashimoto’s One Osaka Party and Your Party, which holds 10 seats in the Upper House and shares a number of policies. Expanding the coalition prior to next spring's local elections and the 2013 Lower House election is likely envisaged.

Hashimoto established One Osaka to unite support for his fiscal and bureaucratic reform plans to integrate Osaka City with Osaka Prefecture to form a ‘united’ Kansai state. Unfortunately the party’s plans seem to focus upon public works projects in order to facilitate more trade. This policy platform strikes one as more of the same.

The question is whether these former LDP members will form a national government in the future with the LDP, or will they end up forming a coalition with the DPJ? Probably the former with new, hopefully inspiring leadership, but I see no evidence of that. It looks like change for change's sake.

Of course these developments are important because they could give support for Japanese property investments.

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

Philippines property - contrarian investment

Property investors beware. You are about to be introduced to one of the best opportunities to buy property you will ever have. The Philippines has long been the 'dislexic' tiger of Asia. It always had a lot of promise, but it could never overcome the legacy of corruption and inept administration. There is perhaps ever reason to think that a solution is not far off, but it will be another 6-8 year. In the meantime, there is every reason to think that the economy will perform ok.

There is good reason to think you will get a great opportunity to buy property there. The reasons are explained in this post I wrote about the current president Noy Noy Aquino. I believe there is very good reason to expect a 'Thai style' military coup. This is of course the time to research, to set up your bank account, and to be ready to transfer funds. During the last crisis - the Asian Currency Crisis - a large amount of money was made and lost.

The implications are that you will never get a better chance to buy property in the Philippines. Any such military-police takeover of government will result in the Philippine peso plummeting to new lows. Check out the currency here, whilst I have indicated support levels on the following chart.

This is the time to be a contrarian investor - both for foreigners and Filipino expatriates. The Philippines is a good long term story. The population is growing at 2% per annum, the economy benefits from a lot of remittances from expatriates abroad, it is the focal point for outsourcing of Western businesses professional services like call centres, etc. The benefits will not be confined to Manila. It is also just a 'stones throw' from China, so expect a lot of tourism, investment when China becomes overheated. The Philippines already has a large Chinese community.

We have written a Philippine Real Estate Guide (2 eBook set) which describes the opportunities in the Philippines property market.

Philippine Real Estate Guide

Foreclosed Japan Guide NZ Property Guide AuthorAndrew Sheldon Applied Critical Thinking | www.SheldonThinks.com

Election implications for Philippines property

I was actually in the Philippines immediately after the election result. Just for 6 weeks mind you, but long enough to observe some of the political play, as well as time for a holiday. I visited Camiguin Island and Puerto Galera. Camiguin Island was recommended to me years ago by a resort developer there. Having been there, it has some attractions, but its way too under-developed. I will publish a separate post on the place, as well as Puerto Galera for property buyers interested in those places.

El Nido, Palawan, Philippines

My assessment of the election is that the economic spending will fall a bit after Arroyo's unsustainable 'spend' on roads. I am suspicious of the new president Aquino's anti-corruption credentials based on some statements, but his appointments look credible. He has conveyed that his economic policy is the same as Arroyo by appointing her finance minister. The Philippines GDP grew 7.1% last quarter....as anticipated by us 18 months ago. The fundamentals for the Philippines are very good. A lot of construction going on, remittances continue, call centre business grows. Expect the poor Aussies and Kiwis, etc to come over for their dental services next, and Americans for their 'uninsured' medical. Out-sourcing continues.

NZ Property Guide Philippine Real Estate GuideForeclosed Japan Guide AuthorAndrew Sheldon Applied Critical Thinking | www.SheldonThinks.com

Election implications for Japanese property

The upper house elections in Japan did not deliver the desired two-house majority for the Democrat Party of Japan. Who is to know whether they will be able to get a reform agenda going. One might hold out for the prospect of defections from the LDP if they prove to be obstructionist. There is a lot of discontent in this country...so reform will come eventually. I think the Democrats are still trying to develop policy. Anyway, yields are ok in Japan. One of my readers tells me they recently bought a high rise building in Osaka offering a 12% yield. No other data that that sorry!

The reason for the decline in support for the Kan-led DPJ administration is talk of an increase in the consumption tax. Clearly people want to see support for consumption or domestic demand to support jobs. Really, however the nation needs to cut costs and raise money from wealthy land-owners who will not be spending anyway. I am not a supporter of taxation, lest not welfare states, however the budget does need to be balanced, and assets ought to be taxed not income in these times. I would not be surprised to see a property tax increase in Japan in order to address the budget deficit. Japan's taxation as a % of GDP is on par with the USA, at 27-28%. I suggest in these times it ought to be taxing assets not private spending, since there is a critical need for it to cut government spending. Taxing assets will place pressure upon asset holders to increase the return on those assets, or dispose of them, such that others might.

Japan has long suffered from a lack of leadership. Kan is accused of speaking idealistically when he mooted the idea of a consumption tax. The problem is not his honesty (i.e. revealing a tax prior to an election), but rather his lack of a comprehensive plan. The problem with Japan is that it lacks 'Western-style' or 'inspired leadership. I don't mean Obama of course.... I mean ME! ME!

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

Forthcoming Upper House elections

Six months ago we highlighted the importance of the forthcoming July Upper House elections.

No factor offers greater prospects for reform than a two-house majority by the DPJ. There is no question that a long period in opposition will help to preserve this coalition together, as well as increasing their zeal for reform. A greater deal of voter support I think can also be expected, particularly given the frustrations with the LDP.

During this period PM Hatoyama needed to convince the electorate of his leadership skills in order to secure a majority of the Upper House. This would have given him control of both houses, which would have allowed him to achieve substantive reform in Japan.

Critics will argue that Hatoyama was a 'lame duck' PM. If I allow myself to be generous, I suspect that he tried to be uncontroversial in these first 6 months in the hope that he would win popular support by avoiding controversy. This strategy has clearly failed him. On the 2nd June 2010 Hatoyama resigned as PM.

His failings were that he allowed seemingly uncontroversial issues like the relocation of Futenma air base, as well as party funding anomalies to define his administration. I think this created the perception that he lacked depth. He was trying 'safely' to secure both houses of parliament. Yet, I think it was the most honest Japanese political administration in a long time. If we reflect on what he did achieve - they were:

1. Child allowance

2. Abolition of public school fees

Clearly these policies were for the liberals in Japan. I suspect though that once a two-house majority had been secured, we might have seen significant reform.

Both Hatoyama courted controversy by receiving large sums of money from his mother without paying gift taxes. Hardly a huge breach of ethics given that it was for a public purpose, and in most countries political donations are tax-deductible.

The resignation of Hatoyama and Ichiro Ozawa allow for a fresh stand before the Upper House elections. The question is whether the new PM can achieve the community support he needs to win the Upper House. This is a big ask just a month out from an election. The leader will need to do a lot of campaigning. Any politician does start out with good ratings, though they also start with some history.

The most likely new PM is Naoto Kan, who served as DPJ president in the past, has been deemed by some as the top contender to lead the nation.

Another option is Foreign Minister Katsuya Okada.

Kan, a former health minister who rose to fame for exposing in 1996 the ministry's responsibility for the spread of tainted blood, has kept his distance from the contentious Futenma air base relocation issue (unlike Okada and land minister Seiji Maehara).

It will be interesting to see if the Social Democratic Party rejoin the ruling coalition, as the DPJ currently have a slim majority in the Upper House. In the DPJ's favour is that the LDP has also experienced its own form of controversy with a series of defections and internal bickering. The new leader will need to win over the hearts and wins of swinging voters dismayed by both sides of politics. Cabinet's approval rating has fallen from over 70% after the election to just 20% today.

So what would Kan do for the party. He has indicated little change in the direction of the party, which is a positive. He remains committed to the US alliance, and his focus will be job creation in daycare services for children and the elderly. This party is attempting to be the voice of the young, trying to achieve generational change.

Tarutoko, also vying for the PM role, has pledged to reduce the number of Lower House legislators by 80. Transport minister Seiji Maehara intends to support Kan. Senior Vice Finance Minister Yoshihiko Noda, leader of an important faction critical of Ozawa, is also supporting Kan.

The new PM will be established by 11 a.m. Friday to be voted in as prime minister, so a new cabinet will be announced soon after. The DPJ holds a strong majority in the Lower House. The fact that Kan will have so little time, will not aid his cause, but he at least over other candidates, has a lot of parliamentary and leadership history to be judged upon, and not so controversial. Kan has signalled that he will increase taxes to reduce the growing public debt. Kan will also be one of the few PM's not to come from a political dynasty, i.e. The last since LDP lawmaker Yoshiro Mori in 2000.

Given that Kan has signalled higher taxes, and these were always expected, it will be interesting to see where the increased tax burden will fall.

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

Japan's political reform in doubt

The latest news from Japan suggests that the chances of reform under the current PM Yukio Hatoyama are quickly deteriorating. The Democratic Party of Japan lost a local election in Nagasaki. I consider that less important considering that their candidate was a bureaucrat, and he was beaten by the Vice Governor. The more important issue is opinion polls, which are being shaped by the financial scandals. They have a few months to turn those fears around, otherwise we are looking at a 'hung parliament', which is not the best basis for reform. See the full story here. Ideally I would like to see the DPJ given a majority in both houses in the June 2010 elections.

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Best buying in Japanese foreclosed property

We have just released our Japan Foreclosed Property eBook (3rd edition). For those of you not aware, this is probably going to be the best 2 year period for buying foreclosed property. There are three compelling reasons:
1. The Japanese elections in mid-2010 could result in the Democratic Party of Japan holding a two house majority in which to make substantial reforms.
2. The Japanese public debt has reached a point (200% of GDP) at which it is going to struggle to raise money. It has been forced into a corner. Going to the international market would mean much higher interest rates. It has to reform and slash costs. The DPJ is waiting for that election. It needs a majority in both houses.
3. The high public sector debt essentially places a ceiling over Japanese interest rates for the next 5 years, if not longer.

The implication is that you are going to have low interest rates looking forward, and you are going to see reform which boosts real incomes. These rises in income will flow through to asset prices like property and equities. Want to know more about the Japanese foreclosed property market.... all is explained in the following Japan foreclosed property report. Why rent in Japan when high yields favour owning property. You can buy a house for as little as 1-3x your annual income.... if you buy in the suburbs like Sakado (less than 1 hour from Tokyo).

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