Political opportunities squandered in Japan - until now

Japan has over the last decade struggled to kick-start its economy, though the current round of Abenomics is certainly the most persuasive reform effort yet. On the last attempt Japan fell back into a "triple-dip" recession (recording two quarters of negative GDP growth) in 2014,[i] after the GST increase to 8%. The economy did return to growth by the end of the year (with GDP expanding 1.5% in the March 2014 qtr),[ii] however the growth was far below expectations given the stimulus supporting the program. There was simply no reason to expect stronger household spending as long as wages stagnate.

There has been a long-standing opportunity for Japan to reform. The task would have been far easier if the nation had taken such measures whilst the global economy was ‘humming’, but such opportunities were squandered due to:

• Controversial corruption allegations (with respect to political donations) against a raft of PMs, political leaders and Diet members[iii]
• Reticence on the part of Diet members to expose their constituents to reform
• Historically an absence for a policy imperative outside of the bureaucracy

Abe was able to resurrect a party coalition with a substantial parliamentary majority, but was not able to achieve any concrete progress with structural reform, which led to his electoral demise in his first term. It was only the ineptitude of the DPJ and his resounding win in the December 2014 election[iv] that seems to have allowed him to mature as a political leader, giving him the time to challenge entrenched interests.

Latest efforts to invigorate Japan

Poor economic data in this latest July-2015 quarter has given market analysts reason to expect more stimulus from the Bank of Japan. Paradoxically, Japanese stocks rose on the announcement, which goes to show that investors are favorably disposed to any effort that supports asset prices, whether ‘real’ or ‘illusionary’. It does not matter if there is confidence in the reform process or not, as long a there is concurrent stimulus. Expectations for BoJ stimulus might prove wrong if instead it is the Fed that pursues stimulus. That is to say, there is a good reason to expect a concurrent Fed program to:

• Raise interest rates by 25bp in Sept-2015
• Quantitative easing in order to stimulate the US market

One might ask whether the US market actually needs such stimulus given that US employment is supposedly on the rise, and new vehicle sales are at record levels. There is other evidence however to suggest that not all is well in the US economy, namely:

• US inventory levels - see the ominous signs of recession below
• Stock and bond prices - note the tendency for stock indices to fall every 7 years (2001, 2008 and now 2015??)
• Workforce participation - trending down for a long time

Source: Trading View & Federal Reserve; trend analysis by Andrew Sheldon

Japan's benchmark Nikkei-225 index rose 0.6% to 20,637pts in response to the poor data.[v] It is possible the Japanese government will resort to more stimulus in the belief that the corporate sector is in the process of boosting investment, as well as an expected ‘flow-on’ effect from lower commodity prices, as well as reduced coal and oil imports, thanks to the recommencement of nuclear energy production by the Japanese utilities, however the contribution is relatively minor.

There is every reason to believe however that any attempt to stimulate the US and Japanese economies will achieve nothing, and that both economies are destined to fall into recession, due to lax activity in the ‘real economy’. There can be expected to be concurrent weakness in asset market.

A muted economy is of course not terribly problematic for governments when you consider that they can have confidence in:

• Their control of the process – with their limited majoritive mandate
• Moral and political relativism – constituents have little choice – and Japan is not singularly a ‘weak economy’. There is also a global disdain for government.
• Media support – the media and public are reticent to trust political opponents. Globally there seems to be a campaign of destabilisation by the media.

Evidence of slowing economy

The problem for Japan is that:

• Without substantive reform, no one will have any confidence in the sustainability in the economic outlook
• Without any expectation of a stronger global economy, more ‘currency competitiveness’ will do little to ignite export industries, since its competitors will simply resort to the same measures.
• Without the tangible prospect of more jobs and higher incomes, the prospect of higher prices will just result in a decline in real wages.

This is precisely what we are seeing, with the results for the June quarter alluding to:

• A slowing in economic activity – with a contraction in household spending and business investment resulting in an annualized 1.6% decline in GDP in the Mar-2015 quarter.[vi]
• Household real incomes falling in the wake of the GST hike, as the cost of living rises.

There are hopes within the government and BOJ that growth will eventually prevail. Economists are forecasting a modest 2% annualised GDP for the Sept-2015 quarter.[vii]

Japan is not all bad news

It is not all bad news for Japan. Consider that:

• Japan ran a current account surplus of ¥8.18 trillion for the 6 months to June 2015, the highest since late 2010.[viii]
• Japan is a big beneficiary of lower crude oil prices, significantly reducing its trade imports
• Japan is also destined to benefit from a substantial reduction in oil, natural gas (i.e. LNG) and coal imports as nuclear power generation is resumed from nuclear plants mothballed in the wake of the Tohoku tsunami disaster
•  The weak Yen is destined to stimulate growth in national income as Japanese exports become increasingly competitive. The yen has fallen 50% against the USD since the end of 2012.[ix]
• The Japanese property market is relatively ‘cheaply priced’ outside of the central business district
• Japan retains a ‘trump card’ insofar as it is able to boost immigration to ‘grow its economy’, in the process increasing demand, serving as well to reduce the burden upon taxpayers in per capita terms.
• Asset prices are bouyant, as is the case elsewhere in the globe. The Nikkei index has steadily risen to an 8-year high during 2015.[x]

Japan’s trade statistics are trending in the right direction, with the trade deficit falling to ¥422 billion (down from ¥6.2 trillion in the previous year) on the back of a 5.9% increase in exports and 8.8% increase in imports. Japan also benefits from stronger remittances of investment income as the Yen weakens, up 26.1% to ¥10.51 trillion.[xi]

The stronger trade balance is largely the result of stronger sales of automobiles and electronic parts, and yet these muted sales are largely the result of the weaker yen rather than stronger export markets. The concern of course is that Japan’s QE program is destined to see other competing nations simply resort to the same policy, rather than engaging in any steps to reform the economy, or the devaluation of their currency in the same vain. This has prompted some economists to expect a 'currency war', which will inevitably serve no one, but simply to undermine confidence in the political actors.

Another bonus for the Japanese economy has been the influx of tourists as the yen has depreciated. The Japanese government has achieved its target of 10 million tourists in 2015, having deferred the target in the wake of the Tohoku earthquake. The tourist bureau is now targeting 20 million tourists by 2020 – the year of the Tokyo Olympics, and 30 million of tourists by 2030. The trade surplus attributable to tourism was a record ¥527.3 billion in the period, on the back of a record 9.14 million incoming tourists and a concurrent 4.9% decline in departing Japanese nationals to 7.62 million. These economic statistics are based upon an average forex rate of ¥120.28 for the period – a 17.4% reduction over the previous period.[xii] Japan’s external accounts remain in good shape, with the nation recording its 12^th successive monthly current account surplus – the latest being ¥558.6 billion.[xiii]

The overarching problem

The problem however is not Japan’s external relationship with the rest of the world, but rather the alienation of its unskilled workforce and savers, who are bearing the bulk of the state’s burden. Part time work and low interest rates are undermining the wealth and income prospects for a great many Japanese people. There is every possibility that Japan will eventually cope by:

• Raising tax on assets
• Raising immigration
• Depreciating the currency
• Retaining its mercantilist policy – if it can expect to rely on any growth in the export economy
• Reforming the economy – to boost Japan’s long-term competitiveness.[xiv]

                    i.        Slashing business regulations

                   ii.        Reducing corporate taxes

                  iii.        Facilitating industry diversification

There is a great deal of concern about Japan’s debt levels. The fact is however that the debt is ‘national’ debt, just as the US debt is denominated in USD terms. Both countries are therefore not in a serious problem in these terms. 

The other problem is that the dispensation to date has been to undermine the financial viability of most Japanese people for the sake of asset-rich Japanese people who live in the middle of the cities. The central hubs of Japan have experienced an asset ‘bubble’ that has not extended into the suburban areas because their ‘negative real incomes’ and poorer job prospects don’t invite such property investment. Nor does their lack of financial literacy give them much change of raising their prospects.

The reform program to date

You could be forgiven for thinking that deflation is the intractable problem undermining Japan’s economy given the attempts to resuscitate inflation. The problem however is not deflation, just as inflation is not the solution. Deflation is actually natural and good. The problem is declining real incomes (or ‘stagnant wages’), that undermines investment and spending. There are of course economist theorists who will argue that ‘2% inflation’ is good for growth because it purportedly brings forward spending. In fact, such illusions are not valid. Certainly PM Shinzo Abe is not relying solely on stimulus. This is merely the ‘grease’ of 'monetary illusion' to lubricate the adjustment period by avoiding apprehensions. The key elements of the structural adjustment program can be expected to be:

• Ending subsidies for the rural economy – curtailing spending – these burdens are being shifted to the ‘end of term’ of the government, so they are largely weighing upon any incoming government.
• Labour market reform which was already adopted by the previous LDP PM Koizumi, and the corporate sector, when it wound back lifetime employment, and shifted a great many workers to casual labour terms.
• Reducing material costs by reducing tariffs on trade and the costs of poor regulation. This has the benefit of reducing the size of government, and improving the sustainability of government, given that it shifts the burden of government to those who can afford (by virtue of profits) away from those who can't afford to carry it.

There are of course those who will argue that 'wealth needs to be placed in the hands of the rich in order to stimulate investment'. The truth is that this fails to acknowledge the disparity or 'wage gap' because Western and third world markets. We can say that the solution to Japan's dilemma, and every Western government is to 'slash the costs of living' by effectively ending all but the basic foundations for government, and thereafter privatising those, to ensure those services are performed efficiently. Efficiently demands consequences. If governments are free to extort wealth, they will not offer good service. No country in the West defies this 'truth', except Japan to the extent that Japan's bureaucrats are motivated by simple routines and an overarching sense of responsibility for the lives of others.

Further reform areas

In June 2014, the Abe administration offered its latest outline of comprehensive reform measures, including corporate tax cuts, agriculture liberalization and deregulation of the energy, environment, and health-care sectors.[xv] A broad online of the critical reform measures by PM Abe are:

• Economic stimulus in the form of:

                    i.        Fiscal spending largely on infrastructure construction as well as ‘key strategic sectors’

               ii.        Quantitative easing to restore liquidity to the marketplace, so people can spend, and so that the resulting currency depreciation will make the export sector more competitive.

                  iii.        Corporate tax cuts to inventivise wage rises and business investment.

• Political independence – Japan has long relied upon the US to preserve its political security, with the US still preserving a number of naval and air bases in Japan, such as Okinawa and Fussa. Proposed amendments to the Japanese constitution are intended to surmount that ‘military dependency’.
• Executive disempowerment – Executive government in Japan has long struggled with a reliance upon the bureaucracy for information and analysis. Former PM Koizumi was the first to develop certain capacities within the PM’s Office to develop policy, with Cabinet having previously relied on the bureaucracy to advance policy initiatives.
• Social reform – There is a need for Japan to revise the way constituents think about the government, society, and their relationship to it. There is an entrenched ‘collectivism’ (or tribalism) in Japan that diminishes intellectual independence. The pressing obstacles include:

                         i.        Attitudes to immigration – An influx of tourists might help that, or hinder.

               ii.     Attitudes to women in the world place that has seen the erection of glass ceiling that largely dissuade women from participating in economic activity – both in absolute and qualitative terms. Female workforce participation is 10% lower than the OECD average.[xvi] The government is intending to raise this level.[xvii]

• Regulatory burden – The business sector struggles to achieve outcomes when they are subject to a litany of unnecessary impediments that undermine productivity and profitability. These impediments are largely to blame for the historic ascension of government-backed monopolies, be they private or publicly-owned, in sectors such as power and agriculture. The solution is perceived to be privatization (for instance – the utilities like TEPCO) and deregulation (i.e. competitiveness). Among these obstacles are:

                  i.        Restrictions on the hiring and firing of staff. Lifetime employment remains an obstacle to revitalisation of companies – particularly in the upper echelons of companies. There has already been a great deal of reform of the unskilled and lower echelons of Japanese corporations, however the incumbents in the upper echelons have avoided any burden. The implication is that there are about “5 million workers who can’t be laid off, even with severance pay” whilst concurrently 40% of the Japanese workforce is struggling to get regular or full-time work.[xviii] Considerable labour market reform has already seen a 6% contraction in the labour force over the last decade.[xix]

                 ii.        Certain highly regulated ‘domestic sectors’ like health. Japan's health-care providers argue the national health insurance system would be adversely impacted if Japanese citizens are forced to buy foreign-produced pharmaceuticals and medical devices.[xx]

               iii.        The construction sector still relies on its privileged access to government contracts

              iv.        The service sector is very inefficient because cultural practices are burdensome and labour-intensive methods.
            v.      Strategic changes in the tax incentives and investment model for government pension funds.[xxii]
           vi.  The Trans-Pacific Partnership Agreement (TPPA) negotiations are expected to transform, or otherwise curtail subsidies for the agricultural sector, which is small-scale, highly subsidised and inefficient. In Feb-2015, Abe reached a landmark agreement that diminished the power of the national agriculture cooperative, JA-Zenchu, to direct the electoral preferences of farmer-members, by offering short term concessions to farmers in exchange for reductions in cropping; that will facilitate the modernization of farming in Japan.[xxi]

The TPP is an ambitious plan to introduce a free trade agreement between 12 countries (The United States, Japan, Brunei, Malaysia, Vietnam, Singapore, Australia, New Zealand, Canada, Mexico, Chile and Peru) encompassing two-fifths of world trade. Abe has had to offer generous support to farmers for the next 5 years in order to advance the plan. The question is whether they will simply ‘take the support’ then sabotage the plan. In Abe’s favour is the fact that his opponents, the Democratic Party of Japan (DPJ), promoted the TPPA whilst in power. Japan has historically been reluctant to remove protection on the agricultural sector, particularly upon 5 “sacred” agricultural products. In negotiations to day, the US has been able to reduce steadfast support for protection to tariff protection upon ‘rice, wheat and sugar’ in exchange for more generous import quotas. The other contentious areas are tariffs on beef and pork.[xxiii]

The Trans-Pacific Partnership Agreement (TPPA)[xxiv] is a transformational regional free trade agreement for Japan and other Pacific Rim countries. Japan’s farm sector have lobbied against the deal, objecting to the removal of high tariffs and other protective measures.

The substantiveness of change

The problem for Abe is that all the good news for Japan harks back to ‘negative sentiments’ rather than his policy initiatives. Consider that:

• The terms of trade is positive because Japanese people are not spending
• The improvement in investment income and corporate incomes is because of currency depreciation. One need only look at production statistics. Factory output declined 3.4% in Feb-2015.[xxv]
• The improvement in exports is due to currency depreciation
• The fall in imports is due to currency depreciation, low confidence as well as curtailment of energy imports (as nuclear power stations are recommissioned).
• Rising property and bond prices are due to ultra-low interest rates; themselves an attempt to buoy demand. In years to come, those asset prices will eventually ‘return to reality’.

Almost all the rise in corporate earnings is due to the effects of a weaker yen, for example. It is nice for shareholders to see prices rise as companies buy back their shares, but far better if companies saw a compelling reason to invest to expand their core business. Unfortunately, though, the population of Japan continues to dwindle.

“In some ways Japan remains less part of the world than it was in, say, the Taisho years almost 100 years ago. [Indeed] older people say they would prefer to be looked after by a robot than by a foreigner, according to one survey”.[xxvi]

As long as the robot is operated by a foreigner, just like Japan’s software, then everyone would be happy. Satisfying Japanese people is all about preserving illusions. And yet Japanese people perplexingly and tragically see the writing on the wall.

“Many people in Japan refer to Uber as the “black cars”, in the same spirit that harks back to the “Black Ships” of Commander Perry, which forced Japan to open its trade.[xxvii]

The fact is that, unless Japan takes significant strides to open up its economy, then a great many companies are destined to abandon the economy, despite its size. The economy is struggling for its lack of ‘openness’, its lack of population growth, and falling incomes. These tragic prospects have even caused a number of Western companies to curtail their investments in Japan, namely GE Capital and Citigroup.

Japan has even struggled in those arenas where it can side-step regulatory hurdles. Apart from the success of Rakuten, Japanese technology companies in hardware have struggled to move into value-added software services (i.e. Toshiba or Fuji Film doing better than Fujitsu). The bigger problem however is that ‘success’ is not commonplace, as most companies have clung to their natural market position; the security of the domestic Japanese market. A handful of large corporations have preserved their strong market position, relying on their privileged position, rather than evolving. For instance, domestic banks have been slow to adopt web-based services, which has reduced their capacity to close branches, reduce banking fees or reduce waiting times for services.

The problems are deep-set. Education is of course another arena requiring reform, however it is not a type of reform that is going to come easy because it harks back to the values that made Japan possible – political privilege and cheap labour. Those values can no longer sustain the nation, and the collapse in birth rates provide a clue as to why the economic growth has arrested. Japan without capitulation is destined to drift into oblivion. The realisation of this fateful path is inevitably the only realisation that can spare it from this fate. There is a need for a foreigner to drive the robot, whether that robot look Japanese or Western is less important.

Autocratic teaching methods which thwart the intellectual independence of Japan’s future wealth creators can only delay the hope of Japan’s resurrection, or place the onus upon imported labour to drive that restructuring. Without suitable education, ‘new age’ start-ups will be few and far between, as their exponents will simply go abroad. Already there is evidence of Japanese ‘thinkers’ finding opportunity abroad. Japan doesn't need more Western CEOs, it needs the 'spirit' of a Western CEO in the role of prime minister, just as the West needs. This is the popular realisation behind the appeal of Donald Trump. People are looking merely at the smoke, but the reality is that Trump would not retained his popularity if he engaged with people on issues. 

Abenomics - Reforming Japan

When PM Shinzo Abe assumed office in Dec-2012, he was unable to articulate a solid reform plan. His leadership was short-lived, however the Japanese people nevertheless gave him a 2^nd term from 2006, at which point he outlined a new suite of policies to kick-start the stagnating economy. Japan was caught in the midst of a deflationary spiral for two decades, with successive leaders struggled  to revitalize the economy. Abe in in the midst of introducing a three-pronged approach, "Abenomics," combining fiscal expansion, monetary easing and structural reform, had the ultimately intent of concurrently boosting domestic demand and GDP, raising inflation to 2% and placing the economy on a competitive footing whence it could create ‘real jobs’ and expand ‘real incomes’.[xxviii]

So far the stimulus has only resulted in muted ‘growth’ as the market has not responded to the limited reforms to date. Inflation rose slightly, but in the wake of collapsing commodity prices, it has since failed to achieve the target. Abe however has not lost heart, though his support base has floundered somewhat. There is of course always the prospect of further aggressive monetary and fiscal stimulus, and further structural reforms. The fiscal measures worth Y20.2 trillion ($US210 billion) included Y10.3 trillion ($US116 billion) of government spending.[xxix] It was supported by concurrent quantitative easing by the Bank of Japan (BOJ) to provide much-needed injection of liquidity to support the spending needed to achieve 2% inflation. The structural reforms — including reductions in regulations, deregulation of labour markets, corporate tax cuts, have not achieved the much-vaunted competitiveness.

These are unprecedented levels of currency debasement by the BOJ. If you consider that:

• The BOJ debt purchases are unprecedented[xxx]
• The reliance of the Japanese government is concerning for a Western nation, and the world’s third largest economy. i.e. With the value of the BOJ assets equal to 57% of GDP in 2014 – that’s more than double the size of the U.S. Federal Reserve (25% of GDP) and ECB asset holdings (20% of GDP) respectively.[xxxi]

The fiscal stimulus has mirrored the policies of recent decades, with the primary benefactors being the construction companies that support the LDP, as well as building ‘critical’ bridges, tunnels, and earthquake-resistant roads. A relatively new aspect of the policy however was explicit measures to stimulate private investment in strategic sectors.[xxxii] Such stimulus has done nothing to rein in the public sector debt, as budget deficit persist at over 5% of GDP. [xxxiii] The deficit should fall below 3% after the GST is increased to 10%. There is every expectation of course that the GST and a revived economy will raise public tax receipts, however this has yet to prove the case. In fact, phase 1 of the GST hike to 8% in April 2014 correlated with reduced consumer spending and a recession.[xxxiv] For this reason the 2^nd hike in the GST to 10% has therefore been delayed until 2017.[xxxv] Japan is drawing no support from the global economy.

For those readers interested in our Japan Foreclosed Property Guide, we are currently in the process of updating it. Readers can however avail of the current addition, and we will forward the new edition upon completion. There will be a price increase thereafter - and it won't be 2%. lol

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

References

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[i] “Japan recession worse than first reported”, Financial Times, website, 8^th Dec 2014.

[ii] GDP result, Dec-2014 Qtr, Cabinet Office, Govt of Japan, website, 9^th March 2015.

[iii] “Shinzo Abe loses ally in TPP trade deal”, Financial Times, website, 23^rd Feb 2015.

[iv] “The Abe habit: Shinzo Abe wins again, but what will he do with his mandate?”, The Economist, website, 20^th Dec 2014.

[v] “Japan stocks rise on stimulus hopes after poor economic data”, NZ Herald, website, 17^th Aug 2015.

[vi] “Japan’s economy shrinks as consumption, investment fall”, Japan Times & Bloomberg, website, 17^th Aug 2015.

[vii] “Japan’s economy shrinks as consumption, investment fall”, Japan Times & Bloomberg, website, 17^th Aug 2015.

[viii] “Japan logs largest January-June current account surplus since 2010”, Japan Times & KYODO, website, 10^th Aug 2015.

[ix] “BOJ’s Kuroda Signals Desire for Stable Yen” by Takashi Nakamichi & Tatsuo Ito, Wall Street Journal, website, 18^th Feb 2015.

[x] “Nikkei retreats from near 8-year high as Greek drama drags on” by Ayai Tomisawa, Reuters, website, Feb 16, 2015.

[xi],[xii] & [xiii] “Japan logs largest January-June current account surplus since 2010”, Japan Times & KYODO, website, 10^th Aug 2015.

[xiv] & [xv] “Abenomics and the Japanese Economy” by James McBride, Council for Foreign Relations, website, 10^th March 2015; “Shinzo Abe updates Japan’s Third Arrow”, Financial Times, website, 16^th June 2014.

[xvi] “Japanese Economy”, Lowy Institute, website, retrieved 16^th Aug 2015.

[xvii] “Attitude change needed to shake up the workforce” by Philip Brasor, Japan Times, website, 25^th Nov 2012.

[xviii] “Which Parts of Japan’s Economy Most Need Reform Right Now?” by Stephanie Johnson, Market Realist, website, 14^th July 2015; “Japan’s Third Arrow is more like 1,000 trial needles”, Financial Times, website, 18^th June 2014.

[xix] “Abenomics can clear Japan’s demographic hurdle” by Andy Mukherjee, Reuters, website, 14^th Mar 2013.

[xx] “Abenomics and the Japanese Economy” by James McBride, Council for Foreign Relations, website, 10^th March 2015.

[xxi] “Abe’s Third Arrow Finds Its Mark” by Tobias Harris, website, 11^th Feb 2015.

[xxii] “Abenomics and the Japanese Economy” by James McBride, Council for Foreign Relations, website, 10^th March 2015.

[xxiii] “Japanese Economy”, Lowy Institute, website, retrieved 16^th Aug 2015.

[xxiv] “The Trans-Pacific Partnership (TPP) Negotiations and Issues for Congress”, Congressional Research Service, website, 20^th March 2015.

[xxv], [xxvi] & [xxvii] “Reforms needed to lift Japan’s economy” by Henny Sender, Financial Times, website, 7^th April 2015.

[xxviii] “Abenomics and the Japanese Economy” by James McBride, Council for Foreign Relations, website, 10^th March 2015.

[xxix] “Emergency Economic Measures for The Revitalization of the Japanese Economy”, Cabinet Office, Govt of Japan, website, 11^th Jan 2013.

[xxx] “Bank of Japan Beats Fed, ECB in Gulping Assets: Chart of the Day” by Toru Fujioka & Scott Lanman, Bloomberg, website, 8^th Jan 2015. See chart.

[xxxi] “Abenomics and the Japanese Economy” by James McBride, Council for Foreign Relations, website, 10^th March 2015.

[xxxii] “Japan’s Abe Unveils 10.3 Trillion Yen Fiscal Stimulus: Economy” by Keiko Ujikane, Bloomberg, website, 11^th Jan 2013; “Shinzo Abe unleashes a (small) stimulus package”, The Economist, website, 30^th Dec 2014.

[xxxiii] “Big Swings in Japan Government Bonds Raise Hopes, Doubts about Abenomics” by Eleanor Warnock, Wall Street Journal, website, 17^th Feb 2015.

[xxxiv] “Defying expectations, Japan’s economy falls into recession” by Jonathan Soble, NY Times, website, 16^th Nov 2014.

[xxxv] “Japan affirms pledge to raise consumption tax in 2017”, Financial Times, website, 12^th Feb 2015.

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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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