STRATFOR ANALYSIS

Japan’s Prime Minister and economy share the same fate

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Japan’s ruling party was expected to perform well during the country’s July 10 parliamentary elections, but the victory it clinched was even bigger than most predicted. Prime Minister Shinzo Abe and his coalition, led by the Liberal Democratic Party, garnered 60 percent of the popular vote as well as the support of parties outside the ruling bloc. The widespread support will give Abe the supermajority he needs to pass constitutional amendments — a highly sought-after power for an administration tasked with turning the Japanese economy around.

The vote confirms that although Abe’s popularity has waned in recent years, his leadership remains unchallenged. The prime minister was re-elected in September to lead the Liberal Democratic Party after running unopposed, and fragmentation among Japan’s disorganized opposition groups continues to limit their effectiveness. But as Abe’s economic strategy struggles to get off the ground, his political future will become closely linked to its success. Should Abenomics continue to founder, support for the prime minister and his party may begin to waver. If it succeeds, however, it could open the door to an extension of Abe’s term at the head of the ruling party and snap elections in the lower house of the National Diet.

Breathing life into Abenomics may be easier said than done, though. Numerous factors are working against the prime minister, and many of them are beyond his control. The Chinese economy is slowing and has shown no signs of picking up anytime soon. This bodes ill for Japan’s own economy, since China is its second-largest trading partner, accounting for some 17 percent of Japanese exports in 2015. To make matters worse, the vast majority of Japanese products heading to China are high-end manufactured goods, such as semiconductors, electronics and vehicles — products that China’s coastal manufacturing zones are beginning to make themselves.

Europe, meanwhile, is slowing down too, particularly in the wake of Britain’s decision to leave the European Union. Though Japan’s direct exposure to the fallout from the Brexit is fairly minimal, the volatility shaking the Continent to its core will disrupt the yen as well. Despite its low levels of growth over the past quarter-century, Japan is still seen as a stable economy that will attract investors looking for safe places to send their money as they pull it out of Europe. The influx of cash will push the value of the yen up, reversing the depreciating effect Abenomics has had on the currency so far.


Insurmountable obstacles
Unfortunately for Abe, his primary tools for countering these external forces in the short term — quantitative easing and a flexible fiscal policy — either have already been exhausted or will delay the other promises of Abenomics. Quantitative easing is approaching its limits, at least in its current form, and the Bank of Japan will soon have to find a more sustainable tactic for introducing stimulus than buying up government bonds. Amid expectations that the central bank will boost its quantitative easing efforts to offset the Brexit’s effect on the yen, bondholders will become more reluctant to sell their bonds, which will make it even harder for the central bank to continue relying on bond-buying to expand the money supply. The Japanese government has already lowered its projections of success accordingly; in the wake of the elections, officials announced that they hoped to raise the consumer price index by 0.4 percent by April 2017, far less than the 1.2 percent target announced in January.

At the same time, Abe’s aggressive expansionary monetary policy and repeated delays of a sales tax hike have pushed back Abenomics’ long-term fiscal consolidation goals. One of Abenomics’ key platforms states that tax reform will rein in Japan’s growing national debt by 2020. (At the end of 2014, Japanese debt equaled roughly 250 percent of the country’s gross domestic product.) With additional stimulus on the horizon this year and sales tax increases now put off until October 2019, it is unlikely that Abe will be able to shrink the government’s debt in any notable way before his time in office ends.

External challenges are not Abe’s only concern, either. Perhaps the biggest long-term problem facing the prime minister — and the one he has the least control over — comes from within: Japan’s rapidly aging society. From 2010 to 2015, the country’s population between 20 and 64 years old fell by 5.5 percent, and it is expected to drop by another 4.1 percent over the next five years. Though Abe’s encouragement of women in the workforce can mitigate some of the impact that this trend will have on the labor pool, it will not change the fact that older citizens tend to be savers rather than consumers. This will make it even more difficult for the prime minister to engineer the cultural shift toward consumption that Abenomics calls for.

Beyond consumption, the transition of corporate leadership to younger generations has stalled. Elderly CEOs are hanging on to power for longer, leaving their younger successors with few opportunities for upward mobility. Former SoftBank President Nikesh Arora, blocked by an older CEO who has held the post for some time, quit for precisely that reason.

An uphill battle
Abe has had some success in pushing through structural reforms aimed at addressing these issues, but few of his initiatives have fully materialized. In theory, the prime minister’s newly obtained supermajority should ease further reforms’ path through the legislature. But the Liberal Democratic Party is split between several factions, some of which want greater market liberalization while others would prefer to protect Japan’s entrenched corporate interests. The ruling party has long maintained close ties to the country’s business elite, which has historically impeded its efforts to enact complicated structural reform. The sole exception to this norm was former Prime Minister Junichiro Koizumi, who promised the people ‘’economic reform with no sacred cows.’’

To his credit, Abe has managed to consolidate enough power in the Liberal Democratic Party to become Japan’s longest-serving prime minister since Koizumi. In fact, his time in office will likely surpass Koizumi’s in the end, despite the fact that Abe has spent much of his political capital on breaking down the Japanese agricultural lobby and forcing through the Trans-Pacific Partnership. Neither was an easy task, nor are the two that Abe will now have to turn his attention toward: labor and immigration reform.

Japan’s overly burdensome labor system is marred by chronic underemployment, low productivity growth and stagnant wages. This can be blamed in part on the country’s traditional compensation scheme, which has been in place since the 1950s. The scheme’s seniority-based pay is designed to foster employee loyalty, but in practice it has had the unintended consequence of reducing labor mobility and flexibility by encouraging workers to spend their entire careers in one firm.

Japan’s shrinking working-age population, meanwhile, has added a new sense of urgency to the country’s need for immigration reform. Yet such reform has been slow to emerge, and it may ultimately prove the most difficult to enact, given the social and cultural hurdles that would have to be overcome among Japan’s ethnically homogenous communities to pass it.

Either way, Abe faces an uphill battle in getting Japan’s economy back on track, and it may cost more political capital than he has to spend. For now, his party stands united behind him. But the Liberal Democratic Party has a history of factionalism. Should the Japanese people grow tired of waiting for Abenomics to work, Abe could see challengers arise from within the ranks, threatening his hold over both party and country.

©2016 STRATFOR GLOBAL INTELLIGENCE

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