Insufficient, Unpopular Measures

This strategy will fail for a number of reasons. The simplest is that Abenomics will not compel Japanese companies to sufficiently expand domestic investment. Companies went abroad to avoid the extremely high cost of manufacturing in Japan, much of it due to high labor costs. China is both a key market for the products produced by these companies and has a strong production base with low labor costs.

To date, Abe’s policies (particularly monetary easing) have done as much damage to ordinary Japanese consumers as they have helped, simply because they have raised prices. The main reason that this damage has not politically crippled the administration is that low energy prices have given consumers a boost. Large corporations with overseas operations have benefited from a weak yen, but ordinary Japanese consumers and small businesses with domestic operations have only experienced rising costs. Base-pay hikes at major Japanese companies will help boost consumer spending in the second half of 2015, as will the recovery from last year's consumption tax hike, but given Japan’s employment situation it is unlikely that these wage hikes will make a significant, lasting difference in consumption levels. At the same time, demographic decline will drive down the number of potential consumers more quickly each year.

Abenomics will also likely fail to boost domestic investment by Japan’s industrial conglomerates. One solution would be to bring in investment from non-Japanese companies overseas. This would require the deep deregulation of long-protected industries, a relaxation of labor controls and the uprooting of deep cultural norms. It would also require Japan’s accession to the Trans-Pacific Partnership and the rapid development of a Japanese Silicon Valley. Together, such radical moves could be enough to draw substantial investment away from the United States, Europe, South Korea and China in just over a decade. Such a scenario, however, would need measures much broader by far than anything Abenomics has considered. It would mean a revolutionary break with the post-World War II order and truly profound adjustments. Such changes would encounter substantial opposition from the industrial keiretsu (Japan's powerful integrated business groups) and key electoral constituencies. More likely, overseas investment into Japan will remain around current negligible levels: $2.3 billion in 2013 compared with $135 billion in outbound investment.

Laying aside the need for more ambitious measures, several short-term factors could undermine even the basic reforms that Abe wants to roll out. The Bank of Japan is currently purchasing bonds at a high rate. It is unclear how much longer this can continue before the market tightens to the point of dysfunction. If the Bank of Japan is forced to pull back before inflation reaches the 2 percent target, Japan could experience a return to deflation. If the Bank of Japan's rapid purchase of debt leads to a debt default or some other catastrophic event, it could well trigger the fundamental break in Japan's current order that Stratfor anticipates. However, a default is unlikely.

But more pressing than these financial considerations is the potential erosion of public support for Abenomics and for the administration itself. Without a surge in corporate investment and a hike in full-time jobs to counterbalance it, Abenomics will have primarily negative effects on the population's quality of life. The initiatives would reduce the value of savings, raise the cost of living, contribute to perceptions of rising inequality and leave the workforce vulnerable to layoffs. The last of these will most acutely harm the very corporate employees that form the backbone of the Liberal Democratic Party's "organized vote." The electorate is already uneasy about the prime minister's reforms and many voters have continued to support the Liberal Democratic Party only because the opposition is hopelessly fragmented. Their negative perceptions will only grow given the outlook for corporate investment and consumer spending. Thus, Abenomics in its current form probably will not last beyond 2017.

Part 4

Summary

Editor's Note:Since the end of the Cold War, the Pacific Rim has seen China rise and Japan stagnate. However, Japan is approaching an epochal shift that will enable it to challenge the current order. This analysis is the fourth and final part of a series that forecasts the nature of that shift and the future of Japan. Part one explored the origins of Japan's slow-burning crisis. Part one explored the origins of Japan's slow-burning crisis. Part two examined the rise of China and its impact on Japan. Part three assessed the failure of Tokyo to enact meaningful reforms.

In the coming years, Japan will transition out of its slow-burning state of crisis as it seeks to make a radical break with its current, decaying Cold War political order. The transformation will take place against the backdrop of significant demographic changes. Since 2005, Japan has seen its 65-and-over population grow by more than 33 percent, faster than any past or future forecast rate. Over the next decade, this rate of aging will slow substantially, as will the decline in Japan's working-age population. These trends will persist until around 2040, when most of those born in the country's 1968-1976 baby boom will have entered retirement. Then, between 2035 and 2045, the rate of the working-age population's decline will pick up slightly, increasing pressure on the system. By 2060, the situation will become dire. Even under constant fertility conditions, Japan's population will fall to around 86 million; if fertility declines, population levels will drop further still to 79 million. As a result, Tokyo will likely be increasingly confronted with internal issues related to economic and social management in the years after 2040.

Analysis

In the next five years, Japan's break from the post-Cold War period will begin. Tokyo will start to dismantle key elements of its current political order and the reforms that have made that order more democratically accountable. The process will require substantial changes in the relationships between the Liberal Democratic Party, civil service and keiretsu, and Tokyo will have to find some way to curb or eliminate the electoral strength of economically non-competitive public utilities while offsetting the growing power of the over-65 voting population. Meanwhile, the Japanese government will need to make reforms to improve the productivity, efficiency and competitiveness of Japanese businesses. Only these changes will ensure that Japan can cope with the acute population aging and workforce shrinkage it will face in the decades after 2020 while guaranteeing the country's national security.

Over the next two years, Tokyo will focus on achieving Japanese Prime Minister Shinzo Abe's "virtuous circle." Each of Abe's proposed economic reforms aim to address the root causes of underemployment, with the hope that higher employment will drive up domestic consumption, thereby boosting the economy and raising employment levels even further. This cycle will need to be in place before the Bank of Japan pulls back on monetary easing or the central government is forced to improve its fiscal position by raising the national sales tax or increasing corporate taxes. The bank's current rate of bond purchasing is unsustainable, and Stratfor expects that the Bank of Japan will cut back on its bond purchases, perhaps significantly, before 2017.

While the prime minister's "Abenomics" measures will make some progress before 2017, the administration's efforts are not extreme enough to put Japan back on the path toward sustainable growth within the next two years. The weak economies of both China and Europe – key destinations for Japanese exports – will make this outcome even more unlikely. Therefore, when the Bank of Japan inevitably pulls back on its bond purchases, Japanese companies with extensive overseas operations will see repatriated funds decline in value, which will reduce their incentive to invest domestically. The cost of Japanese goods will also rise yet again, eroding the country's competitiveness with China and South Korea.

The drawdown in bond purchases and declining investment will lead to fiscal deficits for the Japanese government, putting pressure on Tokyo to raise taxes on either companies or individuals. Whichever Tokyo chooses, by the start of 2017, it will once again find itself facing a dilemma after a short period of economic growth.

But Abenomics will not implode. The Japanese government will likely find a way to avoid defaulting on its sovereign debt and the Bank of Japan will manage to implement a modest amount of monetary stimulus without undermining the country's sovereign debt markets. Inflation may hit 2 percent, wages may rise and Japan will likely succeed in attracting some foreign investment into long-protected sectors and new industries. Abenomics is fundamentally sound and economically rational, but its economic benefits in the long term will be preceded by hardship for individuals. In 2016, as Japan's growth picks up, these side effects will become slightly less glaring, but if the Bank of Japan pulls back on bonds and the government raises taxes, they will resurface.

Life will not substantially deteriorate for ordinary Japanese people, but events will hurt the prime minister and his administration at the polls. Abe survived the December 2014 elections because of an incoherent opposition, but Japan's fragmented playing field will not last forever. By 2017, dissatisfaction among older voters, especially those with ties to the agriculture lobby or to other keiretsu, as well as middle-aged and older small business owners, will begin to undermine Abe's electoral position.

A Quiet Revolution

The fate of the Abe administration will have relatively little bearing on whether the core policies of Abenomics persist. Over the next five years, two trends will emerge, the first being the rise of a new generation of bureaucrats dedicated to the reforms necessary to ensure Japan's long-term security. At the same time, an older population averse to those reforms, especially military normalization, will come to dominate the electoral system. Since avoiding reform is not an option, the government will move away from a system of electoral democracy.

Japan will continue to hold regular elections, and parties will exchange places at the head of Japan's legislature. Beneath the surface, however, the ministries that make and implement policy will begin to reassert their autonomy from the legislature. This will reverse two decades of reforms aimed at strengthening Japan's legislative and judicial branches and increasing the major parties' power relative to key ministries, harkening back to the early post-World War II decades when the bureaucracy was autonomous from politics and informally controlled the nation. This autonomous civil service itself had roots in a much longer tradition of governing through a small cadre of administrative elites that reaches back to the Meiji Restoration and deep into Japan's feudal past. Once the new generation of administrators has secured its position, it will work to ensure that the core elements of Abenomics survive.

China's Continued Rise

Over the next five years, the regional security situation will become increasingly volatile; economic dislocation and political turmoil within China will combine with China's expanding military power. Urged on by the United States, Japan will become more proactive not only in its own maritime patrolling and reconnaissance activity but also in deepening cooperation with Southeast Asian partners. The sheer quantity of vessels and aircraft deployed in the region will raise the risk of short, sharp crises. Such incidents will ultimately serve to bolster popular support within Japan for a defense posture against Chinese aggression.

Greater volatility in the Pacific will fuel the rise of the new generation of activist bureaucrats and keiretsu leaders by underscoring the need for reform. By 2020, these rising civil servants and business leaders will have made significant headway in consolidating their influence within key ministries. Meanwhile, Japan will seek to capitalize on the increased integration of the Association of Southeast Asian Nations to expand Japanese influence in Southeast Asia and nearby India. Japan will pursue these goals with an eye toward containing Beijing, but they will yield benefits independent of China.

Date: 2016-04-22; view: 719