Is Japans structural reform blocked by vested interests?

Is Japans structural reform blocked by vested interests?
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Abe’s recent re-election will bring continued commitment to reform and economic restructuring. However, domestic interest groups and economic stagnation continues to pose serious challenges.

Japan is the world’s third largest economy and has rightly enjoyed a reputation for protean abilities to adapt to challenging conditions. It was singular among non-Western states in moving from a primarily agrarian developing economy to an industrial economy after the Meiji Restoration.

In less than 30 years it went from the rigors of unequal treaties to a role as a major power. Similarly, after its loss and the destruction of WW II, it developed an export-led economy that dominated world markets in consumer electronics, automobiles, and automotive parts.

Japan’s wealth and reputation for adaptability have obscured the increasing risks the country faces and how little is actually being done to address these risks.

The resistance to change is unfortunately deeply rooted in aspects of Japan’s political culture and is unlikely to change in the near term. Earlier 1990s electoral reforms that were designed to decrease factionalism and strengthen the hand of the Prime Minister in advancing his policy agenda do not seem to have been effective.

The Stakes and Dimensions of Economic Malaise

Economic data coming from Japan signal trouble rather than recovery. While foreign investors committed record amounts of cash to Japanese securities in 2013, inflows for 2014 are down 94%. This is the lowest amount since the 2008 global financial crisis.

Japan is on the verge of another round of deflation. The annual pace of price increases fell to .2 per cent in January 2015, which was down .5 points from December. Since this is in part based on lower oil prices, it will lower Japan’s balance of payments deficit, but the overall pattern of employment and consumption remains weak.

The unemployment rate rose .1 per cent from December from the loss of 20,000 jobs. It is hoped that an overall unemployment rate of 3.6% will have companies in search of workers and ultimately lead to higher wages.

Nevertheless, real household consumption dropped .3% between December and January. However, the devalued Yen has led to increases in the export sector and a 4 per cent rise in industrial production over the month of December.

One of the leading sources of Japanese debt is the energy sector. The closing of nuclear power plants in the wake of the Fukushima-Daiichi meltdown produced Japan’s first balance of payments deficit in 31 years.

Japan is the world’s largest importer of natural gas and the third largest importer of crude oil. Japan is therefore very vulnerable to price shocks and the disruption of supply routes.

Recent agreements with the United States and Mexico will shift Japanese dependency on natural gas to cheaper North American sources but not until 2017. In the meantime Japanese households now face 20% higher energy costs than in 2011.

Changes in the structure of the workforce hinder aggregate consumption. While Japan was know for its lifetime employment, tightly structured career paths, and CEOs who made only ten times the salary of the average worker, this has changed over the past 35 years.

In 2012 38.2% of Japan’s workforce was composed of “non-regular employees.” This category, which also includes part-time workers, is paid less and lack regular employment benefits. Their average yearly salary is about $16,400 as compared with $47,000 for regular workers.

In the aggregate, the lost wages for the estimated 20 million workers employed amounts to 60 trillion yen or roughly $494 billion. Were these positions restored to regular employment, it would clearly raise the aggregate demand needed to end deflation.

It could also provide the income needed for younger workers to enter into marriage and increase the overall population. In 2012 Japan’s population fell by at least 284,000.

The Japanese economy suffered a short-term recession in 2014 following a 3% raise in country’s consumer tax. While consumption was strong as consumers bought what they could before the onset of the tax increase, the economy shrunk by 6.7% in the quarter following the increase, and experienced a 2.3% slump in the third quarter.

The December quarter was slightly positive with a .1 per cent rise in business spending and a .3 per cent rise in consumer spending. The IMF forecasts only .6 per cent GDP growth in 2015 and .8 per cent in 2016.

Japan’s public debt to GDP ratio in 2014 is 246.2 and is the highest in the world. It is marginally higher than its 245.0 score of 2013 and significantly higher than its 229.6 score in 2011. By comparison Greece has a score of 180.2.

Conservative Resistance to Reforms

Much of the commentary on Abenomics has focused on the need for the “third arrow,” or need for the restructuring of the Japanese economy as a key to success. This makes sense since fiscal and monetary stimuli will offer limited effectiveness without reforms that create new investment and employment opportunities.

The problem is that the protectionism that counters reform efforts is deeply rooted in special interests and national culture. It is difficult to challenge.

Even Prime Minister Koizumi’s signature legislation that supposedly privatized Japan Post is still in limbo a decade hence. The government’s plan to sell shares in the giant financial institution has been blocked by other financial firms. The projected $7 trillion yen to be realized by the sale was intended for tsunami reconstruction.

Prime Minister Abe has actually come close to following the Koizumi playbook in terms of nationalism, some militarism, and in appointing ministers from resistant LDP factions to press his case with them.

Like Koizumi, he even held a snap election to bolster support for his reforms when his approval ratings dipped, Unfortunately he is also doing relatively little to expose the sheltered domestic economy to foreign competition. His reforms seem incremental at best.

The government’s plan for agricultural reform is to let non-farm companies to raise their ownership share in agricultural companies from 25-50 per cent. This is to reduce the influence of JA-Zenchu group that represents agricultural cooperatives and routinely oppose free trade agreements.

The overall plan is to expand farming and fishing exports tenfold by 2030. This is especially designed to redevelop the areas destroyed by the tsunami but also to increase cooperation between prefectures and reduce competition domestically.

None of this will solve the fundamental problem of protectionism. Japan has long maintained a 778 per cent tariff on imported rice. Similar protections and price supports on five key protected agricultural products has led to expenditures of up to six times the global price for Japanese consumers.

Japanese households spend 14 per cent of their disposable income on food as opposed to under 7 per cent for American households:

Ratio of domestic producer prices to world prices for select agriculture products

 

Abe has voiced support for Japanese entry into to an extensive Asian free trade agreement named the Trans-Pacific Partnership and led by the United States, but his orientation is telling.

In response to a questioning of whether U.S. concerns about automobiles and Japanese concerns about agriculture would block the TPP, he said that he hoped the agreement would help make Japanese agriculture more competitive.

He’s concerned about exports and not imports. He’s also adopted the LDP language of referring to rice, wheat, beef, pork, dairy, and sugar as Japan’s “sacred five” in discussions with farm interest groups.

Earlier, Koya Nishikawa, Chair of the LDP TPP committee, told TPP national delegates in Bali that the tariffs were now subject to review. The LDP leadership has reminded the press that the “sacred five” was a precondition for Japanese participation in TPP talks.

Overall, Japan was only proposed tariff elimination for 85 per cent of imports while other members are proposing 95-100%.

Labor reform is also unclear. To protect against inflation the government helped foster an agreement between unions and businesses, which included a commitment to higher wages, just before the snap election.

Little has been done for temporary workers, except for recent change in regulations that would no longer require firms to hire temporary workers as regular workers after three years of service.

After his snap election victory, Abe renewed his commitment to overturn the Article 9 pacifism clause in the constitution. He may well have a common interest with Xi Jinping in stirring nationalist sentiments to remove public attention from continuing economic malaise.

Categories: Asia Pacific, Economics

About Author

Lawrence Katzenstein

Lawrence Katzenstein has taught at the University of New Orleans and the University of Minnesota. Through an affiliation with the Humphrey Institute he was one of the trainers for the initial Chinese WTO delegation. He has been an exchange professor at the Consolidated Universities of Shandong Province and an embedded social scientist with the U.S. Army in Iraq. He earned a B.A. in political science from CCNY and an M.A. and Ph.D in political science from Rutgers University. While at the University of Minnesota he also completed a teaching post doc in International Business.