Talking (or not talking) about the hard issues of fiscal sustainability

Nik Gower

Prime Minister Abe speaks with confidence and conviction when he promises to make bold reforms and to drill through vested interests to rejuvenate Japan’s stagnant economy. Yet some economic experts believe the speed of reforms are not fast enough to outpace the nation’s aging and shrinking population. If so, Abenomics could be in trouble.

Take for instance the issue of the consumption tax hike. The tax hike is in the spotlight because of its recent rise in April from 5% to 8% which caused the economy to shrink more than expected. GDP fell 7.1% on an annualized basis between April and June, when it was only expected to fall by about 4%. The Prime Minister responded by saying that he remained ‘neutral’ on whether to go ahead with the scheduled tax hike to 10 percent in October 2015. Yet experts believe that a rise in sales tax to European levels is inevitable.

Here’s how two resident experts on Japan’s economy responded to the tax hike conundrum when asked by the well-known British international newscaster, Nik Gowing, “Is Abenomics in trouble?” The question was posed to Robert Alan Feldman and Jesper Koll during Monday’s plenary session at the G1 Global Conference 2014 organized by GLOBIS’s Yoshito Hori. Feldman is Managing Director and Chief Economist at Morgan Stanley MUFG Securities. Koll is Managing Director and Head of Japanese Equity Research at JPMorgan Securities Japan.

Gowing: Robert Feldman, are you here? Given that at the end of August you were quoted as saying that Abenomics is in trouble, I’d like to hand the microphone to you please and also to Jesper Koll. How do you respond to what we are hearing…. and it’s on the record of course. You were quoted on 26 August as saying that Abenomics is in trouble.

Feldman: This is correct. That was the title of the piece I put out on August 17th. The point I was making in that article is that the pace of the ‘third arrow’ reforms is slower than the pace of demographics. That’s the key issue. If we were going to truly achieve the 2% real growth rate that Abenomics is talking about, given that the population is contributing negatively to the economy by about .5%, we may need productivity growth to be 2.5%. Over the last 20 years or so on average it’s been 1%…. Japan has done ‘okay’ in terms of comparisons to other countries in productivity growth.

However, my very simplistic calculations suggest that in order to get up to 2.5%, we would need to double the level of R&D as a share of GDP from about 3% (or more) to about 6 1/2%. When I look at the growth strategy I don’t see the elements in there that would accomplish what we all want Abenomics to do. That’s why I say Abenomics is in trouble. Subsequent to that report I think we’ve seen some good moves. The type of cap to be placed on social security spending is now a common discussion. Six months ago, nobody was talking in public about capping social spending. This is part of the growth strategy and part of the economic fiscal strategy now. So I’m very much encouraged. There has also been a cabinet reshuffle. I think the new cabinet is going to move in that direction.

Gowing: Do you see flexibility when the Prime Minister says yesterday, ‘neutral’? When you see Minister of the Economy Amari saying what he did 10 days ago when he was talking about the extra measures or new measures or having to consider them cautiously? What is this signaling to you?

Feldman: What it says to me is that this is not about the tax; it’s about the package. If he hikes, he takes a risk with the economy. If he doesn’t hike, he takes a risk with the bond market. So the thing to do is to hike for the political reasons that Takenaka-san and Hayashi-san said, but also have counteracting measures. So for example, let’s take the alternative case.

Let’s say he decides not to hike. What alternative measures are going to be taken to keep the bond market under control? What you have to do is say: Okay, everybody knows that a 10% consumption tax is not enough.

Feldman puts his pointer finger to his lips and whispers, “Shhhhh…. Shhhhh….” and then says, “It’s not enough!”

Feldman (continues): I’ve done surveys all around the country where I’ve asked young and old people, “What do you think the breakdown should be between tax hikes and spending cuts in achieving fiscal sustainability?” Most people say half-and-half, but there is a skew towards more spending cuts. So if he decides not to hike the tax to 10% he can alternatively say, “We’re going to take the consumption tax to 15% in increments of 1% each year with no escape clause and at the same time we’re going to take ¥15 trillion out of the social security system. If he puts that in, even if he doesn’t like it, I think the bond market is fine.

Gowing: Jesper Koll, are you here as well? What’s your view from JP Morgan?

Koll: It is my personal view…. Just to underscore what Robbie said, I think it is about the package. There is no magic bullet for Japan’s economy. There is a myriad of problems. The whole promise of Abenomics was that there was going to be a coordinated and decisive monetary policy together with fiscal policy, together with regulatory reform policy. I think that this obsession with whether the economy was up 7% or down 7% is ultimately irrelevant.

The key issue is that over the last four or five months what’s crept in is the lack of leadership on policy coordination. I think over the next couple of months as Parliament opens, if we can get a decisive coordination between the Bank of Japan (BOJ) and the Ministry of Finance, including as Robbie pointed out…. cutting contingent liabilities and some of the entitlements that do need to be cut, plus concrete progress on special economic zones…. Tell me, where did that argument go?

Gowing: We’ll come to that in a moment.

Koll: It’s the entire package. Let me explain. On the economy as a whole consumption goes up and down but the good news is that the underlying labor market continues to tighten very well. Unemployment keeps coming down. Job offers are in excess of job applicants. That’s all out there. So the underlying stream of income and consumer growth is actually warranted. The missing link right now is business investment. Are entrepreneurs prepared to invest capital in Japan? Because here in Japan there are growth opportunities, rather than investing into America or in Thailand or elsewhere. That’s the missing link that we haven’t had so far.

Gowing: And your view about the stimulus from the BOJ later in October?

Koll: Of course, I think ‘yes’ they will.

Meanwhile, bond markets are watching the Prime Minister’s every action. Bold talk alone will not achieve fiscal consolidation.

Note: The original Q&A transcript has been minimally edited to aid comprehension.

2 comments to “Talking (or not talking) about the hard issues of fiscal sustainability”
  1. “I think that this obsession with whether the economy was up 7% or down 7% is ultimately irrelevant”

    Interesting comment from Jesper Koll there, considering that before the consumption tax was raised to 8% he claimed in an interview that the hike would not have a negative effect on growth. Apparently the 1997 slowdown was all down to the Asian Crisis, and the poor health of the banking system, nothing to do with the tax hike from 3% to 5%. Now that his “analysis” was shown by reality to be wrong, he claims the result is “ultimately irrelevant”, and the government should continue following his advice. Nice work if you can get it.

  2. “bond markets are watching the Prime Minister’s every action.”

    Indeed, and the latest bond market news is that yields have DECLINED again, despite the massive pension fund shifting away from JGBs.
    The problem with the debt-hawk narrative is that none of its key predictions ever seem to materialize. Rather, market and other trends have moved in the OPPOSITE direction!

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