We recently had the opportunity to spend 11 days in Japan, our first trip to a country that boasts the world's third largest economy. Honestly, we weren't sure what to expect because Japan has spent much of the last 20 years wrestling with recessions and deflation. And, if a two decade hangover from the 1980's party wasn't enough, the country is also recovering from a devastating tsunami that has shifted their entire energy policy away from nuclear energy.
Viewed from this side of the Pacific, the launch of Abenomics 18 months ago is having a positive impact on economic growth and inflation. But the history of Japan's government stimulus programs over the past 20 years is littered with failures. So the question is: is it really different this time?
Certainly, in structure, scale and scope, Abenomics is much greater than prior efforts. The three "arrows" -- fiscal stimulus (deficit spending), monetary stimulus (quantitative easing) and structural reforms to boost competitiveness -- are designed to be mutually reinforcing (a Japanese folk tale says that three arrows held together cannot be broken). The first two were readily implemented and are producing results. The third is very much a work in progress, requiring both legislative action and great deal of change to Japanese work life.
So what did we observe in our brief trip? First, we were consistently struck by the great deal of pride each person we encountered took in their work. As we settled into our first taxi ride -- with an extraordinarily polite, uniformed driver and an immaculate vehicle -- we could only imagine the horror of a Tokyo native who hails a cab for the first time in New York or Chicago. This pride was evident everywhere we went and in every service provider we encountered. So refreshing and so different than the US!
Second, we sensed real optimism about the direction of the economy. Having family in Michigan, we have seen the impact of pervasive economic devastation first hand. We sensed none of that in the three cities we visited. On the contrary, the people we encountered were upbeat, welcoming and focused on their work.
Our visit came on the heals of the consumption tax increase from 5 to 8% that took effect on April 1. Japan's retail sales reports for March and April showed the impact (a big pull forward increase and then a large decrease). However, we found retailers to be sanguine about the changes, even if they were acutely aware of its short term impact. We came away thinking that Prime Minister Abe must have done an excellent job of communicating his policies. People understood and seemed to accept the tax increase as part of a bigger plan.
So what was negative? You have to look beneath the surface to find it. First, unemployment is very low and many people are employed in ways we would not conceive of here. At department store elevators, we encountered three elevator ushers, assisting shoppers to the next available car, when we wouldn’t even have one here. In our eleven days, I can’t remember ever having to wait to be assisted – there was always some one ready, willing and able to help. (Mind you, we scrupulously avoided the queues at the most popular outlets – the first “street” queue we encountered was for Garrett’s Popcorn. Those of you from Chicago will instantly remember the Garrett’s lines on Michigan Avenue – the same situation exists at Garrett’s near Harajuku in Tokyo.)
Second, the lack of immigration is painfully obvious. The elevator ushers, the hotel bell persons (many female) and the cab drivers were all Japanese. The corollary is that the workforce is not growing, either by birth rate or by immigration, and this will work to limit the growth in the economy. It also implies that while unemployment is low, many workers are performing far below their potential. As part of his structural reforms, Mr. Abe wants to encourage greater female participation in the labor force. However, that would at best provide a one time boost to the work force, likely in the service sector.
Finally, with the first two arrows of Abenomics firmly in place, the government is showing some success in creating economic growth and inflation. However, the third arrow – labor market reform is critical for several reasons. First, with little slack in the current labor force, even modest raises in wages could easily ignite a labor cost-driven inflation cycle that would be difficult to contain. Worst case, Abenomics could give rise to a stagflation situation – high inflation and low growth. Second, for the labor market to be more productive, employers need to be free to hire and fire. Third, to have sustained growth in the labor market (and, by extension, the overall economy), some immigration will be required, as the domestic population simply isn’t growing on its own. And boosting it with female participation won’t be sufficient.
With difficult structural reforms ahead, Mr. Abe has his work cut out for him to establish a long term platform for growth. Our observation was that people are optimistic about positive change. Whether Mr. Abe will have the will to propose sweeping labor and immigration reforms is an open question. Assuming he does, then we will see whether the people will continue to be supportive of him and his policies. Only time will tell.