Japan primed for release of third arrow of Abenomics
Koichi Hamada says focus should turn to labour reform and deregulation
Last April, Japan's government implemented a long-planned consumption-tax hike, from 5 per cent to 8 per cent, and is expected to bring the rate to 10 per cent by 2015. The hike - a key feature of "Abenomics", Prime Minister Shinzo Abe's three-pronged strategy to revive Japan's economy - signals the government's commitment to fiscal consolidation. But it has also dealt Japan a heavy macroeconomic blow.
Preliminary gross domestic product data shows a 6.8 per cent contraction year-on-year in the second quarter - the largest since the 2011 earthquake and tsunami that devastated the country. Moreover, consumer spending has fallen.
But it is not all bad news. Expansionary monetary policy - the second of three so-called "arrows" of Abenomics, after fiscal stimulus - has brought down the unemployment rate to just 3.8 per cent. The ratio of job openings to applicants has exceeded parity.
Such data has given rise to two opposing views. Some economists worry that negative second-quarter data will dampen inflation expectations, thereby undermining Abe's plan for boosting growth. Meanwhile, the Bank of Japan is emphasising the positive outcomes of its monetary policy - and is hesitating to continue its expansionary measures.
If the first view proves correct, the BOJ will need to ease monetary policy further to counter falling inflation. If the BOJ is right, it should maintain its current approach, while the government should either postpone the next consumption-tax increase or implement it in two 1 per cent increments.
Of course, no decision should be made until the third-quarter results are released, providing a clearer picture. Fortunately, that is what Abe intends to do.
In any case, the success of monetary policy is difficult to deny. As the deflation gap narrows, however, the impact of monetary policy will weaken.
That is why it is time for Japan's leaders to shift their attention from the demand-focused first and second arrows to the supply-oriented third arrow: a new growth strategy.
The third arrow emphasises reform of the labour market, deregulation and a reduction in the corporate-tax rate.
A key component is to expand the workforce - a major challenge, given that Japanese society is ageing rapidly. One solution would be to integrate more foreign labour into the economy. But efforts to promote immigration face considerable barriers. A simpler solution would be to mobilise working-age women who already - or plan to - stay at home. By removing the barriers to employment that women face, Japan could substantially increase women's workforce-participation rate.
The second imperative is the removal of excessively cumbersome regulations. Under the current system, it took 34 years to approve the establishment of a new medical school - the result of collusion between officials and doctors.
Abe's plan calls for introducing a series of less-strictly regulated special economic zones, each with a specific objective - for example, adopting new medical technologies or attracting foreign businesses. Such a move promises to help prevent damaging obstructionism by the authorities.
Finally, Abe's growth strategy demands a corporate-tax reduction - a powerful tool for increasing the tax base in a world in which countries are competing to attract multinational companies.
Some of these initiatives, particularly deregulation, will undoubtedly face resistance. But, as long as Abe remains committed to his stated objectives, Japan's economic future will remain bright.
Koichi Hamada, special economic adviser to Prime Minister Shinzo Abe, is professor of economics at Yale University and professor emeritus of economics at the University of Tokyo. Copyright: Project Syndicate