Wednesday, 7 May 2014

In Japan, structural reform picks up steam

In early April, Japanese Prime Minister Shinzo Abe’s controversial plan to increase exports by undermining his own currency looked to be undone by jittery foreign investors flooding into the yen for safety. A weak yen makes Japanese exports cheaper, but as China slows and Ukraine boils, the forex tide was quickly reversing on Mr Abe.

Now, new data from Tokyo appears to signal the country turning around as East Asia’s sleeping giant rumbles into life again. The data indicates a trend away from deflation and towards rising wages and consumer prices. Mr Abe’s quantitative and qualitative easing, along with currency devaluation, are finally pushing Japan forward.

There is still some way to go, but Mr Abe’s so-called ‘Abenomics’ seems to be hitting the goals he set up. The “third arrow” of Mr Abe’s strategy - the growth element - was recently given a confident ‘A’ grade at a Japan Society forum by a high-level government official.

One of the signs to monitor that Mr Abe’s plan to boost corporate earnings through yen depreciation is actually having the desired wage-push inflationary effects is if wages rise concurrently. This is exactly what’s happening. But Mr Abe is walking a fine line. Raising wages, hopefully sparking some inflation, at the potential cost of a drop in consumer spending, could be undone if his new tax hike hurts the economy in unexpected ways.

Mr Abe’s government introduced a temporary new sales tax last month, the first increase in 17 years. This was the part of the plan many in Japan were not looking forward to: the “bitter medicine” of higher taxes to pay for government largesse. The tax, which took effect April 1, added an extra 3 percent to retail prices (normally 5 percent).

The tax hike led companies to lower inventories in anticipation of a decline in consumer demand. In turn, factory output fell threatening to slow the government’s reform plans.   These effects will be temporary, assured the Bank of Japan Governor Haruhiko Kuroda. He believes the “positive cycle in the Japanese economy will not be stopped and the economy will continue to recover moderately.”

However, Japanese consumers may continue to hold off on major purchases until the sales tax runs its course. Mr Abe has been reluctant to impose the tax until now. Critics of the hike point to a similar tax rise in 1987 which they believe contributed to the country’s return to recession.

This tax increase could still be dangerous if the Japanese economy slips backwards. But the new data suggests the opposite might be happening. The Japanese economy is in relatively decent shape and its debt is probably not as significant as strict numbers would suggest. For instance, much of the debt is owed to domestic rather than international creditors.

The further success of Japan’s reform efforts depends on how much political capital Mr Abe is willing to spend on pushing them through. If Mr Abe can go through with the sales tax and maintain good economic performance - which will depend on restarting nuclear power, reinvesting tax revenues effectively, boosting efficiency, and spurring investment - he stands to bolster his own political position.

Vested political and business interests have diluted proposals in the past, but Mr Abe might have convinced important business heads to support him by lifting wages.  This is important because currently, wage gains are below the rate of inflation which will weaken real consumer spending power.

The tightening labour market has put upward pressure on wages. Dai-ichi Life Research Institute said to be sure of growth there needs to be a higher rate of increase in pay.

So while corporations are doing well, especially the Japanese automobile industry, the economy can only function if people are spending money. After all, my spending is your income, and your spending is my income. When everyone tries to limit spending at once the net result is an overall decline in income and a depressed economy. Mr Abe has been trying to climb out of that hole.

To achieve this, he loudly lobbied large corporations to distribute their impressive profits with employees by increasing wages. The IMF agreed, saying that only when the link between corporate profitability and wages is restored will “investment in durables return and finally rid Japan of its deflation.”

Traditionally, change in corporate Japan begins with the most respected companies leading the way.  And already, a number of noteworthy companies are planning to increase salaries in 2014. Japan’s second-largest convenience store chain, Lawson Inc., wants to raise salaries, while Daiwa Securities Group – Japan’s second-largest broker - will raise salaries and extend its mandatory retirement age from 60 to 70.

Japanese manufacturers may also raise wages for the first time in decades. Panasonic Corp. and Hitachi Ltd. both agreed to lift monthly wages by $US20, half of what was requested by unions.

And after six years of trying, unions at Toyota Motor Corp., Japan’s largest automaker, secured a monthly base pay increase of about $US26, falling short of labour’s $US40 request. On top of this, higher seniority pay and annual bonus payments lifted total compensation by about 7.6 percent from the year before.

Nissan Motor Co. and Honda Motor Co. – Japan’s second- and third-largest car makers – also called for base pay increases of just under 1 percent, with Nissan fully meeting its unions requests and offering bonuses equivalent to 5.6 months of wages.

Japan’s exit from deflation to positive inflation over the past year is encouraging for Mr Abe’s strategy. Greater labour market flexibility and making sure profits from yen depreciation are passed on to workers through wage inflation could help the central bank to reach its target of 2 percent inflation this year. All this will help solidify Mr Abe’s influence on the Japanese economy.

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