I previously wrote about the financially precarious dilemma that Japan is facing. It can be read here. Just after I had finished writing it, I read about the Assassination of Shinzo Abe, who served as Japan’s prime minister shortly from 2006 – 2007 and again for a longer period from 2012 – 2020.

I don’t know much about Japans politicians, but I actually did some research about Shinzo Abe and his economic policies back in 2014, when I was taking a course about “East Asian Economies” at the Korea University Business School in Seoul. At that time, the new policy approach of his changes were still relatively fresh and there was some interest in doing research about it.

So I felt that I should write a follow up on Japan, because a) in the last issue I didn’t write much about what went wrong in Japan and how it build up to the current dire debt-situation and b) I think that Shinzo Abe’s economic agenda represents the essence of a more general misconception of how most people and politicians think about how a government can have a positive influence on an economy.

I am not intending to speak ill about the dead here — My basic proposition is that all politicians are power seeking criminals with notorious motives and questionable characters — hence, Shinzo Abe is just one of them. However, his economic policies, which became known as ‘Abenomics’, present a good case study, which can serve as an illustration of some general economic misunderstandings that are predominant across the globe.

When Abe came into office in 2012, Japan already had large deficits, the stock market still had not recovered from its collapse in the early 90s and the economic growth had been weak ever since. This means he was facing a situation in which it was difficult to reduce the debt burden without being a) more prudent and practicing some fiscal austerity by decreasing the deficit spending, or b) fostering economic growth. Abe chose to try for the second one by totally sacrificing the first.

Abenomics became known for being based on “three arrows”:

1. Monetary easing from the Bank of Japan
2. Fiscal stimulus through government spending
3. Structural reforms

Arrow l: Monetary Easing

According to most modern economists, an economy needs to have inflation. The Commonly 2.00% is regarded as the perfect rate of inflation, hence this is the target rate for most central banks. (I will elaborate on this topic later).

Likewise other countries, Japan also experienced high inflation throughout the 70s and early 80s, but since the 90s, they witnessed really low inflation rates mixed with deflationary periods, so that on average the prices remained very stable. This is also the reason why the Japanese Yen became known as a safe heaven currency, to hold during turbulent times.

In reality, this was a great benefit for the Japanese population, because it meant that they could fully benefit from their productivity and wage increases. Additionally, traveling to other counties with higher inflation rates was constantly getting cheaper and cheaper for Japanese citizens.

However, economists and politicians saw the low inflation as a major problem. They claimed to be worried that the cost of living was rising too slowly and people didn’t spend enough.

Thus, the first of Shinzo Abe’s arrow was massive quantitative easing by the Bank of Japan, in order to stimulate bank lending and the velocity of money and thereby also increase the rate of CPI inflation.

The following chart shows the balance sheet of major central banks as a percentage of their respective GDP:

As can be seen, measured against the GDP, the Japanese bank increased the base money substantially and outpaced other central banks by a magnificent margin.

The idea of increasing the cost of living of Japanese people in order to improve their well being, is not only contrary to common sense, but it also goes against all fundamentals of sound economic thinking.

The general goal of an economy, is to increase the standard of living. This is achieved by becoming more productive and therefore being able to lower the cost of production. If goods and services can be produced cheaper, it follows that more people can buy and enjoy them.

A good example is the cellphone industry. When the first cellphone came out, only a few rich people could afford them and the cell phone industry was tiny. Today, almost everyone has a smart phone, which is not only way more affordable, but also the usability and functionality have undergone tremendous increases. Moreover, even very poor people can afford a basic cellphone. Despite — or rather because of — the price reduction, cell phone companies have been able to increase their profits. Apple has become the most valuable company on the planet.

Thus, contrary to general perception, price reductions are beneficial for an economy and it would have been better for Japan, if the central bank would not have been handed a bow to shoot this arrow.

The question is, what was (and is) the Bank of Japan doing with all the printed money?

Arrow ll: Fiscal Stimulus

The answer is simple: Massive spending by the Japanese government to boost GDP.
(In combination with also interfering in the stock market by directly buying Japanese equities)

This is the second arrow in the Abenomics quiver.

Actually, there is nothing new or innovative about this wrongheaded strategy. Massive spending, financed by the government and monetized by the central bank is done by most governments to some extent — and has been famously tried to a large extent by countries such as Simbabwe, Venezuela and (numerous times) Argentine.

The chart shows how the total government deficit to finance the fiscal stimulus measures has constantly increased over the years, saw a massive spike in the pandemic and is forecasted to keep rising rapidly.

Some economists argue that it has been a success, since Japan has seen increases in nominal GDP after Abenomics was started. However, this conclusion does not take into account three crucial aspects:

1. Arguably it came at the cost of a massive increase in debt, which substantially lowers future opportunities since it requires increased amounts of the yearly budget to service these debts.
2. It is also not clear that the economy would not have been growing even more in the absence of these expenditures. The government investments could well have had the effect of diverting market incentives and crowding out some other (probably smarter) investment decisions, which in turn, would have likely been more beneficial for the economy in the long run.
3. The GDP went up in Japanese Yen. Measured in USD it is now lower than it was when Abenomics started.

Thus, also the second arrow was a complete failure. The Japanese Debt-to-GDP ratio is now at 266% and the costs of it must be paid by the already wounded Japanese population in some form. And this arrow will really hurt in the future.

Arrow lll: Structural Reforms

The third and final arrow in the quiver was aimed at structural reforms, to make the economy more competitive.

Arguably, the first two arrows have already been shot into the wheels and done their part to crumple the competitiveness of the Japanese economy. Thus, the third arrow is already predestined to miss its target.

The way to make an economy more efficient, is to make the government smaller.

If the government is small, this frees up resources that can be used more productively and long-term oriented by the private sector. In addition, it also lowers friction costs and time spent for compliance measures that have to be undertaken by entities and are a burden to the economy.

In other words, decreasing the government size, makes room for a more productive resource allocation throughout the whole economy.

While the structural reforms under Abenomics included some positive aspects, such as cutting red tape and corporate taxes, as well as lowering barriers for entering the workforce, it didn’t lead to reductions in the overhead and operational government expenses. Therefore it was also a failure.

In conclusion, Abenomics turned an already bad economic situation into a terrible one. Instead of having a positive influence, all the three arrows are aiming at the very heart of Japan’s economy. These “arrows” have already caused a lot of havoc and put Japan’s economy into a precarious situation — and they might be about to kill it.