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Japanese Economy Update

Agenda for the Second Stage of Abenomics

Jun SAITO
  Senior Research Fellow

2015/10/06

A new set of three arrows

On September 24, after being re-elected as the President of the ruling Liberal Democratic Party, Prime Minister Abe announced a new set of three arrows and declared that Abenomics has entered the second stage.

The new set of three arrows is the following:

The first arrow is “Creating a strong economy that opens-up a brighter future”; The second arrow is “Providing a child care support that fosters family dreams”; and The third arrow is “Establishing a social security system that leads to a stronger sense of reassurance”.

As you can see, the new set of three arrows are now targets to be achieved rather than policy measures to implement which were the focus of the original set of three arrows in the first stage.

Achieving a 600 trillion yen-economy

The new first arrow aims to create an economy of an unprecedented size. The aim of achieving a 600 trillion yen-economy requires an average nominal growth rate of three percent. Since the Japanese economy is yet to overcome deflation, the new first arrow has to first tackle the homework that has been carried over from the first stage of Abenomics, and build up on the achievement thereafter. The measures to be employed have to be a combination of monetary, fiscal, and structural policies; the policies that consisted the original set of three arrows.

The three arrows of the first stage of Abenomics had been greeted with great enthusiasm, and were successful in reactivating the economy, especially in their early phases. However, some important limitations in their achievements had also become evident. Let me briefly go over them.

The original first arrow (bold monetary policy) was successful in overturning the deflationary expectations that were embedded in the minds of the private agents. However, it has not met the commitment of realizing a two percent inflation rate within two years. The headline CPI in the most recent month (August 2015), rose only by 0.2 percent year-on-year. Admittedly, it has a lot to do with the decline in oil prices. But even CPI excluding foods and energy has risen only by 0.8 percent after 2 1/2 years of Quantitative and Qualitative Easing (QQE).

The original second arrow (flexible fiscal policy) has been successful in supporting the economy through the early stages of Abenomics. Positive contributions were made by public investment in FY2013 and FY 2014. Also, on the fiscal consolidation front, consumption tax rate was raised to 8 percent in April 2014 from 5 percent that has been applied for 17 years. However, the progress in fiscal consolidation has been slow: The consumption tax rate hike to 10 percent has been postponed to April 2017; and the means to achieve primary surplus by FY2020 is still to be determined.

The original third arrow (growth strategy to stimulate private investment) has been accused of being slow in its implication. Notwithstanding, there has been a progress in reforming agricultural co-ops liberalization of electricity industry, promotion of more active involvement of females in the society, introduction of national strategic zones, reforms in corporate governance and stewardship, and reduction in the corporate tax rate. In addition, most recent achievement is the successful conclusion of the Trans-Pacific Partnership (TPP).However, focus of the third arrow, which should have concentrated on structural policies, has been blurred by including some demand-side measures as well (e.g. exporting infrastructures abroad). Many of the important issues, including the reconstruction of the Japanese economic system that has become outdated, are still to be tackled.

In order to achieve a 600 trillion yen-economy, the new first arrow needs to mobilize the measures included in the original set of three arrows. Also, it has to finish-up the homework that has been left over from the first stage of Abenomics. The new first arrow, therefore, should be regarded as corresponding to the original three arrows.

Raising fertility rate and reforming social security system

As for the remaining two new arrows, it can be argued that they have implicitly been included in the original third arrow. But focus has been given to, and commitment has been made on, the two specific structural policies; raising fertility rate and reforming social security system.

The new second arrow aims to put a stop to the decline in population. By providing adequate support to child care, fertility rate is expected to rise from the current low of 1.4. The target for the fertility rate, however, remains to be 1.8; which may be ambitious but which still falls short of the 2.1 required to stabilize the population.

The new third arrow aims to reform the social security system so that workers of their prime age do not have to retire involuntarily to look after their old parents. It is important in order to secure workers which becomes increasingly scarce in a society with declining population. However, it does not mention the painful reform required to put the social security system on a more sustainable basis.

Commitment to stabilize the population at 100 million

Notwithstanding its limitations, it is important to acknowledge the intension of trying to set the serious issue of shrinking population at the center of the agenda for the second stage of Abenomics. The main theme of the second stage of Abenomics as mentioned by the Prime Minister Abe should be given more attention: Prime Minister Abe has committed itself to maintain a population of 100 million in the 50 years-time. Commitment to stop the decline in population and to maintain a certain number of population brings to the forefront the most important policy challenges that the Japanese society and economy faces.

According to the projection provided by the National Institute of Population and Social Security Research, the Japanese population of 128 million at 2010 is expected to shrink to 87 million by 2060 (68 percent of the population at 2010) and to 43 million by 2110 (33 percent of the population at 2010). Growth accounting framework, combined with a simple arithmetic, shows that on average potential growth rate could be brought down by an average of nearly 1 percent every year. This is a serious situation for a country whose potential growth rate is as low as 0.5 percent at date, and which is in need of growth necessary to transfer fiscal and social security systems to a sustainable one.

Measures to counter the negative influence of the shrinking population

In order to offset the negative impact coming from the shrinking population, a number of measures have been suggested. One of the most frequently discussed is raising the labor market participation rate of females. Since there are significant number of females who have unwillingly withdrawn from the labor market because it is hard in the current circumstances to have both a family and a job, it is an important and essential policy to pursue. But from the point of view of offsetting the negative impact of shrinking population, it can only be a temporary factor: There can be no more offsets if the female participation rate once reaches the maximum (e.g. the rate of the male or that of females in the Nordic countries).

Another of the popular policy proposals is stimulating innovation. The consequent rise in the contribution of the total factor productivity is expected to offset the rise in the negative influence of labor inputs. It may seem plausible if the increased needs in technology to combat aging (e.g. robots) are taken into account. However, innovation is supplied by the population with talents (e.g. scientists and engineers) as Kuznets (1960) argued. If that is the case, it is not clear whether an economy with shrinking and aging population can actually produce innovation on a sustainable basis.

The ultimate solution of the problem has to be the reversal of the declining trend of the population. Fertility rate has to rise and recover at least to 2.1 that is required to stabilize the population. Even the 1.8 that Prime Minister Abe referred to in his statement introducing the new set of three arrows is very difficult. Raising it still further needs some significant and decisive action.

What needs to be kept in mind, however, is the fact that, even if the fertility rate rises to 2.1 tomorrow, it will take more than 60 years to actually witness a stabilization of the level of population (population momentum). Meanwhile, the shrinking population will keep exerting negative impacts to economic growth.

Therefore, an intermediate measure has to be introduced to manage the problem. An obvious candidate is accepting more foreign workers. Since I have discussed the issue on a separate occasion (http://www.jcer.or.jp/eng/research/pdf/saito20131203eR.pdf), I will not dwell on the subject but to ask the interested readers to refer to it. I stress the importance of seriously considering this option.

Addressing the most important long-term issue facing Japan

The proposed new set of three arrows is still only a proposal by the president of a ruling party. We still have to see how the government takes up this issue: How will it be discussed? Will it be discussed in the Council for Economic and Fiscal Policy, or by a different body? And what is going to be the timeline? Is it going to be discussed by the next “Honebuto” (the basic document compiling measures of economic and fiscal reform and management) expected to be published next June, or will it be included in the next fiscal year budget whose draft is expected to be out in late December?

Whatever the process will be, in order to come up with a set of concrete and meaningful measures, much input from the private sector and academics will be required. It is important that we make the most of the opportunity in order to enrich the discussion so that the policy package will be adequate to deal with the shrinking population issue that is the most important long-term issue Japanese economy faces.