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Abe’s third arrow, the second time round
Abenomics, the term given to the reform package Japanese prime minister Shinzo Abe launched to revive the country’s economy, is based on two myths. One is that the economy has performed badly and the second is that this non-existent failure has been due to deflation. Despite its lack of intellectual justification, the attempt to stop deflation has been a success as the accompanying rhetoric and monetary policy have produced yen weakness. This was an essential step towards solving Japan’s fiscal problem and, as the rhetoric has been about deflation rather than devaluation, the dramatic weakness of the currency has been achieved without international opprobrium.
Over time the devaluation should result in an improved current account. This will allow the fiscal deficit to fall while the economy moves ahead, but it is not enough on its own. The other essential is to reduce the cash flow surplus of the business sector. Having achieved success in step one, largely by accident, there is a chance that Abenomics will succeed in step two. If it does, it is again likely to be an accident.
Mr Abe has announced that corporation tax will be cut sharply. This was heavily leaked in advance but the details, which are crucial to its effect, remain unknown. This obscurity extends to the purpose of the change as well as to its implementation. Past announcements suggest that the aim is to encourage higher growth through higher investment. This is absurd. Japan invests too much at home and the return on new capital is, therefore, depressingly low. Encouraging higher investment is like asking water to flow uphill. (For details, see my recent presentation to the Bank of England’s Chief Economists Worksho: “Abenomics – Myths, Rhetoric and Reality”.)
