Grading Abenomics: It’s a C-

Two years have passed since Shinzo Abe returned as prime minister of Japan and implemented a new economic policy that was quickly dubbed “Abenomics.” Enough time has passed to give a preliminary assessment of what Abenomics has accomplished.

The answer? Not much.

Abenomics consists of three parts, or “arrows:” a monetary policy of aggressive quantitative easing, temporary fiscal stimulus to lend impact to the monetary policy, and structural reforms or deregulation to enable higher long-term growth. The concept behind this three-pronged approach was fine. On average, economic growth has been less than its potential for more than two decades, while a low but persistent deflation took hold. The goal of Abenomics was to bring about 2 percent positive inflation and 2 percent real GDP growth.

On monetary policy, Abe was lucky. The governor of the Bank of Japan was coming to the end of his fixed term at the end of March 2013. This enabled Abe to appoint a new governor who endorsed aggressive quantitative easing – with a target of doubling the monetary base in two years, in order to reach the inflation and growth goal. For the Bank of Japan, this represented a radical departure from its past policies, and was welcomed by investors around the world who promptly bid up the price of Japanese equities.

However, even this rapid quantitative easing was much less radical than what the US Federal Reserve did in the fall of 2008, when it doubled the monetary base in just three months. When this policy appeared to be falling short of its inflation and growth goals, the Bank of Japan announced an expansion of its quantitative easing at the end of October 2014.

Monetary policy is certainly the most aggressive “arrow” of Abenomics. In 2014 deflation appeared to be ending. In November, consumer prices were 2.4 percent above the year-earlier level, but that includes a 3 percent point hike in the consumption tax, so underlying prices were still 0.6 percent lower than a year earlier.

Furthermore, increasing the monetary base – cash plus commercial bank reserves – affects the real economy only if the increased commercial bank reserves are lent out. In the 21 months from the start of the Abe administration through September 2014, outstanding commercial bank loans increased 3.4 percent, a modest gain.

The second arrow of temporary fiscal stimulus was supposed to help monetary policy by injecting additional demand into the economy. The result was a sizable supplementary budget passed in January 2013 within weeks of when Abe took office.

This policy has fallen short in two ways:

First, when the regular budget for fiscal 2012, April that year through March 2013, is added to the supplementary budget, the total is less than in the total budget for the previous fiscal year. National income accounts show a substantial increase in government fixed investment for several quarters after Abe took office, but part of that increase was simply delayed spending of money budgeted in 2011 as part of the post-earthquake reconstruction.

Recently both Japanese and US media reported that the proposed budget for fiscal 2015 is a “record high.” However, it represents less than a 1 percent increase from the fiscal 2014 regular budget. Whether total spending will go up depends on the size of any supplementary budget later in the year. Therefore, budgeted spending under Abe has not provided much stimulus to underwrite the Bank of Japan’s quantitative easing.

Second, as soon as that initial supplementary budget was passed in 2013, discussion reverted to exaggerated concerns about the size of government debt. This led to a decision to allow a planned increase in the national consumption tax – a sales tax on most final goods and services –from 5 to 8 percent starting April 1, 2014. Combined with flat government spending, the tax increase implies that fiscal policy has been contractionary, the kind of policy governments use when the economy is overheated, not when facing deflation and weak demand!

Consumers responded with a burst of buying before the tax increase took effect, especially in the form of residential housing construction, which is covered by the consumption tax. The subsequent drop in spending after the tax took effect was unexpectedly large, pushing the economy back into recession temporarily.

The third arrow of Abenomics is also problematic. The underlying thinking is that a variety of regulations are keeping the economy from growing at its potential. That view is correct, but it’s unclear that the actual policy changes are adequate. This part of Abenomics covers a wide variety of specific areas – a problem in itself, with political effort fractured among too many issues.

One example is policy concerning foreigners working in Japan – a critical issue if Japanese society intends to offset the decline in domestic-born population with an influx of immigrants. But the proposals are minor, such as slightly easing the requirements for skilled-worker visas and extending the “trainee” visa from two to three years. All proposals deal with temporary foreign workers, not immigrants. But the most committed, productive workers will be those who know they can put down roots in Japanese society.

Another example is agriculture, where reform is long overdue. Abenomics includes, for example, proposals to make land purchases to create larger-scale farms easier. But Abenomics also calls for policies, as yet unspecified, to encourage farmers to grow wheat and soybeans – crops involving large economies of scale in production and which will never be price competitive against imports. Furthermore, Japanese negotiators have so far strongly resisted concessions on agricultural products in the Transpacific Partnership, or TPP, negotiations.

Joining this regional free-trade negotiation was touted by the prime minister as indicative of his determination to reform the economy by opening agriculture and other areas up to increased international competition. Joining the negotiations was laudable, but the negotiators’ stance suggests that the determination to pursue meaningful reforms is limited.

Other reforms deal with labor, the role of women, high-tech start-up firms and regulations regarding particular industries such as pharmaceuticals, healthcare and electric power utilities. In most cases the proposed reforms are weak and inadequate, often applicable only within a handful of new special economic zones.

None of this should be a surprise. The reality is that a gradual process of structural reform has been underway for more than two decades, each modest step constrained by powerful anti-reform interests. Over time progress occurs, but dramatic change under Abenomics with measurable impact on increasing economic growth is unlikely.

Overall, Abenomics just does not add up to the image Abe tried to convey when he famously declared in a 2013 speech in New York that “Japan is back.” That said, the Japanese economy is likely to grow somewhat faster over the next several years. One of the side effects of quantitative easing has been a decline in the value of the yen against other currencies, making Japanese exports less expensive in foreign markets.

When adjusted for relative inflation in Japan and other countries, and averaged across all currencies, the yen today is as weak as it was in the first half of the 1980s – a time when yen weakness unleashed a rapid increase of exports. Yen depreciation also causes the price of imports to rise, which increases inflation, but not household income, thereby hurting consumers.

Abe will undoubtedly declare victory as exports, inflation and GDP growth rise. But the objective of the economists who designed Abenomics was to bring about growth and modest inflation fueled by rising domestic demand. That is not happening. My grade? C-.

Edward J. Lincoln is an adjunct professor at Columbia University, where he teaches a course on the Japanese economy and is also a lecturer at George Washington University where he teaches a course on the East Asian economies. This is reprinted with permission from the Yale University for the Study of Globalization