On Abenomics

Right-Wing Hours?
At the end of this year we had the new Prime Minister (PM) Shinzo Abe, who was once the PM, and it's time to talk about his politics. Mr. Abe is said to seek for two kinds of economic policy: monetary expansion and large public spending, which they call grossly "Abenomics".

I would like to focus on what is called Abenomics, what it is and what and whom we think it will affect. However, I don't focus on his political philosophy, especially on his view of the territorial and historical issues that Japan is now having with China and Korea, which has also been paid attention to.

For almost 20 years the Japanese economy has been stagnant and the people, especially the young people, have been said to be getting insular and narrow-minded; They are seeking for relatively stable and secure job like the government and for a relatively calm and quiet life. They don't like luxury but moderation. They don't want any promotion and advance in their workplaces.

They are sometimes called the "Grass-eating people", which may imply what is behind the "Japan Moving Right", or what made Japan conservative, as once the Washington Post and Times reported.

For those who stick to the golden memory, JAPAN AS NO 1, once a byword of the 20-years-ago booming Japan, this time should be the one to be beaten and broken up. Mr. Abe looked like a hero to play such a role whereas the ex-PM of the Democratic Party, Mr. Noda, didn't seem to be able to propose any concrete and effective economic policy to get the economy recovered.  
 
Monetary Expansion: Inflation Targeting
Before the General Election, then the President of the LDP (Liberal Democratic Party: a relatively conservative party in Japan, but not like the Republicans in the US), Shinzo Abe, expressed his new idea on the economic policy to cure the ailing Japanese economy, aiming for the return to power. The press took it up as an intriguing topic, which led yen to depreciate and the Nikkei Average (the stock prices) to appreciate. The idea is inflation targeting. It sounded new to many Japanese.

Stagnating economy has already been a synonym for now the Japanese economy: decreasing prices and lower employment and production.

Lower prices might sound good for us consumers, but it also means decreasing payroll for us workers; We like lower prices but don't like lower pay.

Inflation targeting is thought to be one of the key solutions to such a deflationary stagnation. Here I try describing what it is like.

Banks Create Money
Where does money come from? Money comes from two kinds of banks: (1)commercial banks, (2)central banks.

Central banks were born only less than 100 hundred years ago mainly in developed countries. The role of them is to print paper money and pour it out to commercial banks, through the operations, or by buying and selling the government bonds. Commercial banks pour out money to firms and households by lending it to and borrowing it from them.

Banks create money and increase or decrease it in the economy as a whole. If banks increase money, then the prices go up because the people now have more money to spend and the goods sold in the economy get fewer: More money chases fewer goods in the economy.

Higher prices lead the producers to increase more goods because they find it profitable to sell more. And thus they hire more workers. To lure more workers they need to provide them with higher wages, and higher wages lead the workers to spend more and more. However, in the longer run, the producers cannot produce more than how much they used to produce, only the prices go up.

Abe's Illusion?
The above is called the"transmission mechanism" in the economy. It came originally from the Quantity Equation that the 18-century British economist, David Hume introduced, with which now most economists in the world agree.

Imagining that money flows through every household and firm and that the economy will get well, he proudly promised that he would ask the central bank (BOJ: Bank of Japan) to keep increasing money until the level of inflation,the growth of the prices, reaches 2%. By setting up such a target central banks conduct monetary policy. This is called the "inflation targeting".

This policy has already been conducted by the New Zealand central bank to stop the inflation. Since then many central bankers and economists have been discussing it. Some prominent economists say, no central bank took up the inflation targeting to deal with the deflation and they fear the risk of the inflation targeting and there are still a lot of pros and cons.

Mr. Abe might have had some suggestion from those who know more about economic policy and he tried announcing this policy. At first he said in public that he would try to target 4% of inflation, and later withdrew it. 

Though he doesn't seem to be familiar with economic policy, those engaged in the marketplaces reacted to his announcement, and as a result yen depreciated and the stock values appreciated. It was before the General Election that Mr. Abe made this announcement, and it might have led many voters to hope that he should be better as the new PM and to vote for LDP after all.

However, only the monetary expansion cannot increase the aggregate demand and boost the economy.  Another policy that stimulates the demand should be needed, which is called fiscal policy.  

Public Spending: For Another Pork Barrel 
Mr. Abe tried to spend more on social infrastructure and to strengthen the land of Japan as a whole. The eastern and northern part of Japan that was hit by the Great Earthquake in March 2011 has not still recovered at all and the victims have been still forced to live at temporary houses whose walls are so thin that they feel chilly in winter.

The recovery should be quick as soon as possible. Mr. Abe should tackle this task first of all, proposing the 10 billion supplementary budget to build new houses and roads and to create the new local jobs in the area, where the local general contractors are now hoping that they will receive a lot of orders.

Nevertheless, some people get afraid that this large public spending will be for the sake of the vote to LDP not of something necessary to build and create. This is to a point because LDP has been very good at scattering a lot of money in the name of the public works to collect the local votes for LDP, and this is the source of the power that LDP has had as a ruling party since 1955. It is now being criticized as a revival of the old politics that many Japanese have ever been tired of.

Public spending should not be cut off, and is certainly necessary for the victims and the economy as a whole to get recovered. Many people cannot rely any more on Mr Noda who seemed so irresponsible for taking the challenges. They are obliged to expect Mr. Abe to do it instead of him even though they fear that the tax revenue will be spent on unnecessary buildings.

Can't Avoid Increasing Taxes
The 20-century great British economist, John Maynard Keynes said, "people are dead in the long run".  Economists usually focus on the longer-run issues than the laymen such as the effects of fiscal deficit and debt and the welfare spending for the elderly.

More than 1/4 of the Japanese are now above 65 and less that 3/4 should support their livings by paying higher taxes and the insurance premium. Every developed country has now the similar problem, and we now face the situation where we cannot say any more that longevity is a very good aim in life.

One of the reasons the Japanese economy is stagnant is that there are more aged and less young working people in the society: the aged retire jobs and spend less and save more for their living, whereas less young people work full-time and well-paid, being single and having no child. As a result, more of the spending as a whole would decrease.

For the above reason the Japanese economy has been shrinking for almost 20 years, and we can say that the deflationary stagnation is rather a structural problem than a demand-side one. In this point Mr. Abe may be unable to get the economy recovered well only by stimulating the demand. He should also plan a structural reform to build a new country suitable for the above new situation.

On Consumption Tax
Ex-PM, Mr. Noda decided to increase the consumption tax by 5% in 2015 and accepted severe criticism because it wasn't written in his pledge.

In Japan, for more than 30 years the reform of the tax system has been conducted. The tax system is originally from what the US proposed after WW2, what is called Shoup taxation, and depends more heavily on the direct taxes like corporate and payroll tax.

The aim of the reform is to correspond to the coming aging society. The reform has progressed by changing the taxation into that depending more on the indirect taxes like alcohol, cigarette and consumption tax, which are relatively independent of the economic fluctuation and the stable revenue can be expected from now on.

Mr. Noda tried to raise the consumption tax to make up for the loss of the revenue for the welfare spending rather than the budget deficit. However, the budget deficit cannot be ignored too because it should be covered by the tax that we and our children pay in the future. The deficit will become the debt of the government and the debt will accumulate. Repaying it someday in the near future cannot be avoided and reducing the deficit and debt is of high priority.

Tax Increase Is A Hard Choice
Mr. Abe should increase public spending to create new jobs, while increasing the consumption tax. But he announced that he would never increase the tax unless the economy recovers.

This announcement has some dilemma: if the people expect for raising tax they get ready for it by saving more and spending less, and thus the economy doesn't get recovered. In Japan the benefit was tried twice, given to the family who has children, but the spending didn't increase because, the research says, they saved half of the benefit. They seemed to expect the forthcoming tax hike.

Thought tax hike in the future is more likely to reduce the present spending, Mr. Abe and the Japanese as well should know that postponing the timing of raising the tax is not a right choice. Mr. Abe needs to get ready for accepting harsh criticism for raising the consumption tax as did Mr Noda.    

Spending Cut Is Also A Hard Choice
Tax increase is not popular among voters whether in the US or in Japan. Here in Japan the successive PMs tried to reform the government spending. They cannot raise tax, and how about cutting the spending? But it is also very difficult to do. 

Certainly, cutting the government spending, as Alesina of Harvard University goes, is better at stabilizing the economy as a whole than increasing taxes.

Politics is full of bitter choices rather than full of sweet cakes: If they cut off the government employees' pay, the other people should be happy with it because they don't need high tax. Politics is such a kind of a cake-cutting problem: If your piece of cake is larger, I get angry!

It seems to me that Mr Abe is just only thinking of how to win the Election for the Upper House next year: Voters usually dislike high tax and his followers dislike spending cut. A good politician sometimes need to play a role to be hated and it is the problem whether he can do it.  

Mr Abe should spend more on something effective enough to stimulate the economy and increase the tax at the same time. Increasing the tax and the same amount of spending, theoretically, creates the same amount of the income we gain(*): If the government collects 1 billion yen and spends it on the public works, then it can create new jobs that are worth just the 1 billion yen.

This elementary accounting doesn't seem to make us fear too much the risk of increasing the tax. But in the point of creating new jobs, it should be worth considering.  I hope that Mr Abe will announce when to increase the tax and where to spend it on, and that he will show the plan to cover the expenses necessary for us in the near future.        

(*) The effect of the consumption tax depends on the (Marshallian) demand function, but it is homogeneous of degree 0, which means rather NO CHANGE than decrease in the demand when the tax is higher. However, raising it will decrease the welfare of the people.