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No.18 ,Economy  Jan 20, 2014

Abenomics: What economic picture will its third arrow draw in the middle-term?

[Summary]

The third arrow of Abenomics, a growth strategy, aims at revitalizing industries, creating markets for selected sectors with the promise of future growth, and expanding global outreach. Prime Minister Abe’s growth strategy, formulated in June 2013, gave a timeline for implementing measures to realize these goals; many are expected to be on schedule. This would remedy one of the weaknesses of Japan’s business environment – the ease of starting a business. 

However, not all measures in the growth strategy have a clear direction, nor do they all contribute directly to structural reforms. Creating markets in Japan’s health-care and agricultural sectors are examples of this, though the premier has shown a strong will to deregulate these and may have a clearer vision of their impact. Still, challenges remain for the private sector, in a rigid employment system and with high corporate taxes. Attention should be paid to the premier’s leadership in these fields, for which he has just started coordination but has yet to decide a clear direction.

EGAWA Akio, Senior Researcher at the National Institute for Research Advancement (NIRA)

EGAWA Akio, Senior Researcher at the National Institute for Research Advancement (NIRA)

Prime Minister of Japan Abe Shinzo has introduced “three arrows” for economic recovery and growth. The first and second arrows were launched earlier in 2013, these being monetary easing to fight deflation and flexible fiscal injections to support the economy. The third arrow, a growth strategy known as the “Japan Revitalization Strategy,” was considered a disappointment by the business sector, judging by the Nikkei 225’s major plunge as the Prime Minister gradually announced details of the Strategy in late May to mid June this year. However, this plunge may not have resulted from a skeptical reception of the growth strategy, but from an undervalued yen. Indeed, the index bounced back 20% over the following month, though this has not led to a positive re-assessment of the third arrow.

Much disappointment has been expressed regarding what the growth strategy did not include, but few discussions over the third arrow take an in-depth look at what it does include. It could be worth bringing focus to the details of Abe’s growth strategy, in particular what it aims at, and what sectors it attempts to develop as promising industries. The seriousness of the Abe cabinet in revitalizing Japan’s growth potential should be reassessed, paying close attention to the “bureaucratic wording” used to dress up the strategy’s policy measures, and to other measures suggested by the premier even after the announcement of his growth strategy in June 2013.

Japan’s current business circumstances and the aims of the Strategy

One of main pillars of the premier’s growth strategy is to revitalize Japan’s private sector by improving the business environment.  

How “bad” is it now? According to the World Bank’s “Doing Business 2014” report, Japan ranks twenty-seventh in overall business circumstances (ease of doing business: EoDB) among the 189 countries surveyed. However, it ranks fifth among the G7 countries, falling behind the Asian NIEs (Singapore, Hong Kong and Korea). As seen in Table 1, there are some specific issues (cells colored in grey) that stand in the way of improving Japan’s business circumstances. Of these, “starting a business” and “paying taxes” rank below the top 100, while “dealing with construction permits” and “registering property” rank below the top fifty. The countries whose ranking is within the top ten overall maintain a high ranking for all categories (for example, Singapore does not rank below fifty in any category, compared to one for the United States, two for Korea, and three for the UK, none of them having any category that ranks below the top 100). This suggests Japan must tackle the issues mentioned above if it hopes to improve its rank (i.e. to improve Japan’s business circumstances). 

Table 1: Ease of doing business ranking

Abe’s growth strategy aims to bring Japan into the top three among the G7 (but without a target year), by replacing old businesses, and passing regulatory and industrial reforms, but is short on measures to climb the “paying taxes” category (such as simplifying tax payment procedures and reducing corporate taxes). This explains at least part of the disappointment with Abe’s third arrow. 

What will be delivered by Abe’s growth strategy?

What kind of structural changes will follow from Abe’s growth strategy? Table 2 lists the number of policy measures in each category with a rough schedule of their implementation[1]

The growth strategy consists of three “plans”: Industry Revitalization Plan, Strategic Market Creation Plan, and Strategy of Global Outreach. As the Strategy of Global Outreach aims mainly to accelerate the negotiation of economic partnership agreements, it does not necessarily require new policy measures. Instead, it is time to have a detailed look at the first two plans. 

1: Industry Revitalization Plan

The Industry Revitalization Plan has six pillars. Its basic principle is to (1) accelerate structural reforms first, and then build economic competitiveness by (2) reforming the employment system and reinforcing human resource capabilities and by (3) strengthening science, technology and innovation[2]. To realize this, it suggests that (4) establishing the world’s leading IT society, (5) strengthening the international competitiveness of Japanese megacities as business hubs, and (6) revitalizing small and medium-sized enterprises (SMEs) through innovation will be of help. 

The policy measures for (1) accelerating structural reforms have a clear direction and schedule of implementation, irrespective of the necessity for legislation. This is because the Plan is formulated to restructure and reorganize the industries intensively in a short period of time. In fact, the government will implement, or at least submit relevant bills on, all the policy measures in this category not later than the beginning of the next fiscal year in April 2014. In addition, for the policy measures in the category of (5) strengthen Japan’s international competitiveness as a business hub, the premier takes an initiative to utilize “National Strategic Special Zones” which are created “to serve as gateways for the execution of bold regulatory reforms and other measures as a new approach to realize Japan’s growth strategy.” So the implementation of policy measures in this category will advance favorably. Indeed, the bill to establish the Zones was submitted to the Diet and is discussed in Diet sessions. Most of the policy measures in the categories of (4) IT society and (6) revitalize SMEs through innovation are financial and other assistance schemes for relevant industries and enterprises. As measures which expand the budgets and powers of ministries could be implemented relatively smoothly, policy measures in this category are likely to advance at a favorable pace. 

By contrast, the category of (2) reinforce human resource capability and reform the employment system includes two policy measures determined to “examine,” but not to be followed by clear initiatives. These are “reviewing the worker dispatching system” and “reviewing evacuation standards for registered childcare facilities.” The necessity of amending current legislation has been discussed for a long time, and the inclusion of these measures suggests Abe’s cabinet has finally decided on a general direction for its policy. However, the strategy uses phrases such as “to hold discussions” and “to advance the consideration” (both are translated from one Japanese word, “kentou-suru”). This term in Japanese sometimes means that a government will consider the pros and cons of a policy change, but will take no policy action based on the results. What is more, although many policy measures will be taken in this category, twenty-four measures (of fifty-nine) are about budget requests. These policy directions could prove efficient, if new measures for employment stability and fluidity are implemented after the necessary budgetary treatment in the beginning of the next fiscal year. However, some of them (especially measures aimed at women, the youth and elderly) are really surveys or research to “understand the potential problems” with the current system or with a future reform[3]

Table_2

2: Strategic Market Creation Plan

The ‘Strategic Market Creation Plan’ singles out industrial sectors that could potentially obtain a significant market share in the world but would have difficulties in market formation without the government’s initial support. Health-care, energy, infrastructure, agriculture and tourism are the chosen industries to be supported under this Plan, and the government will take necessary actions to meet its target in 2020 or 2030. The government’s seriousness for reforms should not be judged from the fact that few policy measures will be implemented in the immediate future, as most of them will require a long-term effort until the effects have taken place, or they are fully implemented. Table 2 shows that no new policy actions will appear by the beginning of the next fiscal year. However, some programs for energy sector reform have already been decided, with a list of regulatory reforms to take place in the longer term (and important amendments of relevant legislation approved by the Diet in autumn 2013). Policy measures for infrastructure development are also expected to advance, although slowly, as these meet the needs of both the government and the private sector. 

On the other hand, policies for market creation in health-care, agriculture and tourism may have problems advancing. More than half of the policy measures listed in the categories of health-care and tourism are about improvement or acceleration of existing policies and, as for the discussion in (1) above, several policy measures state the government’s intention to examine the problems of current systems, despite having argued the necessity of amending these policies for a long period of time. These include “consideration of a better system for the supportive contribution to medical insurance for the elderly aged seventy-five and over,” and “consideration of implementing a system which allows foreigners who meet certain conditions to stay for an extended period.” For health-care industries to develop, it is important to introduce “more advanced medical care.” The Plan has many policy measures to conduct empirical research and promote home-based R&D for advanced medical care, but lacks the promotional policies for expanding access by the national public and medical workers (especially for general practitioners) to develop the necessary skills to fully utilize it. 

For agriculture, the Plan includes various new policy measures for facilitating innovation in the sector and for promoting export of agricultural products. A scheme aiming at improving productivity such as “further liberalization of corporate entry into agriculture” is stated with, again, the bureaucratic wording of “will examine it” (although it is included in the Plan). For a problem which obstructs consolidation of farmland, widely regarded as one of the limitations to facilitate productivity in the agricultural sector, Abe’s growth strategy gives no promotional policies but maintains the current policy. 

Further measures for strengthening growth potential: Regulatory reform

Among the policy measures listed in Abe’s growth strategy, those expanding the budget and power of the line ministries will advance most quickly. However, some important deregulation requests from the private sector were not included in the growth strategy at all. 

Requests for reforms from the private sector derive from the perception of a “six-fold burden” arising from the Great East Japan Earthquake in March 2011. The six problems considered to have led the Japanese economy to the difficult situation are as follows: appreciation of the yen, energy shortages, high corporate taxes, strict employment regulations, green-house gas regulations, and a delay in negotiations for free-trade agreements. So far, the first arrow of Abenomics, monetary easing to exit deflation, has had the side-effect of depreciating the yen. Prime Minister Abe has already decided on his reform package for the energy sector (as explained above) and announced the new commitment to reduce Japan’s greenhouse gas emissions by 3.8%, down from the previous government’s commitment of a 25% reduction. Also, the government has started negotiations on an economic partnership agreement with the EU and fifteen countries in East Asia, as well as the TPP (Trans-Pacific Partnership agreement). 

Still, two problems – high corporate taxes and strict employment regulations – remain unsolved. In addition, Japan’s problems of starting business and paying taxes, highlighted in the EoDB ranking, cannot be fully solved without structural reforms. A survey of business managers conducted by the Nikkei newspaper after the announcement of the Abe cabinet’s growth strategy in June 2013 shows that although 88% of respondents assess the growth strategy positively, 95.4% request reductions in corporate tax rates. Other requests related to deregulation (not all of them necessarily related to the starting-up of business) include promotion of corporate enterprises’ entry into agriculture and health care, and expansion of immigration. 

The premier’s responses to the requests from the business sector should be checked. As the government and leading parties will decide the treatment of corporate tax reductions by the end of 2013, the focus here is on regulatory reforms, in particular on corporate entry into agriculture and health care and on strictness of employment. 

The Prime Minister instructed the Council of Regulatory Reform to prioritize discussions on easing restrictions on consolidating farmlands and lifting the ban on mixed medical treatment[4], in addition to a review of the worker dispatching system. The Ministry of Agriculture, Forestry and Fisheries suggested some relevant deregulation measures soon after this instruction, and recently decided to gradually abandon the policy of reducing rice acreage under cultivation in favor of large-scale farmers. The Council’s discussions on easing the ban on mixed medical treatment and on the worker dispatching system are still underway. However, as the Labour Policy Council will finish “examining” the pros and cons of the reform with a view to having it concluded by the end of 2013, the Council of Regulatory Reform is trying to complete its recommendations for necessary amendment of the laws.

The attitude not only of politicians and the administration but also the business sector and national public is important for reforms to succeed

Regulatory reform is the key for regaining the growth potential of Japan’s economy, and the menu for important deregulation is widely recognized at least among policymakers and experts. However, regulatory reforms were not always successful in the past. Such experiences have engendered skepticism about embarking on new reforms. 

What, then, would be the obstacles for regulatory reform? Saito (2013) reviews past minutes of Diet proceedings, meetings of governmental organizations for regulatory reforms and the Council for Economic and Fiscal Policy, and so on, and summarizes the causes for a reluctance to carry out regulatory reform. He identifies eight possible causes in the realms of politics, administration, business, and the national public as consumers. He also focuses on two successful examples of regulatory reform (liberalization of the aviation sector and easing of the ban on selling medicine by non-medical retailers) and analyzes conditions leading to successful reform. Table 3 summarizes these points. It might be suggested that ministries’ awareness of the necessity of changing regulation leads to successful deregulation, if there is either the prime minister’s leadership or a request from the relevant business sector for deregulation, coupled with public attention to the need for reform. 

The current circumstances for regulatory reform are clearly different from those at the time of the DPJ (Democratic Party of Japan) cabinets. It cannot be assessed yet whether there is any difference in individual business sectors’ behavior with regard to regulatory reform between the current and previous governments, but the national public’s awareness of the need for regulatory reform has become more significant, owing to Abe’s branding his reform as “the third arrow.” The leadership shown by the premier on regulatory reform is more convincing, judging from his public appearances and speeches, Abe stating time and time again that regulatory reform is the top priority for him when advancing his growth strategy. Although bureaucrats’ distrust of the private sector may not have changed, the Industry Revitalization Plan works around this by supporting the private sector’s voluntary actions toward innovation. 

Table 3: Causes affecting the success/failure of regulatory reform

Conclusion

To realize the stronger growth potential of the Japanese economy, a good strategy and surefooted implementation are essential. Revitalizing Japan’s industries will start with shifting resources from old industries to new ones and fostering home-based innovation, but more labor market reforms might be inescapable. Regarding market creation in his five prioritized sectors, Abe’s growth strategy may have left some areas untouched, especially in health care and agriculture, but recently the premier has begun to take the initiative for deregulation in these sectors too. The role of the government in market creation is smaller than it was under the previous growth strategy formulated by the DPJ governments. Once officers in regulatory ministries who are eager for reforms have room to express their thinking more freely inside and outside their ministries, structural changes will occur more smoothly and these will strengthen Japan’s potential for growth. 

This article is an updated version of “The Third Arrow of Abenomics: What Economic Picture Will It Draw in the Middle-Term?” published by Bruegel on 29 September, 2013. [2013]

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