Abenomics:  continuity is still the end of an era

On the last Friday in August, Prime Minister Shinzo Abe stepped down, drawing to a close Japan’s longest-tenured post-war leadership. So what is his legacy, and who are the front-runners to be the next prime minister of Japan?

Abenomics: a radical proposal

Abe took office in 2012 promising sweeping reform following the devastating Tsunami the previous year that shocked Japan and accelerated an agenda of change.  Markets quickly coined a new term for his economic revival strategy: ‘Abenomics’.  This was a radical proposal with strong branding built around three goals, or ‘arrows’ that would aim to:

  • Shock inflation higher via monetary policy;

  • Use fiscal levers ‘flexibly’ to support growth and complement monetary policy (but never taking an eye off government debt);

  • Boost potential growth via reforms.

The Bank of Japan reacted aggressively. Asset purchases, relative to the size of the economy, were the largest ever seen, eclipsing the US Federal Reserve’s QE3 programme. Interest rates would be pushed into negative territory, followed by direct action to hold yields down. This had a marked impact on asset prices, even if progress on re-anchoring inflation has been partial. The persistent, but mild deflation which has plagued Japan may have been banished by the BoJ’s actions, but 2% inflation still appears a distant prospect.

Shocking inflation higher was never going to be easy. It would have been more likely to succeed if the other two ‘arrows’ had hit their marks.

Initially fiscal policy was supportive, but its ‘flexibility’ was a key flaw, implying that consolidation was always on its way – a far cry from a promise to be irresponsible. The consumption tax hikes of 2014 and 2019 duly hit hard.

Some structural reforms were pushed through, aided by the tenacity of Chief Cabinet Secretary Yoshihide Suga. Among notable achievements under Abe’s leadership we would highlight:

  • improving corporate governance standards;

  • raising the labour force participation of women (prime-age participation is now above that of women in the US);

  • creation of the Comprehensive & Progressive Trans-Pacific Partnership (CP-TPP), a free-trade agreement deepening ties with 11 other countries. 

But it was never really clear that Abenomics was targeting fundamental changes that would complement inflation, such as raising the share of income going to households - in so doing breaking the barriers to stronger wage growth.

 

A post-Abe world

The sudden departure of Abe has changed the dynamics of appointing a successor, giving more power to the Diet members than the prefectural chapters (394 Diet members and 141 chapter delegates will decide who the next leader is).

This appears to strengthening the dynamics for Suga - who is backed by the largest factions in the ruling Liberal Democratic Party (LDP) - to be appointed as the next prime minister.

Suga appears to be a continuity candidate. His policy views are not well known. But having been deeply involved with implementing Abenomics, it seems unlikely that he would drastically change course. Some speculate that Suga may want a caretaker position, only taking the helm until a general election.

Abe could play a kingmaker role – one reason why Suga is clear favourite. But much can happen before the vote. Shigeru Ishiba, former defence minister, or Fumio Kishida, former minister for foreign affairs, could stage an upset.  Neither Ishiba nor Kishida appear to offer radically different economic policy prescriptions, although Kishida may do more to support social welfare programmes.

Suga and Ishiba seem more likely to continue the effort to amend Article 9 of the constitution - legitimising the self-defence force - whilst Kishida does not appear to view this as a pressing matter and is unlikely to pursue this agenda unless pushed by the LDP. Amending the constitution could make diplomatic relations more fraught with China and Korea, and the next annual Japan-China-Korea trilateral summit will be a key waymark for assessing tensions. Kishida’s diplomatic experience may give him an advantage in managing foreign relations, but all candidates may struggle to enjoy the same relationship that Abe had with US President Donald Trump.

Whoever emerges as the next prime minister will face considerable challenges in the wake of the coronavirus pandemic. It is not clear whether the COVID-19 shock could drive change in the same way as the tsunami that swept Abe to power. A (non-Chinese, non-Russian) vaccine could get Japan back to business in 2021, but might also dampen reform momentum as the economic shock unwinds.

Abe was somewhat unusual in terms of his strength within the LDP, which gave him a freer hand to operate than most Japanese prime ministers have had.  Even so, the constrictions of factional politics and compromise that affected decisions partly explain why even he wasn’t able to live up to the early promise of being a major structural reformer. The next leader is not guaranteed to enjoy the same latitude as Abe, in part because Abe himself may retain considerable sway behind the scenes.

In summary, this points to the likelihood of the status quo being broadly maintained and perhaps even more incrementalism. Ultimately, Abenomics was an attempt to drive major change. It is fair to say, then, that continuity of current policies still represents the end of an era. 

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Risk warning

Risk Warning

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.