Well, this wasn’t in the G20 script: before the ink had even dried on the “Brisbane Action Plan”, the world’s third-largest economy, Japan, lurched into its fourth recession since Lehman Brothers failed in September 2008. The ambitious reform plans of Prime Minister Shinzo Abe (a good friend of Prime Minister Tony Abbott) were supposed to play a big part in getting that extra 2.1% in GDP growth for the world economy over the next five years. Now… hmmm.
The Japanese economy went backwards in the three months to September with growth an annualised -1.6% (after the restated -7.3% in the July quarter, up from -7.1% previously), thanks to a sharp fall in business inventories and weak business spending. Inventories and business spending are notoriously rubbery estimates for the Japanese economists in their early estimates of GDP performance, so this first estimate of September quarter growth could turn out to be a bit ropey — the -0.4% figure could be unwound when the second GDP estimate for the quarter is issued and Japanese statisticians have more up-to-date figures to work with.
But even if that happens, yesterday’s news was a huge shock: economists had expected growth of around 2.1% annual in a big rebound from that second-quarter plunge, which was caused by consumers and business shutting down spending in the wake of the increase in the country’s sales tax from 5% to 8% on April 1. That tax rise was designed to improve government tax receipts, lift budget revenues and start cutting (ever so slowly) Japan’s deficit, and through that, make a start on cutting the country’s debt burden, which is running at 220% of GDP. It was a central part of Abe’s reform plans, along with plans to reform employment, lift female participation in the workforce (one of the G20’s central promises), boost inflation and end deflation. But economists missed the mark spectacularly — not just by a few tenths of a per cent; they missed the entire direction of the Japanese economy under the impact of the tax rise.
Japan, of course, is important to Australia — it’s our second-largest export market and is third biggest source of foreign investment. It was only in July that we were getting excited about the free trade agreement nutted out by Abbott and Abe. Still, as this week shows, there’s always another FTA around the corner.
There’s supposed to be a second lift in the tax rate, another 2%, in October 2015, but don’t bet your boots on that happening now — Abe (and any other Japanese politician) is likely to have little appetite for committing political suicide after seeing a key policy flatten an economy so efficiently. Abe is now expected to respond by calling a snap election later today for December 14. No matter who wins — voters may be less likely to back Abe after his tax rise flattened the economy — the future of the second 2% rise in the tax is problematic.
Abe’s plans were supposed to be underwritten by an unprecedented level of spending from the Bank of Japan, the country’s central bank. But the Bank of Japan failed to support the economy and consumer spending (and business spending for that matter) when it was needed most — through the tax-induced crunch. Perhaps the central bank had an inkling of the problems when it dramatically expanded the size of its spending at the end of October, and why the country’s huge national pension fund revealed plans to boost spending on equities at home and offshore, and would sell down US$220 billion of bonds to finance that switch (those bonds are being bought by the central bank as part of its support program).
That boosted share prices to seven-year highs and dropped the yen to seven-year lows, and yet the economy hasn’t improved. Deflation has gone, but only for the time being, and falling oil prices will help stoke it again, even after the impact of the weaker value of the yen. Unemployment has fallen and wages have been making a tentative move upwards, but the tax rise has smashed consumers. Exports haven’t been helped by the weaker yen — Japan has racked up record trade deficits and Japanese companies are sitting on US$2 trillion in cash (according to Nomura) and not spending much on new investment, wages or bringing back to Japan manufacturing capacity set up offshore when the yen was much higher, which was supposed to be one outcome of Abe’s policies.
Much will now depend on the impact of the Bank of Japan’s second and larger round of spending, and whether it will be any more successful than the first. Many in Japan and abroad put their hopes in Abe’s ability to shock the Japanese economy into growth. But the shock has turned out to be of an altogether different kind so far.