A harder target for Abe's third arrow
Japanese Prime Minister Shinzo Abe has embarked on one of the most contentious stages of his economic growth strategy plan, popularly termed ‘Abenomics’. His government confirmed it will press ahead with raising the consumption tax, from 5 per cent to 8 per cent next April, with a further increase planned to 10 per cent in October 2015. The national sales tax was last increased from 3 per cent in 1997.
This tax hike comprises part of a wide-ranging structural and regulatory reform plan, the third of the ‘three arrows’ of Abenomics.
The first two arrows, monetary easing and stimulus spending, have been relatively easy for Abe to conduct, and have generally been popular and successful. Aggressive quantitative easing by the Bank of Japan since April has doubled the volume of its long-term bond purchases, which has increased the money supply, and depreciated the yen by about 25 per cent against the US dollar, assisting exports. However, there remains a large trade deficit at over ¥960 billion.
The second arrow has been a ¥10.3 trillion stimulus package, directed mostly towards infrastructure and construction, which is the traditional means used by the ruling Liberal Democratic Party to boost the economy and lift employment. Both inflation and GDP growth have increased to 0.9 per cent, and the Nikkei stock market index has risen by around 50 per cent since December 2012, when Abe returned the LDP to power in lower house elections. The target of Abenomics is sustainable inflation and real economic growth rates of 2 per cent by 2020.
The third arrow is far more ambitious and complex. It aims to encourage deregulation, productivity and competitiveness across an extensive range of sectors, including energy, health care, agriculture, education, science and technology, transport, infrastructure and tourism. Export industries, small-to-medium enterprises, and increased participation by women in the workforce are to be encouraged.
Engaging in more liberalised international trade agreements, such as the TPP, are also considered part of the third arrow. Japan’s successful bid to secure the 2020 Olympics in Tokyo is expected to further encourage stimulus spending and long-term growth.
The purpose of the consumption tax increase is to attempt to address the ever increasing government budget deficit, which has exceeded ¥1000 trillion, with a public debt to GDP ratio of 211.7 per cent — the largest in the OECD. As the population of Japan continues to fall and age, the burden of rising health and welfare costs will continue to increase while the income tax revenue base shrinks.
The sales tax hike can only make a minor, temporary impact on this deteriorating fiscal dilemma. The consumption tax increase is to be partially offset by an additional ¥5 trillion stimulus package, including one-off compensation payments to low-income households and pensioners, and tax breaks for home loans and purchases. But the burden on consumers will rise overall in the long term. This poses the danger that such a regressive move will discourage consumer spending and blunt aggregate demand, threatening the gains of the economic recovery made so far.
Abe is counting on firms to raise wages as the economy grows, encouraged by a promised corporate tax cut, with the result of offsetting the consumption tax increases. But there are no guarantees employers will pass on any salary increases. It is more likely that employers will retain them as higher profits and shareholder returns instead.
The third arrow will also face other obstacles in its implementation, such as cultural resistance among many corporations to an increase in women's participation in the workplace, and opposition to participation in the TPP from the influential farmers’ lobby, who are against allowing any increase in cheaper agricultural imports.
Nevertheless, Abe remains in a strong domestic political position. His Cabinet approval rating remains relatively high, at around 63 per cent. Public opinion is divided on the consumption tax increase: a recent poll had 53.3 per cent approving its increase to 8 per cent, but 61.6 per cent opposed raising it to 10 per cent. However, the weakness of the opposition parties means Abe can press forward largely unhindered.
The main opposition Democratic Party advocated the consumption tax increase when it was previously in government, although this was the major reason for its defeat last year. Most other minor parties, such as the Communist Party, are highly critical of the consumption tax increase, but their numbers in both houses of the Diet are too small to be any impediment. The only real potential check on the LDP is its junior coalition partner, the New Komeito Party, but it is generally supportive of the Abenomics program overall.
Abe needs Abenomics to succeed to provide both the economic and political capital required to fulfill his nationalistic dreams of restoring Japan as a premier geostrategic nation in East Asia. A less noted part of Abenomics is a 3 per cent increase in defence spending to ¥4.89 trillion, driven by rising territorial tensions with China over the Senakaku Islands, and concerns over North Korea’s missile threat. Abe therefore still faces a number of potential challenges — both domestically and internationally — to seeing his bold plans reach their fulfillment.
Craig Mark is associated professor of International Studies at Kwansei Gakuin University.