It’s autumn. The temperature’s dropping, trees are shedding, and Japanese Prime Minister Shinzo Abe is starting to lose his footing. Mr. Abe was supposed to unleash his economic “third arrow” – structural reform to go with earlier stimulus – in late summer. This has not happened, and each month that passes will bring the Prime Minister a bit closer in performance to his predecessors, who failed to invigorate the economy and were drummed out of office.
Japan’s challenges are well known. What is not appreciated is that, in principle at least, Mr. Abe has a number of options.
Perhaps most controversial are measures involving the return on capital. Mr. Abe has pushed through a sales tax increase, the first in 15 years. However, it was packaged with renewed spending pledges, on top of those made when the Prime Minister took office. Japan remains caught in the trap of believing that government borrowing from the private sector enriches the country, and the gigantic amount of public debt makes it unlikely that genuine reform will be found on the capital side.
Japan has limited natural resources and, due largely to the perceived political power of farmers, land has also not been used wisely. The Trans-Pacific Partnership (TPP) offers an opportunity for change and Mr. Abe deserves credit for joining the negotiations. It would be a mistake to rely on TPP, however, as meaningful implementation of a final agreement may not come until 2015 or later.
Happily, there are a third set of major changes possible now, involving labor. The size and productivity of the labor force is limited by Japan’s aging population, but also by bad policy. Pensions should be made more portable, it should be easier to hire and fire, and various steps should be taken to more effectively integrate women. Mr. Abe has a range of choices here, but nothing substantial has yet been put forward.
A fourth route has been much-discussed: bolstering innovation. Japanese individuals and firms have shown themselves to be innovative but their performance could be improved, perhaps considerably. Due in part to overregulation and tight government-firm relationships, the financial system is insufficiently specialized in the area of entrepreneurship and the commercial tumult that marks innovation – older firms pushed aside by more dynamic new entrants – is often absent.
It is not the case that Mr. Abe must quickly advance on all fronts. A single set of reforms pertaining to labor or innovation would bring genuine progress, making the longer-term implementation of TPP and even debt reduction easier. But Mr. Abe must act soon, or his status as a different kind of Prime Minister will be put at increasing risk.