Keywords

JEL Classification

7.1 Introduction

In the early 1990s, Japan’s real estate and stock market bubble burstFootnote 1 and the economy went into a tailspin. Since then, Japan has suffered from sluggish economic growth. Two decades later, the collapse of Lehman Brothers in September 2008 and the global financial crisis threatened the entire world economy. In March 2011, a catastrophic earthquake and tsunami struck northeastern Japan. Japan’s government budget deficit–gross domestic product (GDP) ratio breached 200% in 2010, mainly because of the high share of pension fund payments in government spending, and the efficiency and effectiveness of public investment was called into question. The Japanese economy required a stimulus to escape from this pattern of long-term sluggish growth. In December 2012, the Liberal Democratic Party won a general election, making Shinzo Abe Prime Minister of Japan, a post that he had held previously in 2007. “Abenomics” refers to the economic policies advocated by the Prime Minister after the election, which were designed to revive the sluggish economy with policy sets that unleash “three arrows”: (i) fiscal consolidation, (ii) more aggressive monetary easing by the Bank of Japan (which settled on an inflation target of 2%), and (iii) structural reforms to boost Japan’s competitiveness and economic growth. By the end of February 2013, these measures were credited for a 22% rise in the Tokyo Stock Price Index (TOPIX) since Abe’s and the Liberal Democratic Party’s electoral win. In this chapter we will explain the contributions of the three arrows of Abenomics and the current state of the Japanese economy. We will also propose some further remedies that may be required for Japan to recover from its long-term deflation, such as hometown investment trust (HIT) funds, postponement of the retirement age by introducing a flexible wage rate system, and reduction of subsidies from the central government to local governments (see Yoshino and Taghizadeh-Hesary 2014a, b).

This chapter reviews aspects of the three arrows of Abenomics, identifies a chief financial barrier to realizing progress on the third arrow, and proposes a way forward through the creation of a new funding mechanism. In Sect. 7.2 we review aggressive monetary policies and fiscal consolidation being pursued under Abenomics (the first two arrows). In Sect. 7.3 we review Japan’s growth strategy (third arrow of Abenomics). In Sect. 7.4 we present some concluding remarks.

7.2 Aggressive Monetary Policy and Fiscal Consolidation in Abenomics

7.2.1 Aggressive Monetary Policy

The government and the Bank of Japan (BOJ) delivered a joint statement on 22 January 2013 on overcoming deflation and achieving sustainable economic growth. The BOJ set a price stability target at 2% (year-on-year rate of change in the consumer price index). The government set an expectation that the BOJ implement aggressive monetary easing to achieve this target as soon as possible. The BOJ pursued this goal by buying long-term government bonds and increasing the monetary base, in contrast to previous attempts at an expansionary monetary policy that mainly focused on buying short-term government bonds.Footnote 2 Although prices started to rise after the BOJ implemented monetary easing,Footnote 3 a major reason for this was higher energy prices,Footnote 4 and at the time of writing the 2% target has not been achieved.

Although prices started to rise after the BOJ implemented monetary easing, it was unable to raise levels of investment and aggregate demand. The achieved inflation in Japan mainly stemmed from other sources, such as the higher energy prices that resulted from the depreciation of the Japanese yen after the easing of monetary policy.

A simple aggregate supply and demand model will clarify the analysis of how higher energy prices created inflation in Japan.

In Fig. 7.1, the economy initially is in equilibrium with price level PQ0 and real output level Q0 at point A. AD is the aggregate demand curve and AS stands for the aggregate supply curve. The aggregate supply curve is constructed with an increasing slope to show that at some real output level, it becomes difficult to increase real output despite increases in the general level of prices. At this output level, the economy achieves full employment.

Fig. 7.1
figure 1

How higher energy prices created inflation in Japan (Note: We assume that there is technological progress; that is why the output level in full employment also increased. AD aggregate demand, AS aggregate supply. Source: Taghizadeh-Hesary and Yoshino (2015))

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Let us suppose that the initial equilibrium, point A, is below the full employment level. As the relative price of energy resources (crude oil, natural gas, coal, etc.) increases, the aggregate supply curve shifts to AS’. The employment of existing labor and capital with a given nominal wage rate requires a higher general price for output, if sufficient amounts of the higher-cost energy resources are to be used.

The productivity of existing capital and labor resources is reduced so that potential real output declines to Q1. In addition, the same rate of labor employment occurs only if real wages decline sufficiently to match the decline in productivity. This, in turn, happens only if the general level of prices rises sufficiently (PQ1), given the nominal wage rate. This moves the economy to the level of output (Q1) and price level (PQ1). This point is indicated in Fig. 7.1 at point B, which is a disequilibrium point. Given the same supply of labor services and existing plant and equipment, the output associated with full employment declines as producers reduce their use of relatively more expensive energy resources and as plant and equipment become economically obsolete.

On the other hand, on the demand side of the economy, when the price of energy resources rises their consumption declines. Because of this drop in consumption, the aggregate demand curve shifts to AD’, which in turn reduces the prices from the previous disequilibrium level at PQ1 and sets them to PQ2 as the final equilibrium price. Due to less consumption in the economy, this lowers the output levels from the previous point of Q1 to Q2. This point is indicated in Fig. 7.1 at point C, which is the final equilibrium point.

The economy may not adjust instantaneously to point C, even if point C is the new equilibrium. For example, price rigidities due to slow-moving information or other transaction costs can keep nominal prices from adjusting quickly. Consequently, output and prices move along an adjustment path such as that indicated by the arrow in Fig. 7.1.

7.2.2 Fiscal Consolidation

Figure 7.2 compares the gross debt–GDP ratio of selected Organisation for Economic Co-operation and Development (OECD) countries.Footnote 5

Fig. 7.2
figure 2

The GDP–debt ratio of selected OECD countries (%). GDP gross domestic product, OECD Organisation for Economic Co-operation and Development (Source: OECD Economic Outlook)

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Japan’s debt–GDP ratio is the highest among OECD countries, yet budget deficits are still sustainable. Although the Greek government debt–GDP ratio is lower than that of Japan, Greece almost went bankrupt in 2012. The differences between Japan and Greece can be seen in the demand for government debt: domestic investors hold more than 90% of Japanese government debt, whereas about 70% of Greek government debt is held by overseas investors.

As stated in Sect. 1.3 (Comparison of the Economic Collapse in Japan and Greece) of this book, both Japan and Greece have increased their sales of government bonds, meaning that the supply curve of government bonds has shifted to the right in the primary market. Demand for Japanese government bonds by banks, insurance companies, and pension funds is increasing as the sluggish economy has reduced demand for corporate loans (Fig. 1.9, left chart). Monetary easing has increased bank deposits and these funds have often been invested in government bonds. Japanese interest rates, therefore, remain at a very low level.

It remains crucial for Japan to reduce its budget deficit. One way of doing this is to raise tax revenues, and in April 2014 the consumption tax rate was increased from 5 to 8%. However, it is also important to reduce government spending. To reduce government expenditure on social welfare and pension funds, people will have to work longer and not rely wholly on social security and pensions after retirement. This could mean that the retirement age needs to be postponed and wage rates must be based on productivity rather than seniority, as is the case among many Japanese companies. The rationale for this is explained in Sect. 7.3. The Abe government is presently considering these options. (For more information about fiscal consolidation of Japan, see Doi et al. 2011.)

In conclusion, the government will need to manage short-term fiscal policy in a timely and flexible manner, while firmly expressing the political will to restore Japan’s fiscal balance over the medium and long term. The government knows that it must credibly reach the current fiscal consolidation target, which aims to achieve a fiscal surplus by FY2020.

7.3 Growth Strategy

The third arrow of Abenomics is putting forth a growth strategy. The Japanese government has pledged that over the medium and long term, it will take measures to strengthen the competitiveness of domestic firms, overcome energy constraints, and enhance the innovation platform based on a well-defined growth strategy, while at the same time accelerating the removal of domestic institutional obstacles, including regulations. In this section, we review the growth strategies of the current government in Japan and propose additional remedies to foster economic growth. We then define one of these remedies—the use of hometown investment trust funds as new way for financing SMEs and start-ups.

7.3.1 Growth Strategies of the Current Japanese Government

In January 2014, during a National Diet meeting, Minister of Finance Taro Aso identified 10 major aspects of Japan’s growth strategy:

  1. (i)

    The government will encourage companies to increase employee wages, which will encourage the expansion of domestic consumption.

  2. (ii)

    To cover increasing social security spending, the government will increase taxes.Footnote 6

  3. (iii)

    The government’s deficit targets are (a) by 2015, the budget deficit over GDP ratio should be half of the 2010 level; and (b) by 2020, the ratio should be zero. To achieve this goal, the government will make its spending much more efficient.

  4. (iv)

    Since Japan’s population is aging, the government will encourage greater female participation in the labor force, in part by improving child care facilities. The government will also encourage older people to keep working and retirees to rejoin the workforce.

  5. (v)

    The expenses of medical care for the elderly have been increasing drastically. The government will monitor prices of medicine and health care to ensure they reflect market prices. The government will put in place a regional medical care system.

  6. (vi)

    The government will ensure there is sufficient funding for disaster preparedness.

  7. (vii)

    The government will provide more scholarships to students, and increase expenditure on research and development.

  8. (viii)

    The government will provide sufficient funding for repairing aging infrastructure.

  9. (ix)

    The government will ensure SMEs have access to easy financing for research and development.

  10. (x)

    The farming population is aging and the government will provide sufficient funds to ensure an efficient and competitive agriculture sector.

In addition to these remedies, there are others that we believe are necessary to foster the economic growth in Japan, which include the following:

  1. (i)

    reduction of transfers from central to local governments,

  2. (ii)

    diversification of households’ asset allocation,

  3. (iii)

    switching asset allocation pension funds and insurance companies from pay-as-you-go to 401(k)-style,

  4. (iv)

    review of asset management fees,

  5. (v)

    optimal mix of public and private funds,

  6. (vi)

    review of monetary policy goals,

  7. (vii)

    diversification of the energy basket, and

  8. (viii)

    use of hometown investment trust funds to finance riskier businesses.

These remedies are completely explained in Chapter 1 of this book. Below we explain the potential role of hometown investment trust funds in fostering the growth of Japan’s small business sector.

7.3.2 Hometown Investment Trust Funds

In Japan, like other Asian countries, the economy is dominated by small and medium-sized enterprises (SMEs).

As shown in Fig. 7.3, more than 99% of all businesses in Japan are SMEs; they also employ most of the working population and account for a large proportion of economic output.

Fig. 7.3
figure 3

Small and medium-sized enterprises in Japan. SME small and medium-sized enterprise (Source: Government of Japan, Ministry of Economy, Trade, and Industry (2011) White Paper on SMEs)

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On the other hand, the Japanese economy, like other Asian economies, is more bank-oriented than capital-market-oriented compared with western economies (see Fig. 1.12 in Chap. 1).

Due to strict Basel capital requirements, banks have to keep much more capital when lending to risky borrowers such as SMEs and start-up businesses (Yoshino and Hirano 2011). The Japanese economy is dominated by bank loans that have to follow stricter Basel capital requirements (Basel III). Hence banks are reluctant to lend to SMEs and start-up businesses, because they consider these sectors to be risky. Therefore, it is urgent to develop regional funds (or hometown investment trust funds) to provide money to SMEs and start-up businesses in Japan and other parts of Asia. Then, if these regional trust funds are sold through branch offices to regional banks, post offices, credit associations, and large banks, this would increase the opportunities for regional companies to raise funds.

However, such trust funds would not be guaranteed by the Deposit Insurance Corporation and risks would be borne by investors.Footnote 7 The terms of a trust fund would have to be fully explained to investors (for example, where their funds would be invested and the risks associated with the investment) in order to strengthen investor confidence and help the trust fund market to grow (Yoshino 2013; Yoshino and Taghizadeh-Hesary 2014d). Examples of such funds in Japan include wind power generators and musicians’ funds. In the first example, in order to construct 20 wind power generators, public–private partnerships were launched and local residents invested between $1000 and $5000 in a fund. They receive dividends every year through the sale of electricity from each wind power generator in which they invest. Musicians’ funds gather many small investors who buy units for $150–$500. If a musician becomes successful and their music sells well, the sales will generate a high rate of return for the fund.

Examples can be found of both successful and failed funds. Project assessors play a key role in evaluating each project to limit the number of nonperforming investments and losses by investors. Some of Japan’s funds are regarded as charities, with some investors seeing them as a way to invest in their region to support new business ventures.

Such new ventures pose a problem for banks, as although some will have high expected rates of return, the high risks involved make it difficult for banks to finance them. However, if the projects are financed by hometown investment trust funds rather than by deposits transformed into bank loans, they will not create nonperforming loans for banks. Banks can still benefit, and compete with each other, by selling hometown investment trust funds through their branch offices. Investors must be advised that their investment is not guaranteed, although they may receive a high rate of return. If a bank sells successful hometown investment trust funds, it will attract more investors; if it sells loss-making funds it will lose investors. Competition will improve the quality of projects and enhance the risk-adjusted returns for investors.

The hometown investment trust fund has three main advantages. First, it contributes to financial market stability by lowering information asymmetry. Individual households and firms have direct access to information about the borrowing firms, mainly SMEs, to which they lend. Second, it is a stable source of risk capital. The fund is project driven. Firms and households decide to invest by getting to know the borrowers and their projects. In this way the fund distributes risk, but not so that it renders risk intractable, which was the problem with the “originate-to-distribute” model.Footnote 8 Third, it contributes to economic recovery by connecting firms and households with SMEs that are worthy of their support. It also creates employment opportunities at the SMEs as well as for retirees from financial institutions who can help assess the projects.

Introduction of the hometown investment trust fund has huge global implications. The world is seeking a method of financial intermediation that minimizes information asymmetry, distributes risk without making it opaque, and contributes to economic recovery. Funds similar to Japan’s hometown investment trust fund can succeed in all three ways—after all, the majority of the world’s businesses are SMEs (Yoshino 2013).

7.4 Conclusion

To address the high level of Japan’s government budget deficit-GDP ratio and the sluggish economic growth the government of Shinzo Abe, which was elected in December 2012, introduced a reform program called Abenomics, which aimed to revive the sluggish economy with “three arrows”: fiscal consolidation, more aggressive monetary easing from the Bank of Japan, and structural reforms to boost Japan’s competitiveness and economic growth.

As for the first arrow, fiscal consolidation, the government aims to implement its short-term fiscal policy in a timely and flexible manner, while also firmly expressing the political will to restore the fiscal balance over the medium and long term by cutting the primary deficit of the central and local government in half between FY2010 and FY2015 and achieving a fiscal surplus by FY2020.

As for the second arrow, aggressive monetary policy, the BOJ set a price stability target of 2% (year-on-year rate of change in the consumer price index). The government expects the BOJ to implement aggressive monetary easing to achieve this target as soon as possible. Although prices started to rise after monetary easing, this was largely due to higher oil prices, and the 2% inflation rate target has still not been achieved. The current governor of the BOJ, Haruhiko Kuroda, is pursuing a monetary policy that involves buying long-term government bonds and increasing the monetary base (this is in contrast to the former government, when an expansionary monetary policy was mainly carried out by buying short-term government bonds).

As for the third arrow, the growth strategy, the government has encouraged higher wages to encourage the expansion of domestic consumption, raised taxes to cover increasing social security spending, encouraged female participation in the labor force, postponed the retirement age, prepared for a transition to a regional medical care system for the elderly and taken measures to reduce health care costs, provided a sufficient budget for disaster preparedness, increased the share of R&D and education in government expenditure, improved access to financing for SMEs, and is carrying out agricultural reforms to overcome the inefficiency of this sector.

As part of the growth strategy, we put forth a proposal for a new form of financial intermediation called the hometown investment trust (HIT), with the goal of connecting fund providers and their hometowns. The Japanese government is currently considering this new form of financial intermediation as one remedy for addressing Japan’s sluggish growth.