By Yukinobu Kitamura
Hitotsubashi University
Japanese Prime Minister Shinzo Abe discussing his economic policies in a speech in London, June 2013. Photo courtesy of Wikipedia.
Japan’s Prime Minister Shinzo Abe dissolved the lower house of the Diet on 21 November and called a snap general election on 14 December. At the same time, Abe announced that he would postpone the second hike of the consumption tax rate from 1 October 2015 to 1 April 2017.
From a political perspective, most voters understand that a rapidly ageing population needs steady tax revenues from a broad tax base to finance its ever-expanding social security spending. This is why political parties that opposed the increase in the consumption tax rate lost their seats. Voters saw these parties as irresponsible.
Abe repeatedly praises himself on how well his economic strategy (popularly dubbed ‘Abenomics’) has worked. But Abe has been lucky: the business cycle began to turn just as he was elected, so the — pretty good — economic performance under his administration cannot all be attributed to Abenomics.
Abe’s decision to postpone the second hike of the consumption tax rate was based mainly on the latest estimates of quarterly annualised GDP growth in the second quarter, which has been estimated at -7.1 per cent. This figure shocked many market economists and politicians.
But this figure is misleading. Consumers were aware of the tax hike, so there was a rush to buy items, especially consumer durables and housing purchases, before the hike in April 2014. It is not surprising then that consumption fell in the second quarter because consumers had bought many items in the previous quarter to avoid paying more tax. The important figure is net domestic demand of the tax increase. One way of doing this is to compare output in the second quarter of this year to output in the second quarter of last year. This shows growth of -0.1 per cent per annum. The same measure for the first quarter of 2014 was 3 per cent. Overall, there we cannot identify any strong sign of structural change in consumer behaviour apart from demand smoothing and rapid ageing continuing.
The consumption tax hike should go ahead as planned. The Abe government has a double mandate to boost economic growth and escape the deflationary environmentof the past few decades, as well as to recover a sound fiscal position. The second mandate might be politically unpopular, but it must not be ignored or receive a lower priority than the first.
It is also better to implement the tax reform during the early expansionary phase of Japan’s current business cycle, if it has not gone through its peak already. Postponing the consumption tax rate hike until later in the cycle could create a higher risk of recession.
In addition, a large part of the extra revenue from a consumption tax hike would be redistributed to households, mainly through the social security system. A consumption tax hike therefore doesn’t necessarily reduce household’s disposable income. Of course, some may argue that the social security system is too generous to the elderly and too mean to the young. But this is a problem of the transfer system, not the consumption tax per se.
What should Abe do next? For better or worse, Abenomics is a direct successor to old-fashioned Keynesian fiscal and monetary policy that prevailed in the high-growth era in the 1960s. Implementation of the third arrow — radical structural reforms — is eagerly awaited.
To stoke private sector growth, the Abe government must set monetary and fiscal policies consistent with the structural reform strategy. When the economy nears full employment, further government stimulus crowds out private sector activity. In this case, the first and second arrows of Abenomics need to give way to the third. Put bluntly, further expansionary monetary and fiscal policy will harm economic growth in the private sector as the economy reaches full employment.
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