Ginza Six, a luxury shopping complex in Tokyo: Japan’s economy grew this year, but reforms are needed to lift wages and boost productivity (photo: Michiko Takei/Jiji Press/Newscom)
July 31, 2017
Japan’s economy is expected to grow again this year—at 1.3 percent—thanks to a continued pickup in trade and temporary fiscal support. But a rapidly aging population and a shrinking workforce mean that the country will need to speed up reforms to boost wages, productivity, and growth, said the IMF in its annual review of the Japanese economy.
In this interview, Todd Schneider, who led the work on this year’s Article IV Consultation, talks Abenomics—the three “arrows” of monetary easing, flexible fiscal policy, and structural reforms—demographics, and the key priorities to help Japan lift decades’ long deflation and weak growth.
What is the outlook for Japan’s economy this year?
Japan had a relatively good year in 2016 and we see the momentum carrying into 2017 with growth projected at about 1.3 percent. This is largely driven by a favorable external environment, which for Japan means higher exports. The benefits of the temporary fiscal support package, which was passed in August 2016, are also starting to play out and have helped economic growth.
But, underlying domestic private consumption and investment remain moderate, and inflation is stubbornly low. These present risks to sustaining medium-term growth.
You mentioned that deflation continues to be a challenge for Japan’s economy. In 2016, the Bank of Japan enhanced its monetary policy framework in a fresh bid to spur lending and investment. Has that helped boost inflation?
After a comprehensive review, the Bank of Japan upgraded its policy framework late in 2016, introducing yield curve control (YCC), and publicly committing to overshoot the 2 percent inflation target. The switch from a specific annual quantitative target for JGB purchases to directly targeting the shape of the yield curve aims to improve monetary policy effectiveness by making it more flexible and sustainable.
So has this helped boost inflation? The answer is it’s too early to assess the overall impact of YCC on inflation and the economy. But in some aspects the new framework has worked well. Volatility in yields has fallen, and an increase in super-long yields has given some relief to institutional investors facing challenges from the low interest rate environment.
Wages, too, have not risen as quickly as needed to boost consumer spending. How do wages tie into Japan’s inflation concerns and why does it matter for the economy overall?
Unemployment has fallen to a 25-year low and the job-to-applicant ratio is at an all-time high, but we are still not seeing higher pressure for wages from “regular” workers (those in full-time employment). This matters because higher wages translate into higher household income, which then promotes more consumption and inflation.
Japan’s low wage growth is partly caused by structural factors—such as limited labor mobility, lifetime employment, and preference for job security, as well as base pay negotiations guided by current inflation, which as I mentioned did not increase much this year.
Labor market reforms to boost wages and growth, such as promoting worker mobility between firms, closing gaps in pay and working conditions via contract reform, and seeking to ensure “equal pay for equal work” can improve resource allocation, and increase wage pressures and thus help facilitate re-inflation.
Japan’s rapidly aging population and shrinking workforce will have a profound impact on the future of the economy. What can the government do to start mitigating demographic challenges?
Looking at population dynamics and the projected steady decline in the labor force, Japan will need to make labor more efficient and more inclusive—by, for example, bringing more women into the work force in regular (full-time) positions and on an equal pay for an equal work basis.
This means, among other things, labor contract reform, elimination of disincentives to full-time and regular work, and more availability of childcare and elder-care. Many of these issues are covered in the government’s Work Style Reform plan, but could be accelerated.
Financial sector policies aimed at efficient credit allocation to small and medium-sized enterprises would further promote innovation, productivity, and investment. Just as important, financial institutions across Japan—particularly regional and Shinkin banks (regional credit cooperatives)—will have to adapt to the challenges of a prolonged low-growth and low interest rate environment, as well as an aging and shrinking population.
This means adjusting business models (through such avenues as higher fee-based income, reducing costs, and consolidation) and, when seeking profitability in new areas, being mindful of emerging risks.
The planned consumption tax increase has been postponed twice. Why is this is still an important policy for Japan to implement?
It is still an important policy for two reasons. One, Japan’s public debt stands at 240 percent of GDP—by far the highest among the G7 and unsustainable on current policies by staff’s estimation. Increasing the consumption tax rate is a step toward stabilizing and eventually reducing public debt. And two, with an aging population, you will also have increasing demands for social security expenditure-especially healthcare.
Expenditure reform will be needed to curb these costs, but additional revenue will also be needed to finance this important area of public spending. Japan’s consumption tax rate is also low relative to peer countries, but the efficiency of collection is high—suggesting large potential gains. The gradual increases we are proposing to the Japanese authorities should be part of a broader package of fiscal adjustment measures.
Some people ask why a consumption tax rather than an income tax—given that excessive consumption is not Japan’s particular problem. Income tax also needs reforms to address inequality, eliminate work disincentives and broaden the tax base.
However, because working incomes are essential to household consumption, higher income taxes would be counter-productive. With a consumption tax, however, you’re spreading the tax burden across all age cohorts because everybody consumes. Other options like property taxes, inheritance taxes, or asset taxes are also worth looking at to supplement gains from the consumption tax.
Coordinated support from monetary and fiscal policies, together with income policies (higher wages), to maintain the current economic momentum.
Renewed focus on Abenomics’ third arrow –structural reform—particularly with respect to labor markets to eliminate bottlenecks to wages, investment, and productivity.
Stronger policy frameworks, including a credible medium-term fiscal framework, to set expectations, boost confidence, and put debt on a sustainable path.
Enhanced financial sector policies to contain new and less understood risks from the prolonged low interest environment and demographic headwinds.
