By Álvaro Martín:
Last August, and after eight years in power, Shinzo Abe resigned as Prime Minister of Japan for health reasons. His political mandate has been notorious in Japan and all around the world, for policies so well-known as that of Abenomics. In 2012, the era of expansionary monetary policy started, and it doesn’t look as ending any time soon. Mr. Draghi’s “whatever it takes” will remain forever in Economic History textbooks along with Japan’s “three arrows” massive economic stimulus plan. Abe, following a neat and polished political marketing strategy, orchestrated this plan around the three famous arrows.
Firstly, expansive monetary policy would be used to eliminate deflation and take inflation levels up to a moderate benchmark. The second arrow would entail a looser fiscal policy, allowing for higher public debt levels in an effort to supposedly increase potential economic growth. Finally, the third aspect Abenomics contemplated was that related to structural reforms, with the aim of lifting productivity levels and ensuring sustainable endogenous growth throughout the years. Now, many years later, Japan doesn’t look any better (at least in aggregate terms), but many European economies have decided to copy Japan’s strategy. The Japanification of Europe is now more a fact than a mere idea.
The Japanese and European economy have coincided in many more things than just their economic policy over the last decade. Both have very elder populations and present inverted population pyramids. This has led to growing public expenditure, lower economic growth and a stagnation of productivity levels. Debt dynamics have gotten worse since the euro crisis in Europe and since the birth of Abenomics in Japan, even though the cost of debt has been artificially and heavily softened by ultra-low interest rates, reaching in many cases the zero lower bound, which has severely limited central banks’ capacity to stimulate economic growth, even in the short run.
This is not a problem caused by the pandemic—which may have played a role in intensifying it—, but by severely prolonged expansionary programmes which have reduced fiscal space and effectivity of monetary policy, in a moment when we are approaching a fiscal dominance scenario, following Sargent and Wallace’s definition of the term, even though dismissing any scenario of relevant inflation in the near future, at least for the moment.
If Abenomics taught us one lesson it is that central banks are not the genie out of the lamp. Japan’s deflationary tendencies haven’t been fully cured yet, while ten years ago it was thought that a simpler more expansionary monetary policy would serve as a solution for it. Easing monetary policy for more than 8 years hasn’t made the BoJ able to sustain inflation at the stated benchmark for any time.
Just 4 years ago, in 2016, the BoJ doubled its bet and allowed for negative interest rates, a cap on bond yields and allowed for asymmetrical inflation targeting, in case inflation went over the stated goal of 2% per year. This almost never happened, and monetary ammunition was just wasted. In the graph below, we can observe how Japan’s annual inflation rate just got over 2% in one year, staying below the fixed target for the rest of time and showing enormous volatility.
Japan’s rigid labour market just made this worse, as even though unemployment remained very low for almost all of the time, the inexistent labour flexibility made transitioning from an old productive structure nearly impossible, which led to stagnation in productivity levels. This has also been the case of some European countries, such as Spain or Italy which have completely outdated and inefficient productive structures. If we look at the data, for example, we will be able to see how Spain has been able to increase its total factor productivity by just 7.8% since 2010, which is equivalent to an average annual productivity growth rate of just 1%.
European countries also seem to be following the Japanese path to unbearable levels of public debt. Here, it is fair and necessary to state that not all European nations are in the same situation. Prior to the irruption of COVID-19, countries such as the Netherlands presented government debt over GDP levels of 48.6%, along with Germany, which registered similar levels, at 59.8%. On the other hand, countries such as Greece, Italy or Spain entered the COVID-19, recession with public debt levels of 176.6%, 134.8% or 95.5% over GDP, respectively. Japan leads all this public debt explosion scenario, with a registered level in 2019 of 236.6% over GDP.
The Japanese strategy to prevent a solvency crisis was not pretty innovative: debt monetization, with the Bank of Japan holding a total value in government bonds of approximately 100% of the country’s GDP in 2019. Financial repression reinvented.
Finally, let’s talk about Abe’s economic programme’s last point: structural reforms. The third arrow worked pretty well during the first few years of Abenomics and even propelled productivity levels at a faster rate than expected. The worst part came when this first impulse ended, and the country observed how productivity growth was severely constrained by the excessive number of small firms that composed its productive structure. Organic growth of firms wasn’t being attained, a problem that has desolated many countries in Europe through the last few decades, especially in the south.
COVID-19 has forced governments all around the world to develop even more expansionary policies and use up all the fiscal and monetary space available. This has led to a competitive advantage for those countries that had more balanced budgets and lower debt levels before the pandemic erupted. If after the economic recession that will be lived along the next couple of years governments decide to rest on their laurels and let all the debt dynamics to depend just on ultra-low interest rates policies, that will be the definite sign of the deep and lasting Japanification of Europe.
Álvaro Martín studies Economics at Cambridge University and wrote “La revolución del mercado”.