Japan Goes Back to the Stimulus Well

Photo by Brendan Hoffman/Getty Images.

Pop quiz, dear reader. If you're a struggling economy, do you:

A) Continue with your current ineffective strategy?

B) Implement difficult but necessary reforms?

C) Resurrect a cultural phenomenon from 20 years ago?

If you're Japan, you likely selected secret answer D.) A and C, but not B. Now, as fun as it is to walk around with your eyes glued to your phone to catch all the Pokémon, that won't do a whole lot to reinvigorate economic growth. Nor will another feckless round of government spending trigger an economic boom. Sustainable economic growth starts with a strong private sector-yet Japanese officials continually skirt this truth, preferring instead to spend and ease further. Absent those bigger reforms, Japan's latest fiscal stimulus and easing plans aren't likely to be any more effective than past ones.

Consider recent history. Since 2008, five different prime ministers have launched 12 fiscal stimulus packages in Japan. Since he took office, current PM Shinzo Abe has worked hand-in-hand with the Bank of Japan (BoJ), packaging fiscal and monetary stimulus, supposedly a double-shot espresso of economic mojo. The latest "jolt"? The BoJ slightly tweaked its existing quantitative easing (QE) program^[i], and made no change to its existing negative interest rate policy. The only difference was a relatively small increase in annual equity ETF purchases, from ¥3.3 trillion to ¥6 trillion. This, despite owning half the domestic ETF market. Which seems to give Japan Post a rival for the dubious title of the "Bank that ate Japan."

Tuesday, the Abe administration followed up, unveiling the details of a long-hinted-at ¥28 trillion spending program-at this headline figure, the third-largest stimulus package since the 2008 Financial Crisis. However, only ¥7.5 trillion is new, direct spending to be deployed over the next two years. The rest consists of long-term, low-interest loans for major "21^st-century" infrastructure projects ranging from bullet train-line construction and revamping ports for big ocean-going cruise liners to more squishy items like promoting tourism.

Maybe these sound great to you. Maybe not. But whatever your view of the specific ideas, they aren't actual stimulus in the here and now. And, even more importantly, these monetary and fiscal efforts haven't proven very effective at restoring Japan's economy. They're a can-kick, not a kick-start.

During the current global expansion, Japan has fallen into recession (defined here as two straight quarterly contractions) three times. If these stimulus plans were so supportive of growth, we probably wouldn't even need the present round, because the others would already have kicked off the mythical virtuous cycle of Keynesian lore. Monetary easing was supposed to help Japanese exporters in particular. Theoretically, a weaker yen would spur demand for exports, triggering firms to invest, consume, hire and boost wages. Yet the BoJ's huge easing efforts haven't boosted export volumes much at all.

We aren't strictly anti-stimulus: It has its time and place, and one could argue that, with Japan (again) flirting with recession (and even data indicating growth isn't looking terribly strong, once you consider the underlying components), a demand jolt from the government might be decently timed now. June retail sales fell -1.4% y/y as consumption remains stubbornly weak, and industrial production dropped -1.8% y/y.^[ii] Though June's export volumes improved (2.9% y/y), one month's data aren't telling and don't negate years of weak exports.^[iii] So, maybe a little extra demand wouldn't hurt. But fiscal stimulus, even when well-timed and well-executed, isn't a ticket to lasting growth-it's a jumpstart, meant to offset plunging private demand when times are tough. Lasting growth requires a dynamic private sector, which Japan doesn't have.

In particular, Japan suffers from a bloated public sector, protectionist regulations promoted by strong vested interests that discourage competition, and a byzantine labor code that discourages companies from hiring new workers or effectively competing with each other, to name a few issues. Despite three years of promises to addresses these long-running problems via structural reform, Prime Minister Shinzo Abe has yet to meaningfully deliver on what he claimed was the "third arrow" of this economic strategy. Labor market reforms have continually been delayed. Corporate governance reforms adopted Western norms by adding outsiders to corporate boards, but they haven't brought an end to Japan's bizarre web of cross-shareholdings, which hamper competition. And, while Abe has expressed interest in joining the Trans-Pacific Partnership (a 12-nation free-trade agreement including the US, Canada and Australia, among others), that deal is floundering presently and doesn't appear likely to become reality any time soon.

Investors seem like they finally see this, and they aren't cheering this latest stimulus the way they did past efforts. Expectations aren't as lofty. When Abe took office (for the second time) at the beginning of 2013, many investors were enthusiastic about Japan's future prospects. They believed Abe had the will and political capital to put Japan on a more sustainable path of economic growth-and this belief translated into some short-term sentiment boosts for Japanese stocks. However, after three years of interviews, press conferences and new voter "mandates," Abe has little to show for himself, save for some incremental progress on a handful of issues.

Despite the big victory for Abe's Liberal Democratic Party (and its coalition partner New Komeito) in July's upper house elections, there is little evidence Abe will start pursuing reforms now. For one, a recent Cabinet reshuffle suggests LDP higher-ups are positioning themselves as Abe's replacement for 2018's election-and politicians jockeying for their next post generally don't want to upset the vested interests that will be responsible for promoting them.

There is also the possibility Abe refocuses on constitutional reform, specifically to revise Japan's anti-war clause-a lifelong ambition of his, following his grandfather's dreams. The LDP-New Komeito ruling coalition now has a two-thirds majority following the most recent election, so though unpopular with the public, Abe has the numbers to push the issue forward.

While investor sentiment is more aligned with reality now, that doesn't mean Japanese stocks are ripe. Markets move on the gap between expectations and reality. Rational expectations are healthy, but sustained outperformance probably depends on Abe surprising the new skeptics-there are few signs that time is near.

Though we are doubtful of Japan's latest attempts at stirring up growth, it's unlikely this ripples globally. During expansions, perpetual weakness in some regions doesn't preclude growth in others-and most of the developed world has done just fine without big contributions from Japan. We believe this will remain the case in the future, even as Pokémon once again goes the way of the Do-Duo.