Which major economy is most likely to disappoint expectations this year, and perhaps even cause a financial crisis big enough to break the momentum of global economic recovery? The usual suspects are China and southern Europe. But in my view the most likely culprit will be Japan.
While Japan no longer attracts much attention these days, it is still the world’s third-largest economy, with a gross domestic product equal to France, Italy, Spain, and Portugal combined. Its industries still pose the main competitive challenge to U.S., European and Korean manufacturers, and its regional weight is still sufficient to trigger financial crises across the whole of Asia—as it did in 1997.
To make matters worse, the Japanese government bond market is in an enormous financial bubble that could burst catastrophically if Prime Minister Shinzo Abe’s audacious economic program is seen to have failed.
I was an early enthusiast for Abenomics, but I became alarmed about Japan’s prospects last October, when Abe decided to impose a massive tax hike on consumers beginning in April this year. With this crunch point now approaching, I travelled to Japan to get a first-hand feel for economic conditions. What I saw and heard from financiers, businesses and officials has heightened my concerns.
Abenomics was initially a promising program because it seemed to pierce the complacency of previous governments with its “three arrows” of radical economic policy—monetary expansion, fiscal stimulus, and structural reform.
By last October, however, two of these three arrows were veering off course. Structural reforms in labour regulation, corporate governance, competition policy and pension management had already been abandoned or delayed sine die in the summer. When Abe bowed to the longstanding demand from Japan’s powerful Ministry of Finance for a doubling of Japan’s consumption tax, his fiscal “arrow” was transformed into a boomerang, threatening the hopes of economic acceleration in 2014 and 2015.
This boomerang will hit Japan on April 1, when the consumption tax jumps from 5% to 8%, and again in October 2015, when it will rise again, to 10%. The result will be a fiscal tightening worth roughly 2.5% of GDP this year, plus another worth 1% in 2015, according to IMF estimates confirmed by unpublished projections from the Ministry of Finance. This fiscal squeeze—almost exactly equal to those in Britain in 2011 (2.4%) and Italy in 2012 (2.2%)—will cut Japan’s economic growth from 2.5% in 2013 to 1.4%, according to official forecasts.
The reality, however, could