Boston University Undergraduate Economics Association

Case Competition:

Abenomics: The Challenges of Revamping Growth in Japan

Written and edited by: Daniel Currie | Howard Wei | Jeevan Parameswaran | Shivani Desai | Spencer Petitti

Organized by:

Daniel Currie | Federico Mele The following material has been written and prepared by the Executive Board members of the Boston University Undergraduate Economics Association (BU UEA). The case has been assembled through student research based on publicly available information and data. The material is not intended and should not be used for commercial applications. The material has been written for participants of the BU UEA Case Competition. The case is centered around a fictional event based on a current economic issue. Participants are to assume the position of economic consultants to high-ranking government individuals confronted with an intricate and complex economic issue. Figures and data are based on factual, publicly available statistics. The material is to be used as a basis for the participant’s research. The paper is not an exhaustive composition of the economic issue. Participants are expected to perform their own due diligence and extensive research to accommodate their final recommendation.

Introduction: The Second Coming of Shinzo Abe

When Shinzo Abe re-assumed office in 2012, Japan’s economy was in dire straits. In particular, four

key issues plagued the Japanese economy:

1. For over ten years, the Japanese economy had remained in a constant state of deflation.

2. The overvalued yen had led to a decrease in competitiveness of Japanese exports.

3. A major earthquake (2011 Tohoku earthquake and tsunami) had severely dampened growth

prospects, resulting in a 3.7% contraction for 1Q2011.

4. The continued economic malaise stemming from the Great Recession of 2008 had hampered

Japan’s recovery.

To address Japan’s seemingly unending economic woes and usher in a new age of prosperity, Shinzo

Abe adopted a set of unprecedented hyper-accommodative policies, termed “Abenomics”.

The Land of the Rising Sun

Japan, an archipelago of 6,852 islands, has a long and dated history spanning over 30,000 years.1

Today, Japan has a nominal GDP standing at nearly six trillion dollars, making it the 3rd highest in the

world. Since the early 1900s, Japan’s population has also grown to 127 million2 and is often

characterized as one of the most densely populated countries in the world.

The ethnic breakdown of Japan is largely comprised of Japanese nationals (98.5%) alongside very

small proportions of Koreans (0.5%), Chinese (0.4%) and other (0.6%). It is no secret that the

population of Japan is aging; 33% of its population is 60 years or older and this aging trend is

expected to continue due to improving healthcare and declining fertility rates [Figure 1]. An aging

society can pose difficulties to Japan such as ballooning social security and welfare payments, overall

population decline [Figure 2] and can even hinder the effectiveness of monetary policy3.

Japan has undergone incredible growth since the early 20th century and currently has a GDP per

capita of $36,9384 [Figure 3], placing it at 22nd in the world rankings. Japan also prides itself for

ranking 10th in the Human Development Index (HDI). However, inequality has been widening in recent

years as the rich have earned ‘incomes more than ten times those of the poorest’5, translating to a

Gini coefficient of 0.316 [Figure 4].

An analysis of Japan’s economic sectors shows that the bulk of labor (69.9%) work in the services

sector. Japan’s principal economic engines include wholesale and retail trade (24% of GDP) followed

by industrial production (20%) with the financial industry coming in third (20%)7. In order to pull

Japan’s economy out of the Great Recession of 2008, the corporate tax rate has steadily decreased

from around 41% to 38% while the income tax has hovered near 50%.

1 Hammer et al., 2006 (48).

2 Statistics Japan, 2014.

3 Trichet, 2007.

4 Trading Economics, 2013.

5 Förster & Martin, 2012 (14)

6 ibid., (14).

6 7 National Accounts of OECD Countries, 2013.

The current account balance has reached -$15 billion. Additionally, the well-known problem of Japan’s

debt-to-GDP does not seem to be abating; statistics show the ratio to be at 227%8 [Figure 5]. This has

become a constant problem weighing heavily on the government’s mind.9

Unfortunately, as the 20th century timeline shows, the economy was not the only problem Japan had

to face10. Japan’s islands are situated along the region known as the Ring of Fire, subjecting the

country to volcanic eruptions, tsunamis, earthquakes, and other natural disasters that cost billions of

dollars in recovery - both physical and psychological. The devastating Tohoku earthquake and

tsunami in 2011 wreaked havoc on the Japanese people and caused a number of lingering problems.

The Fukushima Daiichi nuclear disaster, which involved the meltdown of three of the six nuclear

reactors, led to large-scale evacuations and a renewed debate surrounding the use and production of

nuclear power. Since the tsunami much of Japan’s nuclear power plants have been shut-down, raising

questions on Japan’s energy supply11. This has lead to a higher trade deficit, a problem that is

worrying, likely to persist, and in need of a sustainable solution.

The Japanese Political Structure

The Japanese political system is based upon a framework of a parliamentary representative

democracy. In this system, the Prime Minister sits as the head of government in the role of the

executive, and the Diet (the combined House of Representatives and the House of Councilors) as the

Legislative branch. The Diet is a highly politicized governmental body that has the power to enact

legislation, approve the national budget, ratify international treaties, and amend the constitution. The

Emperor of Japan performs “only such acts in matters of state”12, consisting of mostly appointments

and other matters of formality. This style of governance focuses power around “the highest organ of

state power”13, the Diet, and is thus more akin to the government of the United Kingdom rather than

that of the United States.

Prime Minister Shinzō Abe is the president of the Liberal Democratic Party (LDP), a conservative

centre-right wing political party that has maintained the majority of power in Japan since its inception

in 195514. Abe served a brief tenure in office in 2006-2007 before resigning due to health concerns

and internal party issues. He was re-elected in September 2012 on a slate promising strong foreign

policy (particularly regarding the territorial disputes with China) and economic growth.

The LDP has long been the most influential political party in the Japan, and currently holds 47% of the

seats in the House of Councillors and 61% of the seats in the House of Representatives15. The party is

generally viewed as pro-business with its promotion of a low-tax environment. The LDP has, however,

decided to move forward with plans for a rise in the country’s sales tax from 5% to 8% in an effort to

8 Central Intelligence Agency, 2013.

9 Riley, 2013.

10 BBC, 2014.

11 Ferris & Solís, 2013.

12 Web Japan, 2010 (1).

13 ibid., (2).

14 Liberal-Democratic Party of Japan (LDP), Britannica Online Encyclopedia, 2014.

15 The National Diet of Japan, 2014.

reduce government debt. If everything remains on schedule, the sales tax will again increase to 10%

in October 201516, in-line with the medium term fiscal consolidation of Abenomics.

Sino-Japanese relations have been strained in recent years due to territorial disputes over the islands

known as Diaoyu in Mandarin and Senkaku in Japanese. It seems unlikely that this political issue will

spill over into the economic realms, as both countries have a heavily vested interest in maintaining

their economic interdependence17.

One highly contentious area of debate is the proposed Trans-Pacific Partnership (TPP). Japan began

discussing the trade partnership in 2010 with hopes of engaging in an enormous free trade agreement

between 11 other potential member states (four current signatories) [Figure 6]., boosting economic

growth in the country. The agreement aims to tackle regulatory and tariff barriers that hamper trade

flows between the cooperating countries18. Nevertheless, the TPP has been criticized by domestic

farmers, consumer protection advocates, and government watchdog organizations for a variety of

issues regarding domestic impact and transparency. This leaves the TPP on the table as a highly

politically sensitive issue that will have lasting effects on the Japanese economy.

The Great Stagnation (1980’s-2007)

In the post-WWII era, Japan was considered a ‘growth miracle’, exhibiting double-digit growth rates

and remarkable industrial transformation. Between 1960-1973, Japan had the most rapid economic

growth, averaging 9.6% real GDP growth annually compared with 4.9% for the entire OECD area.

Unemployment was low, with rates averaging 1.3% over the period.

Following this ‘miracle’ era, stagnation in the economy occurred in 1991-2005. In the early 1990s, the

Japanese economy abruptly fell into recession, a period which has been termed the “lost decade” due

to sustained general economic despair not witnessed in the world since the 1930s. Real GDP growth

averaged only 1.5% during this period. The burst of the stock market bubble continuing into the late

1990s led to significant losses for banks due to large equity holdings associated with their main bank

relationships. A simultaneous decline in real estate prices led to bankruptcies and debt service

problems of private corporations and households. Two major financial institutions, Hokkaido

Takushoku Bank and Yamaichi Securities Company, collapsed in 199719.

Monetary policy has been cited as a significant cause of the recession, as the Bank of Japan slashed

the discount rate from 5.00% in January 1986 to 2.50% in February 1987, leading to uncontrollable

money growth. Following the sharp drop in asset prices in 1990-1991, the Japanese government was

slow to respond, allowing for flawed banking regulation which left Japanese banks more vulnerable to

asset price falls. Although the central bank hiked interest rates by May 31, 1989, it had little effect on

asset inflation. The Bank of Japan tightened its monetary policy for the fifth time in August 1990 when

stock prices plummeted to half its peak. Prolonged deflation combined with a sustained period of zero

short-term interest rates created a situation where the central bank lost leverage to provide additional

16

The Economist, 2014. 17

Katz, 2013. 18

Grant, 2014. 19

Hutchison et al., 2013.

monetary stimulus to the economy.

The Great Recession (2008-2010)

The Great Recession of 2008 had far reaching consequences in the economies of the world, and

Japan was no exception. Although Japan managed to avoid the initial effects of the credit crunch and

enormous financial losses, the global deleveraging that followed placed the export based economy in

a vulnerable position. Research has shown that Japanese output is highly responsive to output shocks

of the United States and Western Europe20, and as such the country faced an annual GDP growth rate

of -1% in 2008 and -5.5% in 2009 immediately following the crisis. Japan may have avoided the

banking collapse experienced in the United States and Europe, but it had no way of adequately

mitigating the lack of aggregate demand in international markets.

The Japanese economy maintained deflationary pressures during the post-crisis years, averaging a

CPI rate of -0.16%21 in the period of 2007-2012. During the same time, the USD/JPY ratio fell under

80 Yen per USD$ from a starting point of about 120 Yen per USD$ [Figure 7]. This dramatic

appreciation of the yen severely hurt the nation’s export industries, as it became significantly harder

for foreigners to purchase the now expensive Japanese goods22. The appreciation of the Yen, coupled

with faltering foreign demand, halved Japanese exports and in 2011 forced their trade balance into its

first trade deficit since 198023 [Figure 8].

During these times of crisis, the Bank of Japan took a lax approach, waiting until October 2008 to cut

its interest rates by a small 0.2% and delaying until December 2008 for a second 0.2% cut. It was not

until the election of the 57th Prime Minister of Japan, Shinzo Abe, that the government took a firm and

substantial “three arrow” approach, strictly focusing on fiscal stimulus, monetary easing, and structural

reforms.

The Abenomics Gradebook

The primary overarching goal of Abenomics was to restore growth in Japan. In the short run, this has

undoubtedly been true. Japan’s GDP growth accelerated in 2013; growth is widely expected to

register at 1.7% year over year for fiscal year 2013, compared to 1.45% YoY in 2012. While the

percentage change may not be overtly high, the pickup was notable in light of sluggish growth in

recent years. However, in the very near term at least, it would appear that Abenomics has fulfilled its

primary target of boosting growth.

The second goal of Abenomics was to end deflation in Japan and achieve an inflation target of 2% by

2015. CPI numbers printed at 1.5% YoY in November 2013, illustrating the rapid progress of

Abenomics. Furthermore, Japan’s CPI (except oil and food prices) rose 0.6% in November, a positive

development after remaining negative for most of the year. Undoubtedly, the sharp depreciation of the

20

Kawai, 2009. 21

World Bank, 2014. 22

The Economist, 2014. 23

International Monetary Fund, 2012.

yen post Abe’s first arrow was a major contributing factor to the CPI pick up.

Along with the inflation target, Abe has also targeted a boost in real wages, as raising the cost of living

without a corresponding improvement in household income would result in overall lower standards of

living for the population. Thus far, efforts to raise real income levels have proven unsuccessful with

changes in real income remaining relatively stagnant (0.4% YoY decline in 2013).

In line with Abe’s inflation targets, the BoJ was also mandated with the task of doubling the monetary

base within two years (JPY 15.5 trillion as of April 2013). Thus far, the average monetary base

outstanding has grown 34.4% YoY in FY2013 to JPY 20.18 trillion. This effectively means the BoJ is

well on track as a third of the progress towards doubling the monetary base has already been

completed.

Though not officially stated, another major consideration of Abenomics was to revive the Japanese

stock market, generating wealth via the infamous “wealth effect”. With regard to this goal, Abenomics

has been an indisputable success. As of early 2014, the Nikkei index has risen approximately 48%

YoY. While Abenomics may not take sole credit for the recent Nikkei surge as other global economic

factors have heavily influenced markets, it nonetheless remains the principal driving force behind the

recent resurgence of the Japanese stock market.

Along with inflation and growth, weakening the yen was naturally yet another crucial driver of

Abenomics’ success. With the Yen approaching the mid-70s against the USD in the run up to Abe’s

second term, the strength of the yen emerged as a major consideration for Japanese exporters. With

the rise of neighboring South Korea’s electronics exports, many major Japanese firms faced stiff

competition and generated minimal to no profits. As a result, tax revenues were heavily impacted,

further deteriorating Japan’s fiscal standing. Since the implementation of Abenomics however, the yen

has depreciated as much as 24% from 84.7 to a peak of 105.4 at the start of 2014. Additionally,

average profits for all firms, particularly large manufacturing enterprises, sharply increased with large

exporters reporting a 34.7% YoY profit growth. In this sense, Abenomics has yet again been a

success, supporting corporate profits disproportionately through a weaker yen.

Despite all the success of Abenomics’ first and second arrows, the third arrow has proven to be the

most challenging. Undeniably, the lack of structural reform remains one of the shortcomings of the

Abe administration’s term in office. Furthermore, the resounding victory in the 2013 upper house

elections could signal that the administration has taken its foot off of the pedal in terms of urgency to

implement non-quantitative reforms and policies.

The preliminary conclusion on Abenomics has overall been very positive, especially with regard to the

firing of the first and second arrows. The success of Abe’s third arrow on the other hand remains to be

seen and thus, the Abenomics’ grade book remains incomplete. While Abenomics remains very much

a work in progress, “so far so good” appears to be the fairest way to describe the performance of

Shinzo Abe’s latest economic experiment.

The Case: What is Japan to do?

Given the deflationary pressures of the past, the Abenomics of today, and the shifting demographics

problem of the future, what steps can Japan take to revitalize its dormant economy and reclaim its

latent growth?

As consultants to the Japanese government you are tasked with providing a practical and realistic

economic policy solution to the country's economic challenges. One week after the case

announcement, each team of consultants is required to submit a one-page policy proposal stating their

preliminary claims and outlining the structure of their analysis. The Japanese government will use this

proposal to determine which teams of consultants will be featured in the final round. The teams

selected for the final round of the competition will create a 10-minute presentation detailing their policy

recommendation. Following the presentation, competing teams will engage in a 5-minute Q&A session

with the judging faculty panel.

The solution presented should be a creative mix of monetary, fiscal, and social policies feasible in the

current politico-economic sphere of 2014 Japan. Some important ideas to consider are:

1. The effect of a sales tax hike from 5% to 8%, with a possible future increase to 10%;

2. The shifting demographics and its effects on fiscal, monetary and social aspects within the

country;

3. The rising fiscal deficit (especially its debt-to-GDP ratio) and its potential impact on Japan’s

government bond yields;

4. The Japanese balance of trade, focusing on how a rise in inflation could affect the real

exchange rate, and thus, net exports;

5. The solutions to these problems and their effect on the national and international political

sphere;

Teams must provide logical reasons and justifications for each of the requirements listed above. As

with any economic decisions, there will be unintended consequences and externalities to the proposed

policies. Although it will be impossible to consider all consequences of the proposed policies, teams

will have to focus on the most relevant ones in order to address Japan's problems in a concrete way.

Good luck!

Executive Board

Boston University Undergraduate Economics Association

Figures

Figure 1: Population Pyramid

2005 vs. 2030

Figure 2: Japan Population Projections (000s): The World Bank

Figure 3: Japan GDP per Capita

Figure 4: Gini Coefficient

Figure 5: Japan’s Debt-to-GDP

Figure 6: Existing FTAs among TPP Countries

Figure 7: Japan’s appreciation and change in broad money

Figure 8: Japan’s trade balance

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