Will this man help Japan say “Sayonara!” to 15-plus years of deflation and slow growth? Photo by Buddhika Weerasinghe/Getty Images.
On Wednesday, Japanese Prime Minister Shinzo Abe previewed his highly anticipated economic reform plan, also known as the “third arrow” (following aggressive fiscal and monetary stimulus) of “Abenomics.” Many investors held high hopes he’d announce plans for badly needed structural economic changes, but those expecting game-changing plans were left wanting, leaving the outlook for Japanese stocks a bit murky. Whether and how these proposals are implemented—and whether further, more meaningful changes are in the offing—will be key looking forward. For now, with details scarce and key planks missing from Abe’s platform, we remain quite skeptical of Japanese equities.
Abe’s speech largely reiterated measures proposed or leaked in recent weeks—a politically safe, surprise-free package, as we’d largely expect six weeks before Japan’s upper house election. Overall, arrow three aims to improve productivity, broaden labor markets, establish deregulated special economic zones to attract foreign investment and ink more free trade agreements. Abe also plans to boost business capital expenditures (capex) with incentives for research & development, launch more public-private infrastructure projects and open electricity markets to private investment. And, as previewed earlier this week, he proposed easing public pension plans’ Japanese bond requirements and allowing higher equity allocations. In theory, this increases pensions’ long-term return potential and gooses demand for Japanese stocks, though the potential impact on public finances likely renders this easier said than done.
Overall, arrow three sets good goals and has some intriguing provisions, but it lacks concrete implementation plans—many measures are simply targets set over very long time frames. For example, Abe targeted 3% annual nominal GDP growth, 10% annual capex growth and a doubling in the amount of profitable mid-sized business over the next decade—goals, not plans. Officials claim specifics will follow once Abe’s cabinet approves the official plan on June 14, but even then, it likely remains unclear whether arrow three suffices to fix all that ails Japan. For one, it’s uncertain whether Abe’s administration will follow through. (Long timeframes give current politicians huge wiggle room, and open the uncertainty of whether the future government will follow through.) Another big question mark is whether they pursue additional, more politically sensitive reforms—either next week or after the election.
Exhibit A is labor markets. Japan’s labor code enshrines the nation’s culture of lifetime employment, so firms largely can’t adjust payrolls during less profitable times. They must cut costs other ways—like paying lower wages to new workers or cutting investment—hence why capex has declined since 1997. Material labor reforms would let firms adjust payrolls if necessary, fostering increased productivity as resources are allocated more efficiently—something Abe seemingly knows, as he floated tentative plans to ease labor restrictions earlier this year. But those met heavy opposition—opposition Abe likely doesn’t want during campaign season—and were dropped. They likely won’t resurface before the election. Nor will a meaningful reduction to the world’s second-highest corporate tax rate—another politically unpopular move.
Now, maybe things change post-election. Abe’s still hugely popular, and his Liberal Democratic Party is widely expected to take the upper house. That likely gives him more political capital. But whether he spends it on unpopular economic measures is impossible to game.
Perhaps that’s why, in recent weeks, we’ve seen signs investors aren’t uniformly confident Abe will push meaningful changes after the election. Japanese markets have rather returned to Earth in recent weeks as investor enthusiasm over monetary stimulus has seemingly faded a bit. Investors seem to realize stimulus alone won’t cut it. At the same time, many folks still seem optimistic—perhaps overly so. There seems a creeping sense that “if Abe can just pass X, everything will be ok.” But if reality falls short of expectations, stocks may slide down “the slope of hope”—the opposite of the proverbial “wall of worry” bull markets love to climb.
Time will tell whether Japanese markets are ahead of reality. Abe could surprise to the upside—but even then, reforms could meet the same resistance as prior prime ministers’ reform plans, and Japan’s economic malaise could continue. Unless deep, difficult reforms take shape, long-term growth investors likely find better opportunities elsewhere.