RiskMarket RiskRegional Non-Integration Emperils Japan’s Economic Growth Strategy

Regional Non-Integration Emperils Japan’s Economic Growth Strategy

Soon after he was elected as prime minister in December 2012, Abe launched his so-called
‘three arrows’ strategy
of monetary policy, fiscal policy and structural reforms to shake Japan’s economy out of its somnolence. Changes to monetary policy included actions to weaken the yen (JPY) and foster expectations of inflation, as well as monetary easing. Fiscal changes included an economic package that pumped more money into the economy through public works and, after a tax hike, measures to mitigate the impact of a tax increase.

The ‘third arrow’ of a Japan revitalisation strategy was supposed to include regulatory changes in employment, healthcare and agriculture, corporate tax cuts and policies to promote innovation. It has become increasingly apparent that implementing the policy changes for this third arrow remains difficult.

Along with the policy initiatives, Abe has tried to cajole corporates into providing support to boost the Japanese economy. With the country’s end-of-year bonus season that benefit millions of the country’s employees coming up shortly, for example, he has pushed Keidanren member companies to use part of the more than JPY200 trillion (US$1.9 trillion) in cash and deposits they are sitting on to pay bonuses and raise wages.

Despite two years of arrows and supplementary initiatives, however, Japan’s economy fell into recession in the third quarter of 2014. A long-anticipated sales tax increase introduced in early April led to two quarters of declines in gross domestic product (GDP). The snap election called for December 14 that Abe surprised Japan with when he announced it last month is supposed to provide a fresh mandate for moving reforms forward.

Regional Developments

Domestic reform is clearly important and short-term changes have been made in efforts to jump-start the economy. Yet the focus on domestic issues and the challenges with overcoming domestic stances that hinder better integration with some other countries in parts of Asia may leave Japan out of developments that could help support a return to economic growth.

Admittedly, Japan is participating in discussions designed to lead to regional free trade agreements. The country is at last participating in Trans-Pacific Partnership (TPP) talks spearheaded by the US and has become part of a study of a Free Trade Area of the Asia Pacific (FTAAP) which China initiated at the APEC summit in November – albeit that The Economist magazine called the FTAAP a ‘distant dream.’ In addition, Japan has already signed bilateral FTAs with India in 2011 and with Australia in 2013. However, the country still risks being left behind as other countries, particularly in Northeast Asia, move forward with bilateral or sub-regional agreements.

At last month’s Asia-Pacific Economic Cooperation (APEC) summit in Beijing, for example,
the Chinese and South Korean governments
confirmed that they had effectively reached agreement to reduce barriers to trade and investment, with only technical issues remaining, and they expect to sign a free trade agreement (FTA) in the second half of 2015. The US and China said they had made a breakthrough on eliminating tariffs on technology products. Moreover, while recent elections in Taiwan show the fragility of ongoing cooperation between the two markets, Taiwan has signed more than 20 trade deals with China over the past five years, including the landmark economic cooperation framework agreement (ECFA) in 2010.

Sub-regional agreements are also coming closer to fruition. In Southeast Asia, the 10 Association of Southeast Asian Nations (ASEAN) countries are targeting an ASEAN economic community (AEC) by the end of 2015, which they hope will create a single market and production base with free movement of goods, services, investment, and skilled labor as well as freer flow of capital. At the recent South Asian Association for Regional Cooperation (SAARC) meeting in Nepal, Indian prime minister Mode proposed open trade among the SAARC countries, and said he planned to set up a special purpose facility to finance infrastructure projects in the South Asia.

Modi also promised to “ensure that our facilities at the border will speed up, not slow down trade.” While some observers expect full implementation of the AEC to take longer and there is no clear consensus yet on developments within SAARC, recent progress has been significant.

China has undertaken a variety of new initiatives on its own as well, including the signing up of 21 countries – but not including Japan – to join a new Asian Infrastructure Investment Bank (AIIB) for which it promises to provide half of the US$50bn in start-up capital. China is also setting up a US$40b fund to promote president Xi Jinping’s Silk Road infrastructure fund and economic belt initiative, as well as to bolster trade ties among Asian economies.

All this is not to say that Japan is doing nothing in Northeast Asia, as there is potential for the country to conclude several multilateral FTAs. Japan is involved in three-way negotiations with South Korea and China for a trilateral FTA, and the three countries are also in negotiations for the Regional Comprehensive Economic Partnership (RCEP), a regional free trade agreement which involves 13 other countries including Australia and India.

While all these developments and more are underway (and it would not be part of ASEAN or SAARC in any event), Japan’s domestic policies or practices continue to hinder involvement in some agreements that could expand its international trade further. Abe’s party has proposed increases in military spending, weapons exports and other policies to support the military, for example – a policy that can only revive concerns in China, South Korea, Taiwan and other countries that were victims of Japan’s wartime aggression.

Moreover, even though Abe has stayed away from controversial visits to the Yasukuni shrine that honours Japan’s wartime dead, he has continued anger other countries in the region by making offerings on key dates, with the most recent of these being in October. Since Japan no longer has the wherewithal to provide as significant financial support as China, either, it is striving to hang on to its role at the Asian Development Bank (ADB) and other long-standing institutions.

Alternative Scenarios

With Japan still seeking to emerge from the doldrums of weak growth that has lasted for more than two decades, this month’s election could represent a watershed. Provided that the result gives the government the support to take a more conciliatory regional approach by empowering it to overcome barriers to progress, while also providing the support for delaying the second stage of the sales tax increase – and assuming that Japan wants to take that approach – the country could indeed see the economy finally start to gain momentum.

Yet if the Abe government does receive a new mandate but fails at the same time to adjust the government’s stance on its wartime activities – which could otherwise mean a shift from a defensive to potentially an offensive military posture – it may continue to face difficulties in concluding agreements and alliances that could play a key role in moving its economy forward even faster.

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