Stalled reforms

Nirvana eludes Japan after one year of Abenomics

The economic nirvana promised by Shinzo Abe when launching his bid to become prime minister a year ago continues to elude Japan.

Since winning the December 2012 election, Abe has made progress on his pledge to end deflation but he hasn't gone far enough. So, while the effect of fiscal and monetary stimulus is showing up in the economic data, the gains may be ephemeral in the absence of structural reforms, which the archery enthusiast had dubbed his "third arrow."

After driving the TOPIX index almost 50 per cent higher in the first five months of the year, investors have paused for breath. The third-quarter GDP report shows why. The slowdown in the annual rate of expansion, from 3.8 per cent in the previous three months to 1.9 per cent, was better than expected. But government spending - one of Abe's three arrows - did the heavy lifting. Household consumption added nothing to growth, even though investment in dwellings shot up.

Tokyo property is hot once again because the Bank of Japan's massive bond-buying - the second arrow - has brought down real interest rates by stoking inflation expectations. But while lower borrowing costs are also helping the government finance its large deficit on the cheap, they have not yet encouraged companies to invest more in factories and machines. Non-residential investment grew an annualised 0.7 per cent in the quarter, compared with an 11 per cent jump in housing investment.

Companies are sceptical about the reshaping of the economy their prime minister has promised. When they see Abe failing to free up online drug sales out of fear of a backlash from chemists, they worry if he will have the nerve to take on more powerful vested interests. And, there are many. Employees on life-time contracts don't want flexible labour laws; part-time farmers want exorbitant farm subsidies to continue; doctors will resist changes to Japan's expensive universal health-care system.

But without structural reforms leading to a revival in animal spirits, growth will remain stimulus-fed, and therefore unsustainable. Money-printing was only supposed to be the starting point of Abenomics. If it also becomes the end goal, then the outcome won't be blissful - neither for the economy, nor for the investors.