At a time when economic optimism is growing and stock markets are hitting new highs almost daily, it is worth asking what could go wrong for the global economy in the year or two ahead. The standard response, now that a war with Iran or a euro breakup is off the agenda, is that some kind of new financial bubble could be about to burst in the U.S. But a very different, and rather more plausible, threat is looming on the other side of the world.
Japan is the world’s third-biggest economy, with national output roughly equal to France, Italy, Spain, Portugal and Greece combined. This year, Japan has become, very unusually, a leader in terms of financial prosperity and economic growth. According to the latest IMF forecasts, Japan’s 2 percent growth rate in 2013 will be the fastest among the G7 countries, easily outpacing the next strongest economies, Canada and the U.S., each with 1.6 percent growth. Japan’s stock market has gained 70 percent since last December, far exceeding the 25 percent bull market on Wall Street, and Japan’s corporate profits are projected to increase by 17 percent, according to Consensus Economics, compared with the paltry gains of 3 to 4 percent in Germany and the U.S.
As someone very much caught up in the economic optimism inspired by the election of Shinzo Abe, I fear it is now time for a reality check. And observing the complacent inertia that seems suddenly to have paralysed Japan after July’s Upper House election, it seems worth recalling the famous maxim (usually attributed to Keynes) about unexpected events: “When the facts change, I change my mind.”
The reasons for pessimism follow directly from the main driving forces of Japan’s new economic programme, the so-called “three arrows” of Abenomics: fiscal stimulus, monetary expansion and structural reform. The second of these arrows — monetary expansion — is flying as fast as ever. But the first, fiscal, arrow is about to turn into a boomerang that could kill Japan’s economic recovery stone dead. In April an increase in consumption tax from 5 to 8 percent, along with some cutbacks in public spending, will produce a narrowing of the structural budget deficit worth 2.5 percent of GDP, according to the IMF.
This massive fiscal tightening, which happens to be exactly equivalent to the U.S. fiscal tightening in 2013, to Italy’s in 2012 and to Britain’s in 2011, is a very big risk to take with the Japanese economy’s still-tentative recovery. While the Abe government has made vague promises to cut other taxes or boost public works spending to offset some of the deflationary impact of the consumption tax increase, it has notably failed to provide any details. Given that the tax hike will hit the economy in April, time is running out for any effective offset to be proposed. It seems, in fact, that the Finance Ministry opposes any significant easing of next year’s fiscal burden. Far from being ready “to do whatever it takes” to promote economic recovery, as I had expected, Japan’s bureaucracy seems to prefer to wait and see how April’s tax hike affects the economy before proposing any compensating relief. The trouble is that by the time a collapse in consumption becomes apparent, it may well will be too late to prevent another recession.