Sunday, March 3, 2024

How is Japan willing to cede its future to China?

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TOKYO — The next blow to the Japanese collective psyche will be to become the fourth-largest economy, trailing Germany. But 12 years later, Japan is still grappling with seeing China overtake it in gross domestic product (GDP).

The Changing of the Guard was advertised with banner headlines in 2010 and 2011, when economics students had more power than their teachers. China, like South Korea, Taiwan, Thailand, and other Asian “tigers,” has adopted some aspects of Japan’s development model.

So why is Japan’s proud political system making it so easy for China to advance?

Many Japanese experts strongly disagree with the terms of this discussion. This force is powerful against the conventional wisdom that GDP is far less important than per capita income, the standard by which Japan blows the doors off China.

And clearly, Chinese leader Xi Jinping has hit the economy so many times that it has slowed progress. From a devastating crackdown on technology to strict coronavirus lockdowns, Mr. Xi has created more headwinds than tailwinds since 2020.

But many global investors and academics can’t help but wonder what Japan’s Prime Minister Fumio Kishida’s Liberal Democratic Party is planning as Asia’s economic clock accelerates and China becomes more competitive. I can’t.

In 2013, the Liberal Democratic Party returned to power with a bold plan to restore Japan’s economic health. At the time, Prime Minister Shinzo Abe was clearly referring to reminding China whose continent Asia is.

Unfortunately, reducing bureaucracy, increasing innovation and productivity, liberalizing the labor market, stimulating a startup boom, empowering women, and attracting more foreign talent will bring Asian finance to Shanghai. His promise to establish himself as a center fell through.

Although Prime Minister Abe succeeded in slightly strengthening corporate governance, other reforms were insufficient, hampering wage growth. Hopes for a virtuous cycle of increased wages and a surge in domestic demand never materialized.

The reason is that Prime Minister Abe relied almost entirely on aggressive monetary easing to save the country. His 30% plunge in the yen in the years since 2013 has produced record corporate profits. The problem is that it also weakened Japan’s competitiveness.

The drop in exchange rates has placed the onus on corporate leaders to innovate, restructure, and take risks. Politicians did not have to recalibrate the engine, moving away from the export-oriented model of the 1970s and towards domestic demand-led growth.

Far from shocking the atrophied economic system, Abenomics has further strengthened its flaws. Japan effectively wasted the past decade when it had a chance to close the gap with China. That has created confusion among investors and academics about what Mr. Kishida, a protégé of Prime Minister Abe, plans to do when it comes to elevating Japan’s own economic strategy.

The late former Prime Minister Shinzo Abe and his protégé, current Prime Minister Fumio Kishida.Photo: Screengrab/Al Jazeera

Kishida got off to a good enough start in October 2021. He rose to the premiership with his own ambitious “new capitalism” plans to increase middle-class incomes. But like his leadership’s plans, Xidanomics was far more aspirational than actual realignment.

The past two-plus years have been a good time for Kishida to change the tax system to encourage startup activity. In fact, he had a bold plan to use Japan’s US$1.6 trillion Pension Investment Fund to fund startups.

This is the most creative idea ever conceived by the Liberal Democratic Party to revitalize the growth of Japan’s venture capital industry. But it has achieved little. Mr. Kishida has prioritized fiscal stimulus and easing of the Bank of Japan over structural reforms.

Kishida also did not reinvigorate Abe’s unfinished reforms. Meanwhile, a slowdown in China and a 17-year high in U.S. Treasury yields have turned the tide on Japan’s post-pandemic recovery. The economy contracted by 2.9% in the July-September period compared to the previous quarter.

There is little in recent data to suggest that the economy gained momentum in the October-December period. This means Prime Minister Kishida will be even more preoccupied than usual and less likely to revive the reform process.

The cuts also reduce the likelihood that the Bank of Japan will “taper” or normalize interest rate policy anytime soon. If Bank of Japan Governor Kazuo Ueda is reluctant to pivot away from quantitative easing in 2023, that could become even less likely as the recession deepens.

All of this means that Japan’s “opportunity cost” problem still exists. When governments choose the easy way out to stimulate growth, they are choosing not to strengthen their economies. This has been a trade-off that the Liberal Democratic Party has accepted for decades, but especially in the last decade.

Image: Hedgeeye

If Prime Minister Abe had made better use of his eight years in office to rebuild the economy, rather than relying on the weaker yen, Japan might have experienced a boom. If Prime Minister Abe’s successor, Yoshihide Suga, had used his 12 months in office to revive Japan’s animal spirit. Or if Coach Kishida hadn’t let 26 months pass without a major upgrade on the scoreboard.

Currently, Kishida’s approval rating is 17%, and he has very little political capital to shake up the economy. Prime Minister Kishida will be too busy to continue his job in 2024 as scandals engulf the Liberal Democratic Party and opposition parties.

As hopes for reform fade, China now has more freedom to govern Asia’s future. With all of China’s challenges, including the huge real estate crisis, the self-destruction that Japanese politicians are inflicting on the economy is directly in the hands of the Chinese government.

Prime Minister Kishida needs to increase government spending to deal with the recession. This recent surge in borrowing is almost certain to pique the interest of credit rating agencies like Moody’s Investors Service, which recently signaled downgrades for the United States and China.

With the country’s debt more than twice its GDP, Tokyo has limited fiscal maneuverability. This will complicate Mr. Kishida’s plan to increase military spending by 50% over the next few years. It’s also good news for President Xi’s China, even as Tokyo’s security ambitions face headwinds.

When Asian investors and academics wonder why Japan thinks time is on its side, or what the Kishida administration is thinking, it’s a valid question. The longer the Japanese government takes to answer that, the better for China’s ability to own its future.

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