01 Jul 2016
Most fundamentally – and regrettably - Brexit represents a further deflationary shock for a country which has been trying its level best to resuscitate the ‘animal spirits’ of inflation.
" Brexit represents a further deflationary shock for [Japan,] which has been trying its level best to resuscitate the ‘animal spirits’ of inflation."
Grant Knuckey, Chief Executive Officer, ANZ Japan
Though it can be argued elements of the shock are reactionary and may be short-lived and acute – for example the impact on commodity prices including energy - the markets have still taken the opportunity to ram home their expectations Japan is now even less likely to climb out of the hole.
This is manifest in the recent fall of Japanese bond yields. Indeed we seem on an inexorable path to the entire Japanese Government Bond yield curve, out to 40 years, falling to negative rates. So instead of rising over time as yield curves have always done (to reflect inflation and future uncertainty), we have them falling over an extraordinarily long period of time – bad for debt levels, bad for the economy.
Not only is this historically extraordinary but it makes the task of restoring economic vitality ever more difficult.
The foreign ownership of Japanese Government Bonds (JGBs), whilst still small at just under 10 per cent of issuance, has been rising very steadily in recent months wrests another small amount of control of Japan’s economy away from the Bank of Japan and the Japanese government. They are marginal changes, but it is at the margin that all event risk presents itself.
Brexit has also been the catalyst for the yen strengthening, ironically as a safe haven. That status doesn't give corporate Japan any relief - it simply erodes their confidence further. And yen strength increases deflationary pressure at an unwelcome time.
Arguably Brexit also strikes a blow against liberal economic ideals and gives a little more ammunition to the anti-globalisation and anti-trade lobby in Japan and globally. This makes it somewhat harder for something like the Trans Pacific Partnership (PPP) – which I see as critical for Japan – to make its way through the US Congress, regional acceptance and to eventual reality.
In short, Brexit has raised the stakes for Abenomics, Prime Minister Shinzo Abe’s three pronged plan for economic renovation, and in all likelihood compressed the timeframe remaining – in the absence of any victory over deflation - until the plan faces its existential crisis.
So what should the priorities be for Japan given this accelerated need for change? My view is fundamentally one of an outsider. I freely admit to having only a foreigner’s understanding of the depth at which some of the barriers to change are embedded within the wonderful Japanese culture. With that caveat in mind, allow me to indulge in some (hopefully constructive) critique.
• Forgetting the narrative
From an outside perspective, the major observation one might make about Abenomics and the ‘three’arrows’ policy framework is it has to date fundamentally failed to live up to the lesson of the Japanese folktale from which its name is derived.
In the ‘three arrows’tale, the warrior Mori-san taught his three sons that whilst an individual arrow may easily be broken, three arrows held together will not yield. Notwithstanding that the folktale wasn’t intended as an economic doctrine, the essential logic of this lesson is critical to the policy.
It is absolutely critical the expansionary monetary policy (arrow one) be bolstered simultaneously by flexible and targeted fiscal policy (arrow two) AND deep reform to labour markets and the industrial and state sectors (arrow three).
So far Mori-san’s lesson has not been heeded. The BOJ has certainly been losing enough of the first arrow and have publicly stated they stand ready to do whatever it takes to generate inflation. Arrows two and three have not been there alongside to any compelling degree.
To be sure, Japan’s ability to utilise fiscal ammunition is compromised by its deficit position and the rating agency wolves stand ready to attack any further deterioration. But at the heart, the rating agencies are, like everyone else, waiting for a coherent and aggressive firing of the third arrow (which I’d suggest would also result in more slack being cut on the fiscal position). Deep and targeted reform is needed.
This is certainly not just my view. In private discussions with BoJ officials I have sensed frustration with the fact all of this concerted monetary effort is not getting the full support of the reform arrow.
It would be incorrect to say there has been no reform at all – it is simply not happening fast enough or deep enough. So what is going to create some more movement on reform, and secondly, where would this reform be best targeted?
• Reform and Rebalancing
One catalyst for more policy aggression many be the outcome of the Diet (the Japanese parliament) upper house elections due on July 10.
Should the LDP end up with a two-thirds majority there (which looks possible), this would strengthen Abe’s control and create a stronger platform for reform. Absent that change in upper house composition, it isn’t clear what else could be the catalyst for accelerated change, short of some form of crisis.
In terms of reform targets, I think it best to view these as a ‘rebalancing’. Japan is unlikely to move radically from its philosophical positions in many areas. But reform can still be deep and fundamental without being radical.
The most obvious reform areas are in the labour market and immigration. Any additional flexibility in the capacity of a company to lay off staff – which at present is extremely difficult in the absence of severe performance issues – would create much-needed momentum in the labour market.
Targeted moves on immigration – which would mainly need to be focused at the lower-skilled end of the labour market, along with home care workers – would put some energy back into the service sector and potentially consumption (one needs to accept immigration reform in Japan will inevitably be piecemeal from a Western viewpoint but it still marks a deep change in a Japanese context).
Another required rebalancing revolves around the weighting of the three central stakeholders to the corporate entity – shareholders, customers and employees.
In the western governance model (and certainly in Australian banks!) the shareholder has primacy and their needs in terms of return (and consequently growth) are the most important ones to be met.
In Japan, whilst it would not be correct to say the shareholder is an also-ran, one can observe customers and staff rank well ahead in terms of priority, in many cases with staff being number one.
In widely-held public companies the shareholder is not viewed as someone who’s bidding must be done – which at one level certainly holds some logic.
This differential weighting of stakeholders in the Japanese corporate model leads to fundamentally different behaviours for companies. It certainly has some negative consequences – it stifles talent and the movement of that talent; it promotes inertia rather than change.
I would posit that the Japanese corporate model needs some rebalancing such that the shareholder voice plays a stronger role. The first step in that direction would be changes in the governance framework, so that independent directors become the norm rather than very rare exceptions, and the role of executive directors is lessened.
By way of caveat, I would certainly not argue Japan needs to go as far as some of the West has in terms of shareholder primacy. This has been in many respects as damaging in the West as the lack of shareholder voice has been in Japan. But rebalancing is required.
Since recently moving from the Mekong (based in Phnom Penh) to Tokyo, one of the most striking observations I have noted is the difference in the mood of the young professionals in the two geographies.
In the Mekong countries, they are generally super-confident, aggressive, demanding advancement (which creates its own problems!). In Japan, they are more deferential, passive and accepting of the status quo. The fundamental belief in a place like Cambodia - that the future will be better than the present – is not evident in Japan.
This is the real tragedy of Japan’s lost decades. Every country owes its youth the prospect of a better future, and I hope that is the lens that the Abe government places on the options before it.
Rather than focusing on the problems of the ageing Mrs Watanabe, perhaps the focus of everyone needs to be squarely on Mrs Watanabe’s grand-daughter and the Japan that she will inherit.
Grant Knuckey is Chief Executive Officer, ANZ Japan
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
01 Jul 2016
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01 Jul 2016