Japan's new prime minister, Shinzo Abe, wants his nation to be strong and respected. He is ordering an upgrade of Japan's already sophisticated military. He wants to change the pacifist constitution to allow Japan to be able to use force if necessary. And he has been as belligerent as China's leaders over islands that both sides claim. Yet even as Japanese and Chinese aircraft and naval vessels threaten to engage one another, Abe plans to dispatch a peace envoy to Beijing as he already has to South Korea, another country with which Japan has a similar feud. Yes, Abe may be a hawk, but in truth, the real danger he poses is not military it's monetary.
Abe has embarked on a plan to kick-start Japan's long-sluggish economy. He has demanded that the Bank of Japan (BOJ) generate more cash to end corrosive deflation, and he has vowed to spark growth with massive government spending on public works. On Jan. 11, Abe announced a $117 billion stimulus package. Investors cheered, sending the main stock index to its highest level in more than two years.
Abe's measures might boost GDP in the short term and weaken the yen, which would aid struggling exporters. But his policies are in reality just a dodge an easy way to pump up the economy without imposing the unpopular reforms that could ignite a true revival. He could end up leaving Japan in deeper trouble by pushing the world's third largest economy (after the U.S. and China) closer to a debt crisis that would ripple through the global economy and spawn more turmoil than the woes of much smaller Greece or even Spain could. Prominent economist Ken Courtis calls the Prime Minister's strategy "a Himalaya skydive without a parachute."
The Japanese government has tried Abe's policies before, and they didn't work. His Liberal Democratic Party (LDP), which has governed Japan for all but four years since 1955, has been a relentless advocate of pump priming as the path to growth. The BOJ, despite Abe's criticism that it has been too conservative, hasn't been stingy either. The central bank has kept its benchmark interest rate near zero for long stretches of time since 1999. And it has been an active proponent of unorthodox measures to spur growth, including quantitative easing (QE) programs to buy bonds and other assets to lower interest rates and encourage more spending and borrowing. Last month the BOJ expanded its commitment to its latest QE scheme to more than $1.1 trillion.
All this largesse has gotten Japan nowhere. Last year the economy sank into its third recession since 2008. Worst of all, Japan's penchant for big-budget spending has blown out the nation's finances. At nearly 240% of GDP, Japan's government debt is the most burdensome in the industrialized world. The same old policies will not produce better results. Abe's promised infrastructure binge a possible $2.3 billion will likely just pile up more national debt. His badgering of the BOJ, moreover, undermines its cherished independence and could turn the central bank into an ATM for the LDP.
Slathering Japan with cash won't tackle the underlying causes of its slow growth. The economy remains too bound up in bureaucratic red tape, too closed to the world and too resistant to change to experience a turnaround. What's needed is not more spending but more reform. Deregulation is essential to encourage competition, efficiency and entrepreneurship. Greater easing or a bigger budget won't energize Japan's once pre-eminent, but now sliding, consumer-electronics firms or persuade young people to launch their own companies. Trade barriers must come down to better link Japan with a dynamic Asia. The nation needs to open the door wider to immigrants to offset its aging population. It isn't clear if Abe is committed to these reforms.
In many other countries, Abe's actions would be punished by capital flight and economic ruin. (Even the U.S.'s debt-to-GDP ratio, which is less than half of Japan's, has elicited much angst globally.) Most Japanese government debt is held by loyal citizens who finance the state with a large pool of savings. That means Abe doesn't have to rely on exacting foreigners to cover his deficits (as Greece and Spain do), keeping borrowing costs low. Still, he can't avoid the forces of economic gravity indefinitely. Japan is a linchpin in Asia's security and stability. But by weakening the central bank and Japan's already fragile financial position, Abe could erode what shreds of confidence remain in its economy at home and abroad. Investors are cheering now; they could be crying later.