Shinzo Abe's Stimulus Is a Lesson for the World
Everybody in the G-7 group of leading economies talks about the need for new fiscal policy, but nobody has done anything about it—until now. Japanese prime minister Shinzo Abe’s new fiscal package contains within it the prospect of a better way to do stimulus.
For too long, fiscal stimulus has been seen as inimical to structural reform. But done properly, macroeconomic stimulus can be reform, and be more fiscally responsible as a result.
Japan’s high and rising net public debt level is cause for concern, of course. I supported the introduction of a consumption tax increase there in late 2014, due to the risk of a rise in debt payments forcing a sharp adjustment. Yet that experience taught us a lesson—the depth and duration of the contraction in consumption after VAT went up surprised everyone.
More striking was the fact that Japanese interest rates went down when the next tax rise was postponed, and stayed down. Government bonds have risen further in price since the plan for this latest stimulus package was leaked. It may be confounding to see in a nation where the ratio of net government debt to gross domestic product is 160 percent, but it means Japan does have fiscal space in which to act.
It matters what Mr. Abe does with the money. Simply labelling something “infrastructure” guarantees neither rapid implementation nor gains in productivity. In recent decades, the actual funds spent by the government have been a fraction of the packages announced, due to lack of project readiness and conditional funding.
What is promising about Mr. Abe’s latest stimulus package is not its size—the real amount spent will certainly be less than half of the announced ¥28.1 trillion ($276 billion)—but its ties to labor market reforms. The first rounds of Abenomics, the prime minister’s attempt to revitalize the Japanese economy in 2013 and 2014, showed the power of such a combination. Spending to increase the availability of public childcare places and cuts to taxes that penalized families’ second earners contributed to a substantial rise in women joining the labor force.
The initial impact was disinflationary, putting downward pressure on wages, as labor market reforms usually do, so the benefits were hidden. The lasting increase in labor supply, however, has enhanced Japan’s long-term fiscal sustainability. We can expect that part of the new package that further promotes participation in the labor force and eases the burden on those caring for family members to have a similarly large payoff.
Another promising aspect of Mr. Abe’s package is his proposal to raise the minimum wage and potentially to raise public sector wages for teachers and others. Encouraging an upward spiral of wages into prices and back is the best path to nominal GDP growth, while some meaningful ongoing inflation is necessary to reduce Japan’s public debt. The point is that interventions in labor markets that initially increase deficits can have salutary longer-term effects on fiscal balances and growth.
There is a lesson here for eurozone governments: Use expansionary fiscal policies to promote well-designed reform rather than austerity to try to force change. For all the blood spilled in terms of unemployment and benefit cuts in Europe since the financial crisis began, the yield in terms of labor market reform has been meager, and in product market liberalization even worse. Given the damage to growth, adverse demographics, and the need for structural reform, the prospects for public debt are only getting worse.
Fortunately, eurozone governments already accept the principle of tying fiscal expansion to structural reform instead of trying to induce reform by deterrence, through the so-called “flexibility clause” in the stability and growth pact. Jeroen Dijsselbloem, head of the eurozone’s committee of 19 finance ministers, and Pier Carlo Padoan, the Italian finance minister, have both pointed out that the pact is meant to encourage structural reforms by permitting “medium-term objectives” for deficits to be postponed when adjustments are painful or public investments are made.
The eurozone’s mindset needs to move further—it currently allows too little shifting of expenditure and still fails to see fiscal policy as a source of reform. Perhaps the Japanese example will lead to progress on this score.
The hesitation in Japan, the eurozone and, for that matter, the United States to stimulate structurally in this way is usually justified on grounds of political economy rather than economic logic. The fear is that anything wasteful can be labelled public investment or that the legislative process will turn well-designed initiatives into handouts.
This received wisdom should be set aside. Japan’s implementation of labor reform through fiscal stimulus shows that a leader with a clear majority can push reform through fiscal expansion. Japan also shows that even when accompanied by visible waste and suspicion in financial markets, fiscal stimulus can result in measurable improvements in supply and productivity.
We should expect an upside surprise with Japanese growth and labor market efficiency next year. Other countries with more room for maneuver, and even worse labor and product market inefficiencies, should follow suit.