uea case competition 2014
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Boston University Undergraduate Economics Association
Case Competition:
Abenomics: The Challenges of Revamping Growth in Japan
Written and edited by: Daniel Currie | Howard Wei | Jeevan Parameswaran | Shivani Desai | Spencer Petitti
Organized by:
Daniel Currie | Federico Mele The following material has been written and prepared by the Executive Board members of the Boston University Undergraduate Economics Association (BU UEA). The case has been assembled through student research based on publicly available information and data. The material is not intended and should not be used for commercial applications. The material has been written for participants of the BU UEA Case Competition. The case is centered around a fictional event based on a current economic issue. Participants are to assume the position of economic consultants to high-ranking government individuals confronted with an intricate and complex economic issue. Figures and data are based on factual, publicly available statistics. The material is to be used as a basis for the participant’s research. The paper is not an exhaustive composition of the economic issue. Participants are expected to perform their own due diligence and extensive research to accommodate their final recommendation.
Introduction: The Second Coming of Shinzo Abe
When Shinzo Abe re-assumed office in 2012, Japan’s economy was in dire straits. In particular, four
key issues plagued the Japanese economy:
1. For over ten years, the Japanese economy had remained in a constant state of deflation.
2. The overvalued yen had led to a decrease in competitiveness of Japanese exports.
3. A major earthquake (2011 Tohoku earthquake and tsunami) had severely dampened growth
prospects, resulting in a 3.7% contraction for 1Q2011.
4. The continued economic malaise stemming from the Great Recession of 2008 had hampered
Japan’s recovery.
To address Japan’s seemingly unending economic woes and usher in a new age of prosperity, Shinzo
Abe adopted a set of unprecedented hyper-accommodative policies, termed “Abenomics”.
The Land of the Rising Sun
Japan, an archipelago of 6,852 islands, has a long and dated history spanning over 30,000 years.1
Today, Japan has a nominal GDP standing at nearly six trillion dollars, making it the 3rd highest in the
world. Since the early 1900s, Japan’s population has also grown to 127 million2 and is often
characterized as one of the most densely populated countries in the world.
The ethnic breakdown of Japan is largely comprised of Japanese nationals (98.5%) alongside very
small proportions of Koreans (0.5%), Chinese (0.4%) and other (0.6%). It is no secret that the
population of Japan is aging; 33% of its population is 60 years or older and this aging trend is
expected to continue due to improving healthcare and declining fertility rates [Figure 1]. An aging
society can pose difficulties to Japan such as ballooning social security and welfare payments, overall
population decline [Figure 2] and can even hinder the effectiveness of monetary policy3.
Japan has undergone incredible growth since the early 20th century and currently has a GDP per
capita of $36,9384 [Figure 3], placing it at 22nd in the world rankings. Japan also prides itself for
ranking 10th in the Human Development Index (HDI). However, inequality has been widening in recent
years as the rich have earned ‘incomes more than ten times those of the poorest’5, translating to a
Gini coefficient of 0.316 [Figure 4].
An analysis of Japan’s economic sectors shows that the bulk of labor (69.9%) work in the services
sector. Japan’s principal economic engines include wholesale and retail trade (24% of GDP) followed
by industrial production (20%) with the financial industry coming in third (20%)7. In order to pull
Japan’s economy out of the Great Recession of 2008, the corporate tax rate has steadily decreased
from around 41% to 38% while the income tax has hovered near 50%.
1 Hammer et al., 2006 (48).
2 Statistics Japan, 2014.
3 Trichet, 2007.
4 Trading Economics, 2013.
5 Förster & Martin, 2012 (14)
6 ibid., (14).
6 7 National Accounts of OECD Countries, 2013.
The current account balance has reached -$15 billion. Additionally, the well-known problem of Japan’s
debt-to-GDP does not seem to be abating; statistics show the ratio to be at 227%8 [Figure 5]. This has
become a constant problem weighing heavily on the government’s mind.9
Unfortunately, as the 20th century timeline shows, the economy was not the only problem Japan had
to face10. Japan’s islands are situated along the region known as the Ring of Fire, subjecting the
country to volcanic eruptions, tsunamis, earthquakes, and other natural disasters that cost billions of
dollars in recovery - both physical and psychological. The devastating Tohoku earthquake and
tsunami in 2011 wreaked havoc on the Japanese people and caused a number of lingering problems.
The Fukushima Daiichi nuclear disaster, which involved the meltdown of three of the six nuclear
reactors, led to large-scale evacuations and a renewed debate surrounding the use and production of
nuclear power. Since the tsunami much of Japan’s nuclear power plants have been shut-down, raising
questions on Japan’s energy supply11. This has lead to a higher trade deficit, a problem that is
worrying, likely to persist, and in need of a sustainable solution.
The Japanese Political Structure
The Japanese political system is based upon a framework of a parliamentary representative
democracy. In this system, the Prime Minister sits as the head of government in the role of the
executive, and the Diet (the combined House of Representatives and the House of Councilors) as the
Legislative branch. The Diet is a highly politicized governmental body that has the power to enact
legislation, approve the national budget, ratify international treaties, and amend the constitution. The
Emperor of Japan performs “only such acts in matters of state”12, consisting of mostly appointments
and other matters of formality. This style of governance focuses power around “the highest organ of
state power”13, the Diet, and is thus more akin to the government of the United Kingdom rather than
that of the United States.
Prime Minister Shinzō Abe is the president of the Liberal Democratic Party (LDP), a conservative
centre-right wing political party that has maintained the majority of power in Japan since its inception
in 195514. Abe served a brief tenure in office in 2006-2007 before resigning due to health concerns
and internal party issues. He was re-elected in September 2012 on a slate promising strong foreign
policy (particularly regarding the territorial disputes with China) and economic growth.
The LDP has long been the most influential political party in the Japan, and currently holds 47% of the
seats in the House of Councillors and 61% of the seats in the House of Representatives15. The party is
generally viewed as pro-business with its promotion of a low-tax environment. The LDP has, however,
decided to move forward with plans for a rise in the country’s sales tax from 5% to 8% in an effort to
8 Central Intelligence Agency, 2013.
9 Riley, 2013.
10 BBC, 2014.
11 Ferris & Solís, 2013.
12 Web Japan, 2010 (1).
13 ibid., (2).
14 Liberal-Democratic Party of Japan (LDP), Britannica Online Encyclopedia, 2014.
15 The National Diet of Japan, 2014.
reduce government debt. If everything remains on schedule, the sales tax will again increase to 10%
in October 201516, in-line with the medium term fiscal consolidation of Abenomics.
Sino-Japanese relations have been strained in recent years due to territorial disputes over the islands
known as Diaoyu in Mandarin and Senkaku in Japanese. It seems unlikely that this political issue will
spill over into the economic realms, as both countries have a heavily vested interest in maintaining
their economic interdependence17.
One highly contentious area of debate is the proposed Trans-Pacific Partnership (TPP). Japan began
discussing the trade partnership in 2010 with hopes of engaging in an enormous free trade agreement
between 11 other potential member states (four current signatories) [Figure 6]., boosting economic
growth in the country. The agreement aims to tackle regulatory and tariff barriers that hamper trade
flows between the cooperating countries18. Nevertheless, the TPP has been criticized by domestic
farmers, consumer protection advocates, and government watchdog organizations for a variety of
issues regarding domestic impact and transparency. This leaves the TPP on the table as a highly
politically sensitive issue that will have lasting effects on the Japanese economy.
The Great Stagnation (1980’s-2007)
In the post-WWII era, Japan was considered a ‘growth miracle’, exhibiting double-digit growth rates
and remarkable industrial transformation. Between 1960-1973, Japan had the most rapid economic
growth, averaging 9.6% real GDP growth annually compared with 4.9% for the entire OECD area.
Unemployment was low, with rates averaging 1.3% over the period.
Following this ‘miracle’ era, stagnation in the economy occurred in 1991-2005. In the early 1990s, the
Japanese economy abruptly fell into recession, a period which has been termed the “lost decade” due
to sustained general economic despair not witnessed in the world since the 1930s. Real GDP growth
averaged only 1.5% during this period. The burst of the stock market bubble continuing into the late
1990s led to significant losses for banks due to large equity holdings associated with their main bank
relationships. A simultaneous decline in real estate prices led to bankruptcies and debt service
problems of private corporations and households. Two major financial institutions, Hokkaido
Takushoku Bank and Yamaichi Securities Company, collapsed in 199719.
Monetary policy has been cited as a significant cause of the recession, as the Bank of Japan slashed
the discount rate from 5.00% in January 1986 to 2.50% in February 1987, leading to uncontrollable
money growth. Following the sharp drop in asset prices in 1990-1991, the Japanese government was
slow to respond, allowing for flawed banking regulation which left Japanese banks more vulnerable to
asset price falls. Although the central bank hiked interest rates by May 31, 1989, it had little effect on
asset inflation. The Bank of Japan tightened its monetary policy for the fifth time in August 1990 when
stock prices plummeted to half its peak. Prolonged deflation combined with a sustained period of zero
short-term interest rates created a situation where the central bank lost leverage to provide additional
16
The Economist, 2014. 17
Katz, 2013. 18
Grant, 2014. 19
Hutchison et al., 2013.
monetary stimulus to the economy.
The Great Recession (2008-2010)
The Great Recession of 2008 had far reaching consequences in the economies of the world, and
Japan was no exception. Although Japan managed to avoid the initial effects of the credit crunch and
enormous financial losses, the global deleveraging that followed placed the export based economy in
a vulnerable position. Research has shown that Japanese output is highly responsive to output shocks
of the United States and Western Europe20, and as such the country faced an annual GDP growth rate
of -1% in 2008 and -5.5% in 2009 immediately following the crisis. Japan may have avoided the
banking collapse experienced in the United States and Europe, but it had no way of adequately
mitigating the lack of aggregate demand in international markets.
The Japanese economy maintained deflationary pressures during the post-crisis years, averaging a
CPI rate of -0.16%21 in the period of 2007-2012. During the same time, the USD/JPY ratio fell under
80 Yen per USD$ from a starting point of about 120 Yen per USD$ [Figure 7]. This dramatic
appreciation of the yen severely hurt the nation’s export industries, as it became significantly harder
for foreigners to purchase the now expensive Japanese goods22. The appreciation of the Yen, coupled
with faltering foreign demand, halved Japanese exports and in 2011 forced their trade balance into its
first trade deficit since 198023 [Figure 8].
During these times of crisis, the Bank of Japan took a lax approach, waiting until October 2008 to cut
its interest rates by a small 0.2% and delaying until December 2008 for a second 0.2% cut. It was not
until the election of the 57th Prime Minister of Japan, Shinzo Abe, that the government took a firm and
substantial “three arrow” approach, strictly focusing on fiscal stimulus, monetary easing, and structural
reforms.
The Abenomics Gradebook
The primary overarching goal of Abenomics was to restore growth in Japan. In the short run, this has
undoubtedly been true. Japan’s GDP growth accelerated in 2013; growth is widely expected to
register at 1.7% year over year for fiscal year 2013, compared to 1.45% YoY in 2012. While the
percentage change may not be overtly high, the pickup was notable in light of sluggish growth in
recent years. However, in the very near term at least, it would appear that Abenomics has fulfilled its
primary target of boosting growth.
The second goal of Abenomics was to end deflation in Japan and achieve an inflation target of 2% by
2015. CPI numbers printed at 1.5% YoY in November 2013, illustrating the rapid progress of
Abenomics. Furthermore, Japan’s CPI (except oil and food prices) rose 0.6% in November, a positive
development after remaining negative for most of the year. Undoubtedly, the sharp depreciation of the
20
Kawai, 2009. 21
World Bank, 2014. 22
The Economist, 2014. 23
International Monetary Fund, 2012.
yen post Abe’s first arrow was a major contributing factor to the CPI pick up.
Along with the inflation target, Abe has also targeted a boost in real wages, as raising the cost of living
without a corresponding improvement in household income would result in overall lower standards of
living for the population. Thus far, efforts to raise real income levels have proven unsuccessful with
changes in real income remaining relatively stagnant (0.4% YoY decline in 2013).
In line with Abe’s inflation targets, the BoJ was also mandated with the task of doubling the monetary
base within two years (JPY 15.5 trillion as of April 2013). Thus far, the average monetary base
outstanding has grown 34.4% YoY in FY2013 to JPY 20.18 trillion. This effectively means the BoJ is
well on track as a third of the progress towards doubling the monetary base has already been
completed.
Though not officially stated, another major consideration of Abenomics was to revive the Japanese
stock market, generating wealth via the infamous “wealth effect”. With regard to this goal, Abenomics
has been an indisputable success. As of early 2014, the Nikkei index has risen approximately 48%
YoY. While Abenomics may not take sole credit for the recent Nikkei surge as other global economic
factors have heavily influenced markets, it nonetheless remains the principal driving force behind the
recent resurgence of the Japanese stock market.
Along with inflation and growth, weakening the yen was naturally yet another crucial driver of
Abenomics’ success. With the Yen approaching the mid-70s against the USD in the run up to Abe’s
second term, the strength of the yen emerged as a major consideration for Japanese exporters. With
the rise of neighboring South Korea’s electronics exports, many major Japanese firms faced stiff
competition and generated minimal to no profits. As a result, tax revenues were heavily impacted,
further deteriorating Japan’s fiscal standing. Since the implementation of Abenomics however, the yen
has depreciated as much as 24% from 84.7 to a peak of 105.4 at the start of 2014. Additionally,
average profits for all firms, particularly large manufacturing enterprises, sharply increased with large
exporters reporting a 34.7% YoY profit growth. In this sense, Abenomics has yet again been a
success, supporting corporate profits disproportionately through a weaker yen.
Despite all the success of Abenomics’ first and second arrows, the third arrow has proven to be the
most challenging. Undeniably, the lack of structural reform remains one of the shortcomings of the
Abe administration’s term in office. Furthermore, the resounding victory in the 2013 upper house
elections could signal that the administration has taken its foot off of the pedal in terms of urgency to
implement non-quantitative reforms and policies.
The preliminary conclusion on Abenomics has overall been very positive, especially with regard to the
firing of the first and second arrows. The success of Abe’s third arrow on the other hand remains to be
seen and thus, the Abenomics’ grade book remains incomplete. While Abenomics remains very much
a work in progress, “so far so good” appears to be the fairest way to describe the performance of
Shinzo Abe’s latest economic experiment.
The Case: What is Japan to do?
Given the deflationary pressures of the past, the Abenomics of today, and the shifting demographics
problem of the future, what steps can Japan take to revitalize its dormant economy and reclaim its
latent growth?
As consultants to the Japanese government you are tasked with providing a practical and realistic
economic policy solution to the country's economic challenges. One week after the case
announcement, each team of consultants is required to submit a one-page policy proposal stating their
preliminary claims and outlining the structure of their analysis. The Japanese government will use this
proposal to determine which teams of consultants will be featured in the final round. The teams
selected for the final round of the competition will create a 10-minute presentation detailing their policy
recommendation. Following the presentation, competing teams will engage in a 5-minute Q&A session
with the judging faculty panel.
The solution presented should be a creative mix of monetary, fiscal, and social policies feasible in the
current politico-economic sphere of 2014 Japan. Some important ideas to consider are:
1. The effect of a sales tax hike from 5% to 8%, with a possible future increase to 10%;
2. The shifting demographics and its effects on fiscal, monetary and social aspects within the
country;
3. The rising fiscal deficit (especially its debt-to-GDP ratio) and its potential impact on Japan’s
government bond yields;
4. The Japanese balance of trade, focusing on how a rise in inflation could affect the real
exchange rate, and thus, net exports;
5. The solutions to these problems and their effect on the national and international political
sphere;
Teams must provide logical reasons and justifications for each of the requirements listed above. As
with any economic decisions, there will be unintended consequences and externalities to the proposed
policies. Although it will be impossible to consider all consequences of the proposed policies, teams
will have to focus on the most relevant ones in order to address Japan's problems in a concrete way.
Good luck!
Executive Board
Boston University Undergraduate Economics Association
Figures
Figure 1: Population Pyramid
2005 vs. 2030
Figure 2: Japan Population Projections (000s): The World Bank
Figure 3: Japan GDP per Capita
Figure 4: Gini Coefficient
Figure 5: Japan’s Debt-to-GDP
Figure 6: Existing FTAs among TPP Countries
Figure 7: Japan’s appreciation and change in broad money
Figure 8: Japan’s trade balance
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