The Limits of Abenomics

Economic success reflects both reality and psychology. The biggest question in the global markets right now is whether Japan is about to get a boost to both. The Nikkei has been staging a stealth comeback after this summer’s plunge, and corporate profitability and business confidence are as strong as they have been in years. But does the rebound signal a true recovery? Prime Minister Shinzo Abe would like us all to think so and is pinning his long-term hopes on the 2020 Olympics as a turning point for the country’s two-decade malaise.

It’s appropriate that his economic-reform program, Abenomics, which was introduced early this year, is broken down into a military-style series of “arrows” including new monetary, fiscal and growth stimulus. The challenge of China, not only territorially in the Pacific but also economically in the world, is what’s causing Japan to rethink whether it can afford to be a rich also-ran nation forever. I remember being in Japan over three years ago when China took its place as the second largest economy in the world, right behind the U.S. There was plenty of hand-wringing (how can we compete with 1.3 billion cheap workers?) but also a kind of patronizing pseudonationalist posture (we’ll show the Chinese how to really innovate and move up the economic food chain), as the chattering classes tried to turn the shift into an opportunity for Japan to play Greece to China’s Rome. It hasn’t worked, as evidenced by both the military tension in the region, as well as China’s continuing economic ascendance relative to Japan. The Middle Kingdom increasingly dominates everything from trade talks to U.S. economic diplomacy in the region. As author and Japanese-investment guru Peter Tasker put it in a blog post about the country’s future, “The status quo is much riskier [for Japan] than it looks.”

That’s exactly what Abe is trying to change. And you could argue that in some ways, he’s succeeded. Monetary policies that mimic those of the U.S. Federal Reserve have encouraged new stock-market highs and also currency lows, which have boosted Japanese exports on the world markets — the manufacturing sector is doing nearly as well as it did at its 2007 peak. But as in the U.S., the Japanese “recovery” has been a bifurcated one. The biggest and most globalized firms are doing well, but wage growth is still sluggish and consumer sentiment has weakened. (It won’t be helped by a coming tax hike.) “Abenomics is widely heralded as a boon to Japanese society, but the benefits are not being felt evenly,” says Julian Jessop, chief global economist of London-based Capital Economics.

Many of the changes are only skin deep. The central-bank money dump in late spring and early summer may have buoyed stocks, but the deeper changes promised by Abe — like the deregulation of protected sectors, trade liberalization, red-tape cutting and changes in corporate governance — are yet to come. Sony’s recent brush-off to American activist investor Daniel Loeb, who has been pushing for the company to spin off part of its entertainment arm and focus on its struggling consumer-electronics business, is a reminder that corporate Japan is still a very insular and unwelcoming place. It’s also an increasingly uncompetitive one. Over the past decade, the cost of labor at U.S. companies has fallen by 14%, while unit labor costs in Japan have increased by 10%. No wonder Apple and Google have trumped Sony, and Toyota plans to make the Lexus ES 350 in the U.S.

Meanwhile, there’s growing competition from China, which has been moving up the manufacturing food chain by practicing a kind of Japanese-style incremental innovation in areas like auto production and consumer electronics — what might be dubbed Kaizen 2.0. China is second only to the U.S. in R&D spending in nominal terms, and the Chinese are making steady progress. Companies like electronics firm Haier and automakers Geely, Chery and BYD may one day become global brands. Staying ahead of them will require a sea change in the way Japan does business; it needs everything from massive improvements in corporate governance to immigration reform to a push to get more women into the workforce to increase productivity. “The culture changes that are needed [are] a core part of the long-term recovery story,” says Michael Purves, chief global strategist for Weeden & Co., an institutional broker dealer based in Greenwich, Conn. And everyone knows that culture is a lot harder to change than stock prices.