Abenomics has two problems: Consumers and companies

Companies and consumers alike are declining to play their assigned roles in Abenomics, undermining Japan’s chances of escaping deflation and economic malaise.

With exports falling, despite a cheap yen, and inflation sagging again, pressure will be on the Bank of Japan, which concludes a two-day policy meeting on Friday.

Thus far Abenomics, a mix of extraordinary monetary policy, fiscal stimulus and longer-term structural reforms, has met with some early successes, driving inflation and growth higher. But households, crimped by the failure of income to keep pace with inflation, are not spending as hoped, as demonstrated by disappointing June retail sales data released last week, which showed a year-on-year fall.

That’s in large part due to an April increase in a consumption tax from 5% to 8%, itself an attempt to get out in front of Japan’s rather dire long-term debt and tax revenue issues.

It is hard to be surprised by Japanese consumers assuming a defensive crouch, habituated as they are to year after decade of tough economic times.

What’s been more surprising, and even a tad ironic, is the way in which Japanese companies, long criticised for not maximising shareholder values like their Western peers, may now be doing so in a way which brings Abenomics unstuck.

A key plank of Abenomics – spectacularly successful in market terms – was the Bank of Japan’s determined campaign to weaken the yen, which is now about a quarter less valuable against the dollar than before the policy was announced. This was intended to unleash a virtuous cycle in which companies expanded production to take advantage of their new competitive edge in the global market. People would be hired, new plants and machines purchased or built and the rise in prices engineered by the BOJ financially would be taken up and made genuine by real growth.

That’s not what has happened.

Recent data showed exports falling 2% in June compared to a year before, the second straight monthly fall. Complicating matters is an 8.4% rise in imports, in part because Japan’s nuclear plants are down and energy is more expensive in depreciated yen. That adds up to the worst June trade deficit ever in Japan, and a 57% rise in the trade deficit for the first half of the year.

Margins over size

In part, this all may imply a change in Japanese corporate culture. Companies, many of which have diversified their production bases outside Japan in an attempt to make themselves less vulnerable to demographic issues and a formerly high yen, now seem happier to simply take the low yen as a windfall gain. Rather than pressing their advantage by investing at home, corporate Japan is enjoying the newly fat margins while they last but taking nothing for granted.

Certainly the optimistic Japanese corporate managers of the 1970s and 80s would have taken advantage of a weak yen not just to fatten margins, as now appears to be the case, but to scale up.

But 20 years of deflation and demographic stagnation at home, combined with the importation of shareholder culture, means that Japanese corporate strategists are now behaving more like their peers internationally, pocketing gains from yen weakness rather than empire building.

On a long view that might imply better allocation of capital in Japan, but in the short term it brings up some unhealthy realities for Abenomics.

It surely must also be true that both corporate managers and consumers realise that while we have heard the twang, the third arrow of Abenomics – structural reform – has yet to be felt. Structural reform may well eventually produce a growing economic pie, but it will expose portions of the economy to new competition, something workers too will feel.

All of this leaves many investors with a feeling that Abenomics, in failing to thrive, may be running off the rails.

That line of thinking is probably premature.

While Prime Minister Shinzo Abe’s popularity has fallen markedly, both he and the Bank of Japan are fully committed to the policy and can be counted on, especially at the central bank, to meet economic or market reverses with more of the same policy which preceded them.

At this meeting that probably simply means more debate on how to reach their 2% inflation goal by the promised deadline in 2015. That’s far more likely to result in a change in communications rather than in policy, at least this time. But if the trend in data stays gloomy, it may not be long before we see further easing.

That may move financial markets in the desired direction, but, given the tactics of corporations, leave unanswered the question of whether Abenomics was designed for a Japan which no longer exists.