Curious Capitalist

Grading Abenomics: After Stock Slide, Japan Economic Reforms Under Scrutiny

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Is Japan now officially in bear market? It’s a question being asked by many investors today, given that the Nikkei closed yesterday 20 percent down from a recent high on May 22nd. The market was up slightly, by 1.9%, on Friday, but mainly off the back of bargain buying. In technical terms, a 20 percent drop is often labeled a bear market. But what’s happened in Japan hasn’t happened in a vacuum – it’s part of a larger central bank inflated money bubble that I’ve been writing about for some time – one that may be starting to pop.

It’s not surprising to me that the Nikkei and the emerging markets have been taking the biggest and fastest correction over the last few days. As savvy emerging market experts like Morgan Stanley’s Ruchir Sharma have been saying for some time, emerging markets have been inflated by central bank money, and given their inherent riskiness, they were always to become volatile at the first sign of a pull back from “quantitative easing,” the Fed’s asset buying strategy.

But Japan is a somewhat different story — the big question there is whether this Nikkei correction (or bear market, as you prefer) heralds the early death of “Abenomics.” That’s the nickname of the policy regime launched last year by Japanese Prime Minister Shinzo Abe, which includes aggressive monetary easing of the kind we’ve already seen from the Federal Reserve in the U.S., as well as promises of major structural changes to the economy, like deregulation of protected sectors, tax reform, trade liberalization, red tape cutting, and a new push for innovation and entrepreneurship. Abe calls his monetary, fiscal and growth reforms the “three arrows” in his quill, referring to an ancient Japanese legend in which three arrows bundled together prove to be stronger than one.

But as in the U.S., the only arrow that has really been deployed is the first — monetary policy. Just as the Fed’s program of asset buying led the Dow to record highs, the announcement that the Bank of Japan would ramp up purchases of Japanese government bonds several weeks ago sent investors into higher-risk assets like stocks, pushing the Nikkei to a six-month rally. But the first sign of Fed tapering sent investors running to the door, and as the old investment adage goes, the last ones in (in this case, investors in Japan’s assets) were the first ones out.

Meanwhile, as the U.S. is slowly but surely pulling into a real recovery, Japan is still in the doldrums, with economic problems that are much larger and more entrenched than those of the U.S. Since the post-World War II period, Japan’s modern blue chips have always been run by a small, revolving group of old men in dark suits. Both management and labor are notoriously inflexible, and many firms have dysfunctional conglomerate structures in which people don’t talk to each other (Sony once had three divisions unknowingly working on a plug for the same device), and a focus on incremental innovation at the expense of big disruptive ideas (that’s one reason that Apple, and not Sony, invented the iPod).
Meanwhile, Japan’s global competition has gotten sharper. Over the past decade, U.S. companies have become leaner, meaner and more innovative, and the cost of unit labor in the U.S. has fallen by 14%, according to a recent report by London based Capital Economics. At the same time, unit labor costs in Japan have increased by 10%. No wonder Toyota recently announced it would start manufacturing the Lexus in the U.S.

Japan desperately needs corporate reform and a boost in competitiveness to cope with its debt and terrible demographics. But experts say even if Abenomics makes a dent at the policy level (and it’s clear that the markets, so far, don’t believe it will), it will still be up to corporations to decide whether to play along. “Corporate Japan’s main goal is still to keep the requisite number of senior positions open for the requisite number of old boys,” says Alicia Ogawa, a director at Columbia University’s Center on Japanese Economy and Business. “Change comes very slowly.” Until the real economy in Japan makes real change, it’s doubtful that putting a new policy name on old habits will do much for Japanese markets, or the country.

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