I originally published this post on The Waltham Economy of Asia Review on February 25, 2014.
Much has been written about Japan’s Prime Minister, Shinzō Abe, who took office in 2012. Lovingly or derisively called Abenomics depending on who is writing, Abe is working to jumpstart the Japanese economy through “three arrows”: monetary policy changes, fiscal stimulus, and structural reforms.
Abenomics is both needed and dangerous. It can wake the sleeping Japanese economy, but in doing so, may add income inequality to the long list of social and demographic issues Japan will have to confront in short order.
Like many other commenters, I hope that Abenomics succeeds. For the past two decades, Japan has suffered from sluggish economic growth. Japan’s economy frequently contracted on an annual basis in the years preceding the global financial crisis (see chart below). Similarly, the 2000s were a time of persistent deflation in Japan, despite unconventional monetary policy from the BOJ. In short, there is little doubt that Japan desperately needs a bold economic shift such as Abenomics to increase the rate of growth and defeat deflation.
Economic growth and a return to low, stable inflation rates, however, is not a panacea for all of Japan’s problems. In fact, success of Abenomics may exacerbate and bring to light a problem that has been latent beneath the surface for years: income inequality. The OECD estimates that from 1985 to 2006, the average annual income of the poorest decile has decreased by 0.5% in Japan while increased by 0.3% for the top decile. Furthermore, it estimates that the Japanese Gini coefficient (a measure of income inequality where a higher coefficient means more inequality) has consistently been higher than the OECD average since 1996 and has been increasing faster since 2003. Chances are the only reason why Japanese income inequality is so rarely talked about is because other social issues such as the rapidly aging population, draconian immigration laws, and an incredibly highly leveraged government overshadow it.
Income inequality is positively associated with inflation because households at various income levels have different capabilities to insulate themselves from the loss in the value of cash due to inflation. Proportionately, the poor and middle class rely more on their wages, which do not change with inflation. In practical terms, this means that the real wealth of poor and middle class households is likely to be eroded as inflation increases. On the other hand, the wealthy are more likely to invest their paychecks and to have significant existing investments. Investments mean that the value of money can grow with (or, hopefully, more than) the rate of inflation. Inflation can create winners and losers, which means that the wealth landscape changes.
There are a number of reasons why income inequality is a concern. Though plenty of commenters feel that there is a moral argument to be made for less inequality, I am compelled by the economic argument. Berg and Ostry of the IMF argue that while countries may be able to grow in the short-term with inequality, more inequality is associated shorter periods of sustained growth.
Considering how long Japan has suffered from sluggish growth, it is certainly grasping for sustained growth. If income inequality is associated with shorter periods of growth, the inflation caused by the success of Abenomics could ultimately prove deadly.
As Shinzō Abe aims his three arrows, he should be careful to avoid his foot.