The Mythical Third Arrow

BOJ Governor Haruhiko Kuroda isn’t laughing about the lack of progress in economic reform. Photo by: Jason Reed/Getty Images.

Bigfoot. Nessie. The Abominable Snow Man. All rumored to exist, but evidence to that effect is a wee bit lacking. Add to that list the promised structural reforms—the third of Japanese Prime Minister Shinzo Abe’s “Three Arrows” economic revitalization plan, also known as “Abenomics.” Abe is once again teeing up investors’ expectations for big reform plans, but talk is cheap. His government’s recent actions suggest their true focus lies elsewhere, and investors who expect meaningful change likely end up disappointed (again).

For years, it has been a foregone conclusion that Japan probably can’t return to the global economic forefront without deep structural reforms—to just about everyone but Japanese politicians, that is. So when Abe campaigned in 2012 on promises to vitalize the long-lagging country with his three arrows of monetary stimulus, fiscal stimulus and broad reforms, Japanese markets were jubilant. Arrows one and two were unleashed soon after Abe took office that December, prompting some short-term optimism that Japan was turning a corner. However, arrow three has largely remained a myth—often rumored, but (like Nessie) seen only in vague, fuzzy generalizations that can’t be substantiated.

Abe and his cabinet have spent the last year and a half talking about reform. A lot. Problem is, they haven’t done anything material. Abe spent his first six months negotiating with business and party leaders behind the scenes, promising big change in public speeches, but when he finally announced his agenda last June, it was a dud. The much-hyped speech was high on generalities and low on actual change. Most gave him a pass since upper-house elections loomed in July, and Abe indicated he’d unveil deeper, more concrete proposals in September—then, too, his announcement fizzled. In January, he swore he was still on the case, compared himself to a “drill bit” ready to cut through any and all vested interests and red tape. But all we’ve seen since are some similarly awkward metaphors (lost in translation, we assume).

Now Abe promises third arrow 3.0 in June, but we’re skeptical as ever. Sure, the measures telegraphed thus far sound fine. Revamping the Government Pension Investment Fund to increase equity demand, incentivizing more women to join the workforce, simplifying some tax deductions and even fostering immigration would all benefit Japan. But all fall well short of the big corporate tax changes, improved corporate governance, labor market reforms and freer trade that are most crucial to Japan’s long-term competitiveness. These more significant reforms will take a ton of political capital—a finite commodity.

Abe took office with a ton of clout thanks to his party’s landslide victory, with his personal approval rating topping out over 70%. However, he has been spending that capital elsewhere: on his life-long ambition of restoring Japan’s military might and rewriting Article 9 of Japan’s constitution, the anti-war clause. First came a failed attempt to revise Article 96 to ease the requirements for constitutional changes—a possible end-run around his coalition partner’s opposition to reforming Article 9 (New Komeito, a pacifist party, didn’t bite). Now, Abe and New Komeito are in talks over reinterpreting the constitution in a way that would permit the use of “collective self-defense”—giving Japan a bit more wiggle room to respond to perceived affronts with military force. Any horse trades Abe makes here are trades he probably can’t make when negotiating economic reform.

While Abe claims he’s dedicated to economic reforms as well as national security, talk is cheap. Actions are more telling, and all the action seems to be happening on the military front. It all recalls Abe’s first stint as PM in 2006, when he was handed a mandate to continue predecessor Junichiro Koizumi’s economic reforms. Instead, he focused on his pet nationalist agenda, like Article 9 and making school curriculum more “patriotic.” The economy soon started going south, Abe was out of political capital, and he was gone.

He could soon find himself at a similar political tipping point. While GDP rose 1.5% (5.9% annualized) in Q1, this is likely due to consumer spending getting pulled forward ahead of April’s sales tax hike, not a sign of resurgent demand. The weaker yen sent export values through the roof at first, but that never translated to a huge production boost, and now the effect is waning—yet higher energy import costs still sting. Many seem to hope the BOJ will step in, but Governor Haruhiko Kuroda has said the next move is Abe’s. In a recent interview, Kuroda said the BOJ’s monetary policy has created a “golden opportunity to make those structural reforms.” Read: Kuroda has done his part, firing arrow #1, giving some sectors of the economy (and voter sentiment) a quick but temporary boost. The question, as ever remains: Will Abe live up to his end of the bargain?

Recent signs aren’t encouraging. Legislation creating a legal framework for casinos to operate in Japan—an economic tailwind and widely considered low-hanging fruit with broad support—looks to be delayed until 2015 because legislators are preoccupied with ... drumroll ... defense! Distraction in action. Unless the tide turns, and reform actually happens, Japan likely continues dashing investors’ hopes.