China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

Japan’s (Abenomics’) Failure – are there Growing Risks for other Asian Countries and the World Economy?

December 3, 2014

In the third quarter, Japan’s economy tumbled again into a recession. “Abenomics” – i.e. the economic program of prime minister Shinzo Abe (LDP) – proved to be a failure. Expressed very briefly, “Abenomics” means that the Bank of Japan (Nippon Ginko) two years ago was committed to massively print money in completely uncharted waters in order to combat the long-lasting deflationary problem.

Furthermore, Abe wanted to do something about the excessive government debt (more than 240 % of GDP), for example by raising the VAT from 5 to 8 last April – a measure that obviously contributed to the current recession and made Japanese consumers even more reluctant. For this reason, another planned VAT hike has been postponed.

Bad advice

One of the intellectual fathers of “Abenomics” was Nobel Prize winner Paul Krugman who during a long time had complained about Japan’s “irresponsible monetary policy” (and who also had accused the Swedish Riksbank for a similar failure – and who, unfortunately, has quite a number of supporters among Swedish academics and financial analysts). The idea of the whole experiment was to print money in borderless amounts for government expenditure – government expenditure that should give positive multiplier effects on consumers and private corporate investors. Furthermore, some inflation should be created this way.

Today, it seems to be obvious that the Krugman-/Abe-experiment has failed. Extreme monetary expansion cannot work in the long run and never replace a structurally well-founded growth/supply side policy. If it was that easy…Something to remember in Sweden and in Frankfurt (ECB) as well.

It would be good idea if the world listened less to Krugman and consortes. With quite some luck, the previous monetarization in the U.S. by the Fed may be managed without major distortions. Janet Yellen understands economics. But Japan and Europe (ECB; Sweden included) function quite differently and have probably very different reactions functions for increased liquidity.

M x V = P x Q

Old fundamentals may help. Let’s for example, look at Irving Fisher’s so-called “equation of exchange” (1911): M x V = P x Q (M = money in circulation, money supply, V = velocity of money circulation, P = price level, Q = expenditures in real terms).

In our context, V, P and Q are the interesting variables. V stands for the average frequency that one unit of the currency/money is spent. An important point in this context is the fact that the “equation of exchange” is an identity equation which means that it is always valid whatever number you put in it. Consequently, the new number for V is not known in advance when M is changed. The same can be said about P (inflation) and Q. These simple facts make the effects of strongly extended money supply uncertain and, consequently, the whole basket of different kinds of quantitative easing (QE) – an instrument which central banks so actively apply these days or intend to use as an instrument for better growth and higher inflation (the Riksbank, unfortunately, included).

Now, in order to make the whole process of monetarization work, it is necessary that the velocity of money circulation increases visibly. Consumers and investors should be willing to spend more money more rapidly. And here we come finally to the point: consumers and investors must believe in the future. This is about behavioral economics.

Behavioral economics needs more attention

In the Japanese case, this necessary condition for a successful expansion of the money supply is not there. The Japanese are not showing enough confidence in the future. This is why any continuation of Abenomics will fail again under current structural conditions. A new policy failure – and the economic outlook for the currently third largest economy in the world will worsen much more.

In this case: at some point – within the forthcoming decade – negative contagion from Japan on other Asian countries and the whole global economy could happen. Consequently, the next Japanese government has to think more about giving real confidence in the economic future. So far, 25 years have gone without positive results. Institutional economics and the lack of behavioral studies explain a lot of this ineffective economic policy.

Economic history tells us that printing money and other liquidity-creating measures never really could cure long-term problems in the real economy.

This is indeed an important experience that academic researchers, decision-makers in central banks/governments and on financial markets should remember more actively.

 

Hubert Fromlet
Senior Professor of International Economics, Linnaeus University
Editorial board

 

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The G-20 Financial Reform Agenda after Five Years

November 5, 2014

Highlights

  • Five years ago, the declarations of the G20 in landmark leaders’ summits in London and Pittsburgh listed specific commitments on financial regulatory reform. When measured against these declarations, as opposed to the surrounding rhetorical hype, most (though not all) commitments have been met to a substantial degree.
  • However, the effectiveness of these reforms in making global finance more stable is not so far proven. This uncertainty on impact mirrors the absence of an analytical consensus on the crisis itself. In addition, unintended consequences of the reforms are appearing gradually, even as their initial implementation is still unfinished.
  • At a broader level, the G20 has established neither an adequate institutional infrastructure nor a consistent policy vision for a globally integrated financial system. This shortcoming justifies increasing concerns about economically harmful market fragmentation. One key aim should be to make international regulatory bodies more representative of the rapidly-changing geography of global finance, not only in terms of their membership but also of their leadership and location.

 

1 This Policy Contribution from September 2014 is an updated version of the author’s contribution to the 2014 China-US-Euro Economists Symposium “Reform: Challenges and Opportunities” jointly organized in Beijing on May 17-18, 2014, by Bruegel, the China Finance 40 Forum, and the Peterson Institute for International Economics.

 

Read the whole report The G-20 Financial Reform Agenda after Five Years

Nicolas Véron
Senior fellow at Bruegel, Brussels, Visiting fellow at the Peterson Institute for International Economics, Washington DC



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Emerging Markets – the Same Old Story

February 6, 2014

1. Financial markets have become nervous again about emerging markets. We have seen this flock mentality some months ago. Now it’s back again. Surprised?

2. The answer is “yes” and “no”. Yes, because many analysts never seem to understand how emerging markets really work. They are far from perfect. Shortcomings can be found in many respects: politics, social issues, the financial system, other institutional conditions, macroeconomic balance, etc. No, because financial markets frequently tend to show flock mentality, overconfidence and overreactions also when it comes to emerging markets. This is not new. Now, it’s time again.

3. Many financial analysts complain about lame structural efforts in many emerging economies. What do they expect? Sure, there are so many institutional and political impediments for improvements in this group of countries. Corruption, nepotism and rent seeking are just three of them. How on earth can rapid reduction or elimination be expected in all these complicated areas? By the way, emerging countries do not have homogeneous political, social and economic conditions

4. Consequently, emerging markets have been analyzed too negligent for a long time – and they still are. They are, of course, different from mature countries which by the way can be very reluctant on economic reforms as well. Thus, we should analyze the group of emerging economies and their individual “member countries” at least somewhat differently.

5. One of the major analytical problems is the fact that Western emerging market analysts too much and for too long time have been concentrating on GDP growth and too little on other important indicators, those from microeconomics and financial markets included. Too much focus on GDP growth may be misguiding, particularly in the medium and longer run.

6. Furthermore, it’s not good enough to watch developments in China, India or other emerging economies only from the screen. All these emerging countries function differently compared to our part of the world. “Screen analysis” gives, of course, country analysis even more herd behavior.

7. However, it’s not easy to get out of this analytical dilemma. Most employers would not allow their economists, strategists or sales planners to travel to all these interesting emerging countries in order to get more necessary impressions from “field research”. But it should be done wherever the financial resources are in place.

8. Speaking on my own behalf, I have to conclude that my recent trip to China a few weeks ago gave me more input for the interpretation of the Third Plenum’s communiqué than all the hundreds of pages I read about China’s new economic strategy. Or I should put the following way: just reading about these 16 major points of reforms and their 60 subtitles would not have been enough.

9. What makes future economic developments in China particularly exciting is the great number of goal conflicts that may emerge from these 60, more detailed reform areas. Such an analytical exercise demonstrates that structural reforms in emerging countries are not easy at all.

10. Deepened studies of this kind could make many Western analysts a little bit more humble. The current arrogance against many emerging countries – despite all their really existing shortcomings – cannot always be considered as fair.

 

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board

 

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