Japan’s Very Big Budget

That Japan would announce a record budget is hardly a surprise. In the wake of its consumption tax increase last April 1, the country had slid into yet another recession. Shinzo Abe may have won re-election (convincingly) in December, largely on the lack of any organized opposition, but dismal turnout, the decimation of pure-play nationalist parties, and the jump in the Japan Communist Party protest vote all sent signals that voter patience with the Abe administration had its limits.

So while Abe’s heart is in his nationalist program of “normalizing” the Japanese military and revising historical perceptions, it was clear that he needed to return the economy to growth and continue to execute on his Abenomics program for reviving Japan’s perennially struggling economy.

Hence the announcement on January 14 of the largest budget in the nation’s history, one packed with plenty of fiscal stimulus to jump-start the economy and buy Abe the cover he needs to implement additional much-needed but politically difficult reforms. The government announced spending plans of JPY96.3 trillion ($824 billion). Notably, though, it expects a 9 percent increase in tax revenues, to JPY54.5 trillion, the highest level since 1991, a mix of higher corporate profits, which have been aided by the weaker yen, and the impact of the consumption tax hike.

In the meantime, Abe has taken defense spending to a record JPY4.9 trillion, as the government seeks to step up procurement of assets that it will use to defend its islands from rising Chinese assertiveness. That increased spending, a fillip for Japan’s local defense industry, prompted a predictable response from China’s media, with the Global Times quick to point out that the record spending coincides with the 70th anniversary of the end of World War II.

The budget will very likely do what Abe hopes: exit Japan from recession, with the aid of a cyclical rebound and a weak yen. Attention will then turn to the start of the new fiscal year on April 1, when the government will be hoping that robust corporate profits, a planned reduction in the corporate tax rate, and the Bank of Japan’s efforts to boost inflation will translate into meaningful wage increases for Japan’s vastly put-upon consumers.

Abe will be hoping that Japan would then enter a virtuous circle of rising wages, rising demand, rising prices, and rising profits, but it is very unlikely that a country with a declining population will be able to sustain that happy scenario without some serious structural reforms. Abenomics indeed calls for such reforms, but the government has so far underwhelmed on this score. Abe’s main opposition on reforms comes from within his own party, principally in the form of backbenchers representing Japan’s rural districts. Abe will need to convince this group of the need for major change, such as the Trans-Pacific Partnership, a regional free trade agreement that could benefit Japanese business but that is the subject of deep skepticism among the nation’s elderly farmers, who fear an influx of cheap foreign produce. It is perhaps notable, then, that 15 percent of the budget is being devoted to regional stimulus, including subsidies for the fishing and farming sectors. (A notable exception is Okinawa, where Abe’s ruling Liberal Democratic Party (LDP) is embroiled in a long-running row with local authorities over the relocation of a U.S. military base. Its budget allocation was cut.)

Meanwhile, the increased tax revenue keeps alive hope that Japan might just be able to reach its targets for reducing the budget deficit, currently 5 percent of GDP. Indeed, Japanese officials point out that, the record spending notwithstanding, the new budget cuts borrowing for the third straight year, to a six-year low of JPY36.8 trillion. However, analysts observe that this improvement is mostly a result of windfall corporate profits from the über-easy money polices of the Bank of Japan.

That may be sufficient to enable Japan to meet its short-term target of halving its primary deficit. In the longer term, though, the government will need to make some painful cuts in social welfare spending, and Abe has shied away from these in the current budget. While the budget reduced spending in areas such as clean energy and education, welfare outlays still accounted for about a third of all spending. At some point, the government will need to cut entitlements. That means reduced benefits and higher costs, especially for Japan’s elderly population, another key constituency for the LDP.

Last week’s budget is a continuation of the aggressive fiscal and monetary policies Abe has pursued since returning to power at the end of 2012. Those toolboxes are, however, nearly empty, and Japan is still left with its fundamental dilemma: stimulating growth in an economy preset for demographic reasons to contraction while simultaneously adopting policies of fiscal austerity. Leaving aside outright debt monetization, the only way forward involves politically painful reforms. Well into the third year of his second term as prime minister, and fresh off re-election, it is now or never for the Abe government.