Robert Feldman | Tokyo
I think PM Abe will be an effective reformer, although the signs may be hard to read. His agenda is market-oriented and supported by the public. He has the political skills and support to push this agenda. Equities, the yen, and real estate should benefit from more reform. The rise of interest rates and yields will be modest, in light of low inflation and falling fiscal deficits. The main risk is complacency, in public and corporate sectors.
First, it is important to recall the reality of the Koizumi years, not the rose-colored memory. There were many compromises along the way to reform. Second, PM Koizumi was continuously bashed by the media and resisted by anti-reformers in his own party. So will it be with Mr. Abe. Mr. Koizumi had the philosophy and fortitude to persist. So does Mr. Abe.
The real problem — efficiency.
The public wants reform, and has voted for it. Investors want higher earnings, both from corporations and from fixed-income investments. The only path to such higher earnings is higher efficiency.
Growth philosophy — rising tide to 4% GDP growth. Thought leaders in the ruling party have an agenda to address these issues, the Rising Tide Theory. They are pushing for greater innovation, more flexible labor markets, a tight fiscal/loose monetary policy mix, and fair income distribution. The result, they claim, would be nominal GDP growth of 4%, with only 1% inflation — i.e., 3% real growth.
So far, opponents of the Rising Tide Theory have only been able to criticize, not offer alternatives. Thus, the Rising Tide theory is winning the public debate.
Execution — ambition versus disappointment. That said, the political economy of execution has a key contradiction. To achieve lofty goals, one must set ambitious targets. On the other hand, falling even slightly short of targets typically generates sharp criticism. Thus, setting ambitious targets undercuts the credibility needed to achieve the targets. The only answer is to stick firmly to policies, and appeal to the public on the basis of the outcome. PM Koizumi was a master of this. He never achieved 100% of his goals, but even 70% was major progress. The public rewarded him at the polls.
PM Abe has taken up the challenge. He has defined an ambitious agenda in education, innovation, tax reform, labor reform, pension reform, trade reform, medical reform, and other issues. He has created competition between task forces in the PM’s office and the bureaucracy. If anything, the press is criticizing him for not being tough enough, which only strengthens his hand. Facing an election next July, even foot-draggers in the LDP will be forced to go along.
Market implications. For markets, more successful reform means positive surprises for growth and an end to deflation. Both near-term and long-term earnings are likely to beat expectations. This combination implies that equity prices and the yen should be strong, and that real estate will continue to recover. Yields should rise, but modestly, due to progress on fiscal consolidation.
The big risk — complacency. If market pressure on government and board rooms is ignored, then