Trickle-Down Economics Is Failing Stagflationary Japan

If time travel were possible for Japanese officials, it would be highly tempting to return to the Tokyo of March 2013 and avoid the last nine years of economic folly.

The moment in question was when Haruhiko Kuroda was named head of the Bank of Japan. The hire, made by then-Prime Minister Shinzo Abe, was a wise one. Kuroda was well-known from his 1999-2003 stint as Ministry of Finance’s point man for international affairs. The eight years he spent in Manila running the Asian Development Bank and fighting poverty from 2005 to 2013 only enhanced Kuroda’s skill set.

Yet Kuroda was always set up to fail. Abe and his boosters didn’t know it in 2013, but the strategy they foisted on Governor Kuroda—weaken the yen, and fast—left the BOJ but with one option. And that was flood global markets with yen.

Folks at the time fancied Abe some bold, smart reformer. The buzz was that deflation-plagued Japan was about to experience a supply-side shock, painting Abe as some amalgam of Ronald Reagan and Margaret Thatcher. Instead, Abe took Tokyo in the direction of Argentina or Vietnam.

Currency devaluation had long been the ruling Liberal Democratic Party’s go-to move to juice gross domestic product. Abe hired Kuroda to turbocharge the process—and turbocharge he did.

Along with hoarding ginormous blocks of government debt and stocks, Kuroda fired massive “bazooka” blasts of liquidity into markets. Before long, the yen was down 30%, economic growth returned and corporate profits hit records.

Missing, though, was the virtuous cycle Abe’s inner circle envisioned. CEOs sat on cash rather than sharing it with workers or investing big in new growth-boosting industries. The problem, of course, was that Japan’s leaders forgot the 1980s are over. The industrial system that Abe’s trickle-down economics aimed to revive no longer exists. Not when Japan’s domestic service sector is at least as important as the export engine.

Even Kuroda is realizing that the weak-yen obsession left Asia’s second-biggest economy worse off. The immediate fallout is surging costs of energy and other commodities Japan must import. Japan might soon get the 2% inflation Kuroda was hired to produce, but it’s the “bad” kind that slams household and business confidence. This is how “stagflation” happens.

As Kuroda said in December: “The yen’s depreciation might have an increasing negative impact on household income through price rises.” He added that “a quantitative analysis by the bank’s staff shows that the effects of the yen’s depreciation in terms of pushing up prices of durable goods have increased in recent years.”

The “yen’s depreciation,” Kuroda concluded, “basically has a net positive impact on Japan’s economy. That said, the yen’s fall has positive and negative effects, and due attention should be paid to the fact its effects will materialize in various ways.”

Fair enough. But missing from this BOJ autopsy is the bigger problem: how a weak yen deadened the urgency for Tokyo to make the economy more competitive and nimbler and for corporate chieftains to innovate, restructure and take risks.

By 2018, the BOJ’s balance sheet topped Japan’s $5 trillion of annual gross domestic product. A lower yen, the central motivator of that balance sheet binge, has been a modern history’s greater corporate welfare scheme. It helps explain why Japan Inc. is losing competitiveness. And why as India and Indonesia produce increasing numbers of tech unicorn startups, Japan is largely watching from the sidelines.

When Argentina, Vietnam or other upstarts devalue exchange rates, the aim is to jolt the system—the policymaking equivalent of a heart defibrillator. When a developed Group of Seven power like Japan does it, it acts more like a sedative over time that deadens an economy ‘s animal spirits. It simply removed much of CEOs’ resolve to remind Apple, Tesla and Samsung of Japan Inc.’s fabled past as global innovation central. Why take risks when the central bank constantly has your back?

If time travel were a thing, Kuroda would return to March 2013 and try a very different approach. Dare to dream, because now the weak-yen policy is taking on a new life of its own. The yen, as economist Udith Sikand at Gavekal Research observes, is now down another 5.5% in the month since Russia invaded Ukraine.

“With the 24% rise in U.S. dollar oil prices since February 24 therefore equating to a 31% rise in the yen price of oil, some Japanese policymakers are beginning to suggest that much more yen weakness—and the imported inflation it brings with it—could soon become too much of a good thing,” Sikand says.

The good news is that current Prime Minister Fumio Kishida is telegraphing plans for a “new form of capitalism” just as the old ones fail Japan. The bad news is that from slowing domestic growth to Covid-19 to Ukraine, Japan’s leaders might now be sufficiently focused on reforms.

The last nine years of squandered time was a vital window of opportunity Tokyo can’t get back. This explains everything about why Japan’s economy, still exudes a stuck-in-time quality that won’t do it many favors in the Chinese era.