Abe needs to stay focused on reforms, not taxes.

Photographer: Kazuhiro Nogi/AFP/Getty Images

Why Abe Should Take Krugman's Advice

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Paul Krugman was an early and enthusiastic fan of Japan's efforts to end deflation. In a January 2013 New York Times column, the Nobel laureate argued the world should learn from Tokyo's "breaking ranks" with the "dismal orthodoxy" of growth-killing austerity.

Krugman's advice hasn't changed. Even as Japan's economy struggles to shake off an April sales-tax increase, lawmakers are mulling another. In a meeting with Prime Minister Shinzo Abe last week, Krugman warned the move could be the death-knell of "Abenomics," no matter how many yen the Bank of Japan prints. And he's absolutely right. Raising taxes on households again would further crimp spending and doom any chance of reaching the 2 percent inflation target the government has set for itself.

Fortunately, Abe seems to recognize this. While the prime minister continues to say that he won't decide one way or another until he sees the most recent quarterly growth figures (due on Monday), Tokyo insiders are predicting he'll call a snap election next month to win a mandate to scrap the tax, currently scheduled for October 2015. 

There are two problems with this. First, Abe continues to face strong resistance from "austerians" within his own Liberal Democratic Party, who fear that markets will lose trust in Japan if it doesn't get its ballooning debt -- now up to 250 percent of gross domestic product -- under control. They warn that a delay in hiking the tax will cause bond yields to spike -- as if courting recession with another ill-timed tax hike will win Japan points with punters.

A successful election might help Abe tame these rebels. The bigger problem is that, as Japanese leaders obsess about tax tweaks and a possible campaign, they're not focused on the structural reforms needed to make Abenomics work. Last month, BOJ Governor Haruhiko Kuroda expanded his already extensive quantitative-easing experiment, boosting bond purchases to about $700 billion annually and buying riskier assets. Kurodanomics isn't enough, though. Plans to loosen labor markets, cut trade tariffs, improve corporate governance and champion new job-creating sectors like casinos remain in their infancy. Now they're off the table until early 2015, at best.

Abe's faltering approval ratings make matters worse. They took a measurable hit after a 3 percentage-point rise in the consumption tax to 8 percent in April. With real wages down 2.9 percent in September -- the 15th consecutive year-on-year decline -- and the yen plunging, Japanese consumers are clearly feeling pain. Support for Abe's cabinet is now 44 percent versus 52 percent a month ago, according to public broadcaster NHK. You can bet the farm lobby, a core constituency of Abe's LDP, will use this dynamic to extract concessions that run counter to the prime minister's reform goals. An election campaign will no doubt generate promises of new white-elephant projects. 

This whole tax issue is policy kabuki. Yes, Japan needs to tame its debt problem. Yet offsetting the fallout from higher taxes has already forced Abe's government to increase borrowing to support regional economies. And even if next year's tax hike goes ahead, a considerable share of any new revenues is already earmarked for Olympics 2020 construction.

Perhaps, as BOJ adviser Masahiro Kawai told Bloomberg's Toru Fujioka: "By postponing the tax hike, Abe would lose fiscal trust, raise risk premiums and make the BOJ’s job much harder." The bigger risk is that a further slowdown in growth will derail the kind of long-term structural changes Abe has pledged and Japan desperately needs. No doubt the prime minister appreciated Krugman's support last year. Abe should take the laureate's advice now.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Willie Pesek at wpesek@bloomberg.net

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net