It was worth a shot.

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Abenomics Won't Work. And That's OK.

Chen Zhao is co-director of macro research at Brandywine Global Investment Management and the former chief global strategist and managing editor at BCA Research Group.
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Japanese Prime Minister Shinzo Abe recently announced plans for yet another round of aggressive economic stimulus. But it's doubtful that this new initiative will make much difference. The problem is that the policy objectives of so-called Abenomics are ill-conceived to begin with -- and given demographic reality, they'll never work.

The stated goal of Abenomics -- an ambitious combination of fiscal stimulus, monetary easing and structural reforms -- is to end chronic deflation and revive Japan's stagnant growth. Judging by these two objectives, the program has clearly failed. Growth in real gross domestic product has hovered between 0 percent and 0.5 percent since 2009. So far this year, it's back to 0 percent. There was a brief surge in inflation on the back of a falling yen in 2014, but with the currency having rebounded, prices have resumed falling.

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That's because Japan's "economic problems" are almost entirely rooted in its demographics. Its labor force has shrunk 0.17 percent a year since 2000. Last year, its population declined for the first time in almost a century, with significantly more Japanese dying than being born. More than a quarter of its citizens are over age 65.

It's entirely possible that near-zero growth is the natural state for a mature economy in such circumstances. In other words, there's nothing wrong with Japan: Increasing productivity growth, as reflected by rising per-capita GDP, means that the standard of living for most Japanese continues to improve, even as the economy has almost stopped growing because there are fewer people producing goods and services each year.

How about mild deflation? Isn't that a worrisome ailment? Not really. In fact, modestly declining prices could also be natural for an economy with rising productivity but a shrinking labor force. On one hand, a shrinking population tends to shrink demand. On the other, sustained productivity growth means an ever-increasing aggregate supply. In combination, these factors imply that aggregate demand has become chronically deficient. The general price level falls as a result.

When you accept these premises, the conceptual flaws in Abenomics become obvious. The underlying growth rate for Japan's economy can only be increased if there's a significant technological shock driving up productivity, or if policy makers are willing to accept immigration on a large scale to reverse the shrinking labor force. Since Abenomics can't influence technology, and doesn't address immigration policy, it will continue to fail, no matter how hard the government tries.

The result is that Japan's economy, known as "the rising sun" when it dominated the world some three decades ago, will keep shrinking in relative size. And Japan will return to its rightful place as a prosperous island with high accumulative wealth and an affluent population, but with little impact on the world economy.

With his Liberal Democratic Party having won two-thirds of the seats in Japan's legislature, Abe is likely to get his way on more forceful fiscal policy. Although fiscal stimulus will probably be more effective than monetary policy in generating aggregate demand, such an effort must be sustained: The lack of demand in Japan is chronic, and a one-off fiscal stimulus won't jolt its economy into a lasting expansion. In the meantime, the Bank of Japan must be ready to take additional easing action to prevent any additional rise in the yen.

With Japan's budget already severely constrained by accumulated deficits and debt, there's no chance that the government will sustain fiscal stimulus on the necessary scale. And it's unlikely that the Bank of Japan will augment its bond-buying efforts. We can be almost certain, in short, that the second round of Abenomics is dead before arrival.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Chen Zhao at chen.zhao@brandywineglobal.com

To contact the editor responsible for this story:
Timothy Lavin at tlavin1@bloomberg.net