By Willem Verhagen
Over the past few weeks the Abe government announced further details on the third arrow of Abenomics (structural reform). Let us go through three of the main items:
1. Corporate governance is relatively weak in Japan, an important reason behind the productivity shortfall. It is vital, therefore, that Japanese managers are incentivised to increase the return on equity (ROE). Several initiatives have already been taken. The newly created JPX Nikkei 400 index is expected to become the most important benchmark for Japanese equities for large institutional investors. The criterion for being included in this index focuses on ROE. The Government Pension Investment Fund (GPIF) reform is also important because it involves a substantial increase in the strategic weighting of Japanese equities. As a result, the GPIF is expected to increase the pressure on Japanese listed firms to raise ROE. And the Tokyo Stock Exchange will publish a Corporate Governance Code which will require firms to publicly explain reasons for not complying with it.
2. The corporate tax rate will be brought below 30% within a few years. From an international perspective Japan has a relatively high rate and the aim of this policy is raise competitiveness in global markets, encourage inward FDI and raise economic growth. It is unclear how this tax cut will be financed but this will probably involve a broadening of the tax base which means that small companies which do not pay any tax now will have to pay tax in the future. Our enthusiasm about this measure is limited. In fact, in view of the high share of retained earnings, we would have preferred a tax increase financed by a tax cut on dividends.
3. Another area of significance when discussing productivity is the heavily regulated labour market. The principle is relatively simple: the key is to encourage bigger gross flows between the pool of employed and unemployed persons to gear the labour market more towards an environment characterised by every changing technology and tastes. However, as long as aggregate demand is robust, this can go hand in hand with a net flow from unemployment towards employment. Here the progress remains rather incremental. Key developments are that highly paid workers will now have their salaries based on performance rather than hours worked and an objective system for dealing with layoffs will be established. The conclusion is that much more work need to be done in this area.
All in all, the measures announced are a step in the right direction and surpass initial market expectations. The Abe government certainly shows a willingness to tackle difficult reform areas and, so far, has been able to monster the political support to push them through – the government took further steps towards liberalising the agricultural sector, for instance, which has a very powerful lobby. As a result, we believe this is not the end of the third arrow but rather that the government will try and increase its range further in the future.
Willem Verhagen is senior economist at ING Investment Management
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