If history is a reliable guide, the Japanese economy will wilt when the country raises its sales tax on April 1. When Japan last increased the levy in 1997, consumer spending collapsed. But the three-pronged defence Prime Minister Shinzo Abe is putting in place makes a repeat doubtful.
Lifting the consumption tax from 5 to 8 percent could remove 6 trillion yen ($58 billion) from the economy, according to Morgan Stanley economist Robert Feldman. That’s equivalent to 1.2 percent of GDP. However, a supplementary budget and corporate tax rebates will return the entire amount to consumers and producers this year. That’s the first line of defence. A government panel is also expected to recommend a permanent reduction in the nation’s 36 percent corporate tax rate.
The second line of defence is sketchier, but the outlines are starting to form. On March 28, Abe identified special zones where regulation on land, labour and product markets will be made friendlier for business. It will be a couple of years before the extent of deregulation is known. In the interim, the prime minister will rely on the stock market, which pooh-poohed his growth strategy last summer, to give him the benefit of the doubt. A revival in slumping Japanese equities is crucial to keeping consumers and companies optimistic.
Should the second-quarter economic data show a deepening of consumer and investor pessimism, Japan will need to activate its third line of defence: the central bank. If the Bank of Japan’s 2 percent inflation goal retreats farther into the future, it will be compelled to expand its already-large asset purchase programme.
It will be a delicious irony if the central bank most ridiculed in the past for not doing enough to beat deflation demonstrates a greater resolve than its American or European counterparts. If investment and wage growth is revived, Abe would be able to raise the sales tax again next year to 10 percent as planned, showing his commitment to fiscal consolidation. In the meantime, the country’s defence mechanisms mean Japan is unlikely to suffer a repeat of its painful economic history.