Japanese prime minister Shinzo Abe has officially let fly his much-anticipated “third arrow,” announcing on Monday a series of economic reforms that included, among other things, a corporate tax cut.
His first two arrows were, of course, a loosening of monetary policy that included a massive quantitative easing program and a fiscal stimulus package.
Those arrows — particularly the quantitative easing program — were wildly successful in pushing down the value of the yen and in reviving the animal spirits in Japanese stocks. But their effects on the real economy were mixed at best, and I would argue that over the long term will make not one iota of difference.
Japan will never get its economic mojo back. Its aging and shrinking demographics all but guarantee that Japan will eventually slide into oblivion.
Will the ‘Third Arrow’ of Economic Reforms Do the Trick?
As for the third arrow, I expect its effects even in the short term to be virtually nil.
At 35.6%, Japan has the second-highest corporate tax rate in the world after the U.S., which tops out at about 40% after allowing for state and local levies. Yes, not even the notoriously high-taxing French (33%) extort as much money from their companies.
Details have not been released, but early estimates suggest that Japan’s corporate tax rate could fall to as low as 20%.
So, given the high current tax burden faced by Japanese companies, a reduction in the tax rate should mean an investment boom in Japan, right?
All else equal, yes. But alas, all else is not equal.
As Capital Economics notes, return on investment in Japan is low by global standards due to existing overcapacity and, in any event, Japan already has some of the highest levels of capital spending in the G7. While a lower tax bill might boost corporate profits and give Japanese equities a jolt, it’s hard to see this unleashing a Reagan or Thatcher-style economic transformation.
I touched on Japan’s problems in my last issue of Macro Trend Investor. Remember, Japan is the oldest country in the world with a quarter of its population already over the age of 65. Japan’s population peaked seven years ago at 128 million and hasn’t stopped shrinking since — Japan has about a million fewer citizens every year. By 2060, the Japanese government estimates that Japan’s population will have shrunk to 87 million people, and as much as 40% will be older than 65.
In a modern consumer economy, an aging and shrinking population is devastating to growth. Fewer people mean fewer consumers — and less spending, unless you believe that a smaller consumer base will somehow buy more goods and services per capita. That could only happen if real income per capita outpaced population decline, which is a scenario that is hard to envision. Rising income would only come with rising production per capita … which, again, only makes sense in a stable or growing population.
Likewise, older consumers buy much less than those in middle age (certain items like healthcare notwithstanding). So again, an aging and shrinking population means less spending and slower economic growth.
This is why Japan’s recessionary conditions are not cyclical but structural.
Think about it: Why would builders build new homes if there are fewer people to live in them? Why would companies invest in new capacity if there are fewer consumers to sell to?
Hey, I’m a believer in small government, and I’m generally very favorable towards tax cuts. I see nothing wrong with Abe’s decision to lower taxes in a bid to make Japan more competitive.
But let’s get realistic. It’s not going to be a game-changer.
The third arrow will also have policies aimed at getting Japan’s women back to work. Details are yet to be released, but again, it’s hard to see this having a big impact. Unless Japan can somehow convince its women to have large, four- to five-children families and institute economic policies that would somehow make that affordable in modern Japan (never mind changing social attitudes keeping women at home that have endured for centuries), it’s hard to see any of this mattering much.
If you want to play the inevitable failure of Abenomics and Japanese stocks, look for opportunities to short the rallies using an inverse ETF or fund such as the ProShares UltraShort MSCI Japan (EWV). Or for a safer bet, you can short the yen via the ProShares UltraShort Yen ETF (YCS).
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.