Archive for IB Economics

Will ‘Abenomics’ Save the Japanese Economy?

Abenomics

アベノミクス: Abenomics in Japanese

PDF File: “Will ‘Abenomics’ Save the Japanese Economy?” by Kim Sang Keun

I. Introduction

Ever since Shinzo Abe came to power, the Japanese government led by LDP has vowed to revive the stagnant economy by implementing bold economic policies. In effort to overcome so-called ‘Lost Decades,’ which has deteriorated the ego of many Japanese people, Abe has announced three simple economic policies that earned the name ‘Abenomics’ after its proposer. This includes indefinite quantitative easing, flexible public finance policy and economic growth strategy.[8] In this paper, we will look at the economic logic behind the Abenomics and problems and risks associated with it.

II. Economic Logic Behind Abenomics

Through Abenomics, the Japanese government hopes to revive its economy by implementing bold, powerful economic policies that will pull its economy out of deflation, depreciate Japanese yen, and induce CPI inflation rate of 2% per year. The Japanese government saw the constant decline of overall price level by lack of aggregate demand as the main culprit of the long-term recession that its country was going through.[3] In order to ‘reflate’ its economy, Abenomics tries to implement quantitative easing, fiscal policy through expanding government spending, and provide economic growth strategy. We will first look at the quantitative easing and its economic theory behind what the Abenomics is trying to achieve.

For analyzing the economic theory of Abenomics, the Mundell-Fleming Model for a large open economy was used in this paper as the main model. The following are the IS-LM equations for the model:

IS: Y = C(Y-T) + I(r) + G + NX(e)

LM: M/P = L(r,Y)

Notice that the assumption of r = r* was dropped, which is an equation for a small economy that cannot influence the world interest rate. As Japan is the third largest economy in the world, the assumption that it has little influence on the world financial market had to be dropped. Therefore, the interest rate was treated as an endogenous variable. As a result, LM curve got a positive slope, instead of being vertical.

2

3

First of all, the Bank of Japan is targeting a 2% CPI inflation rate and increasing the money supply circulating in the economy by buying various financial assets such as the government bond, which is essentially monetary expansion policy.[3] It could be said that this indefinite quantitative easing is the core of Abenomics. On the graph above, the increase in the money supply shifts the LM curve to the right, raising the income from Y1 to Y2, and lowering the real interest rate from r1 to r2. The decrease in the real interest rate then increases the net capital outflow as is illustrated on the second graph.

4

As the net capital outflow increases from CF1 to CF2, the supply of Japanese yen in the market for foreign exchange increases. The exchange rate falls from e1 to e2, depreciating the Japanese yen. This makes the Japanese goods relatively cheaper to foreign goods and the net export rises from NX1 to NX2. There are two channels for this mechanism. First, as the monetary expansion lowers the interest rate, this stimulates the investment. Second, as the monetary policy causes the currency to depreciate in the market for foreign exchange, this stimulates net exports.

5

All in all, the Abenomics tries to devaluate its allegedly over-appreciated yen and cause an inflation rate of 2% as the output increases. As a result, the Japanese yen has depreciated until the 103.42 (JPY/USD) recently on May 22nd. This is the lowest in almost 6 years, ever since the Global Financial Crisis that hit the economy around the world in 2007. This is shown in the exchange rate graph above.

6

7

Secondly, the Japanese government is trying to initiate fiscal policy by expanding government expenditures. As the government implements fiscal expansionary policies the IS curve shifts to the right. As the graph above illustrates, this shift in the IS curve leads to an increase in the level of income from Y1 to Y2 and an increase in the interest rate from r1 to r2. The increase in the real interest rate reduces the net capital outflow from CF1 to CF2.

8

As the net capital flow falls, the supply of Japanese yen in the market for foreign exchange falls. This induces the exchange rate to appreciate from e1 to e2, which decreases the net export from NX1 to NX2 as the Japanese goods become more expensive relative to foreign goods.

As the graph illustrates, the fiscal expansion by Abenomics will raise the income and output for the Japanese economy. However, it is to be pointed out that although implementing both the fiscal and monetary expansionary policies will increase the output of the Japanese economy, the effect on the exchange rate is conflicting. Yet, this problem is accounted for as the Japanese government will set its ‘desirable’ exchange rate, possibly above 100 JPY/USD, and fix it so that other variables can freely adjust, although it might compromise some of the output to some degree. Or if the Japanese government considers the increase in the economic output, and therefore the inflation rate, more important over the exchange rate, it might decide to compromise fixating the exchange rate to their ‘desired’ level for the economic growth.

Thirdly, on June 5th, the Japanese government announced the third policy for Abenomics, which includes economic growth strategy. The government announced plans for bringing up the financial integrity of Japan, however, there were no significant policies that were announced.

III. Problems and Risks Associated with Abenomics

9

10

There is a rising skepticism towards whether Abenomics would really revitalize the Japanese economy as the exchange rate appreciated breaking the 100 JPY/USD boundary and as Nikkei Index crashed. Although, theoretically, Abenomics has a sound Keynesian background, many are pointing out the fact that it is too focused on the demand side of its economy, not on the supply side.

13

Japanese Demography Data[11]

One of the fundamental problems that Japan is facing is its ageing population. As the population pyramid gets inverted, the labor population is shrinking every year. This brings about number of problems for the Japanese economy. First, the government commitment in spending on pensions, medical expenses and social security will continually act as a substantial burden to the already indebted country with a public debt of 240% its GDP.[11] This will further worsen the financial integrity of the Japanese government leading to an erosion of international confidence in Japanese economy. The lack of confidence can raise the risk premium (CDS) shifting the IS* curve to the left and LM* curve to the right, as θ increases for r = r* + θ. But, the exchange rate would depreciate more than what is desired by the Japanese economy, and it would force the Bank of Japan to decrease the money supply in order to bring up the yen value, shifting the LM* curve back to the left. This would aggravate the situation and lower the total income in the Japanese economy. This then would induce the interest rates to depress the prices of financial assets, which will then reduce the collateral being used as bank loans. As a result, this will lead to financial problems for Japan, further exacerbating the problems. Secondly, its dwindling workforce cannot sustain the economic output level that is maintained in the future.[11] As it is shown on the data, the demography will drastically change so that more young people will have to support for the older population, which implies that this change in demography is the main culprit for the last two decades of deflation and stagnant economic growth.[11] This has another implication to why the consumer demand might be falling behind.

In this sense, it could be said that Abenomics is failing to address the core problem of its economy. It must ask why consumer demand is inherently weak. Another major reason why the Japanese economy is stagnating is the poor productivity. This may sound strange to many people as Japan was once praised as technologically advanced country. However, according to the statistic, Japanese productivity lags badly behind world’s leading countries in many areas. For example, it lags 30% behind the U.S. in manufacturing with automobiles industry in exception.[9] Therefore, corporate reforms are needed in order to let inefficient firms downsize or die and be replaced to better ones.[9] In the case of Korea, as it suffered trough the so-called IMF Crisis in 1997, it underwent painstaking corporate reforms to let the inefficient firms die and raise the overall competitiveness of its economy. So it is doing relatively fine in terms of corporate competitiveness and financial integrity compared to Japan, although this is shaking a little due to Abenomics.

What is problematic right now is that the third policy for Abenomics lacks fundamental and specific content, which started to give erode out public confidence in Abenomics. As it was mentioned, this resulted in the crash of Nikkei Index and the re-appreciation of Japanese yen, breaking the 100 JPY/USD boundary. Shinzo Abe, afraid of losing the votes, has put aside the painstaking reforms to later, such as corporate tax cuts that will improve the productivity of Japanese firms. There was a discussion within the Japanese government in cutting the corporate taxes from 30% to 20% and to implement new policies that will make the labor market flexible.[5] However, flexible labor policy means temporary job losses[11], and it seems that Shinzo Abe is putting these essential reforms after the Japanese upper house elections. This could erode out confidence in Abenomics losing its force towards reviving the economy.

There is another risk associated with Abenomics. As the yen depreciates, net export increases as domestic products gets cheaper abroad, however, imports get more expensive. This is a big problem for Japan as ever since the Fukushima nuclear disaster, the word ‘energy crisis’ was lingering around the Japanese newspapers for two years. As Japanese public refused to use nuclear power, the Japanese government had to turn to more expensive imported energy, such as LPG, oil and naphtha, increasing the monthly value of Japanese energy imports from 1.4 trillion yen to 2.2 trillion yen.[12] This could deteriorate the competitiveness of Japanese companies, as energy prices go up. In addition, export accounts for only about 14% of its economy.[1] So the core of Abenomics should be in order to revive the domestic economy, not through export. The increase in energy prices could raise the domestic consumer prices without actually improving the income of the Japanese firms and consumers. Therefore, there is a risk towards Abenomics in that expensive energy imports will drag the Japanese economy into another lost decade.

IV. Conclusion

In conclusion, Abenomics is a sound Keynesian policy that could save the Japanese economy from deflation. The Mundell-Fleming Model was used to illustrate the economic theory behind Abenomics. However, there were considerable risks associated with Abenomics, such as the ageing population, poor productivity and the energy crisis. The key to success for Abenomics would be dependent on whether the Japanese government effectively manages these risks and confronts the fundamental reforms that would improve the supply side of its economy.

Reference

1. 박영철, 아베노믹스 실패 가능성 높다, <주간조선>, 2013.03.18, http://weekly.chosun.com/client/news/viw.asp?nNewsNumb=002248100014&ctcd=C05

2. 박형준, 日 환율-주가-금리 3각 부메랑… 아베노믹스 두달만에 휘청, <동아일보>, 2013.06.05, http://news.donga.com/3/all/20130605/55643597/1

3. 이형근, 아베노믹스, 디플레이션 탈출과 엔고 시정 추진, 2013년, 평화문제연구소, 통일한국 제352호, pg34-35, http://www.dbpia.co.kr/Article/3129836

4. 정성춘, 이형근, 서영경, 일본 아베노믹스의 추진 현황과 정책 시사점, 2013년, 대외경제정책연구원, 오늘의 세계경제, Vol. 13, No. 5

5. 차학봉, 아베노믹스 세 번째 화살 ‘不發’, <조선일보>, 2013.06.06, http://news.chosun.com/site/data/html_dir/2013/06/06/2013060600263.html

6. 한영기, 아베노믹스의 효과 및 과제, 2013년, 한국은행 동경사무소

7. 한창만, 아베노믹스 ‘거꾸로 효과’, <한국일보>, 2013.02.20, http://news.hankooki.com/ArticleView/ArticleView.php?url=world/201302/h2013022021083122510.htm&ver=v002

8. Adams, W. J. (2013). Japan: Assessing the Future of Abenomics, The Boston Company, http://www.thebostoncompany.com/assets/pdf/views-insights/April13_Views_Insights_Future_of_Abenomics.pdf

9. Katz, R. (2013). Abenomics Is Bad Medicine, The Wall Street Journal, http://online.wsj.com/article/SB10001424127887324590904578287472450294546.html

10. Mankiw, N. G. (2013). Macroeconomics Eighth Edition, Macmillian

11. McNerney, G. J. (2013). Will ‘Abenomics’ Ensure Japan’s Revival?, Thomas White International, http://www.thomaswhite.com/pdf/Will-Abenomics-Ensure-Japans-Revival.pdf

12. Schaede, U. (2013). Abenomics cannot succeed without cheap nuclear power, The Japan Times, http://www.japantimes.co.jp/opinion/2013/06/05/commentary/abenomics-cannot-succeed-without-cheap-nuclear-power/#.UbFlP-uPJBy

Data

13. St. Louis Economic Research: http://research.stlouisfed.org/fred2/graph/?id=DEXJPUS

14. Naver금융: http://info.finance.naver.com/marketindex/worldExchangeDetail.nhn?marketindexCd=FX_USDJPY

15. Naver금융: http://finance.naver.com/world/sise.nhn?symbol=NII@NI225#

Advertisements

Leave a comment »

Is Abenomics Coming to a Halt?

Abenomics

Abe Shinzo, the Japanese Prime Minister, advocates yen devaluation

Wall Street Journal: Abenomics Will Be Felt Beyond Yen

Hankook Ilbo(Korean): 아베노믹스 ‘거꾸로 효과'(Abenomics ‘Reverse Effect’)

Abe Shinzo had explicitly announced that he would artificially devalue yen in the hope that this will help its export-dependent economy. His idea was that devaluation of yen against other currencies, especially USD, would improve price competitiveness of Japanese products overseas. This announcement was quickly criticized by many nations dependent on export such as Korea and Germany.

The Japanese government said that it would pump ‘infinite’ amount of money supply in the economy until it reaches its target inflation rate of 2%, thus achieving the devaluation of yen. Wall Street Journal expected that the inflation rate would make it less attractive for Japanese households to save and invest their money else where or simply use them to go on shopping. “Deutsche Bank said in a note Wednesday, spurring a “meaningful reallocation” of these deposits into offshore assets.” Therefore, Abe’s policy should have helped to vitalize the consumer sector of Japanese economy and at the same time increase its export to foreign countries.

However, Hankook Ilbo, a Korean newspaper, has published an article that Abe’s devaluation of yen is actually having a reverse effect on Japanese economy. According to the report published by Japanese Ministry of Finance in February 20th, 2013, exports decreased 9.4% compared to the previous month, while imports increased 8.2%. This resulted in 1.63 trillion yen deficit.

The newspaper analyzed that the main reason for this deficit is the rising prices for the energy imports due to the yen devaluation. The nation has been importing more of energy supplies such as LNG, oil, and naphtha, as it tried to diversify energy usage and reduce nuclear power following the Fukushima Nuclear Accident. According to Hankook Ilbo, “If Japanese firms fail to significantly recover from this deficit, Abenomics will be hit hard.”

In addition, many Japanese firms are showing their reluctance in raising wages for workers, which is very important for Abenomics to work in order to revive the real economy. They believe that devaluation alone will not simply rejuvenate the economy. Many Japanese companies have been outsourcing their factories overseas and it would be very hard to retrieve all those back to Japan in very short period.

Of course, it has only been several months, so it will be hard to tell whether Abe’s yen devaluation is doing well for the Japanese economy. But, I think that, from reading these articles, it would be better off for a Japanese economy to appreciate yen due to significant the increase in the energy import. The devaluation certainly is doing no good for Japanese economy and disturbing other export-driven economies such as Korea, Germany and etc.

Leave a comment »

Patent Lawsuit: Apple, Samsung and the Prisoner’s Dilemma

Apple vs. Samsung in a Patent War

CNET News 1: “Apple vs. Samsung: 50 suits, 10 countries – and counting”

CNET News 2: “Samsung, Apple CEOs meet without coming to agreement?”

Meritz Investment Bank (Korean): PDF File

A hostile patent litigation between Apple and Samsung started ever since Apple accused Samsung of copying its designs for smartphones and tablet PCs. In response, Samsung dodged back with patent lawsuits concerning the mobile technology. According to CNET News, this litigation chaos augmented into 50 lawsuits against each other in 10 different countries. Apple became wary of Samsung’s ever-increasing market share of the smartphones and tablet PCs.

A smartphone or a tablet PC market can be said to be an oligopoly. There is only a handful of firms offering the product: Apple, Samsung, HTC, Sony, and so on. It is definitely different from a PC components market where there are lots of firms providing the identical product.

As Samsung’s market power is increasing in both the smartphone and the tablet PC market, Apple has opened a Pandora’s Box by filing a lawsuit against Samsung, as it was mentioned above. This has triggered the problem of Prisoner’s Dilemma, of which the ‘players’ in a ‘game’ are forced to choose the option that makes both of them worse off. In this case, the ‘players’ are Apple and Samsung, and the ‘game’ they are playing is the chicken game of patent litigations.

Table based on Game Theory: Prisoner’s Dilemma

This table illustrates the situation that Apple and Samsung is facing. According to the table, whatever the opponent chooses to do, the best option for a player is to file a lawsuit against the opponent. For example, for Samsung, it is the best option for it to file a lawsuit against Apple because the best-case scenario is that it will possibly kick Apple out of the market. The worst-case scenario is that both Samsung and Apple will possibly be kicked out of the market. However, this case is better than Samsung being kicked out of the market while Apple stays in the market with the market gain, in the point of view of Samsung. The reason behind choosing to file a lawsuit is the same for Apple.

As a result, they reach a Nash equilibrium, in which both of them file a lawsuit against each other, making them worse off. The patent lawsuit can be seen as a deadweight loss that is ‘wasted’ in a litigious process. Some people argue that the only people gaining from this situation are the lawyers. Consumers are the ultimate victims of this patent war because the ligation burdens are passed through higher prices for the products Apple and Samsung produce.

However, it should be noted that this ‘game’ of patent lawsuits is repeated numerously, 50 lawsuits as it was mentioned. Meritz Investment Bank’s analyst Lee Secheol anticipated in April that Apple and Samsung would stop and reconcile with each other as the ‘game’ is repeated. He anticipated that both firms would realize that this situation is making them worse off and that they would sit down at the negotiating table.

According to CNET News, CEOs of Apple and Samsung did have a meeting. However, they have never came up with an agreement. The fact that they had a meeting to reconcile showed that both of them realized they were in a situation of prisoner’s dilemma. However, their disagreement over withdrawing from a patent war also showed that this issue has become somewhat emotional, which makes it beyond the problem of prisoner’s dilemma.

Consumers should realize that this is not only doing harm to both the companies but also doing harm to themselves. This patent war will inevitably lead to an increase in the prices of products that Apple and Samsung produce and will significantly limit the number of choices that consumers can make if one of them are kicked out of the market as a result of a lawsuit. Also, the products they purchase may be limited in functions or features due to the patent constraints.

Leave a comment »

California’s Tradable Permit on Oil Refineries

Californian Government Implements Tradable Permit on Oil Production

The Reporter: News Article

According to The Reporter, California decided to implement the tradable permit policy for the production of oil, which is responsible for the global warming. The government has budget deficit of “$9 billion” and it hopes to gain “$14 billion” by 2015, profiting from auctioning tradable permits to the oil companies.

The main reason for implementing tradable permit policy is that there is a negative externality associated with the production of oil. The social cost exceeds the private cost and this makes the society to take care of the environmental cost. In order to internalize the cost of pollution of the oil production and move the quantity supplied from Q market to Q optimum, the Californian government introduced tradable permit.

The government or EPA sets the amount of pollution allowed and auctions the pollution rights (tradable permits) to the oil companies. If the amount of tradable permit is appropriately chosen, it effectively moves the quantity supplied to Q optimum both eliminating the negative externality and increasing the government profit. The government would profit P times Q optimum amount of money.

However, some critics argue that the increase in the price of oil will increase the overall price of consumer goods. The cost of production will increase for virtually all the consumer goods that are produced from oil-running factories. Also, the means of transporting goods from city to city will be more expensive. All this will contribute in increasing the price of consumer goods. The economic size (or social welfare) would decrease also.

The overall increase in the price of oil and the price of consumer goods will lead to the decrease in the consumer spending overall. United States, especially California, is a place where the public transportation is not as advanced and popularly used as Korea. People usually drive their cars to go to work and go shopping. The increase in the price of oil will act as a disincentive for the people to go out on shopping. This will shift the demand curve from Demand 1 to Demand 2 decreasing the price of consumer goods from P2 to P1 and decreasing the quantity demanded from Q1 to Q2. Again, the economic size (or social welfare) will decrease. Some argue that the tax revenue form the taxes such as VAT will decrease countering the benefits by profits from implementing tradable permits.

In conclusion, the tradable permit will increase the profit of Californian government and at the same time cut down the level of pollution contributing to the global warming. However, the government should be fully aware of the complicated consequence or unintended effects of implementing any sort of policy distorting the market will have.

Leave a comment »

List of Definitions for Section 2

1. Market is a place where the consumers and the suppliers meet together. Here, the resources are allocated through the price mechanism. The price and the quantity demanded are determined by the equilibrium price. However, a market does not need to be a physical place where people meet face-to-face. Online shopping is one example of how the market is formed without requiring the consumers and the suppliers to meet face-to-face.

2. Structure of Market in the spectrum of competition

  • Perfect Competition occurs where there are many competitors who produce the same product and the market sets the price.
  • Monopoly occurs when there is only one supplier for the market. These monopolists set the price and profits very highly. They may set as many barriers as they can to stop other possible competitors from entering the market they are in control of.
  • Monopolistic Competition occurs when the market has both the characteristics of perfect competition and monopoly.
  • Oligopoly occurs when there are just few competitors in the market. However, they have interdependence to each other. Also, they may spend a lot of money on advertisement and promotion.

Summary of market types

Type of Market

Number of Firms

Freedom of Entry

Nature of Product

Examples

Demand Curve for Firms

Perfect competition

Many

Unrestricted

Homogenous

(undifferentiated)

Cabbages

Carrots

Horizontal

the firm is a price-taker

Monopolistic competition

Many, Several

Unrestricted

Differentiated

Plumbers

Restaurants

Downward sloping, relatively elastic, some control over price

Oligopoly

Few

Restricted

Undifferentiated or Differentiated

Cement

Cars

Kinked

Monopoly

One

Restricted or Completely blocked

Unique

Local water companies

Downward sloping, inelastic, considerable control over pric

Table Obtained from Triple A Text

3. Demand is defined as ‘that quantity of a good or service that would be bought at each and every price over a period of time’. Must include these three factors:

  • The desire for a product
  • A willingness to pay for it
  • The ability to pay for it

4. Supply is defined as the quantity of goods and services that will be supplied to the market at various prices over a given period of time. These are some of the determinants of supply:

Leave a comment »

Aids for Developing Nations

Map of Africa

Aids for developing countries could be beneficial for their economic growth. What the many of the developing nations have problem in common is the lack of security. If a nation’s security is bad, it is highly unlikely that people will work hard to achieve high economic development. One way the developed countries could help these countries is through stabilizing security either by sending police or UN peacekeeping forces. The major reasons why people become rebels is that the price of the necessities are very high and they have no work. By providing the necessities at low price, they could solve the major part of the security and the economy of the developing countries.

As soon as the security issue is resolved, the developed countries could send aids to the developing nations if the leadership of their country is reliable. If the large sums of money is squandered in the official’s ‘personal uses,’ then the likelihood that the nation will experience the economic growth is very slim. The developed nation must guide the developing nations to spend the financial aids to build on to the capital goods. In the short run, this will result in the increase in the imports and therefore the increase of expenditure, however, this will increase the productivity of the developing nation and increase the exports in the long run.

Leave a comment »

Zimbabwe – Developmental Economics

Today, we have discussed about Zimbabwe’s economic situation and what were the barriers to Zimbabwe’s economic growth. There was many opinions about why Zimbabwe was still in suffering from economic difficulty.

One of the many barriers to Zimbabwe’s economic growth was its very high inflation of about 100,000 percent for its currency. It would require you millions of Zimbabwean dollars to just buy a pack of toilet paper. Also, it would require you to carry briefcase or even carts to buy rice and necessities for everyday life. One of the jokes that was mentioned in the class was that if a person rode a bus, the bus fee would increase even during when the person is riding the bus. This is how serious the Zimbabwe’s inflation is. So, inflation is one of the major reason why Zimbabweans are suffering from economic downturn.

I was surprised at how high the literacy rate in Zimbabwe was. In fact, it is about 90% for the whole population. It is quite surprising the fact they have very high literacy rate despite the economic situation. Generally, countries have low literacy rate if they have a bad economic situation.

Despite the high human capital, Zimbabwe’s economy is no better than those of other nations in Africa. Another major reason discussed in the seminar was that the corrupt leadership in Zimbabwe was hindering economic progress in Zimbabwe. Nugabe is a founding leader of Zimbabwe. He was one of the beloved leaders for liberating the Zimbabwean people from the white minorities. However, as years passed by, Nugabe got obsessed in maintaining political power. This has cost the economic situation in Zimbabwe, which has great potential to strive because of its high human capital and enriched resources. Also, he has oppressed the media, which has resulted in the vacancy of criticism against the regime.

In conclusion, Zimbabwe’s major barriers to economic growth were hyperinflation and political oppression. If Zimbabwe got rid of these barriers, it is highly likely that Zimbabwe will strive with its high human resources and its natural resources.

Comments (2) »