While the effects of the 'three arrows' of the Japanese Abenomics policy mix – bold monetary easing, flexible fiscal policy, and the growth strategy –have attracted worldwide attention, reduced policy uncertainty is also expected to contribute to the country’s economic growth by stimulating long-term investments in the private sector.
Political stability and economic growth
When the two chambers of the parliament are controlled by different parties, or when the opposition controls the legislature under the presidential system, decision making on important policies is bound to be stalled or postponed. The recent 'fiscal cliff' in the US is a well-known example. In Europe, the government changes in the Eurozone countries increased uncertainty over the fiscal policy, resulting in the instability of the euro. In Japan, political power was transferred from the Liberal Democratic Party (LDP) to the Democratic Party of Japan (DPJ) four years ago, but the LDP regained control through the general election in December 2012. However, the Diet had been in a flux until this summer. During these government changes, certain economic policies, such as those related to tax, social security, and the labour market, have fluctuated.
A series of empirical studies have shown that political instability and frequent changes in governments have a negative impact on the national economy (Aisen and Veiga 2013). According to these studies, the economic impact of political stability is quantitatively massive, far exceeding those of major growth policies, such as trade liberalisation and corporate income tax cuts. Thus, there is a good possibility that the outcome of the House of Councilors election this past summer, where the ruling coalition parties won the majority of seats, will serve as a significant driver of Japan’s economic growth.
Many hurdles remain, however, and the Japanese government is faced with difficult policy decisions on a range of issues in which there are conflicts of interest among the Japanese people. In particular, it must:
- Lay out a clear path toward fiscal sustainability;
- Reform the social security system; and
- Negotiate the Trans-Pacific Partnership (TPP) and other economic partnership agreements (EPAs).
Whether or not the end to the divided Diet dispels the uncertainty over the future course of economic policies is a key determinant of the success or failure of the government’s efforts to motivate companies to take positive actions.
Negative influence of policy uncertainty
Various research attempts have been made to examine the economic impact of uncertainty (Bloom 2009, Carrière-Swallow and Céspedes 2013). In particular, it has been found that policy uncertainty has a substantial negative impact on the real economy, such as the GDP, equipment investment, and employment (Baker et al. 2013).
Uncertainty about future economic policies and regulations has a significant influence on corporate management decisions with respect to medium- to long-term investment in equipment, research and development, business expansion overseas, human capital, and so forth. For instance, a country’s corporate taxation rate affects the cost of capital – a key element in determining the profitability of investment. Labour market regulations – such as those for employment protection, temporary agency workers, and workers hired on fixed-term contracts – affect the cost of employment. The social security system, which involves costs to companies in the form of employers’ contributions, has a similar impact. Meanwhile, the government’s policy for the TPP and other trade issues results in changes in the costs of international trade and direct investment, thereby affecting corporate decisions regarding business expansion in the global market. Since such investment is irreversible in nature and involves substantial adjustment costs, a wait-and-see strategy could be a rational choice for companies if the future course of policy is uncertain. Therefore, greater uncertainty about the future has a detrimental effect on investment and employment.
Which specific policies have created uncertainty?
However, most studies conducted to date h