The figure for third-quarter Japanese GDP growth was recently revised downward to only 1.1 per cent annualized. This will be taken as sharply negative for Prime Minister Abe's ‘three arrows' approach. But GDP growth is not a clear sign of the success or failure of Abenomics. GDP is badly misleading with respect to the health of the Japanese economy and the value of current policy. Its flaws are evident in accounting after the 3/11 disaster, Japan's staggering government debt, and the role of imports.
The misleading nature of GDP was on display two years ago when forecasters considered the impact of the 3/11 triple disaster on the Japanese economy. The earthquake, tsunami and radiation concerns wiped out hundreds of billions of dollars in wealth — in physical property, in land value, and in high-margin manufacturing. It was a human tragedy first and foremost, but also an economic one.
Yet many forecasts afterward focused on reconstruction spending driving GDP higher, as if attempting to repair the damage was more important economically than the damage itself. This is because GDP measures transactions, not prosperity in any sense. What was lost matters less in computing GDP than the new transactions that took place afterward. 3/11 was followed quickly by stronger GDP growth, but treating that as actually representing a healthier economy is perverse.
With regard to debt, Japan shunts expenditure into a ‘special' budget that overlaps with the general budget, obscuring what is spent and borrowed. Total borrowing ranges between US $400 and $475 billion annually which is wonderful for GDP accounting: more money borrowed means more available for the government to make purchases, which by definition add to GDP. In contrast, if the borrowed money were left as private savings it would not contribute to GDP. The wealth of a country is plainly not expanded simply by transferring funds from the private to the public sector, yet GDP is boosted.
Hence Japanese governments constantly announce spending packages, including as part of the Abenomics arrows. These have no economic value but produce a short-term increase in GDP as an accounting matter. The GDP gain is wrongly taken to mean something, but it is apparent within a few months that the economy remains stuck. Somewhere Paul Krugman is shouting the word ‘multiplier'. Government spending is sometimes claimed to have a multiplier effect on GDP beyond the simple additive accounting trick. The evidence says otherwise. Japan has accumulated 800 trillion yen in debt over the past 20 years. Nominal GDP has hardly budged over this period while real GDP growth is barely 1 per cent annually.
One possibility is that Keynesian multipliers are absurd. But there is evidence that the problem actually lies with GDP. A recent Financial Times article claimed that the initial estimate for Japan's GDP growth was disappointingly low due to a less-favourable trade position — the value of imports rose faster than the value of exports. In the past, the Japanese growth model was indeed based in large part on a weak yen, more exports and fewer imports, and thus higher GDP.
But the Financial Times argument is wrong-headed in this case because Abenomics is different. It is supposed to be an attempt to fight deflation and boost consumption. More consumption should mean more imports, which are just consumption of foreign goods and services. Under a policy designed to increase consumption, more imports is a sign of economic vigour.
In GDP expenditure accounting, however, imports are treated as harmful. The result is that what should be a sign of success — stronger consumption — becomes a sign of failure.
GDP cannot reveal a genuine success for Abenomics through more government borrowing nor can it reveal failure through higher imports. It is not ‘the economy'; it is an accounting tool that (badly) aggregates different kinds of transactions.
What matters for Japan right now is the same thing that ultimately matters for every economy: the buying power, and thus the prosperity, of households. This is not automatically boosted by net exports or government borrowing, and certainly not by disaster reconstruction. Rather, higher household incomes build wealth over time. Disposable income started the year poorly but appeared to be stronger in the second and third quarters. This is not definitive success but it does mean Abenomics is not yet failing. There is still time for the indispensable third arrow of reform to improve people's lives in a substantial and durable fashion - an improvement that cannot be judged through GDP.