Why reducing inequality is key to the success of Abenomics

Japan is not immune from the increase in inequality observed in other advanced countries in recent years. Anecdotal evidence suggests that concerns over income inequality have grown among the Japanese population, and the previously widely held notion that ‘all Japanese are middle class’ is a thing of the past. As seen in Figure 1 when measured using the Gini coefficient (before fiscal redistribution), inequality in Japan has steadily increased over the last three decades. The latest available figure implies that income inequality in Japan, starting from the lowest among the G7 countries in the mid-1980s, has converged to nearly the G7 average of 0.50.

Figure 1. Gini before taxes and transfers (market income)

Source: OECD.

Against this background, in the rest of the column we discuss why inequality is important – not only in its own right but also from a macroeconomic point of view – and present an evaluation of Abenomics in terms of its inclusiveness.

Why is it important to focus on inclusive growth in Japan?

In our view, concerns over inequality and inclusiveness of growth are driven not only by social and moral considerations, but are also directly relevant to macroeconomic outcomes and to the ultimate success of Abenomics – for at least two reasons.

First, if the perception that economic growth is not shared fairly within the Japanese society becomes prevalent, this could erode support for much needed reforms, such as deregulation and further international trade integration.
Such reforms are crucial to boost potential long-term growth, but might imply short-term costs for some segments of the population.

The second reason is that in recent times, the consensus among economists has been shifting from the past belief of a trade-off between economic growth and equality (e.g., Okun 1975) to a new view in which ensuring equality is seen as critical for sustainable growth.
An example of this new conventional wisdom can be found in the work of Berg and Ostry (2011), who empirically document how greater equality can help sustain growth. According to several authors (e.g., Son and Kakwani 2003, Gramy and Assane 2006), equality also strengthens the poverty-reducing effect of growth.

Evaluation of Abenomics’ inclusiveness

In light of the above discussion, in a recent paperr (Aoyagi et al. 2015), we assess the implications of Abenomics in terms of inclusive growth, using a panel of Japanese prefectural data over about 30 years. The dependent variable is the measure of inclusive growth developed by Anand et al. (2013), which can be interpreted as a measure of growth in average income ‘corrected’ for the equity impact of such growth. The explanatory variables are proxies for the implementation of Abenomics reforms, which include reaching the 2% inflation target of the Bank of Japan (BoJ), labour market reforms aimed at reducing duality, increasing female labour participation, and further boosting labour supply in general.

Based on our regression results, Table 1 presents some scenario analysis summarising the impact of Abenomics on our inclusive growth variable and its two sub-components (average income growth and equity change).The inclusive growth variable is calculated by taking the weighted average of the growth of per-capita income and the change in the index of inequality. The index of inequality takes the value of zero in the case of complete inequality (i.e., one person possesses the entire income) and one in the case of complete equality (i.e., everyone possesses the same income). In other words, our inclusive growth measure takes into account both average income growth and changes in the income distribution.

Table 1. Scenario result table, inclusive growth

According to our analysis, moving toward the 2% inflation goal of Bank of Japan – one of the main objectives of Abenomics – would promote growth while having a negative impact on equality. The latter can be explained by the fact that the most vulnerable households cannot protect their real income against an increase in inflation.

However, the overall impact of reaching the 2% inflation target on our inclusive growth measure is positive, because the ‘growth’ effect of permanently getting out of deflation (which stimulates growth by changing expectations and raising incentives to consume and invest) more than offsets the negative impact of inflation on equality. Table 1 also shows that for working-age households, the negative equity effect is smaller, and the positive growth effect is stronger, compared to the sample of all households.

As shown in Table 1, reducing labour market duality (proxied as a scenario which brings the ratio of part-time to full-time job openings from its current level of 21% to the pre-bubble level of 5%) would improve inclusive growth by raising average income.

This is consistent with the idea discussed in Aoyagi and Ganelli (2013) that Japan’s excessive duality reduces productivity through a ‘training channel’ as non-regular workers receive less training than regular ones, and an ‘effort channel’ because non-regular workers tend to be less motivated and therefore are less productive than regular ones. Reducing duality thus increases average income by raising productivity. As expected, such an effect is stronger when we include in the regression only working-age households. However, reducing duality implies a slight decrease in equality, because it prevents some workers who can only work part-time from being employed.

Table 1 also presents the impact of increasing female labour force participation (FLFP) by about five percentage points, which historically has hovered around 48% (more than 20 percentage points lower than male participation). As it can be seen, increasing the female labour participation by this amount would boost our inclusive growth measure by 0.83 percentage points, by increasing both income growth and equality. The estimated effect is even stronger (1.13 percentage points) for the working-age household sample.

Labour input, calculated as the number of workers multiplied by hours worked, has been in decline in Japan since 1979, reaching negative growth in the early 1990s. In our scenario analysis, we consider a case in which reforms aimed at increasing labour supply manage to shift the growth of labour input from negative to zero. Under this scenario, inclusive growth would be 0.42% higher, mostly due to average income growth, but also with equity slightly improving.

Summarising the findings

In summary, the results presented in Table 1 suggest that if only the first arrow is launched (i.e., if only the inflation target of Bank of Japan is achieved), Abenomics would still achieve positive average income growth, but with some deterioration in income equality. The scenario analysis also shows that, as long as inflation reaches and stays at around 2%, our overall measure of inclusive growth improves, because the ‘growth’ effect of inflation is stronger than its ‘inequality’ effect.

· In the case in which inflation stays at around 2% and third arrow reforms (higher female labour participation, reducing duality, increasing labour input) are implemented, Abenomics increases average income growth while keeping inequality broadly unchanged (all household sample) or improving it (working-age household sample).

Furthermore, our regression results also show that there are non-linearities in the impact of inflation on growth. Due to a threshold effect, if monetary policy becomes overburdened because of a lack of structural reforms, resulting in runaway inflation above the Bank of Japan’s 2% target, overall inclusive growth (not only equality) will be reduced.

Overall, our empirical results and scenario analysis support the argument that the best way for Abenomics to ensure gains in both growth and equity is to successfully launch the third arrow.

Conclusion

As stressed in the 2014 IMF Article IV Report on Japan, implementing structural reforms holds the key for faster growth in Japan and is vital to Abenomics’ success. In this column, we have presented recent empirical research showing that fully launching the third arrow is equally important to foster income equality and inclusive growth.

Disclaimer: The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.
Editors’ note: This column was reproduced with permission from the Research Institute of Economy, Trade and Industry (RIETI).

References

Aoyagi, C, and G Ganell (2013), “The Path to Higher Growth: Does Revamping Japan’s Dual Labor Market Matter?” IMF Working Paper, WP/13/202.

Aoyagi, C, G Ganelli, and K Murayama (2015), “How Inclusive Is Abenomcis?” IMF Working Paper, WP/15/54.

Berg, A G, and J D Ostry (2011), “Inequality and Unsustainable Growth: Two Sides of the Same Coin?” IMF Staff Discussion Note, SDN/11/08.

Grammy, A, and D Assane (2006), “The poverty-growth-inequality

triangle hypothesis: An empirical examination,” Journal of Policy Modeling.

Okun, A M (1975), Equality and Efficiency: The Big Trade-Off (Washington: Brookings Institution Press).

Son, H and N Kakwani (2003), “Poverty Reduction: Do Initial Conditions Matter?” Mimeo, The World Bank.

This article is published in collaboration with Vox EU. Publication does not imply endorsement of views by the World Economic Forum.