Stagflation is ruining Takaichi's honeymoon
New PM needs to ensure that the 99% feel that 'Japan is back'
William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades."
Barely a month into office, Japanese Prime Minister Sanae Takaichi's honeymoon was disturbed by the announcement of a 1.8% economic contraction. And bad news on the economic front will likely worsen, and fast, in ways Takaichi's team seems not to realize.
No, the verbal skirmish with China over Taiwan is not the problem (though clearly, losing Japan's largest source of tourists and potentially demand for exports does not help). Stagflation is the foe Takaichi must defeat if she hopes to outlast the 12-month average that doomed eight of Japan's last 10 prime ministers. But oddly, Takaichi's economic team has barely even acknowledged that gross domestic product and average wages now regularly lag inflation.
"Stagflation is not easy to cure," says economist Richard Katz, "because the remedies for the 'stag' part worsen the 'flation' part, and vice versa."
Making matters worse, Takaichinomics, at least as articulated so far, could hasten inflation gains in 2026. This is because right out of the gate, Takaichi, like her mentor, former Prime Minister Shinzo Abe, is prioritizing monetary and fiscal loosening over reforms to increase productivity and innovation.
Any central banker who thinks they face a rough December should spare a thought for Kazuo Ueda. Just two months ago, the Bank of Japan governor was likely hoping his board could make good use of its Dec. 18-19 meeting to hike interest rates to 0.75% from today's 0.50%.
Ueda's place in the economic history books was first put in jeopardy by Donald Trump's trade war. Though aimed at China, the fallout from the U.S. president's tariffs has arguably damaged Japan more. Trump's fingerprints are all over the economy's nearly 2% contraction in the July-September period, the first negative reading in six quarters.
The intensifying spat with China is its own headwind. It began with Takaichi's Nov. 8 comment that a Chinese attempt to grab Taiwan by force would be a "survival-threatening situation" for Tokyo, including aiding any U.S. response. Already, China's President Xi Jinping has urged tourists not to visit Japan and banned Japanese seafood imports.
Here, it is reasonable to worry about what economists call "opportunity cost." A long-time hardline conservative, Takaichi seems more in her element saber-rattling with Xi's Communist Party than the forces of economic malaise at home. Also, based on her rhetoric, Takaichi seems more worried about Japan sliding back into deflation than 3%-range inflation becoming the norm.
This is a complete misunderstanding of the public mood. Polls showed that rising living costs were a central reason why her ruling Liberal Democratic Party lost its majority in both houses of parliament. Takaichi's sales pitch was to dust off "Abenomics" and create the virtuous cycle of wage and gross domestic product gains to which the late Abe never got around.
Takaichi even resurrected Abe's "Japan is back" slogan. But which Japan? Sure, the 1% is ecstatic as the Nikkei 225 Stock Average hovers around the 50,000 mark, record territory for the bourse. Average Japanese households facing falling inflation-adjusted incomes, not so much. "Higher corporate profits and stock prices do not make Japanese voters feel they are back," notes Katz, author of "The Contest for Japan's Economic Future."
Things are unlikely to improve as Team Takaichi reloads Tokyo's stimulus cannons with a 21.3 trillion yen ($135 billion) economic package. The yen is inching toward 160 to the dollar as Takaichi makes clear that another BOJ rate increase is a non-starter. This means more imported inflation at a moment when Trump's tariffs are putting upward pressure on global commodity prices.
She is also prodding Japan Inc. to raise wages. A valid goal, for sure. But unless Tokyo acts fast to get Japan out of the bottom half of Organization for Economic Cooperation and Development members in productivity growth, a wage surge would just exacerbate inflation.
Had Abenomics done more to cut bureaucracy, devise a meritocratic labor system, rekindle innovation, create more jobs from the ground up versus top-down and empower women, the economy might be better placed to absorb surging wages. This is why reviving a strategy that failed to tackle Japan's biggest challenges 13 years ago, without major upgrades, is a recipe for the failure of yet another government.
Stagflation is understandably a dreaded dilemma for any top economy. The most traumatic example, arguably, is the U.S. in the late 1970s. Back then, it took the Federal Reserve pushing short-term rates to 20% to get the rate of inflation back below GDP growth.
It is unthinkable that Ueda would follow Fed Governor Paul Volcker's 1979-1987 tightening playbook. With a debt-to-GDP ratio approaching 260%, even pushing Japan's benchmark to 5% could see Tokyo's debt servicing costs explode, crippling Asia's second-biggest economy. As it is now, the Ministry of Finance is having a hard enough time selling 10-year and 20-year debt at routine auctions.
The solution is above Ueda's paygrade. Only disruptive supply-side reforms could increase worker efficiency by 1% per annum, which the Japan Productivity Centre think tank says is the minimum necessary to curb wage-push inflation. Neither a weak yen, nor a tax cut nor budgetary gimmicks can stop stagflation from deepening. If Abenomics could not do that in 12 years, what makes anyone think Takaichinomics can do it in 12 months?
If Takaichi stays the Abenomics course, and prioritizes geopolitical dustups over vital upgrades to tame stagflation, Japan may be voting on a new, new leader less than a year from now. The only way to ensure Japan is "back" is for the other 99% to feel it.