Lasting recovery

The world's third largest economy expanded at an annualized rate of 2.2 percent in the October-to-December period, the government said on Monday, February 16. However, the recovery from six months of contraction was weaker than economists expected and follows a controversial increase in sales tax in April from five to eight percent.

The poor economic performance had led PM Shinzo Abe to delay a second sales tax hike to 10 percent - originally planned for October 2015 - until 2017, and call a snap election, which his party won.

But as Asia's second largest economy struggles with stagnation and deflation along with the largest debt-to-GDP ratio in the developed world, many have called into question the effectiveness of "Abenomics" - a combination of monetary, fiscal and structural policies.

Marcel Thieliant, Japan Economist at Capital Economics, talks to DW about what "Abenomics" has achieved thus far and says the current recovery may last all the way to early 2017.

DW: How did the Japanese economy manage to come out of recession in the fourth quarter?

Marcel Thieliant: The main reason why the economy pulled out of recession last quarter was that inventories were no longer a large drag on growth as they were in the third quarter.

Domestic demand, in contrast, was not expanding much faster than in the third quarter, which highlights that the economic recovery remains sluggish.

Would this be enough to restore business confidence and increase investment?

A rising number of firms are facing capacity shortages, so business investment should start picking up soon. However, business confidence remains mixed, so we think that the recovery in capital spending will be rather subdued.

How long do you expect this latest recovery to last?

With monetary policy set to remain expansionary for the foreseeable future, the current recovery may last all the way to early 2017.

But demand will likely fall sharply following the renewed increase in the sales tax from 8 percent to 10 percent in April 2017.

What factors are causing the Japanese economy to slumber?

The sharp shrinkage of the working-age population remains the key headwind to growth. Meanwhile, corporate profits have been bolstered by the sharp fall in the exchange rate since the launch of "Abenomics," which has lifted the value of exports and repatriated profits from overseas subsidiaries.

But firms have not passed on much of this windfall to workers in the form of higher wages, so consumers have come under pressure.

What does the Japanese economy need to get back on the growth path?

Most importantly, rapid population shrinkage needs to be slowed, ideally via more immigration. In the meantime, productivity growth is already fairly strong, but there is still scope for catch-up relative to the US.

We believe that allowing more foreign firms to operate in the country and deregulating the labor market could yield substantial benefits.

What has "Abenomics" achieved thus far?

The most visible achievements of "Abenomics" have been on the labor market. The unemployment rate has fallen to the lowest level since the late 1990s.

What's more, the share of women willing to work is at a record high, while the share of older persons willing to work has climbed to levels last seen during the bubble years of the early 1990s.

However, "Abenomics" has been relying too much on expansionary monetary policy, while structural reforms have mostly been disappointing. That said, there have recently been some signs that the government is willing to tackle the powerful agricultural lobby.

This should allow policymakers to grant more concessions in the ongoing negotiations on the Trans Pacific Partnership (TPP), and increases the chances that an agreement may finally be concluded.

The TPP should result in a drastic fall in food prices, which would be beneficial for consumers. It may also spur productivity gains by encouraging foreign direct investment in Japan.

Marcel Thieliant is Japan Economist at Capital Economics, a UK-based economic research consultancy.