Virus, typhoons and taxes propel Japan toward recession

The prime minister took power in the aftermath of the financial crisis, amid a deep slump and after several recessions. There seemed to be no clear route out of the stagnation: Corporations were hoarding cash, and a "lost generation" of people in their 30s and 40s, who had missed the opportunity to secure lifetime jobs during the country's boom, seemed doomed to remain underemployed.

Successive governments had found themselves without the political and fiscal leeway to address the country's long-term challenges. Labor shortages, rising welfare liabilities and falling consumption from a declining population are already pressing issues, and will only get worse. The International Monetary Fund forecasts that Japan's gross domestic product is on track to fall by a quarter in the next 40 years due to a spiraling demographic decline.

"When you lose 500,000 customers per year, you will have a very hard time to have consumer spending be an engine for your country's growth," said Michael Thomas Cucek, assistant professor of Japanese politics at Temple University's Japan campus. "This was always on the horizon."

Protesters rally against the Obuchi government, in power between 1998 and 2000. Consumption taxes have long been contentious policy for Japanese lawmakers. © Reuters

With the economy in the mire, necessary long-term measures, including raising taxes to meet the inevitable increase in health care and pension liabilities from the aging population, had proved all but impossible. Attempts to raise the sales tax were particularly politically toxic. The IMF says that Japan needs to increase the tax to 15% by 2030, and 20% by 2050, but it took two decades to get the public to accept even a modest 5% rate. Attempts to raise it further have brought down governments.

Abenomics promised to break the cycle of short-termism. Huge stimulus packages, starting with 13 trillion yen (then $117 billion) in 2013, would reflate the economy and give space for structural reforms. Bringing more women and more migrants into the workforce would ease labor shortages. Labor reform would make the workforce more competitive and push up wages. With government support, companies would embrace technology, particularly in payments, where a continued dependence on cash was seen as holding the economy back.

For a while, it seemed to be working. For the first time in decades there was a swagger to the Japanese economy. In 2013, the Nikkei Stock Average jumped 57%. Although growth was still not stellar, hiring increased.

"You have young people with a very positive outlook about their lives, due to the extremely massive hiring that has been possible under both the [fiscal] stimulus and loose monetary policy," Cucek said. "This generation is very upbeat."

But even as the early Abenomics surge fizzled out, the government kept spending. Gross public debt has risen to nearly 240% of GDP after successive stimulus packages. Despite the kick-starts to growth, reform has been slower than the government hoped.

Real wage increases have been limited. Companies have continued to add to their cash reserves rather than investing. Japanese businesses and consumers have stoically refused to move to cashless payments. The country's electronic payment ratio -- the proportion of household transactions that are made using digital methods -- is just 20%, compared to 69% in the U.K. and 96% in South Korea. Realpolitik meant that some of the harder reforms were delayed. The tax hike was postponed twice.