Japan’s economy produced $4.7 trillion in 2016, as measured by purchasing power parity. That makes it the world’s fifth largest economy after China, the European Union, the United States and India. It’s not on pace catch up, because it only grew 0.5 percent.Japan has 27 million people. Its GDP per capitais $38,900, or 44th in the world.That means its standard of living is lower than the United States or the EU, but higher than China or South Korea. (Source: “Japan’s Economy,” CIA World Factbook.) Japan has a mixed economy based on capitalism, although its government works closely with industry. In fact, central bank spending equals 18 percent of the country’s gross domestic product. It accounts for almost all of government borrowing. Japan’s largest exports are automobiles, steel products and semiconductors. Its main imports are oil and liquid natural gas.AbenomicsOn December 26, 2012, Shinzo Abe became Japan’s Prime Minister for the second time. His first term was 2006 to 2007. He won in 2012 by promising economic reform to shake the country out of its 20-year slump.”Abenomics” has three principal components, called the “three arrows.”First, he instructed the Bank of Japan to initiate expansive monetary policies through quantitative easing. That lowered the value of the yen from $.013 in 2012 to $.0083 by May 2013. That’s expressed in terms of the value of the dollar, which rose from 76.88 yen to 120.18 yen. (Source: “Japan at the Brink,” The Wall Street Journal, November 19, 2014.)Making the yen cheaper should have increased exports. Their prices drop in dollar terms, making them more competitively priced. But Japanese companies didn’t increase exports as expected. Some companies didn’t lower their foreign prices.They pocketed the profits instead. Others had already outsourced factories to lower-cost areas, so the devaluation didn’t help. Still others weren’t helped because they had moved production into their markets, such as Toyota to the United States.The devaluation hurt Japanese businesses reliant on imports. Their costs rose. It also hurt consumers, who had to pay more for imports. (Source: “Japan’s Export Volume Falls Despite Weak Yen,” The Wall Street Journal, December 17, 2014.)Second, Abe launched expansive fiscal policy. He increased infrastructure spending. He promised to offset the rise in Japan’s 225 percent debt-to-GDP ratio with a 10 percent consumer tax in 2014. The consumer tax backfired. That briefly returned the economy to recession.In 2016, he spent another $276 billion. Of that, $202 billion was government loan programs. The rest went toward infrastructure construction. That includes construction of a magnetic levitation train. (Source: “Japan’s $276 Billion Stimulus Plan Is Smaller Than It Looks,” CNN Money, August 2, 2016. “Japan Announces More Stimulus Measures as Economy Struggles,” The New York Times, August 2, 2016.))Third, Abe promised structural reforms. He promised to modernize Japan’s agriculture industry.He said he would reduce tariffs and expand plot sizes. That puts him against the powerful rice lobby. But in 2015 the Central Union of Agricultural Cooperatives (JA-Zenchu) agreed to reduce its power over farmers. That allows the government to promote more efficient production methods. Abe participated in the Trans-Pacific Partnership. (Source: “Abe’s Third Arrow Finds Its Mark,” The Wall Street Journal, February 11, 2015. “How Japan’s Economy Put Itself Out to Pasture,” Japan Times, December 25, 2014.)Seven Characteristics of Japan’s EconomyThe following seven factors hinder Japan’s growth. Abe must address these challenges to restore growth.Keiretsu is the structured interdependent relationships between manufacturers, suppliers and distributors. This allows the manufacturer monopoly-like power to control the supply chain. It also reduces the impact of free market forces. New, innovative entrepreneurs can’t compete with the low-cost keiretsus. It also discourages foreign direct investment for the same reason.Guaranteed lifetime employment meant companies hired college graduates who stayed until retirement. The recession made that strategy unprofitable. By 2014, only 8.8 percent of Japanese companies offered it. But 25 million workers 45 to 65 are still employed under the system. Most have outdated skills and are just cruising until retirement. That burdens corporate competitiveness and profitability by artificially raising wages for these workers.An aging population means the country must pay out more retirement benefits than it receives in income taxes from the working population. It hires temporary workers from nearby South Asian countries but does not welcome immigrants. That reduces the consumer base. (Source: “Forecasting Japan: The Failure of Reform,” Stratfor Worldview, September 30, 2015.)The yen carry trade is a result of Japan’s low interest rates. Investors borrow money in low-cost yen and invest it in higher-paying currencies, such as the U.S. dollar. It’s one reason the dollar’s value soared 15 percent in 2014. A lower yen normally increases the price of imported commodities, triggering inflation. But plummeting oil prices in 2014 meant the BOJ didn’t have to worry about inflation, and could keep rates low.Japan’s massive debt-to-GDP ratio means Japan owes more than twice as much as it produces annually. The biggest owner of its debt is the Bank of Japan. That has allowed the country to keep spending without worrying about higher interest rates demanded by skittish lenders. Japan briefly became the largest holder of U.S. debt in 2015 and again in 2017. Japan does this to keep the yen low relative to the dollar to improve its exports. World’s largest net food importer is because Japan has just one-third as much arable land per person as China.Japan’s Lost DecadeIn January 1990, Japan’s stock market crashed. Property values fell 87 percent. The Bank of Japan fought back. It lowered the interest rate from percent to 0.5 percent by 1995. It didn’t revive the economy because people had borrowed too much to buy real estate during the bubble. They took advantage of low rates to refinance old debt. They didn’t borrow to buy more. (Source: “Japan Interest Rates,” Federal Reserve Bank of St. Louis.)The government tried fiscal policy. It spent on highways and other infrastructure. That created the high debt-to-GDP ratio. (Source: “Putting Japan’s Lost Decade in Perspective,” NPR, February 24, 2009.)By 2005, companies had repaired their balance sheets. In 2007, Japan’s economy started to improve. It was up 2.1 percent in 2007, and 3.2 percent in Q1 2008, leading many to believe it had finally grown out of its 20-year slump.The 2008 financial crisis sent GDP growth plummeting 12.9 percent in the fourth quarter. It was the worst decline since the 1974 recession. Japan’s economic collapse was a shock, since Q3 growth was only down 0.1 percent, following a decrease of 2.4 percent in Q2 2008. The severe downturn was a result of slumping exports in consumer electronics and auto sales. That sector was 16 percent of Japan’s economy. It had been a driving force behinds the country’s economic revival from 2002 to 2008.Earthquake, Tsunami and Fukushima Disaster ImpactOn March 11, 2011, Japan suffered an 9.0 magnitude earthquake. It created a 100-foot tsunami that flooded the Fukushima nuclear power plant disaster. It occurred just as Japan’s economy was emerging from the Great Recession. In 2010, GDP increased by a healthy 3 percent. That was the fastest growth in 20 years.Japan lost much of its electricity generation when it shut down nearly all its nuclear power plants after the earthquake. The economy shrank 0.5 percent in 2011 as manufacturing slowed due to the crisis.How It Affects the U.S. EconomyThe Bank of Japan had been the largest holder of U.S. Treasurys until China replaced it in 2008. Both Japan and China does this to keep the value of their currencies low relative to the dollar. That keeps their exports competitively priced. However, this strategy drove Japan’s debt to 182 percent of total GDP output even before Abenomics. (Source: CIA World Factbook)A low yen made Japan’s auto industry very competitive. That was one reason that Toyota became the number #1 automaker in the world in 2007. But if Japan’s central bank decides that a low yen isn’t boosting growth, and oil prices rise, then it may let the yen strengthen to reduce inflation. It would purchase fewer Treasury bonds. That would allow yields to rise, and boost U.S. interest rates.