Japan's Prime Minister Shinzo Abe speaks during a lower house budget committee session at the parliament in Tokyo February 20, 2014. REUTERS/Yuya Shino TOKYO (Reuters) - When Tokyo asked for bidders to build what is expected to be the world's largest fish market on the city's vacant eastern edge there were no takers.

In a graphic illustration of how the hopes for "Abenomics" are falling short, the city was forced to raise by two-thirds its budget for the project to more than $1 billion before some of Japan's top construction companies stepped forward.

"Wages and material costs are rising, and that's why we failed to attract bidders the first time we tried," said Koji Ishii, a city official overseeing the project, on a sprawl of landfill at Toyosu, next to Tokyo Bay.

Tokyo's predicament highlights a deeper problem for Prime Minister Shinzo Abe's economic revival plan for Japan, comprising his "three arrows" of hyper-easy monetary policy, fiscal spending and growth-generating structural reform.

The construction industry has gone through a scorching restructuring over the past decade and a half of hard times since Tokyo last opened the fiscal taps, government officials and managers in the business say.

Many firms are choosing to walk away from government projects rather than invest more in equipment or hire workers - fixed costs that would be hard to shed in the next downturn. In the midst of a building boom, Japan's construction companies, who stand to benefit most directly from Abe's policies, are acting as though the good times will not last.

Some critics argue that spending on public works projects - a mainstay of Japan's economic stimulus efforts in the 1990s - is wasteful and Abe would be better off focusing on deregulation and reform.

But progress on that "third arrow" has been slow, and while Bank of Japan's massive monetary stimulus has been generally judged effective, the fiscal boost many hoped would keep the economy rolling is proving hard to restart.

BLUNTING THE SECOND ARROW

Problems with the "second arrow" of Abenomics are biting at a crucial moment for Japan's recovery. Investors have grown wary of slowing growth as Japan's economy heads for a speed bump: a 3-percentage point hike in the consumption tax hike in April.

The benchmark Nikkei stock index is down nearly 8.5 percent this year - making Japan the worst performing major stock market.

Even before Abe's public works push, contractors were already struggling to absorb demand for new building projects tied to the 2020 Tokyo Olympics and reconstruction work in the areas of northern Japan destroyed by a 2011 tsunami.

"Prime Minister Abe has been driving more public works, but we have work to be done for reconstruction in northern Japan and we have to control the number of projects we can take," said Junichi Ichikawa from Obayashi Corp, one of the contractors involved in the construction of Tokyo's new fish market.

With companies cautious and workers scarce, local governments have been forced to cancel or scale back plans. As a result, money budgeted for bolstering the economy has stayed stranded in public coffers.

Japan had to roll over to the next budget $37 billion it failed to spend out of the $98 billion earmarked for public works in the last fiscal year to March 2013. Government-funded construction projects contributed only a third as much to growth in the fourth quarter as they had in the previous two quarters.

Earlier this month, the Ministry of Finance issued an unusual directive urging other government agencies to expedite public works spending in the face of an endemic shortage of labor, especially in skilled jobs where experienced workers are retiring and a younger generation has not been trained. The government also hiked the allocation for labor costs by 7 percent.

OPEN FIELD, FAILED AUCTION

At the Toyosu site, three cranes and a half dozen trucks were moving soil this week as a knot of workers assembled a fence, the first phase of a project to transform an expanse of open land as large as almost 60 soccer pitches into a wholesale fish market to replace the current, crowded market in Tsukiji, a tourist destination for its early morning bustle.

The project is due to be completed by early 2016. The area nearby is also slated to be redeveloped to house Olympic athletes and major events for the 2020 games.

Three groups won bids for the project, led by Taisei Corp, Shimizu Corp and Kajima Corp. Obayashi, Takenaka Corp, Tokyu Construction, Kumagai Gumi, Nishimatsu Construction are also involved.

The Tokyo government will make up for the higher cost of the new fish market by delaying projects for ventilation and water distribution systems for the new market. The initial failed bidding process, in November, means that the project is already a month behind schedule, officials said.

The Toyosu project is just one, high-profile, example of a widespread problem.

In the northeast of Japan's main island, Honshu, the area destroyed by the 2011 tsunami and earthquake has seen a sharp rise in unsuccessful public works auctions. In December, a third of all jobs failed to attract bidders, government data show. That was up from zero percent just after the disaster.

Other areas of Japan are also struggling to spend: 86 auctions for public works projects had to be re-run or cancelled in Abe's home area of Yamaguchi, including a $24-million disaster prevention centre that had been planned for the city of Iwakuni, Japanese media said.

"There are too many projects issued at the same time, so companies have grown very selective because if you pick a big project and then can't gather enough workers, you go under," said Shozo Doi who runs a construction firm on the suburbs of Japan's second-largest city, Osaka.

Nearly half of the construction companies surveyed by the Ministry of Land, Infrastructure and Transport in December predicted it will be difficult for them to secure skilled workers in the next two months. The survey also showed that the shortage of skilled workers needed to work on the biggest projects has deepened since the spring of 2013.

SHRINKING WORKFORCE

Japan's construction workforce - like its population at large - is shrinking and aging, government data show. It is a third smaller than when public works peaked in 1997. As of 2010, about a fifth of all construction workers were over 60 years old.

"Construction companies don't believe the status quo will last for another 10 years. That's why they don't want to employ more workers," said Yorihisa Matsuno, a lawmaker from the opposition Japan Restoration Party who recently raised the issue of the stalled public works pipeline in parliament.

"It's very risky to employ people in Japan. The lifetime employment system means you can't fire them easily."

At the same time, many projects are running over initial budgets because of rising costs for materials like steel and cement. Part of Abe's economic plan is to push prices higher and break away from the deflationary, slow-growth spiral that had held in Japan for a decade and a half.

But the experience of the construction sector shows the risk from higher prices. Government outlays on roads, buildings and bridges are buying less for the same amount of money. Prices for steel girders, or H-bars, used in large-scale projects in Japan have jumped to 82 yen per kg from 70 yen per kg in less than a year. The biggest jump in prices has been recorded in the areas of highest demand - the disaster area north of Tokyo.

The Economic Research Association, which tracks prices for construction materials, said its reading for a basket of materials in Sendai - the northeastern city at the heart of Japan's reconstruction boom - stands at the highest level since it began keeping records in the early 1990s.

With Japan's economy slowing, many analysts believe the Abe government will ready another fiscal stimulus package - and more public works spending - later this year. There is also a building expectation that the Bank of Japan will have to expand its already unprecedented injection of money into the economy.

"It's hard to say public works is the best policy, but it has to be done," said Koichi Haji, an economist at NLI Research Institute. "The government has not come up with a better alternative yet."

(Editing by Alex Richardson)