Research Dept. News
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Monthly Report, num 291 - May 2006
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International review - Japan
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Japan: land of rising optimism
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Japan rejoins leading group of growth economies…
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The hard drivers of world growth have been able to welcome a new associate, a prodigal son absent for a long time. Japan is that prodigal son of the world economy which, after a decade without any periods of lasting growth, is back on track. The GDP grew by 2.7% in 2005 but the news of the month is that the prodigal son has returned changed and redeemed.
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…and consumers gain confidence.
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The change is that the biggest contributor to recovery is private consumption, the traditional poor cousin of Japan’s economy. The current recovery is based on factors of domestic demand and this is something new. Beyond the numbers of the national accounts, this implies a change toward a more optimistic attitude, as suggested by recent government surveys which show the highest confidence levels in the past 15 years. This confidence, which because it deals with Japanese caution could not be otherwise, is based on objective reasons. One is the improvement in the labour market with an unemployment rate in February of only 4.1% and with appreciable improvement in wages. Another factor is the better performance in the real estate sector which now is not dropping but rather showing a moderate recovery.
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These expectations in consumption, however, have not yet shown up in the indicators. Retail sales have still not recovered the upward trend predominating in 2005. One of the reasons is that the prudent Japanese, although they now see things fairly clearly, first prefer to replace their savings accounts that are in poor shape following so many years of economic slack. This is crucial because without the consumers a continuation of the expansionist cycle is impossible.
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Recovery of investment expected.
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Investment slowed down all last year and at this time the level of utilization of production capacity is very high, as shown by the latest Tankan surveys of economic sentiment. The rise in machinery orders, both domestic and foreign (the most volatile) signals a recovery of drive in investment. This, however, will need to have support in domestic demand, that is to say, in the Japanese consumer, because the strong contribution of the foreign sector to growth in the final quarter of 2005 is more like hitting the bottom than a prelude to future growth. The goods and services balance for the past 12 months shows a slight downward trend, eased by the recovery in exports but always dominated by the strength of imports.
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Energy prices raise inflation but what matters is psychological effect.
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The end of deflation is another reason for optimism. The CPI excluding foods rose by 0.4% year-to-year in February. This coming to the end of the tunnel, however, has three ifs and buts. With the rise in the cost of energy, Japan is importing inflation which, when this ends, should pull the indices down; the GDP deflators are still not reflecting price increases, and, furthermore, prices in Tokyo in March showed nil growth. In spite of everything, the psychological effect has now taken place and perhaps that is the most important.
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The high level of utilization of production capacity, consumer expectations and the end of deflation mark out a course which the central bank is quite clear about but this is still a thorny path.
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Japan cannot ignore reforms still needed in debt and low productivity.
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In the first place, still to be resolved is the matter of the high government debt accumulated during the years of stagnation which could drain away from growth. Also still waiting is reform of the banking system and the matter of Japan’s growth potential. With an aging population, productivity and the reduction of unit labour costs are basic elements for increasing this potential yet these indicators lately have not gone very well. Without meeting these challenges, Japan’s recovery, while solid and optimistic, may have a relatively lower ceiling than that of other advanced economies.
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