Japan: Finally, growth Global Economic Outlook, Q2 2015
Japan has come out of recession. A large share of growth came from strong exports, while consumer spending remained weak, and business investment declined. The job market remains a bit of a puzzle.
Japan has come out of recession. The government reports that, after having declined sharply in the second and third quarters of 2014, real GDP grew in the fourth quarter, though not by much. It was up at an annualized rate of 1.5 percent. For all of 2014, GDP actually contracted compared with 2013. A disproportionate share of fourth-quarter growth came from strong exports, while consumer spending remained weak and business investment declined. Exports, on the other hand, registered strong growth from the third to the fourth quarter, likely as a result of the weak Japanese yen, which made exports cheaper for foreigners. Weakness in consumer spending probably reflected the continuing stagnation of wages. Declining business investment means that companies are not yet convinced that demand will rise, or that deflation will be avoided. While investors were disappointed that growth wasn’t stronger, there is reason to expect an improvement in performance in the quarters to come. Certainly the sharp drop in the price of oil will boost consumers’ discretionary income. And the more aggressive monetary policy should boost inflation and, in the process, lower real interest rates.
Japan also appears to be moving away from deflation. The GDP report shows that in 2014, nominal GDP increased faster than real GDP for the first time since 1998.1 That is because the GDP deflator, a measure of inflation for all components of GDP, increased in 2014 for the first time since 1998. The GDP deflator is a broader measure of inflation than the consumer price index. The fact that it increased is good news and suggests that the aggressive monetary policy is bearing fruit. However, critics may point out that last year’s increase in the national sales tax played a role in boosting nominal GDP. This is true. On the other hand, there is reason to believe that the boost to nominal GDP is not only due to the tax increase. The government also reported that employee compensation (wages, bonuses, and benefits) increased in 2014 at its steepest pace since 1998.2 Thus it appears that inflationary pressures are beginning to develop.
Yet last year’s tax increase resulted in recession, which is why next year’s tax increase is postponed until April 2017.
Conflicting labor market signs
As for wages, some of Japan’s largest companies have announced sizable wage increases, among the biggest in a decade. Prime Minister Shinzo Abe was pleased and said, “With the usual negotiations between business and labor, executives get stuck in a deflationary mind-set. I am counting on this progress to continue.”3 The companies that are now increasing wages are mostly export oriented and have benefitted substantially from a declining yen. They are flush with cash that they can share with their workers. Yet smaller, domestically oriented companies have been hurt by a rising yen, which raises import prices. They are not yet increasing wages. Still, the overall effect is an increase in wages, which, in turn, will help boost consumer spending.
Nevertheless, Japan’s job market remains a bit of a puzzle. The government reports that the unemployment rate, which stood at 3.6 percent in January, is near the lowest level in 18 years.4 In addition, the ratio of jobs available per job seeker is the highest in 23 years, and the number of job offerings is up 5.6 percent from a year earlier. Given a clearly tighter job market, one would expect a surge in wages. But while big companies are starting to boost wages, smaller ones are not. Instead, wages are mostly stagnant and, adjusted for inflation, have been consistently falling for the past 17 months. Companies are increasingly hiring contract or part-time workers rather than full-time employees. This is having a dampening effect on overall compensation. It appears that businesses are being excessively cautious owing to the perceived weakness of the economy. Consequently, they are reluctant to commit to hiring full-time workers. Another factor that could be suppressing wages is the rise in labor force participation, especially among women. In the past two years the female participation rate has risen rapidly. From a demographic point of view, this is good as it boosts the ratio of workers to retirees and helps replace the large number of aging workers who are retiring. It should also help boost economic growth.
The sizable drop in the value of the yen, largely a result of an aggressive monetary policy, is starting to pay off in terms of export strength. The government reports that January exports were 17.0 percent higher than a year earlier.5 However, export growth slowed to 2.4 percent in February, partly due to the timing of the Lunar New Year holiday. This was the sixth consecutive month of rising exports. The weaker yen allows exporters to either cut prices or boost margins. In addition, a stronger economic recovery in the United States is playing a role in Japan’s export rebound. Meanwhile, the government also reported that imports fell 3.6 percent in February versus a year earlier. This was largely due to the decline in the price of oil. It also led to a decline in the trade deficit. Japan has run a trade deficit for the last two-and-a-half years.
A weaker yen should benefit the industrial side of the economy. Indeed, Japanese industrial production increased 3.7 percent from December to January but was down 2.8 percent from a year earlier. In addition, the government reports that shipments of industrial goods were up 5.6 percent, while inventories of industrial goods were down 0.4 percent.6 These numbers bode well for future increases in output, especially as businesses will need to replenish inventories and meet rising demand. However, it should be noted that industrial production remains only 2.4 percent above the level seen in 2010. Thus, after a sharp decline in recent years, production has finally rebounded to the level of five years ago.
Last year, Japan’s budget deficit was 7.1 percent of GDP. Meanwhile, Japan’s total sovereign debt is in excess of 200 percent of GDP. Moreover, with an aging population, the deficit is set to worsen as the number of retirees rises faster than the number of workers. Thus it is not surprising that Japan’s government is keen to raise taxes in order to get its finances under control. Yet last year’s tax increase resulted in recession, which is why next year’s tax increase is postponed until April 2017. However, the government has gone out of its way to confirm that the next tax increase will not be postponed again.7 It wants to reassure markets that Japan will return to fiscal probity.
Why there is concern about market sentiment is not clear. Japan has among the lowest bond yields in the world. This suggests that investors are not worried about Japan’s ability to service its future debts. Plus, the best way to reduce the debt-GDP ratio is to boost GDP growth rather than slow the growth of debt. Regarding that, Abe said that the Trans-Pacific Partnership (TPP), a free-trade agreement between Japan, the United States, and other Pacific Rim nations, is nearing completion. He said, “At last the end is in sight.”8 A TPP deal could be the factor that forces Japan to liberalize domestic markets, thereby boosting productivity and growth. Among the sticking points between the United States and Japan has been the latter’s reluctance to liberalize its agricultural market. Protection of farmers costs the economy substantially, and reducing protection would free up resources and likely boost growth significantly. Abe said, “After the war, our agricultural population was more than 16 million people, [and] now it is 2 million . . . and their average age is greater than 66. It is past time for a big reform of agriculture.”9 By Japanese standards, this is a revolutionary statement, taking on one of the country’s most powerful vested interests. His statement bodes well for reform.