Since the year began, the Nikkei stock index has posted a gain of nearly 9 percent. That’s the best performance of all of the major stock indices of the G-7 nations, according to economist John Park of Kudlow & Company.
In June 2004, corporate goods prices in Japan posted a 1.4 percent annual gain. This index shows the progress that has been made against deflation. According to Park, the effect of deflation is easing in Japan, and it shows in the recovery in household spending by 4.8 percent, corporate profits by 24.6 percent, and corporate capital investment spending by 10.2 percent.
The recovery can also be seen in the surge in the benchmark bond yield, which is up to 1.8 percent, from 0.4 percent about a year ago.
While still burdened with bad loans, the Japanese economy has made real progress against the problems of deflation. The Bank of Japan has been expanding the monetary base at an average rate of 20 percent since 2001, and the bull market seems to be fueled by this liquidity.
The data confirm the emerging view among analysts that the world’s second-largest economy is on a recovery track after more than a decade of slowdown, when sporadic periods of growth alternated with downturns.
“All we can say is that the numbers are fantastic,” said Tatsuya Torikoshi, senior economist at Daiwa Institute of Research in Tokyo. “If we look at just the numbers, Japan is leading global growth.”
Purchases of clothing and life insurance helped boost consumer spending in the January-March period, while exports continued to boom, especially in electronic components and autos. The main upward surprises were in consumer spending and capital investment. The recovery started with exports but has broadened into the rest of the economy.
The International Monetary Fund is forecasting growth as high as 4 percent this year. But it cautioned that risks remain and urged continued reforms, such as reducing bad loans in the banking sector, privatizing the postal system, and reducing trade barriers.
The IMF’s calendar-year forecast would appear to put the economy on course to easily exceed the Japanese government’s forecast of 1.8 percent growth in gross domestic product for the fiscal year ending March 31, 2005. Japan’s economy posted a solid annualized rate of 5.6 percent growth for the first three months of this year, as healthy consumer spending combined with robust exports.
China, until recently blamed by Japan for stoking deflation through cheap exports, may actually be providing the Japanese economy with a much-needed inflationary push. Strong demand from China is helping to soak up excess Japanese capacity in steel, paper, glass, cement, electronics, machine parts and other industries feeding China’s investment and construction boom. Service industries, especially shipping, are also benefiting, as demand from China squeezes capacity and restores pricing power.
However, the biggest danger to the Japanese economic recovery is its continuing dependence on exports. That means things can quickly go wrong if there are any troubles in the U.S. or Chinese economy ? the two major engines for Japan’s export rise. Some analysts fear both economies could undergo periods of weaker growth in months ahead, reducing demand for Japanese goods.
For this recovery to continue, Japan is counting on outside help. If America can keep zipping along on a rebound for the next two years, as the Trends editors expect it to, then Japan is “back in business.”
Beyond uncertainty in the demand for exports, the other danger analysts cite is the continuing risk of deflation. For about five years, prices have been falling in Japan, a very unusual situation for an industrialized nation, because economists typically have to worry about inflation. Dropping prices depress profits and paychecks and create expectations that discourage investment. This is the sort of environment that the United States faced in the 1930s.
That’s why some Japanese analysts, like Shuji Shirota, economist with Dresdner Kleinwort Wasserstein in Tokyo, believe renewed recession is likely as soon as next year. “The economy is expected to lose momentum by the latter half of the year,” he said, citing deflation and a backlash “correction” toward weaker growth in the January-March period.
Exports for the quarter grew 4.2 percent, while private sector investment surged 5.1 percent. Private consumption, long a weak spot, edged up 0.8 percent, as people snatched up liquid-crystal display TVs, game machines, video equipment, and other home appliances. That growth was propelled by a blossoming digital gadget market both at home and abroad. That’s why some are calling this an “IT recovery.”
Jeremy Warner, writing in London’s Independent, reported “a real sense of optimism and renewed confidence in the air. The world’s second-largest economy is growing again, albeit only marginally in nominal terms, business investment is picking up, exports are booming, and even Japan’s 12-year long banking crisis shows signs of abating.”
He points out that “Japan at long last seems to be getting macroeconomic policy right again, both at the fiscal and monetary level. After years of blaming each other for economic calamity, Japan’s two most important policy-making organizations, the Ministry of Finance and the Bank of Japan, seem to have settled their differences to pursue a co-coordinated, pro-growth approach to policy.”
The key element of this policy is zero interest rates. While the markets remain skeptical, Warner insists that the Bank of Japan intends to maintain the policy for as long as it takes to inject a bit of inflation back into the Japanese economy.
The other key feature of macroeconomic policy in Japan, according to Warner, is currency intervention. “The Ministry of Finance is spending trillions of yen buying dollar assets. That in turn depresses the value of the yen against the dollar, which has helped support the Japanese recovery story by enabling Japanese exporters to exploit the explosive economic growth going on in China.”
Other issues are contributing to Japan’s new economic situation:
On the labor front, Toyota is negotiating with labor unions to switch factory workers from age-related pay to a merit-based scheme. It has decided to leave the seniority-based pay system behind because the game has changed completely. The company realizes that in a globally competitive environment, it must encourage people to improve themselves.
Toyota is not alone. The Financial Times reports that “In recent years, Japanese companies have been adapting to changing demographics and a frostier economic climate by gradually breaking the link between age and wage. A survey released [in December 2003] by Keidanren, the business federation, shows that 40 percent of its 1,584 members have either scrapped or modified age-related pay, or are in the process of doing so.”
In the post-war period, companies promised higher wages related to experience, and were therefore able to foster loyalty, allowing them to train staff in new manufacturing techniques without fear of losing them to competitors.
But as the workforce ages, it’s more difficult for a company to meet the high wage bills, especially as the government presses businesses to raise the retirement age. This is largely another consequence of Japan’s atrocious demographics.
Official Japanese statistics show that record numbers of Japanese marriages are being dissolved. The average age of marriage for women is at a high of 27.4 years, and the number of babies born last year was the lowest since official records began. The national fertility rate is also at a record low.
That means fewer workers to sustain pension payments for the aging Japanese workforce. For the last 20 years, the Japanese have worked under assumptions that no longer prevail. Some analysts fear that Japan has not gone far enough toward reforming its industrial system to cope with the new realities. There’s no doubt that the corporate recovery has been filtering through to households, and consumers are comfortable spending again.
But while employment conditions do look like they’re past the worst, companies are still wary of hiring full-time staff, and bonuses are shrinking. Consumption should stay strong this year, but it’s still far from a full-fledged recovery.
The unemployment rate was 4.7 percent in April, unchanged from March and down from a record high 5.5 percent hit in January 2003. But analysts said the jobless rate may be artificially low due to the replacement of full-time employees by temporary and part-time hires, and by an increasing number of people giving up their attempts to find a job.
Another reason for skepticism is pension reform to cope with an aging population. Changes are expected to require most workers to pay more into the system and receive less. Ongoing pension reforms will inevitably lead to less disposable income. This attracted a lot of press attention and could weigh on consumer sentiment.
The Financial Times points out that Japanese households have been famed for their thrift. If they were not saving in response to government policies aimed at securing a plentiful supply of cheap financing for Japanese industry, they were stashing away cash for their retirement.
But since 1990, when Japanese consumers saved 14 percent of their income, the household savings rate has fallen steadily and hit 6.2 percent in 2002. Recent figures show that, in the first half of last year, households withdrew more from their reserves than they put in for the first time since records began.
The fact that households are running down their savings could point to a fundamental shift in Japan’s economy. But unlike some parts of Asia that are in the throes of a consumer-led boom, Japan’s new spending patterns are born of necessity as people raid savings to maintain their standard of living.
Japan is expected to have roughly one person over 65 for every two of working age by 2025, a higher dependency ratio than any other industrialized nation. Social security costs will rise to address Japan’s dire demographics, and tax breaks for housewives will be abolished later this year. Neither factor will foster domestic consumption.
To cope with this, Japan is seriously considering revising the government retirement system. The Financial Times reports that some radical steps may be in the works. “One idea being discussed at cabinet level is to pay people according to their needs, not their age. Some estimates say as much as 80 percent of total Japanese assets belong to people over 60. The pension system is thus a transfer of assets from the poor to the rich. Another idea is to guarantee a basic minimum pension ? to be funded from a rise in consumption tax ? and to leave any extra retirement savings plans to individual discretion.”
Despite the labor and demographic challenges, the Japanese stock market seems poised for continued recovery. Eiji Kinouchi, an analyst with Daiwa Institute of Research, recently declared the bearish market that has been around since the 1990s is finally over. And, a bull market lasting more than 10 years is about to begin.
With that in mind, the Trends editors offer six predictions for your consideration:
First, we agree with some experts who expect the yen to weaken against the dollar in the months to come. As the yen’s slide gathers speed, it will further help drive up the Nikkei average. Under some scenarios, the short- and medium-term trends could create another asset bubble that will push the Nikkei average to 40,000 in the coming decade.
Second, Japan is going to have to take more aggressive steps if it’s going to keep the recovery going. It needs a leap in productivity outside the manufacturing sector. As the Trends editors began reporting more than a decade ago, the Japanese service sector is one of the world’s least productive. Today, it is only 60 percent as efficient as its U.S. counterpart. McKinsey & Company, the management consulting firm, contends that Japan could grow much more quickly if it deregulated its service sector and let market forces take over. The key is to re-deploy excess personnel into jobs that will be more productive.
Third, Japan will need to raise the retirement age to keep people off the retirement rolls and in productive jobs. The retirement age is already being gradually raised from 60 to 65, but 70 is much more realistic. For that to work most effectively, the seniority pay system, which rewards people according to their age, needs to be watered down even more.
Fourth, Japan must boost the role of women in the labor market. Its economy needs them to contribute now, by working more, as well as in the future by producing more children. The solution to both of these problems is to improve child-care facilities. Legislation designed to greatly reduce the cost of child care for working mothers is now being studied.
Fifth, in the short term, Japan’s outlook is favorable because of its demographics. The children of the baby boomers, the generation of workers aged around 40, will expand over the next decade. People in this age bracket earn and spend a lot, and are the primary buyers of housing, so they will keep the economy going for the next several years.
Sixth, in the long term, Japan’s low birth rate and large population of retirees threaten to unleash a severe depression after 2015. However, if Japan can make the necessary reforms during the next decade, its long-term future is encouraging. To avoid economic disaster, it needs to overhaul its child-care, retirement, regulatory, and compensation systems by making the reforms that we’ve discussed.
References List : 1. To access the article "Summer Rally?" visit the Kudlow & Company website at: www.kudlow.com2. The Associated Press, May 18, 2004, "Japanese Economy Grows 5.6 Percent," by Yuri Kageyama. ⓒ Copyright 2004 by The Associated Press. All rights reserved.3. The Associated Press, May 21, 2004, "International Monetary Fund Says Japanese Economy on Recovery Track." ⓒ Copyright 2004 by The Associated Press. All rights reserved.4. The Financial Times, January 12, 2004, "China’s Growth Helps Japanese Economy," by Peter Riddell. ⓒ Copyright 2004 by The Financial Times Limited. All rights reserved.5. The Associated Press, February 18, 2004, "Japanese Economy Growing Stronger," by Yuri Kageyama. ⓒ Copyright 2004 by The Associated Press. All rights reserved.6. The Independent, December 6, 2003, "Japanese Economy Stands at the Crossroads of Reform," by Jeremy Warner. ⓒ Copyright 2003 by Independent Newspapers (UK) Limited. All rights reserved.7. The Financial Times, December 18, 2003, "Businesses Aim to Cut Japan’s Links Between Age and Wage," by David Pilling. ⓒ Copyright 2003 by The Financial Times Limited. All rights reserved.8. New Zealand Herald, December 3, 2003, "Women Force Change on Japan," by Fran O’Sullivan. ⓒ Copyright 2003 by The New Zealand Herald. All rights reserved.9. The Financial Times, January 6, 2004, "Japan’s Once-Thrifty Households Undergo Change of Heart," by Barney Jopson. ⓒ Copyright 2004 by The Financial Times Limited. All rights reserved.10. The Financial Times, January 16, 2004, "Radical Steps Needed to Unlock Japan’s Labour Market," by David Pilling. ⓒ Copyright 2004 by The Financial Times Limited. All rights reserved.11. Nikkei Report, March 25, 2004, "Market Outlook: Top Analyst Predicts Start of Long-Term Stock Rise," by Tatsuya Okada. ⓒ Copyright 2004 by Nihon Keizai Shimbun, Inc. All rights reserved.
