Financial Times, 8th December 2009
Since its bubble burst in 1990 Japan has suffered from a badly skewed economy. It has saved and invested too much and consumed too little. Investment is only worthwhile if it produces growth. Over the past two decades Japan has invested more of its GDP than any other G5 economy and has grown more slowly. Much of Japan’s investment has simply been wasted. This absurdity has been obvious and yet ignored. As it has seldom been discussed, the problem has never been addressed. At last, by luck rather than better understanding, things are looking up.
Japan runs a current account surplus at the same time as over-investing at home. Only high domestic savings has made this possible and while the fact of Japan’s high national savings’ rate is well known, its sources have been persistently misunderstood, both in Japan and internationally. It is commonly attributed either to the high savings of individuals or the meanness of companies’ dividend policies. In fact, household savings are lower even than in the US, the government has large negative savings and companies’ undistributed profits are negligible. Capital consumption is the equivalent of depreciation in national accounts and only its high level, mainly in the corporate sector, has enabled the national savings’ rate to be so high. A comparison between Japan and the US shows how important this is. The latest data show that capital consumption amounted to 12.5 per cent of US gross domestic product but 21.1 per cent of Japan’s, whose high level is simply the result of past over-investment. A fall in investment is thus an important first step towards getting Japan’s economy into better balance.
The output of companies is shared between wages and broadly defined profits, which include depreciation. Labour incomes are much lower in Japan than in other mature economies, with household disposable income, as a proportion of GDP, far lower than in any other G5 country. But, with the recession, wages are now taking a higher proportion of output than ever before and the labour share is now higher than in the US. With the recovery, profit margins will no doubt improve and the labour share fall back a bit but, even if profit margins remain stable, profits before tax should rise usefully as depreciation falls.
This will be a very helpful development. Good profits will reduce pressure on companies to cut employment, while a higher labour share of output will allow household spending to rise, even without a further fall in savings’ rates. In combination this provides the prospect of a rebalanced economy driven by consumption rather than by investment.
Business investment has fallen sharply over the past year and, while this is very helpful for the longer term in rebalancing the economy, it has been bad for demand in the short-term. To prevent the recession from being even more severe, the government has had to run an even higher budget deficit than before. High budget deficits and low bond yields are a worry everywhere, but are the usual and, in the short-term, helpful responses to the recession. Without the deficits, the recession would have been many times worse. With recovery, however, the problem will rapidly reverse. Governments will have to reduce fiscal deficits quickly and, even if they do, the bond market looks like an accident waiting to happen.
Japan, with its high gross debt to GDP is often seen as being especially vulnerable, but in many ways it is better placed than either the US or the UK. This is partly because the debt problem is frequently overstated, as net debt is only about half the gross level, but also because the switch from investment, financed by untaxed depreciation, into incomes and spending which are taxed twice, will mean that tax revenue should rise rapidly with recovery. Japan is a country of high tax rates, but has the lowest tax revenue to GDP among G5 countries. It combined, in the first six months of this year, the top corporation tax rate with negative revenue from it. It is easier to raise tax revenue when it is low than when it is already high and particularly easy when tax rates are already high but not collecting much revenue.
In addition, the Japanese bond market has little if any exposure to two great threats found elsewhere.
A rise in inflationary expectations is one and such fears are less likely to pick up in Japan than almost anywhere. Another is the need to reverse quantitative easing. But the Bank of Japan, unlike the Bank of England and the Federal Reserve, has no mass of bonds on its balance sheet that must be sold.
The new DPJ government is lucky. It has been elected at the bottom of the recession and expectations for it are low. No government today will find policy easy, but the DPJ has the advantage of intuitively favouring consumption over investment. Having the right attitude is not a sufficient condition for having the right policies but it is a necessary one.
Copyright The Financial Times Limited 2009