The Nikkei Financial Daily (Market Eye Column)., 25th December 2006
Substantial revisions to Japan’s GDP data were published on 8th December, 2006; they show that the economy grew even more slowly than was previously feared, and this applies to any time period chosen from the past 10 years to the past one or even the past quarter.
The most significant changes were those made to private consumption. It now appears that the slow rate of growth in private consumption previously recorded was an overstatement, compared with the rate which was actually achieved. Consumption is now shown to have fallen over the past year and to have only risen by 0.8% p.a. over the past decade. Even before the revisions the Cabinet Office had announced that “Private consumption is almost flat”. These new data underline the fact that Japan’s economy remains dependent on export growth and that the frequently heard claims that the economy is now driven by domestic demand are not supported by the data.
Japan’s economy has an “Elephant in the Room”; that is to say a very large problem which few people apparently dare mention. This would pose a threat to the economy, even if it were widely recognised and discussed. It is, however, made worse by being ignored. This “Elephant” is the excessive and unsustainable level of investment. Despite a downward revision in the latest data, private non-residential investment was still recorded in the third quarter of 2006 at 15.9% of GDP. This is nearly 50% higher than the level of such investment in the US, despite the fact that the US economy has an underlying growth rate which is around twice that of Japan.
For the moment, the Japanese economy is being sustained by growing export volumes, which in turn stimulate investment, because exports require much more capital per unit of output than the goods and services which respond to rises in domestic demand.
In recent years the household savings rate has fallen and, although the decline appears to have halted recently, it could obviously resume its fall, and this would be extremely welcome. What is, however, unlikely, is that such a fall could be sufficient on its own to sustain strong consumption growth over the next two or three years.
This is very important as, in order to move to a sustainable growth path, Japan must shift to a consumption driven economy. As a further significant decline in the household savings rate is unlikely, a rise in the contribution of consumption to overall growth requires a rise in household disposable incomes as a proportion of GDP. The problem with this is that it must be accompanied by a fall in profits. It will be difficult to keep the economy growing at a satisfactory speed while this happens, because investment is more volatile than consumption and usually falls when profits are weak.
Before the revisions to the data, it appeared that GDP was still growing above trend so that, if the rate were maintained, real wages should start to accelerate in due course. On the latest data this has become doubtful. A pick up in the rate of growth is needed and this depends crucially on export demand remaining strong, notably in the US and China, which together take 40% of Japan’s exports. In neither country have the recent data been encouraging.
Although published before the recent downward revisions to Japan’s growth, the OECD’s latest Economic Outlook (No. 80 November 2006), remarks that for Japan “deflation is not over yet”. It would indeed be deeply depressing if it were, as it would imply that the output gap in Japan had closed. Given the slow growth in GDP over the past decade and the acceleration in the rate of decline in the working population, this would imply that the underlying trend of growth for Japan was now less than 1% p.a.
The absence of inflation to which the OECD refers is shown by the most recent data. Over the year to November the Tokyo CPI is unchanged and the GDP deflator for Q3 is down 0.7%.
Fortunately for Japan, the yen has remained weak and, so long as domestic demand in the rest of the world is sustained, Japan should be able to benefit from this weakness and the competitive advantage that it brings, by increasing exports at a brisk pace. Provided that the world economy remains buoyant, Japan should be able to grow fast enough to allow real wages to accelerate.
It is, however, far from certain that this will happen and it must be hoped that the Bank of Japan will not increase interest rates until the output and price data give greater justification for such action than they do today.