Nikkei Veritas – Market Eye column, 28th September 2008
Japan’s economy is disappointing the optimists yet again. The recent fall in GDP was treated as a surprise by much of the financial press. According to a Financial Times article of 14th August by Michiyo Nakamoto and Chris Giles Japan was “…an unlikely victim of global economic woe.” While some commentators have been more realistic, the expectation that Japan would be relatively immune from the current global downturn has been shared by many. An example is provided by the OECD, which has been steadily revising down its forecasts for this year and next, but less aggressively for Japan than for the US and the Eurozone.
It is unlikely that changes in either fiscal or monetary policy will put the Japanese economy back on the path to recovery. The Ministry of Finance and the Bank of Japan therefore tend to express less pessimism than they probably feel. As they are not going to revitalise the economy through action, they are anxious not to be blamed for comments that might make things worse. Meanwhile those involved with the stock market have careers and incomes which realism, let alone pessimism, puts at stake. It is no wonder, therefore, that the economy fails to live up to the hopes of those who most often express their views on it. But there is also, as I have regularly pointed out in this column, a more deep-seated reason. Japan continues to suffer from long-term structural imbalances, which are unlikely to be addressed until they are discussed and debated – something which has been most notable by its absence.
Japan has relied, for the limited growth that it has managed in recent years, on exports and on the corporate investment which depends on them. Domestic demand has been weak and misallocated, with consumption being too low and corporate investment too high. Relative to GDP, Japanese companies spend 50% more on domestic investment than US companies. This would only be worthwhile if Japan grew much faster than America, but in fact it grows much more slowly. Japan gets bad value from these investments, much of which is wasted, and the result is a very poor return on capital.
The economies of the world, including China’s, are slowing and, as they do, Japan’s reliance on exports becomes an acute rather than a chronic problem. Japan therefore needs to boost its domestic demand. As investment is too high and dependent on exports, this must come from consumption. Higher consumption can only be achieved by Japanese households having higher incomes or lower savings. But over the past decade savings have fallen from 11% to 3% of incomes and while they could fall further, it seems unlikely that they will decline enough to drive the economy forward. Higher consumption thus requires higher consumer incomes, which are lower in Japan, as a proportion of GDP, than in any other major economy.
If consumers are to be relatively better off, they can only become so at the expense of some other sector of the economy and the only candidates are the government, foreigners and companies. As the government is seeking to reduce its deficit and the current account surplus is already so large, the only likely way to increase consumer incomes is for wages to rise and profits to fall.
The idea that falling profits are essential for a sustained recovery of the economy is, naturally enough, not an idea which appeals to those involved with financial markets. But it has a more serious problem, which is the difficulty of moving to a consumption driven economy without the economy being very weak while the change occurred.
It is easy to see how the Japanese economy could be performing well in a few years’ time, with consumption taking a much higher proportion of GDP. The difficulty is how to get there. If the government could wave a magic wand and shift income from profits to wages, the immediate result would probably be a severe recession. On past experience, consumption would rise in response to the rise in wages, but would only do so slowly. Investment, however, would fall sharply as profits fall so that, on balance, the economy would be weak in the short- term. Japan’s structural imbalances thus remain a major impediment to growth, which is unlikely to be solved quickly.