Japan to deliver the deep internal reforms required to jump-start its idling domestic market and transform it into a strong engine of global growth. Unfortunately, this moment has yet to arrive. Japan still relies on growth in the world economy, which means the world cannot yet rely on Japan.
Consider what is really happening in Japan’s domestic economy. Employment and wages have risen for the first time since 1997, and on its own terms the economy appears much healthier. External factors, however, particularly export orders for industrial goods, still play a too-large role in determining productivity, profits and domestic investment plans–and, ultimately, employment and wage growth.
If we look back over the past 15 years, Japan’s economy has tracked the U.S. and global cycle. It appeared to rebound on the back of the global recovery in the mid-1990s, only to be hit again by the 1997-98 Asian financial crisis. Then Japan regained its footing, only to retrench in the aftermath of the 2001 U.S. recession.
Today Japan is enjoying the aftereffects of an enormous “shot in the arm” provided by the surge in industrial-equipment exports to China in the 2002-04 period. Japan’s export base increased at about a 20 percent annual rate between 2002 and 2004, with almost a quarter of this growth coming from China. At times during this period, Chinese imports were rising at about a 50 percent annual rate, while Japan’s exports to China were rising at an almost 60 percent rate–the majority of these exports concentrated in the all-important industrial-equipment sector.
This is a thin base on which to build national economic recovery. The surge in Japanese exports in the past four years has had a huge impact on Japanese productivity and profitability. In the 2000-04 period, Japanese productivity was running at a near 5 percent annual rate, and corporate profits accelerated to almost a 40 percent year-over-year rate by the second half of 2004. But these dynamics have changed markedly in the past 18 months. Export growth is still holding up at about a 10 percent annual rate, but productivity gains are meager and profit gains are slowing sharply–up at only a 5 percent annual rate in the first quarter of this year.
It is hard to deny that Japan has become much more competitive–particularly in the auto and electronics sectors. But it’s also hard to see that these competitive dynamics have imbedded themselves in the domestic business culture to such an extent that the Japanese economy can propel itself forward in the absence of rapid growth elsewhere in the world, especially Asia. Asia now accounts for 50 percent of overall Japanese exports, of which the China share alone is 20 percent. Indeed, China is set to surpass the United States shortly as Japan’s main export market.
The question is, what have this export growth and surge in profitability done for the domestic market? Overall domestic sales growth is running in the range of 2 to 3 percent a year in real terms, and growth in investment spending is up to about a 4 to 5 percent annual rate. These numbers reflect good performance from a historical perspective but lag the 2 to 3 percent sales growth in the United States, and pale in comparison with near-double-digit U.S. investment growth.
The Japanese consumer is playing a role here, with consumer spending rising 2.4 percent in the first quarter as a result of relatively small gains in employment and wages. These are the first advances in 10 years. However, much of Japan’s competitive resurgence has come as a result of repressing employment and wages (not unlike in Germany). Can these gains continue at the same pace in the slower-growth–and apparently lower-productivity–economy ahead?
Financial markets appeared to reassess the Japanese outlook in May and June. Although the Nikkei has recovered somewhat, equity markets are considerably more cautious on the outlook than at the peak. Japanese GDP is forecast to grow no more than 1.7 percent, and some Japanese analysts are looking for growth rates of only 0.9 percent by 2008. Given the headwinds of central-bank tightening and what appears to be a slow slide in equity values, enthusiasm for Japan’s resurgence–like the economy itself–is likely to continue to cool.
