The Medium-Term Outlook for the Japanese Economy (up to Fiscal 2009) Issues to be
Resolved if Japan is to Escape From Deflation and Achieve Sustain
December 01, 2004
Since mid-2004, under the impact of production adjustments in the electronic devices sector, the slowing of export growth and a rise in raw materials prices, among other factors, the Japanese economy has begun to shows signs of entering an adjustment phase. However, against the backdrop of a recovery in consumer confidence, consumer spending has remained firm, the stance of the corporate sector on capital investment has held steady, and the economic trend has not seen any significant slump.
The following three factors are likely to hold the key to the trend of the economy in fiscal 2005: (i) the economic pulling power of external demand, (ii) the impact of the rise in the price of crude oil, and (iii) the pressure for adjustment in the manufacturing sector.
Although the US and Asian economies are decelerating gently, it is unlikely that the overall economic trend will lose momentum. Given the solidity of overseas economies, Japanese exports, although likely to slow, should avoid a major downturn, and thanks to the improvements in profitability achieved by the corporate sector and the fall in the prices of imported raw materials, the negative impact of the strength of the yen is unlikely to worsen unless the appreciation of the yen accelerates.
Given the difficulty in passing on cost increases to the price of final goods, the rise in the price of crude oil is likely to exert a downward pressure on profits but as sales growth is expected to generate additional revenue, is unlikely to have any serious impact on business results. However, it should be noted that because the rise in the price of crude oil will also exert downward pressure on overseas economies, there is a risk that its negative impact on the Japanese economy will grow as a result of a fall in exports.
Given that global demand is holding firm and that the kind of rapid expansion of production capacity seen in 2000 has been avoided, production adjustments in the electronic devices sector are likely to be relatively slight. Moreover, as the economic pulling power of machinery other than electrical machinery (materials-related machinery, automobiles, etc.) is increasing, it is unlikely that the level of production activity in the manufacturing sector as a whole will see a major fall.
Given these considerations, although the Japanese economy must inevitably undergo some adjustment in the short term, from the second half of fiscal 2005, it is likely to head towards recovery, led by the corporate sector.
The outlook up to fiscal 2009 depends on four key factors: (i) the profitability of the corporate sector, (ii) the recovery potential of the household sector, (iii) Japan escaping from deflation, and (iv) the restoration of soundness to public finance.
Although the rise in the prices of materials will continue to squeeze profits, the continued efforts of the corporate sector to improve business efficiency, curb personnel costs, and reduce the interest burden mean that profitability is likely to improve still further.
Given the persisting downward pressure on the labor share, there is little hope for any significant improvement in income conditions. However, the sharp downward trend of incomes since 1998 has been halted and income conditions are likely to see a gentle recovery in the future. As a result, taking into account the increase in the tax and social security burden, disposable incomes are likely to remain at much the same level. Moreover, as propensity to consume is likely to rise owing to the recovery in consumer confidence and ongoing population aging, consumer spending is set to grow at a rate of around 1% a year on a nominal basis.
Thanks to the narrowing of the supply-demand gap narrows, from 2006 onwards, the prospect is that Japan will be able to escape from deflation. However, as employers are likely to continue to curb wages, the rise in prices is likely to be a slow one. Furthermore, most of the increase in raw material costs will continue to be absorbed by the corporate sector and it is likely that little will be passed on to the prices of final goods.
If public finance is to be set on the road to soundness, Japan must simultaneously achieve a higher rate of growth through economic revitalization, a rationalization of expenditure and an increase in tax revenues. Any increase in the burden on households is conditional on eliminating anxiety over the future in the household sector, and to this end it will be essential to rebuild the social security system.
Given these considerations, it is likely that the Japanese economy will continue to recover at a gentle pace after fiscal 2006, led by the corporate sector. However, the gradual increase in the burden on households means that it will be difficult to raise consumer spending from its present low level. As the recovery potential afforded by domestic demand is likely to remain weak, it will not be possible to eliminate the risk that an external shock will cause the economy to lose momentum.
To maintain the latent economic growth rate, it will be necessary to "normalize" (i) the "three excesses" of the corporate sector, (ii) the capacity for innovation in the corporate sector, (iii) the national standard of living, and (iv) fiscal and monetary policy. Given these considerations, the corporate sector must (i) concentrate management resources in growth areas, (ii) implement advance investment in future industries and (iii) rebuild personnel and wage systems. The government, for its part, must implement a range of measures to strengthen the constitution of the Japanese economy and support reform in the corporate sector. Reviews of the social security system, devolution and public finance must be priority issues and the burden on households should be increased only once the prospects for the reform of these systems have been established.
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Hideki Matsumura / Hisashi Yamada