Overview

The Japanese economy escaped from its plateau phase in mid-2005 and there are now signs that the recovery trend is gathering strength. However, the high price of crude oil, uncertainty over the future of the US economy and the increased burden on household finances, among other factors, still give still grounds for concern. This article first considers whether the economy will be able to overcome these negative factors and maintain its present recovery trend during fiscal 2006. It then examines the fact that Japan is in the process of resolving the "problem of the 3 excesses" under which it has labored since the bursting of the bubble, but at the same time is entering an era of full-scale population decline and, on the premise that the economy is currently at a "historical turning point", goes on to consider the outlook for the medium-to-long term.

A preliminary analysis of economic conditions overseas indicates that the global economy is currently facing "three risk factors": (i) a housing bubble in the United States, (ii) high crude oil prices and (iii) an imbalance of trade between the US and China. However, owing to China's state of oversupply, the stability of the yuen exchange rate and a backflow of oil money, a paradoxical state of affairs has arisen, in which high prices for crude oil and other natural resources are found side by side with low sales prices and stable interest rates and, in the short term, the emergence of the three risk factors is likely to be avoided. The balance will be disrupted once China's state of oversupply is resolved and interest rates around the world begin to rise in earnest.

Although the pace of economic recovery is likely to slow to some extent during fiscal 2006, owing to a slight slowdown on the part of the US economy towards the second half of the year, the fact that high crude oil prices are exerting downward pressure on business performance and the fact that the burden on household finances is set to rise as a result of a cut in the fixed rate income tax reduction and an increase in social security contributions, the basic recovery trend is set to continue owing to the fact that companies are beginning to take a medium-to-long term approach to capital investment and income and employment conditions are steadily improving.

A medium-term economic forecast based on population trends suggests that the burden of personnel costs on the corporate sector will be alleviated, while the boost to consumption provided by one-off retirement benefit payments to the dankai generation of late baby-boomers and the rise in home purchasing by the "dankai junior" generation and its knock-on effect in the form of the purchase of consumer durables means that economic growth is set to continue after 2007. In the absence of any substantial external shock, economic expansion is likely to continue to around 2010, until when the number of people in the core home-purchasing age bands will continue to rise. By contrast, from 2010 onwards, population trends are set to exert downward pressure on the economy, as the boost to the economy provided by the retirement of the dankai generation and home purchasing among the "dankai junior" generation tail off and the fundamental growth of consumption in parallel with population growth slows. Moreover, given the risk that the Chinese economy will move into an adjustment phase after the Beijing Olympics and the Shanghai World Expo, it is possible that the Japanese economy will experience its first recession due to population decline around 2010-2011.

However, although population decline is set to accelerate from the second half of the 2010s onwards, and the basic growth potential of consumer spending as calculated on the basis of the age structure of the population is set to see a sharp fall, there will also be a number of new growth frontiers. If new growth frontiers based on the "active senior market", the "global market" and the "outsourcing market" are developed, it should be possible to ensure an average growth rate of between 1% and 2% for fiscal 2011-2015 and even of 2% in the second half of the decade, if the global economy begins to recover.

Once Japan escapes from deflation and the nominal growth rate begins to recover, long-term interest rates will naturally rise. A rise in interest rates will exert pressure on business results by raising interest expenses. On the other hand, higher interest rates go hand in hand with economic recovery and as long as the rate at which interest rates rise matches the rate at which the economy recovers, its impact on business income will be virtually neutral at the macro level. In the medium-to-long term, however, if China's oversupply is resolved and Japan's current account surplus decreases, it is possible that interest rates will rise faster than the nominal growth rate. This makes it all the more important that, over the next five years or so, during which the stability of prices and low interest rates that Japan has enjoyed until now will basically be maintained, companies should strive to further enhance their profitability and that the government should set out a roadmap for restoring soundness to government finance.

Six major policy issues must be resolved over the next five years: (i) the decentralization, outsourcing and rationalization of the government sector, (ii) the strengthening of human and intellectual capital, (iii) the establishment of a market with unified rules applying both in Japan and outside, centering on the Asian region, through the FTA, (iv) the creation of efficient and innovative financial markets, (v) the establishment of an efficient social security system that encourages people to work and (iv) a radical reform of taxation systems. As to the key issue of how far to raise the consumption tax rate, provided expenditure is subjected to a thorough rationalization, an increase of four points should make it possible to bring the primary balance back into surplus during the first half of the 2010s.

For more information on the content of this report, please contact: Hisashi Yamada / Makoto Ishikawa the Japan Research Institute, Limited.

Tel: 03-3288-4524
E-mail：yamada.hisashi@jri.co.jp / matsumura.hideki@jri.co.jp

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