Despite four years of economic stimulus, Japan’s economy remains only 2.2 per cent bigger in real terms than when Prime Minister Shinzo Abe came to power promising massive structural reforms.
But while Japan’s government is pushing companies to increase investment at home and raise wages to boost demand, stimulate the economy and escape deflation, the pace of improvement remains subdued.
Better than expected Q1 growth means Japan avoided another technical recession, defined as two consecutive quarters of negative growth. The faster than expected pace of growth suggests the Japanese economy is managing to shake off the effects of a slowdown in China and a stronger yen — at least for now — with domestic demand having more momentum than previously thought.
Size of the economy
Prime minister Shinzo Abe has pledged to expand the size of the economy to Y600 trillion. Recent growth in nominal GDP, driven by higher prices, is one of the most encouraging signs of success for Abenomics.
The decline in Japan’s population makes it crucial to measure GDP and growth relative to the number of workers. By this measure, Japan has not done badly in the last two decades.
Where is Japan going?
After two decades of economic stagnation, Japan’s return to growth is hampered by the twin challenges of an ageing population and the mountain of public debt built up during years of on and off deflation.
The country’s main bet is to focus on higher growth, rather than fiscal consolidation, to tackle the world’s largest public debt of 246 per cent of gross domestic product. But progress has been slow.
Japan’s government bases its fiscal plans on an optimistic scenario of revitalised growth. Most private economists think even the baseline case will be a challenge.
Most forecasters think there is still some spare capacity in the economy, so Japan can grow above its 0.5 per cent long-run trend. China’s slowdown has hit 2016 growth forecasts.
The drag from a falling population means Japan will grow much more slowly than G7 rivals. The public remains hostile to higher immigration, one force that could raise overall growth.
Movements in the bond and currency markets are a barometer of investor expectations about a country’s economic prospects - and those of its rivals.
The Japanese Yen in particular tends to benefit from its perceived-safe haven status, particularly when there is turmoil in the Chinese markets.
Bank of Japan quantitative easing has driven long-term bond yields to record lows. Some market participants are worried about liquidity, as the BoJ buys ever more of the total stock. Read more
Japanese government bond yields fall to record lows
One of the great successes of Abenomics is to end the long-term overvaluation of the yen. Strong US growth could weaken the yen further; a loss of will by the Bank of Japan could strengthen it.
The other main channel for Abenomics has been a higher stock market, fuelled by record profits and reforms to corporate governance.
Unemployment in Japan is currently at a 20-year low but the sharp division between regular workers with jobs for life, and part-timers with no security, has muted the effect on wages.
Labour mobility for regular workers is very low, while part-timers are often looking for security ahead of a pay hike.
The government has been urging companies to boost pay, helping to contribute to a virtuous circle of increased consumption, inflation and demand.
Proportion out of work
The labour market is tight but it has been tighter in the past. Some economists think the full employment rate may be 2.5 per cent or even lower.
Regarded as a more sensitive measure of slack in the labour market than the unemployment rate, it has also hit record highs recently.
Japan’s fiscal forecasts are banking on the structural reforms of Abenomics generating an acceleration in productivity growth to 2.2 per cent a year by the 2020s — the level prevailing in the 1980s.
A recovery in productivity will be a crucial test of the success of Abenomics. In common with many other advanced economies the recent trend has seen noticeably lower growth.
The problem is more acute in Japan. With a shrinking labour force GDP growth must be based on higher productivity. Growth in output per hour has been low or negative since the global financial crisis.
Japan lags other advanced economies. GDP per hour was around 28 per cent lower than the average for the other G7 countries in 2014.
Japan’s mission to banish deflation, which has dogged the economy for the best part of two decades, has faced headwinds both at home and externally. Pressure is building on the BoJ to launch another stimulus package.
Consumer price inflation
Headline inflation has been dragged down by falling oil prices, but this weakness makes it hard for the Bank of Japan to convince the public that higher inflation is on its way.
A sharp inflation slowdown since the new financial year began in April has put the BoJ under pressure to ease policy further as it battles to sustain public confidence in its policy.
Bank of Japan governor Haruhiko Kuroda regards inflation expectations as crucial to his policy because they can be self-fulfilling, for example through demands for higher pay.
The slowdown in China, and the wobbles in the rest of Asia, threaten to hamper the growth of Japan’s exports. For 30 years until 2010, Japan had recorded a trade surplus every year, and its persistent trade surpluses were once the subject of political battles with the US.
But in 2014 Japan’s trade deficit was the worst on record, as the weaker yen has meant the country has been hit by a painful rise in the cost of imports. This came as the country was forced to import more fossil fuels after the Fukushima disaster.
Current account balance
Despite weakness in the trade account due to fuel imports, income from Japan’s large portfolio of foreign assets has kept the current account in the black.
Exports have not done as well as expected given the weakness of the yen, reflecting the slowdown in China, and two decades of offshoring by Japanese manufacturers.
A weaker yen boosted the value of Japan’s overseas holdings in 2014. The country has been the world’s biggest creditor nation for 24 consecutive years
Japan is banking on consumption rising to help it push inflation higher. But while wages have risen, this has not turned into rising consumption. Some policymakers fear this could be due to Japan’s aging demographics and pensioners struggling on fixed incomes. There are now seven pensioners for every 10 salaried workers — and the ratio is rising fast.
Consumption has also been weak since Japan lifted its national sales tax from 5 to 8 per cent in April of 2015 as part of its acute need for revenues.
Consumers have proven unwilling to dip into their pockets, partly reflecting the lingering after effects of a 2014 hike in sales tax, and the prospect of another in 2017.
With the price of many imported staples rising due to the weak yen, and wages slow to pick up, consumers have felt little benefit from Abenomics.
The car market is one of the most exposed to Japan’s aging demographics. The population is not just falling, but moving to the dense Tokyo area.