OECD Observer: Growth in Japan has been surprisingly strong. What caused this upturn?
Randall Jones: The key factor seems to be that the restructuring efforts of firms during the past few years, such as shedding jobs and cutting costs, have paid off in higher profits. Indeed, profits increased by 16% in financial year 2002, with a further rise projected in FY 2003. Improved profitability has supported a rebound in business investment and helped to stabilise employment and wages in the first half of 2003, with positive effects on private consumption, which increased at a 1% annual rate in the first half of 2003. The stronger growth in domestic demand offset a slowdown in exports, despite strong demand from China.
Many economists are now forecasting that the Japanese upturn will continue. Should we be encouraged?
RJ: Japan has recorded seven consecutive quarters of growth, at an annual rate of around 3%. That means this recovery is already proving to be more durable than the previous one, in 1999-2000, which lasted six quarters. Already, we are starting to see stronger Japanese export growth as the long-awaited rebound in world trade is materialising.
While this should ensure that the Japanese recovery continues through 2004, there are a number of serious problems that could jeopardise the robustness of the Japanese economic upturn. Deflation, which began in the mid-1990s, continues to have a negative effect on the economy. Although the headline inflation figure is approaching zero, the underlying rate of deflation, excluding the impact of higher regulated prices, remains around 0.5%. Meanwhile, bank lending is still declining at an annual rate of about 2%. The pressure for a rise in the yen and the strains associated with rising public debt – now at 150% of GDP – pose risks to a durable expansion. Indeed, the fiscal position is not sustainable, making a credible medium-term consolidation plan essential.
Another issue is that the steady downward trend in the household saving rate since 1998, which has supported private consumption, may not continue. Already, the savings rate has fallen from 11% to 6%, which is well below the OECD average.
How do you see the longer-term outlook?
RJ: The Japanese upturn is indeed good news, but a cyclical recovery does not reduce the urgency of accelerating the pace of structural reform, especially in the financial and corporate sectors, to boost Japan’s growth potential. Under the Koizumi government, some progress has been made in implementing reforms. In the financial sector, for example, banks self-assessment of asset quality has been improved, while the proportion of nonperforming loans has been reduced. Urban zoning regulations have been reformed to encourage more efficient use of land, while the requirements for starting new companies have been eased. Furthermore, Japan recently allowed the creation of special structural reform zones in which some key regulations can be relaxed in certain areas.
However, a successful programme to revitalise the economy would require a wide-ranging package of structural reforms, in particular to strengthen domestic competition, which would improve efficiency, and so benefiting consumers.
One priority for reform is the banking sector, which remains burdened with a high level of non-performing loans, weak capital and low levels of profitability. A robust and sustained economic recovery requires a reversal of the declining trend in bank lending. A second priority is to enhance competition in a number of domestic sectors. In essence, Japan has a dualistic economy, with a highly productive, dynamic export sector alongside a low productivity domestic sector. This results in prices that are high by international standards, thus reducing the welfare of Japanese consumers.
The recovery is encouraging and a broad reform programme now, accompanied by appropriate macroeconomic policies to keep progress steady, would help ensure that Japan’s decade of economic stagnation is coming to an end.
©OECD Observer No 240/241, December 2003