The blow of the Asian crisis, domestic banking failures, burgeoning fiscal deficits and a severe recession in 1997-98, with an unprecedented rise in unemployment to higher than US levels: the sun might not have gone down on the land where it is said to rise, but the world’s second largest economy has been decidedly gloomy in recent times. Yet, economic turnarounds do happen and though they are always difficult to be sure about in the early stages, a glimmer of light may have appeared on Japan’s horizon. The question is, does it herald a new dawn for 2000 or just a false one?
Japan’s latest recession was one of its severest since the war, as witnessed by the cumulative loss in output by end-1998 of around 5.25% from the previous cyclical peak seven quarters earlier. Businesses cut spending to maintain cash flow as sales plunged. Outright dismissals became less rare, while there was a squeeze on overtime and bonuses. Together with lower regular wages, this all cut into disposable incomes and household expenditure. Anxiety about jobs mounted in the face of the inexorable rise of the unemployment rate. People became worried about their health-care costs, about the value of their pensions and tax liabilities in the light of the increasingly severe public financial situation. Little wonder households tightened their spending. Even the external sector could provide little buffer against the downturn, with Asia’s crisis hitting especially hard.
So, has it all really ended? Most indicators show that there was probably some growth in 1999, with GDP expanding in real terms by about 1.4%. But 2000 is not easy to call, partly because of the conflicting evidence that is so typical of the early stages of recovery. The labour market in particular is still flashing red – the unemployment rate has risen to nearly 5% – it averaged 4.1% in 1998 and was only 2.1% in 1990 – and it may well stay around that level for some time yet, particularly as it takes time for trends in the business cycle to feed through to unemployment. But elsewhere the signs are encouraging. Confidence has returned, financial markets have rebounded and private spending has picked up, leading to destocking and a resumption of output growth.
But why did confidence turn up in the first place? One important reason is government. Not only did it gain points for introducing a fairly bitter medicine to stabilise the ailing banking system, which should work – at least for now – but its macroeconomic policies have been eased markedly. This includes the world’s first attempt to run a zero-interest-rate policy. Moreover, the government applied budgetary stimulus fairly relentlessly over the past year and a half, as well as dishing out lavish new public loans and credit guarantees. It all finally proved enough to convince both consumers and investors to loosen their wallets.
A burgeoning deficit
Old fashioned pump-priming may have proved its worth in sparking the economic turnaround, but the price has been a wide government deficit of around 7.5% of GDP. Much of the deficit was run up by the nation’s 3,300 local governments, whose role in terms of stabilising the economy has been key to the government’s strategy. However, the central government deficit did slip off the rails a little too. Most of the government deficit – about 6.7 percentage points – is believed to be structural, which means that economic recovery alone will not cure it. Hence, the urgency of consolidation, and with growth so weak, government indebtedness has shot up. Total gross debt of general government (which also includes social security) is expected to reach about 114% of GDP in 2000, which puts it up at Italian levels.
Can the government turn its financial situation around, even with ageing-related cost pressures likely to build? It is a daunting challenge and it will take several years to surmount. Growth is not expected to be particularly dynamic and may be outpaced by real interest rates. Debt will therefore continue to rise. That means looking for cuts elsewhere, in health care for instance, where there is some room for tightening. The government might also look to cut back on public investment. Another option would be to sell off some government assets, like land, equipment and buildings, to help reduce debt, as well as some financial assets, such as its 59% share in Nippon Telegraph and Telephone. However, the overall contribution of such sales to reducing debt would be negligible.
Still, the government’s unenviable financial situation does not appear to have dented public confidence yet. True, there could be a relapse in 2000, for example, if company restructuring hits job security and unemployment rises. But a relapse is unlikely, as most of the downsizing will take the form of early retirements. Moreover, there is a lot of pent-up household demand and confidence is returning to the business sector as well.
Nevertheless, corporate restructuring, which should probably have begun years ago, may act as a drag on growth next year. This will exert downward pressure on labour compensation – wage payments per worker fell by 1.4% in 1998 – and though companies will continue to reduce labour costs by freezing new hires and holding down bonuses, a rise in redundancies seems inevitable. Aggregate employment dropped by 0.7% in 1998, the first decline since 1975, with a large fall in the construction and manufacturingsectors. Blue-collar workers were not the only ones to feel the pinch. Management jobs which, according to the Ministry of Labour, are in greatest excess supply, also declined, by 5.8% in 1997 and 1.9% in 1998. Early retirement and other voluntary schemes still appear to be important, but the rise in unemployment due to involuntary separation accounted for more than 60% of the increase in unemployment in 1998. When the Japanese rate finally bobbed above the US rate in December 1998, it was the first time it had done so in its post-war history.
Although the difference is just half a percentage point – 4.7% compared with 4.2% – it is an unwelcome grain of salt in Japan’s wounded economy. The recession led to lower spending across all income groups and a double digit decline in housing starts. It was also deep enough to send bankruptcies soaring. The government has since taken action to reduce them. Nonetheless, those companies that survived now face the three-pronged challenge of reducing their corporate debt, which built up strongly in the recession, boosting profitability and generating the returns demanded by their shareholders. Some have already begun to act, under pressure from financial markets, by cutting back on investment more savagely than at any time in the post-war era. Rationalisation has become a buzz word, whether through mergers, plant closures or asset sales. But is it all enough? For the corporate sector to achieve its profit goals and expand returns on assets and equity, more than a standard cyclical recovery will be required. Changes are needed in corporate governance that will help to focus managerial minds on profitability. And labour’s share of national income will have to decrease by a few percentage points too.
But corporate restructuring is unlikely to rattle the economy, even if it changes it. In fact, most of the corporate restructuring will take place in large firms where less than a fifth of the work-force is employed. If redundancies start to rise, then it may be cold comfort to remember that a similar process of shedding workers by large established firms has been under way in the United States for nearly 20 years, and that shedding neither prevented the economy from expanding rapidly nor unemployment from falling, whatever the early adjustment problems. It is the stuff of Joseph Schumpeter’s idea of creative destruction.
Still, Japan is not accustomed to unemployment and announcements of massive job cuts, such as the one at Nissan in October, will be a bitter psychological pill to have to swallow, even if a recovery is under way. The government will no doubt feel some social pressure to react against those cuts, but it should resist it and hold its course of opening up the economy to inward investment. And if structural reform is maintained to allow a greater market allocation of resources, then Japan’s economic horizon will surely brighten.
Economic Survey of Japan, OECD, 1999.
Andersson, T., Avery, P., "Asia’s Industrial Crisis: what really happened", OECD Observer No 217/218, 1999.
Kawamoto, A., "Unblocking Japanese reform", OECD Observer No. 216, 1999.
©OECD Observer No 219, December 1999