Despite the massive quantitative easing and stimulus spending the country of Japan remains mired in recession. The economy shrank at an annualized pace of 1.6% from April to June. Consumers are cutting back on spending and exports seem to be in a new slump, as the world economy slows further. The question for the reformist government of Japan is what to do next, to rekindle growth and investment in the world’s second largest developed economy?
Japan is the third largest economy in the world in nominal GDP (Gross Domestic Product) at $4.210 trillion USD (United States Dollar) and the fourth largest in PPP (Purchasing Power Parity). Globally, the Japanese have enormous strengths in world trade and investment. The country is a leader in the manufacturing of high tech and precision goods.
Japan remains the largest world creditor and earlier this year became the largest consumer of American debt as well. China had previously been the largest creditor to the United States (US) since 2008, but has recently been cutting back on the purchase of US Treasury Securities. This allowed Japan to regain the position after a seven year hiatus.
The nation of Japan is the world’s third largest manufacturer of automobiles and maintains the largest electronic goods industry. Although competition from China, South Korea and Southeast Asia is increasing, Japan remains a global leader in the fields of hybrid vehicles, optical instruments and robotics.
The rapid slowdown in China and the impact that will have in the regional trade, has made any real rebound for Japanese growth more problematic.
Private domestic consumption comprises near 60% of economic activity in Japan. The total decline in the second quarter at 0.08%, was double from what analysts had expected. It was the first dip since the the second quarter of 2014, when a rise in the national sales tax had a huge negative impact on consumer spending.
A 0.03% decline was seen in exports as demand in Asia and the United States for Japanese goods slumped. Overall, growth for the year is now expected to dip further to just 1.5%. The Japanese government is under tremendous pressure to return the economy to growth. The response could lead to more fiscal and monetary stimulus later this year.
The present administration of Prime Minister Shinzo Abe has staked his political future on returning the economy back towards policies, that will ensure greater economic activity. In what has been dubbed Abenomics, a massive round of stimulus spending, quantitative easing and structural reforms has been ongoing, since the P.M. won reelection in December of 2012. These three arrows are to provide reflation, more government spending and a growth strategy, after nearly two decades of economic stagnation.
The weaker consumption rate is partly attributable to rising food prices. This is largely the result of the policies enacted by the Bank of Japan (BOJ) . The weakening of the yen has pushed the price of imports higher. The higher consumption tax of 8% passed in 2014 from the previous 5% rate, has put an additional damper on greater consumer spending. The scheduled additional 2% hike bringing the total to 10%, has already been delayed in implementation this year. This was due to slower growth in consumption than anticipated in 2015.
In 2013, through quantitative easing Japan purchased between 70 to 80 trillion yen worth of bonds. In 2014 this was raised to 80 trillion yen a year, the equivalent of $679 billion USD at present exchange rates. It is continuing this year unabated.
Another dose of monetary easing would force the yen even lower, which in turn would only push prices of food and other goods higher. A higher rate of monetary expansion could do irreparable damage to the value of the yen. The BOJ is hesitant to enact another round of quantitative easing, in the absence of more structural reforms and lower government spending.
The economy of Japan has only expanded 2% since the end of 2012, despite the fiscal stimulus of nearly 3% of GDP during the same period. Living costs have increased as a result of government policies to combat deflation, but wages have not kept pace. This is a real detriment to a further expansion in consumer spending.
The Japanese government continues to pressure companies flush with cash, to raise wages and expand capital spending. This is unlikely to happen, since demand for Japanese exports are now in decline as well. In fact, the opposite is likely to occur as orders and industrial activity slows further.
More fiscal spending although increasingly likely in the present circumstances, is problematic as well. Japanese government debt to GDP already the highest in the world, has increased from 211.17% in 2012 to 230% in 2014. In comparison, the United States government debt was at 102.98% of GDP last year. At the end of 2014, the Euro area on the whole was at 91.90%.
The budget deficit in Japan last year was equal to 7.70% of GDP. It has been above 8% since 2010. It is becoming increasingly difficult, for the government to sustain these extraordinary high levels of debt. The rate in most European countries is half the Japanese rate. In the United States government debt is expected to be just 2.6% of GDP in 2015.
The promise of a balanced budget by 2020/21 becomes ever more illusory, as political pressure mounts to spend even more money, to further stimulate the economy. A number of world credit agencies beginning at the end of 2014, have threatened to cut the A+ rating on Japan’s spiraling government debt. The delay of the additional 2% in the national sales tax, has only intensified international credit agency calls, for Japan to get spending under control.
The largest item in the Japanese budget is social welfare spending. This is not surprising considering the present demographic trends. That is, low immigration and a rapidly aging society. The population of Japan at 127 million in 2014, is already in decline. The registered reduction was 271,058 at the beginning of this year and is set to accelerate dramatically in the decades ahead. The rate is set to hit 700,000 by 2025 and peaking at a million or more by 2060.
A declining workforce and a more elderly population, will only compound the difficulty of generating growth in the Japanese economy. Although the government would favor an increase in immigration to Japan, the idea is still unpopular with most voters. The increase in foreigners living in Japan rose only by 59,528 in the past year.
As with immigration, further structural changes are becoming more challenging. This is because many of the reforms, run in the face of Japanese culture and tradition. The third arrow structural reforms to date, have been mostly stifled by lobbies of special interests. Yet, the need for changes have become increasingly obvious.
The inability to foster greater growth in the Japanese economy has practical consequences. In 1989 for example, only 4% of the Japanese stock market was owned by foreigners. That number now exceeds 30%. This does put greater emphasis on a reform agenda, but it has been sputtering to date.
The inflexible Japanese labor market is a continuing drain on the economy. Nearly 5 million permanent employees have redundant, yet they cannot be removed from their positions. This is regardless of any possible severance package. Two fifths of the employees of Japan, are relegated to uncertain low paid jobs. This is especially true for women and the young. Foreign nationals can have great difficulty in securing employment in Japan.
The civil service will in itself, be a major impediment to change. Special interest groups from farmers to professionals of all kinds, will provide opposition in some form or another to an extensive reform package. The changes that are enacted will be smaller and piecemeal, with compromises muting much of the impact. Structural reforms will need to be forced on many groups, that will necessarily resist the more sweeping alterations to accepted practices.
Of the three arrows of Abenomics, two have already reached their practical limits. More monetary easing and stimulus spending, will not provide the impetus necessary to return the country back towards growth. In fact, these alternatives have reached a point where further efforts could well do major damage to the economy of Japan. The only real option remaining is a massive structural reform of the Japanese economy.
Despite the new challenges presented by a rising China and a declining America in East Asia, Japan will continue to find great difficulty in making the necessary functional reforms, to change the present dynamic. The restoration of Japan to growth and prosperity in the 21st century, will require a radical change in the way the economy is organized. This will require a break with many current business and commercial practices that served Japan, well enough in the past. However, for the future change will be necessary, if there is ever going to be a return to sustainable growth.