Japan 2007: Japan stuck in second gear
The successful restructuring of the corporate sector was a key pillar in Japan’s economic recovery. But while growth has remained above 2% for the most part of this century, the country is still faced with structural and political challenges that could hinder its economic expansion. Han Nee Tay reports.
After a few false starts, the Japanese economy is now firmly on track, having had the longest expansion in more than 60 years. It is widely acknowledged that the most difficult reforms have been put in place – largely in the corporate and banking sectors – paving the way for a sustained recovery. Economic growth is expected to hover around the 2% mark for the next few years, largely helped by consumption and investment from the corporate sector. As a result of this corporate recovery, Japan has emerged from its long economic downturn less reliant on external economies and in particular, the US, its largest trade partner.
“The corporate sector removed imbalances, such as excess capacity, excess debt and excess employment, that is why they are able to increase business investment in a sustainable manner now,” said NikkoCiti’s chief economist Kiichi Murashima. “That’s why the
vulnerability of the corporate sector to external shocks has declined in a meaningful manner over the last five years. From that perspective, this economic recovery is more sustainable than the precarious recoveries that we had seen before.”
However, as recent political events have shown, Japan could still find it hard to shake off the shackles of its painful past. Prime minister Shinzo Abe resigned in September after losing the majority in the upper house of parliament following a string of scandals that had eroded his government’s credibility. Abe was replaced by Yasuo Fukuda who is also not thought to be particularly reform-minded. The damage done to the Liberal Democratic Party (LDP) under Abe’s administration means that there is a lot of work for Fukuda to do before he can definitively show that he has a real mandate to run the country. So far, Moody’s seemed to be among the most positive about Fukuda’s leadership, although it would be one of quite few. The ratings agency gave the government a vote of confidence early in October, by upgrading Japan’s debt rating for the first time since 1993 by one level to A1 on expectations that Fukuda would reign in spending. Fukuda had committed himself to balancing the budget within five years but economists said Japan’s fiscal reforms must include raising taxes to lift the country from its ¥834.4trn debt. Reducing spending alone will not be enough.
“Over the medium term, I’m very pessimistic,” said Hiromichi Shirakawa, chief economist at Credit Suisse. “Because the income inequality problem, the widening gap of the income gap between major cities and regional cities are exaggerated in the media, it makes it very difficult for politicians to make any proactive fiscal reforms . . . 2% [economic growth] is still a dangerous number because we may still require tax hikes and that in turn may weaken the economy again. We need 2%–2.5% GDP growth on a sustained basis.”
Shirakawa, ranked fourth in the 2006 Nikkei survey, said that Japan must endure tax reforms but the fragility of the regional economies made it hard for politicians to raise taxes without losing political support and creating further pain. There had been talk of increasing consumption tax but this has now fallen on the wayside following the scandals that had rocked Abe’s government.
The regional economies are a major weak point in Japan’s overall recovery and their small and medium-sized firms are struggling to make ends meet as domestic consumption remains stubbornly weak. A rise in consumption tax could further hit personal spending. According to a Business Outlook Survey released last month, medium and small firms are expecting a further fall in investment this year by five percent and 9.9% respectively compared to last year. Big firms, on the other hand, are expecting an increase of 8.6% in investment for this fiscal year.
“Economic conditions surrounding small businesses are still very harsh due to low consumption, higher input costs due to rising energy and the lack of pricing power,” said NikkoCiti’s Murashima. “There are too many companies and people have no inflationary expectations which makes it hard for companies to raise prices.”
A fundamental problem for the Japanese economy is the persistently low consumption level. Japan’s consumer price index was down 0.2% in August on a year-on-year basis, although economists are forecasting a 2% growth for the fiscal year. Still, despite the fact that the economy is out of the woods, the Japanese people remain extremely cautious in their spending, keeping about 52% of all their financial assets in savings and deposits at the end of 2006. This figure compares with just 13% in Western countries, according to analysts. Personal consumption contributes to about 55% of Japan’s GDP.
Part of the reason for this cautious spending is the fact that wages in Japan are not rising fast enough. Japan’s traditional salary system dishes out rewards based on length of service, but with an ageing working population increasingly replaced by younger workers, the national wage level increases remain weak. The average monthly wage rose for the first time in nine months, although just a measly 0.1% versus the corresponding period last year, according to statistics from the Ministry of Health, Labour and Welfare. But compared to the past decade, wages are down an astonishing 10%. Some believe that as the labour market tightens due to the ageing population, wages will increase, but it could take years before wages rise significantly enough for them to make a difference to spending patterns.
The situation is not helped by the fact that the Japanese are stuck in a deflationary mindset. Without any inflationary expectations, if prices rise, they are more likely than ever to cut back on their spending. Against this backdrop, small firms are finding it hard to raise prices even though they are faced with higher costs, largely due to an increase in commodity and energy prices.
Economists said that the small and medium-sized companies needed to undergo the same kind of restructuring that the corporate sector had over the last 10 years or so, but that the government was unlikely to let this happen as it would lose political support from the regions.
These firms, including small regional banks, need to face consolidation and labour needs to be redistributed in order to increase efficiencies. However, the perceived huge income gap between the major cities and the regions is adding pressure on the government to lend a hand to the regional firms instead of tightening the market. The government cannot be seen to be too harsh on the regions and on small firms, such is the quandary facing Fukuda’s administration.
“For the past two years, the focus has been on the problem of inequality, which is likely to remain a barrier to any pro-market reform,” Richard Jerram, economist at Macquarie Securities wrote in a recent report. “Politicians from both parties espouse similar concerns for the disadvantaged or vulnerable parts of society. This seems to include pensioners, low income workers and people living in the regions. In other words, a large part of the population.”
Credit Suisse’s Shirakawa also said that the government was in a difficult position regarding the small firms. “You can’t be too tough on the small regional businesses but at the same time, we need a kind of balance,” he said. “The Japanese people have become too used to asking the government to rescue them – this is too much.”
At the heart of all this is the lack of consumer confidence. Because of what the country had struggled through over the last 10 years and also because of the burden of having an ageing population, people remain uncertain about the future. It does not help that the government admitted to losing pension records linked to 64m claims in May. This is a major problem for a country for which 21% of its population is 65 and over.
The fact remains that economic reform is not top priority with the administration of Fukuda, whose father Takeo was also prime minister in the late 1970s. Observers said that the administration’s number one job at the moment is to repair the damage done to the reputation of the LDP.
“The fact that [Fukuda] recently said that Japan had to reform or be left behind in world progress, sounds good. Whether he can really produce change is the big question,” said Mark Mobius, fund manager at Franklin Templeton Investment Fund which has US$68m invested in Japanese stocks. He added that “a more open system which would give minority shareholder more rights and power and a system which would allow for firms to more easily be taken over or merged” would underpin economic growth.