Japan has been battling deflation and economic stagnation since its real estate and stock market bubbles burst in the early 1990s.
Weeks after Prime Minister Shinzo Abe took office in December of 2012, he pledged to revitalize Japan’s economy.
The three “arrows” of his policy package, coined “Abenomics,” were monetary easing, increased government spending, and business deregulation. Abe’s arrows might have staved off a recession and excessive deflation, but they’ve missed the mark on growth. The main obstacle to growth seems to be the country’s rapidly aging demographic profile.
The Bank of Japan’s Outlook for Economic Activity and Prices as of October 2016 forecasted 2017 real GDP growth in a range of 1.0%-1.5%, up from an estimate of 0.8%-1.0% for fiscal 2016. “Faster growth is critical to stopping and reversing the run-up in public debt, which is projected to reach 240% of GDP by 2018,” observed the OECD in its November forecast. But it’s not looking promising. The BOJ expects growth to slow again in 2018 back to the 2016 range.
The OECD’s November forecast had pegged growth at the lower end of the BOJ’s range for both years.
Even so, Japan’s economy at least has coped with the yen’s recent appreciation, as the OECD pointed out. And thanks to Tokyo’s hosting of the 2020 Olympics, short-term growth might benefit from increased infrastructure spending. Yet the Olympics might just leave behind lots of gray-haired spectators and white elephants, i.e., mega-sports domes with no economic purpose that are expensive to maintain. Japan’s prospects for growth don’t seem promising. The sun still seems to be setting rather than rising on the country’s economy.
On the bright side, the 1/16 FT reported: “Morgan Stanley’s global strategy team considers Japan the top stock market for 2017. There are three assumptions underlying their bullish conclusion, including first, the depreciation of the yen, and second, the expectation that growth in Japan will be stronger than most investors anticipate. Finally, the strategists believe Japan will be the beneficiary of stronger-than-expected global demand. … Today, however, global investors aren’t believers. They are underweight.” We aren’t as optimistic.
Let’s review some of the persistent challenges facing Japan’s economy:
(1) Deflation. Surprisingly, the weaker yen hasn’t abated the deflationary pressures in Japan. The CPI jumped during the spring of 2014 due to a sales tax hike from 5% to 8%. However, the inflationary pressure was short-lived, and the CPI began falling again at the start of 2016 through September (Fig. 12). November’s relatively steep increase in the total CPI of 0.5% y/y was due to higher food prices, while prices for other consumer goods fell. Excluding food, the CPI fell -0.3% y/y. Japan’s consumer spending remains weak, and consumer confidence remains low (Fig. 13 and Fig. 14). In the face of slow growth, Japan needs more tax revenues to sustain government spending. However, Abe decided to delay the next sales tax hike, which was set to take effect in April 2017, until late 2019 because it might further “damage domestic demand,” reported Bloomberg in a 6/1 article.
(2) Ultra-low interest rates. Deflation has persisted despite the Bank of Japan’s (BOJ) highly aggressive and unconventional monetary policies. In a series of bold moves, the BOJ unexpectedly cut interest rates below zero on January 29, 2016. On September 21, 2016, the BOJ slightly reversed course, indicating that the limits of monetary policy may have been reached. It aimed to maintain the 10-year government yield at near 0% by altering the pace of Japanese government bond purchases. The 10-year Japanese government yield turned positive during mid-November 2016 for the first time since mid-February 2016. However, it is still incredibly low, at 0.05% as of January 20 (Fig. 15). (See our chronology of BOJ monetary policy.)
(3) Aging population. The good news is that Japan’s unemployment rate has been falling since peaking at 5.5% in July 2009 and was down to 3.1% near the end of last year. However, Japan’s aging population, coupled with a low fertility rate, is behind the tightening labor market. The 1/7 Economist reported that Japan’s workforce has shrunk by about 2 million since it peaked at over 67 million in the late 1990s. Government forecasts show that it could drop to 42 million by mid-century. Unlike other countries, Japan has been exceptionally slow in opening its labor market to foreign labor. The number of foreigners rose in 2015 to a record high of 2.2 million, but that’s far from closing the labor force gap, noted The Economist. The Japanese government’s efforts to create incentives to encourage more of “its own people who are capable of working” to join the workforce might not go far enough.
Another problem in Japan’s labor market is the increase in those who have less permanent jobs. According to a 1/5 article in the Japan Times, 40% of Japan’s workforce consists of non-regular workers. The lack of job security and low wages only serve to weaken consumption. Wages have been falling since 2013. Deflation has helped to boost real wages, but the recent surge in food prices isn’t helping. At the end of 2016, real contractual earnings fell to same level as nominal earnings (Fig. 16). That’s one good reason why consumer confidence is so low.
(4) Export dependency. Prime Minister Abe is eager to export Japan out of stagnation. Besides exports in real GDP, which grew 6.5% (saar) on a quarterly basis during Q3, each of the other categories of growth were tepid: private investment (-1.4%, saar), imports (-1.4), and government consumption (1.2) (Fig. 17). Monetary stimulus has weakened the yen, which lifted exports but perhaps not as dramatically as Abe had hoped. Exports have risen 14.5% since the start of 2012.
In the meantime, the yen has fallen 32% against the dollar since then (Fig. 18 and Fig. 19). The yen, widely viewed as a “safe haven currency,” strengthened briefly in 2016 due to the global financial turmoil earlier last year, particularly leading up to the Brexit vote. The yen started to depreciate again after Trump’s victory and continued to fall when the Fed proceeded on its gradual path to raise interest rates during December of 2016. Looking ahead, the yen is likely to depreciate further, with several more Fed rate hikes likely during 2017.
Trading with the US could be more challenging for Japan under President Trump. Japan’s economy appeared poised for growth at the end of last year in view of the pending Trans-Pacific Partnership (TPP) trade deal that was being negotiated under President Obama. But President-elect Trump has promised to abandon the TPP when he takes office, so Japan might have to find other ways to achieve its export goals with the US and other Asian countries. That need may explain Abe’s eagerness to meet Trump after Election Day on November 17--he was the first foreign leader to do so. Japan’s largest export market is the US, followed by China and then Western Europe (Fig. 20).
(5) Signs of life. Industrial production moved higher at end of 2016, driven by a resurgence in exports (Fig. 21). So too, December’s M-PMI was promising, rising to 52.4, the highest since the end of 2015. But that’s still a ways off from its 2013 peak (Fig. 22).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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