The Japanese economy has now grown for six consecutive quarters, and government officials talk confidently of the end of the "lost decade." This recovery is different from the aborted ones of 1996 and 1999, they assert. Corporate restructuring has proceeded much farther; non-performing loans are falling; and growth is occurring despite cuts in public works spending.
These certainly are all positive indicators to economists. So, is this the end of Japan's lost decade?
I remain skeptical. Although growth is positive, the level of growth remains too low to justify this optimism. When the government announced back in September that the economy had grown at a rather high four percent annualized rate in the April-June quarter, economists were encouraged that a real recovery was beginning. But that number has since been revised
downward. The current picture is one of only two-and-a-half percent annualized growth in the April-June quarter and an even slower 1.4 percent rate in the July-September quarter. A solid recovery should include several quarters of unusually high growth, and that is simply not happening.
The domestic economy consists of corporations, households and government. With government spending constrained (and public works spending thankfully falling), any domestic-led growth must come from households and corporations. But neither appears poised for more rapid growth. (Exports are another matter, but they do not tell us much about the health of the
Households are particularly important because consumer spending is the largest single part of the economy— about 54 percent of GDP. In the past several years, consumer spending has grown slowly while household income has actually fallen, implying that consumers are saving less and spending more out of their income. How much longer can this continue? The fact that
consumer spending fell slightly in the July-September quarter suggests that consumers have reached their limit. If people stop reducing their savings, then increased consumer spending will depend on a rise in employment and pay. The winter bonus was up slightly, but overall there are only weak signs that either jobs or pay will increase much in the coming year.
For the corporate sector, what matters is corporate investment in plant and equipment. The upturn in investment suggests that the long corporate restructuring and downsizing process is now complete. And as existing plant and equipment ages, companies need to replace them.
However, let's look at corporate investment in a different way: how much investment in the economy is necessary to provide the right amount of additional productive capacity in a growing economy? The data indicate that in the July-September quarter of 2003 corporate fixed investment was 16.6 percent of GDP. In contrast, corporate investment in the United States is a
lower 10-to-12 percent of GDP, and this is sufficient to support a higher economic growth rate than that occurring in Japan. Why should Japanese firms be investing so much more than American firms (relative to GDP)? They should not. The current rise in investment will cause corporate profits to fall as companies use their new investments to produce more output than people want to buy. As this happens, companies will once again cut back on investment.
For these reasons, I do not believe that this recovery will make the "lost decade" something of the past. The government must, therefore, continue to focus on critical economic policy reform issues. To be specific, Prime Minister Koizumi needs to pursue the following three policies
vigorously during the coming year.
First, accelerate the disposal of non-performing loans. The Resona and
Ashikaga Bank actions were a step in the right direction, but much more remains to be done. What the government has done in the past several years may appear to be pretty tough, but it is not tough at all by the standards of other governments that have dealt with similar problems.
Second, keep the government deficit high. I agree with the effort to cut public works spending, but the government should either expand other categories of spending or cut taxes. At some point, the deficit will need to be cut, but this is not a critical issue now.
Third, further deregulation and reform of corporate governance remain necessary. Sure, progress has occurred on these fronts in the past decade. However, corporations are investing too much because they face too little pressure from shareholders and lenders to become more profitable. Rules for corporate financial reports need to be sufficiently clear that managers know
they face the likelihood of shareholder lawsuits when reports are dishonest.
And regulation continues to hold back expansion of new sectors that are
needed to provide future employment, such as healthcare for the elderly.
If the government moves forward on these policy areas, then your New Year's akemashite omedetou gozaimasu will have had some real meaning. If on the other hand, the government slacks off on the necessary policy agenda, then there will not be very much that's medetai in the new year.