No. 4 — January 28, 2000


Weekly Review

--- by Douglas Ostrom

Japan's economy may be on the mend, but the recovery is unnecessarily slow. That message, delivered by Secretary of the Treasury Lawrence Summers to Prime Minister Keizo Obuchi on the sidelines of the January 22 meeting in Tokyo of Group of Seven finance ministers and central bankers, overshadowed the G-7's relatively modest reiteration of concern about the strength of the yen. While Japanese policymakers could be expected to disagree with the hint that they were doing too little to jump-start sustained growth, they tend to agree that the economy is weak. Recently announced data support this view.

Mr. Summers' immediate target was the late December announcement that Tokyo thought price-adjusted gross domestic product would rise 1 percent in the fiscal year beginning April 1, 2000 (see JEI Report No. 1B, January 7, 2000). While this figure would represent a modest pickup from the 0.6 percent real GDP increase estimated for the current fiscal year, it pales against the gains recorded in recent quarters not only by the United States but by other G-7 nations as well. As a latecomer to the economic expansion party, Japan might be expected over the next year or so to record faster growth than its partners. Moreover, compared with its economic performance until the early 1990s, when a 2 percent GDP expansion was regarded as the equivalent of a downturn, the 1 percent projection is even more dismal.

Mr. Obuchi reportedly said that Mr. Summers had pressed him to establish a goal of 2 percent real growth in FY 2000. Publicly, however, the Treasury secretary indicated that he had merely "expressed some concerns about the complacency of diminished expectations." Few observers would dispute Mr. Summers' contention that Japan's rate of potential expansion is well over 1 percent, particularly during a period of recovery from a steep, protracted recession.

Mr. Obuchi no doubt reminded the Clinton administration official that the 1 percent figure is not a target, or even a forecast, but merely an "outlook" on which to develop the FY 2000 budget. The Ministry of Finance, for one, probably would be very happy to plug into the outlook a number that is more pessimistic than what it really expects. That way, tax revenues would be larger and the red ink smaller than the predictions for the upcoming fiscal year (see JEI Report No. 1B, January 7, 2000). If a more robust GDP forecast were adopted, MOF would be under pressure to permit larger expenditures and would face the likelihood of a bigger budget deficit.

Although Mr. Summers was the most public of the G-7 participants in arguing that Tokyo needed to do more on the economic front, the American news media suggested that others at the meeting shared the Treasury secretary's concern. In fact, in an apparent reference to Japan, the postmeeting communique called for "a more balanced pattern of growth among our economies." Japan was able to extract from its partners a supportive statement on the yen: "We welcomed the reaffirmation by the Japanese monetary authorities of their intention to conduct policies appropriately in view of their concern, which we share, about the potential impact of yen appreciation for the Japanese economy and the world economy."

Nonetheless, independent observers suggested that Tokyo failed in its much-publicized attempt to win the agreement of other G-7 capitals to intervene in currency markets should the yen come under renewed upward pressure (see JEI Report No. 3B, January 21, 2000). If anything, these analysts said, several slight changes in the final statement's wording could be interpreted as shifting greater responsibility to Tokyo for the yen's exchange rate.

G-7 finance ministers and central bankers also noted in the communique that, although they found signs of an upturn in Japan, "a sustained recovery remains to be established." That conclusion is fairly consistent with Tokyo's official view, as expressed in the monthly economic report released January 21 by the Economic Planning Agency: "All in all, the economy has not yet gotten out of the severe situation." Moreover, EPA pointed out, the expected "baton pass" that moves the source of growth from the public sector to businesses and consumers is, at best, in its very early stages.

Even those cautious statements may be too optimistic. For instance, seasonally adjusted vehicle sales fell further in the last three months of 1999 after posting drops in the spring and in the summer. Although the decline between the first and fourth quarters was a modest 5.4 percent, it came against the backdrop of years of weak sales.

The authors of the EPA report said that they saw signs of increasing capital spending in some industries. This language left open the possibility that overall business investment still is declining, as, in fact, is the case. EPA's own data on machinery orders other than for ships or from the electric power industry, a key leading indicator of plant and equipment outlays, dropped a seasonally adjusted 2.8 percent in the fourth quarter from the previous three months based on actual data for 11 months and an EPA forecast for December. Although this indicator had risen in 1999's first and third quarters, the April-June and October-December declines were enough to push it 6 percent below the level of the fourth quarter of 1998. This pattern suggests that capital spending, which accounted for 15.8 percent of GDP in the July-September 1999 period, is not likely to revive strongly anytime soon.

Perhaps the clearest picture of the health of the world's second-largest economy comes from a trio of EPA statistics: the leading, coincident and lagging indicators. According to revised figures released January 24, the first two are flashing an unmistakable signal that the economy is on the rebound. The leading indicators were above the boom-or-bust dividing line of 50 percent for four straight months through November, the most recent period for which data are available. The coincident indicators have been sending an even more upbeat message, with five straight recovery readings. Together, these statistics suggest not only that the economy's performance is improving but that the upswing is likely to continue.

However, the less-watched lagging indicators portray a very different scenario. This index remains mired around 30 percent and has shown virtually no sign of improvement in recent months. Since the start of 1997, the series, which measures how broad-based a recovery or a recession is, has moved above 50 percent only once, when it hit 56.3 percent in July 1997. Moreover, it has not topped the boom-or-bust line for more than three months in a row since early 1992. In retrospect, the weak readings in 1997 at a time that the coincident and the leading indicators were flashing green were a sign that the economic recovery could not withstand the hike in the consumption tax that occurred in April.

Unemployment, raw material inventories and other lagging indicators are important because they are indicative of the strength of the feedback mechanisms typical of sustained growth. For example, if joblessness is high, then additional money in workers' pockets will not spill over as readily into increased consumer spending as it otherwise would. Likewise, above-average inventories suggest that stronger demand will be met by means of a message to the warehouse rather than a call to the employment office.

In other words, growth does not build on itself under these conditions. Thus, as long as Japan's economy remains in its current state, the possibility of a slip back into full-fledged recession is very real. Faster growth over the short term, as Mr. Summers appeared to suggest, would turn the lagging indicators around quicker and minimize this risk.

The possibility that the lagging indicators soon will turn up sharply is remote. Indeed, unemployment, one of the few yardsticks among the eight lagging indicators that currently is positive, may go negative in coming months.

Should Japanese economic conditions remain as they are — or get worse — Mr. Summers is likely to finish his eight-year stint in the Clinton administration having sung for the whole time essentially the same tune as did the Bush administration, which regularly faulted Tokyo for inadequate attempts at stimulus. Japanese officials long ago may have come to regard this song as unpleasant background music. Nevertheless, they have to hope that voters do not pick up the melody before the next lower house elections, which could occur at almost any time but will be held before the U.S. presidential election. In any event, Mr. Summers' successor probably will continue the refrain.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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