No. 11 — March 17, 2000


Weekly Review

--- by Douglas Ostrom

Anyone not perplexed by economic conditions in Japan does not understand the situation. Gross domestic product shrank 5.5 percent on a price and seasonally adjusted annual basis in the final three months of 1999 on top of a revised 3.9 percent contraction in the July-September quarter, the Economic Planning Agency disclosed March 13 (see Table). However, the very same EPA reportedly was planning to upgrade the status of the economy to a "self-sustaining recovery" in its monthly report for March, due out just days later. These incongruous developments speak volumes about the current confusion over what the Japanese economy really is doing and also about economic pronouncements during an election year.

For weeks, Tokyo had been preparing the country and policymakers in Washington and elsewhere for a grim set of GDP figures. In an unusually spirited public relations offensive, EPA head Taichi Sakaiya and others suggested that the economy had shriveled again in 1999's fourth quarter, but in the next breath, they added that a big upturn was expected in the first three months of 2000. In other words, the October-December data were to be considered an aberration.

By contrast, American analysts, armed first with forecasts of the economy's performance in late 1999 and now with the actual numbers, have proclaimed Japan to be back in recession since, by the U.S. definition, two successive periods of negative GDP results equal a recession. These experts easily could have argued that Japan experienced a triple-dip downturn in the 1990s. By some accounts, it endured a recession from 1991 to 1993, was in a recovery phase from 1994 to early 1997, got hit by a second dip in 1997, staged another turnaround beginning in late 1998 or early 1999 and arguably had returned to recession in the second half of 1999.

Annual changes in real GDP capture the economy's chronically weak performance over the course of the 1990s. Last year, for instance, Japan managed just a 0.3 percent increase in aggregate output, not even regaining the ground lost in 1998, when price-adjusted GDP declined 2.5 percent. As such, 1999's rebound was the weakest on record following a year of contraction in figures dating back to 1955. Moreover, the performance of the world's second-biggest economy was far below what most forecasters had expected. The consensus estimate was a gain of almost 1 percent (see JEI Report No. 8A, February 25, 2000).

Historical GDP data also shed some light on the government-supplied spin that a strong recovery currently is underway. Notably, EPA does not adjust the GDP figures to reflect the extra day provided by a leap year. Thus, Japan will have 91 days to produce 90 days worth of output in the January-March period. Since 1955, real growth has averaged an astounding 10.7 percent on an annualized basis in such quarters. By contrast, the economy's average annual expansion over the entire 1955-99 time frame was 5.5 percent. Other calculations suggest that the leap-day effect inflates the annualized rise in January-March real GDP by at least 4 percentage points. In short, managing robust-looking growth in the current quarter should be easy. Whether the economy truly is healthy is another issue altogether.

Unfortunately, the many data series that track the economy's course do not yield an unequivocal answer. For example, the Ministry of International Trade and Industry's "all industry" index was flat in the last quarter of 1999. (Given the theoretical identity of this gauge and changes in GDP, either MITI and/or EPA has a serious measurement problem.) However, EPA's own index of coincident indicators flashed very positive signals for the seven months through January, although that outcome was in part the result of the agency's use of some MITI data. The leading indicators meanwhile turned in a neutral reading or better from March 1999 through January. At the same time, though, the lagging indicators, whose improvement sometimes is used to confirm a recovery, remained mired in recessionary territory in January, as they had been for the previous 27 months.

Government officials and some analysts looking at the components of the October-December GDP data took certain comfort from the figure for plant and equipment spending, which climbed 19.8 percent and reached its highest level since the third quarter of 1998. Optimists — policymakers included — consider this jump to be evidence that companies might lead Japan out of its economic morass. That would be a reversal of the normal sequence of events, in which business investment revives only when consumer spending and other sources of demand are well-established.

Such an outcome would be particularly amazing given the huge amount of excess capacity that corporate Japan still is acknowledged to have. Admittedly, capital spending could expand even in the face of surplus plant and equipment if the money was going into the New Economy or into information technology for the Old Economy. Nonetheless, most analysts who have considered the question regard emerging industries and technologies as too small a force to account for the hypothesized chain of developments.

In fact, the increase in capital spending late last year might be bad news if it signifies that firms still have not absorbed the message about the need to restructure. The business community could be assuming that the economy can duplicate its strong performances of the past and, as a result, is cranking up expenditures. If a recovery is slow in coming — and consumer spending figures suggest that it could be — then manufacturers and nonmanufacturers alike might be forced to backpedal furiously in coming quarters.

Apart from the surge in capital spending in the October-December period, the interpretation of which is debatable, and developments in the foreign sector, where declines are counted as good news for prickly relationships with such trading partners as the United States, the components of the fourth-quarter GDP were uniformly grim. The second straight big cutback in government investment at least was expected because of Tokyo's slowness in developing a new stimulus package. Announced in mid-November (see JEI Report No. 44B, November 19, 1999), the latest pump-priming initiative came too late to give the economy a lift in the fourth quarter.

The substantial 6.3 percent decline in personal consumption expenditures, which came on the heels of a sizable drop in the July-September quarter, is harder to explain since consumers are supposed to pick up the growth "baton" early in the process of a self-sustained recovery. According to the most optimistic spin, the cutback reflected corporate restructuring efforts that had reduced workers' incomes, particularly yearend bonuses. However, this interpretation is difficult to reconcile with the jump in capital spending, which suggests that firms either are putting off restructuring or have completed the process.

The GDP figures for 1999 as a whole leave little doubt that in the current environment, Japan's economy expands only when government fixed investment increases. This reality, the very antithesis of the self-sustained growth that Tokyo insiders apparently stand ready to proclaim, will not be lost on politicians during the upcoming election season. Statements to the contrary, the administration of Prime Minister Keizo Obuchi is likely to find a way either to boost the economy or to appear to be doing so before the polls for the Diet's lower house, which by law must be held by October 19.

In scheduling the elections, politicians may want to consider another aspect of the leap-year phenomenon dating back to 1955. That is the economy's dismal performance nearly every spring following a leap-year quarter. The GDP figures for this year's payback period, which will be available in September, may not be the ideal data on which to base claims of sound economic policymaking. With that in mind, the Liberal Democratic Party and its coalition partners may decide to hold the elections just before the numbers come out. In any event, the possibility of another drop in GDP could supply the rationale for an additional dose of government-provided stimulus.

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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