No. 23 — June 16, 2000


Weekly Review

--- by Douglas Ostrom

Japan's economy expanded an astonishing 10 percent on an annualized, seasonally adjusted basis after inflation in the first three months of 2000 (see Table), the Economic Planning Agency announced June 9. This performance should silence those analysts, mostly foreign, who had described the nation as in a recession given the back-to-back contractions in gross domestic product that occurred in the third and fourth quarters of 1999. These experts presumably now are reading from the same page as Japanese business forecasters and government policymakers who argue that the economy has been in a recovery phase for the better part of a year. Yet the latest GDP data provide reason for continued caution about the short-run and long-term prospects of the world's second-largest economy.

For months, experts had agreed that Japan's first-quarter GDP number would look good, in part because EPA does not adjust for the extra day in leap years, such as happened in February. Simply eliminating the statistical advantage of one more day to produce and purchase goods and services would trim an estimated 4 percentage points or so from the economy's 10 percent showing. Moreover, even in nonleap years, the January-March GDP figure can be unexpectedly robust, although after revision, it often ends up being less striking. For example, growth in the first quarter of 1999 initially was reported at 7.9 percent (see JEI Report No. 23B, June 18, 1999). Even the current revised figure of 6.3 percent is surprising in light of the economy's net shrinkage over the balance of last year.

Most analysts actually had anticipated a somewhat stronger GDP number in this year's opening quarter, particularly after the Ministry of Finance announced only days earlier that its corporate investment survey had revealed a substantial gain in capital spending in the January-March period. And, in fact, EPA said that outlays for plant and equipment jumped 17.9 percent in the first quarter on top of a revised 13.5 percent surge in the October-December period. The latter figure originally had been reported as 19.8 percent, but it was scaled back largely as a consequence of extraordinarily weak capital spending by financial services providers &emdash; a reality that EPA had refused to acknowledge in an interim revision of the fourth-quarter GDP data (see JEI Report No. 22B, June 9, 2000). The lower business investment figure was the main reason that the shrinkage in the economy at the end of last year &emdash; now put at 6.4 percent &emdash; was even greater than the first preliminary figure of 5.5 percent.

Interestingly, the economy's extraordinary first-quarter performance was achieved without the benefit of government-supplied stimulus. In fact, an uptick in current government expenditures was overwhelmed by a 26.8 percent plunge in public works spending. To the surprise of many Japan watchers, the mid-November pump-priming package (see JEI Report No. 44B, November 19, 1999) still had not kicked in by the early months of this year. As a result, public works outlays declined to their lowest level in price-adjusted terms since the fourth quarter of 1992, when the first of Tokyo's stimulus initiatives in response to the slowdown of the 1990s was in its initial implementation phase.

A jump in business investment accompanied by a drop in public works is exactly what economic policymakers in Tokyo have sought. They had to be particularly heartened by the fact that the economy navigated this transition while managing robust growth.

Yet other parts of the desired picture refuse to fall into place. For one thing, the surge in capital spending may not be sustainable. Normally, consumer spending rises ahead of substantial commitments by business to expand or upgrade capacity. While personal consumption did rise a healthy 7.2 percent in the January-March period, at least half of that increase probably was a consequence of the leap-year effect, which added an extra shopping day to the quarter. Moreover, even with this gain, consumer spending earlier in the year was lower than it had been last spring. Perhaps in reaction, a leading indicator of business investment &emdash; private-sector equipment orders other than for ships or from the electric power industry &emdash; sustained its fourth straight seasonally adjusted monthly decline in April after rising sharply in the final months of 1999.

Other indicators also are flashing caution regarding Japan's general economic prospects. EPA had announced in May that the leading, coincident and lagging indicators were all above the boom-or-bust level of 50 in March, meaning that the economy was in an expansion phase (as measured by the coincident indicators and confirmed by the lagging indicators) and would remain in that stage for at least several more months (the leading indicators). The agency, however, announced June 5 that while the coincident indicators had remained robust in April, the lagging indicators, which had been revised downward for March, were in the "bust" range, where they generally have been since 1991. Moreover, April's leading indicators were below 50. These figures imply that a recovery still cannot be verified. If, in fact, one is underway, it could end prematurely if the leading indicators continue to be weak.

The new GDP statistics represent the final installment of data for FY 1999, which ended March 31. Tokyo had estimated in December 1998 that the economy would grow 0.5 percent in real terms during this period (see JEI Report No. 1B, January 8, 1999), but amid rising optimism in mid-1999 about the economy's prospects, the government upped its forecast to 0.6 percent. As it turned out, the initial outlook was right on the money, making the government a more accurate prognosticator than private-sector forecasters, who, 15 months ago, generally had expected a third straight year of economic shrinkage (see JEI Report No. 7A, February 19, 1999).

Analysts, domestic and foreign alike, hailed the return of growth in FY 1999 after two years of backsliding. For their part, commentators eulogized the late Prime Minister Keizo Obuchi for fixing a troubled economy. Yet the definition of what constitutes an acceptable economic record for Japan has been changed dramatically, particularly vis-a-vis the country's own past. In only a single year between FY 1955 and FY 1990 did the economy turn in a worse performance than in FY 1999, and that exception was FY 1974, in the midst of the first oil crisis, when real GDP shrank 0.7 percent. The second-lowest growth rate over this period occurred in FY 1983, when the economy managed a real gain of 2.5 percent. A showing that strong in either FY 2000 or FY 2001 would rate as a major surprise. Tokyo, for example, expects 1 percent inflation-adjusted growth in FY 2000 (see JEI Report No. 1B, January 7, 2000). Longer-run forecasts seldom put the economy's expansion potential much above 2 percent a year.

The near-term GDP outlook is for some payback in the April-June period for the first quarter's rapid growth. That would extend the leap-year pattern of strong gains in the January-March quarter and weak growth, or even a contraction, in the second. Of course, the spring GDP data will not be available until long after the June 25 elections for the Diet's lower house. Thus, in response to the question, "What have you done for me lately?" the Liberal Democratic Party and its coalition partners will be able to claim that they delivered unbelievable growth. Analysts on both sides of the Pacific would tend to agree, especially regarding the characterization of the 10 percent GDP surge in the January-March period as unbelievable. But if the question is not about Japan's economic performance of late but rather about prospects, the LDP-led government's response would have to be less upbeat.

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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