No. 35 — September 15, 2000


Weekly Review

--- by Douglas Ostrom

The Japanese economy, characterized in recent quarters by a gait of one step forward and half a step backward, has managed two full steps ahead without any reverse movement. The broadest measure of national output — the gross domestic product — rose in the April-June period at an annualized rate of 4.2 percent on a price and seasonally adjusted basis from the previous quarter, according to data released September 11 by the Economic Planning Agency (see Table). This result was better than projections made three months ago when even government economists forecast a payback for the first quarter's robust expansion of a revised 10.3 percent. It also was a slight improvement from early September. At that time, many analysts were predicting a gain of around 2 percent. However, the components of growth in recent quarters raise doubts about the sustainability of Japan's current recovery.

The interpretation of the latest figures depends on the frame of reference. After the economy's sizzling performance in the January-March period (see JEI Report No. 23B, June 16, 2000), which was partly a consequence of having an extra, leap year-provided day in February in which to produce and consume output, a contraction would not have been surprising or particularly worrisome. As it was, the growth in GDP in the spring was entirely attributable to booming public investment. It surged 66.3 percent on an annualized basis after dropping a surprising 26.8 percent in the first quarter.

Clearly, the impact of the fall 1999 stimulus package (see JEI Report No. 44B, November 19, 1999) has been slow in coming. To the extent that Tokyo wants to wean the economy from its dependence on an expansionary fiscal policy, this component of second-quarter progress was disappointing. The obvious preference is that the source of momentum be plant and equipment spending. It is being touted not only as a generator of aggregate demand but also as the means of effecting the transition to a high-technology economy (see JEI Report No. 34B, September 1, 2000). Yet business investment fell 12.7 percent on the heels of a strong January-March showing.

Looked at over two quarters, a time frame that neutralizes the impact of the leap year, neither public investment nor capital expenditures appear nearly so troublesome as they do in a quarter-to-quarter comparison. Moreover, the expansionary process seems much more normal. The economy grew at an annualized 7.2 percent rate during the first half of 2000, not a great deal slower than public works outlays, which were up 10.4 percent. Consumer spending, on the rise in both the winter and the spring, climbed an annualized 5.7 percent over the six months. Significantly, this increase was greater than the 2.5 percent gain registered by capital spending.

The fact that the numbers for public works outlays were up the most, personal consumption somewhat less and business investment still less hardly comes as a shock. That sequence is exactly what might be expected in the early stages of a recovery, as an expansionary spending policy not only creates infrastructure but also puts more money in consumers' pockets, leading to increased sales that use existing capacity more fully rather than trigger outlays for new plant and equipment. However, the spring GDP data do cast doubt on the prospect of future growth being built on structural change stimulated by investment in high technology.

Observed over the period of a year, a span that removes the effects of seasonal adjustment, the picture changes once again. Between the second quarter of 1999 and the spring of this year — throughout which, EPA says, Japan was in a recovery phase — real growth totaled a scant 1 percent. Worse yet from the standpoint of those who worry about Japan's trade relations, an increase in net exports accounted for almost all of this gain; domestic demand contributed only 0.3 percentage point of the overall rise.

In this sense, the 12 months through June were characterized by the often hypothesized but seldom realized phenomenon of export-led growth. The prominent role of trade in a year-to-year comparison stands in contrast to its relatively modest contribution to growth in the April-June quarter. However, given the strength of the yen in recent months, the fact that net exports were maintained at a constant level in the spring is a modest surprise.

Taken together, Japan's quarterly, semiannual and annual GDP data point to an economy in a rather typical, if slow, recovery mode. Furthermore, over the long term, the recent performance of two of the chief props of the expansion — trade and public spending — will not be sustainable. In the face of the probable slowdown of growth in the United States and elsewhere as well as the continued strength of the yen, Japan's real exports will not increase at double-digit annual rates, as they have in three of the past four quarters.

Public spending is even more of a problem over the long run. Japan's budget deficit is the world's largest. Moreover, the nation's accumulated public debt, the result in part of one stimulus package after the other over the past eight years as well as sluggish tax receipts for most of the 1990s, is now, by some measures, also the largest on the planet. Reflecting this reality and the difficulties that Japan will have balancing its budget — let alone paying off a significant portion of the national debt — Moody's Investors Service Inc. announced September 8 that it again was downgrading yen-denominated domestic securities issued and guaranteed by the government (see JEI Report No. 44B, November 20, 1998). The drop from Aa1 to Aa2 probably will modestly increase the cost of servicing the debt. Perhaps more importantly, Ministry of Finance officials likely will seize on the rating change as evidence that Tokyo needs to swallow the bitter fiscal medicine long advocated by the ministry.

Should MOF prevail and Tokyo end up later this year with only a tiny stimulus package, one that puts public works on a sharply declining trajectory, the economy still might expand, but it would do so more slowly. Under any scenario, however, the world's second-largest economy is apt to remain in the slow lane indefinitely. Today, the belief that Japan can manage growth of more than 2 percent for a 12-month period is considered optimistic thinking. That perspective implies that the performance of the Japanese economy is not likely to approach the recent run of the United States, which has enjoyed for the past three and a half years GDP expansion rates at least double those projected for Japan.

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

Issue Index aaaa 2000 Archive Index aaaa Subscriber Area aaaa Home