No. 6 — February 16, 1996


Weekly Review

--- by Douglas Ostrom

After months of hedging the Economic Planning Agency finally has declared Japan's recession at an end. In its monthly economic report, submitted to the cabinet February 9, EPA mustered the courage to use the word kaifuku (recovery) for the first time in recent memory. Since last July the operative phrase to describe the economy's current state had been ashibumi (standstill).

Past history as well as the current language suggest that EPA's judgment remains a highly tentative one. In its new report the agency described the ongoing recovery as moderate (yuruyaka) and noted that many trouble spots remain, especially regarding employment. Not far from many observers' thoughts was the September 1994 EPA declaration of a recovery in progress from the recession that had begun by official reckoning in early 1991. In the middle of last year EPA had to reverse its conclusion as the economy faltered. In any event the final arbiter regarding the beginning and the end of recessions is not EPA itself but an EPA-affiliated panel comprised of outside experts; their evaluation of the on-again, off-again recovery will be rendered some months from now.

The available data provide ample evidence not only for the proposition that conditions are getting better but also for the fear that the recovery remains vulnerable to a number of threats. Most analysts point to trends in the industrial production index as providing the most solid evidence that a recovery is underway. On a month-to-month seasonally adjusted basis the index rose 1.3 percent, 1.5 percent and a preliminary 0.8 percent in October, November and December, respectively, the three most recent months for which figures are available. Even with this increase, however, the index remained below the level it had reached in March of last year — before the economy's "double dip" in the spring and summer.

The broadest index of current economic conditions — the coincident indicators, where 50 is the dividing line between recession and recovery — paints a somewhat less optimistic picture. While the preliminary value of the index registered a healthy 75 in October, breaking a string of five consecutive monthly readings below 50, it fell to an even 50 in November, the most recent month for which this series is available. However, the leading index, designed to predict the course of the economy a couple of months hence, was above 50 in both October and November, hinting that conditions were looking up at that time. Two observations are hardly conclusive, of course. The lagging index, designed to confirm a recovery, remained consistently below 50 last fall, giving further evidence that the economic upturn is tentative at best.

Unsettled labor market conditions (see JEI Report No. 5B, February 9, 1996) are a major reason the lagging index remained weak. Policymakers worry that record-high unemployment and other signs of distress among the work force will make consumers excessively cautious. Indeed, in October and November, again the two most recent months for which figures have been released, price-adjusted household consumer spending fell 1.7 percent and 2.4 percent, respectively, from year-earlier levels.

Companies, by contrast, appear more optimistic than previously. Profits are up, and interest rates are down compared to recent years. The long-term interest rate on government bonds averaged 3.5 percent in January. While this yield was the highest in five months, it still was significantly below the 4.8 percent level registered a year earlier. Partly as a consequence of lower interest rates, many economists believe that plant and equipment spending could be poised to rebound significantly. As if to underscore this possibility, the EPA announced February 13 that equipment orders other than for ships or from the electric power industry — a statistic widely regarded as a leading indicator of capital spending — rose 11.5 percent from the previous quarter during the October-December period.

Other data paint a moderately optimistic picture of the economy. Seasonally adjusted new car registrations, while showing an up-and-down monthly pattern, have been on an overall upward trend since the middle of last year. January registrations, in fact, were at their highest level in well over a year.

Analysts looking at all these numbers as well as the effects of the stimulus package that the government announced last September increasingly are optimistic. Robert Feldman of Salomon Brothers, Inc.'s Tokyo office predicts, for example, that real gross domestic product will expand 2.7 percent in the fiscal year beginning April 1. Japanese forecasters uncharacteristically are in the same ballpark as their American and European counterparts on near-term GDP estimates. Analysts at Sanwa Research Institute, an arm of Sanwa Bank, Ltd., figure that growth will reach 2.5 percent in FY 1996. By contrast, price-adjusted GDP increased by only 1.1 percent over the entire FY 1992-FY 1994 span, or less than 0.4 percent annually. FY 1995 growth is likely to be around 1 percent. Taken together, these figures suggest that the economy's performance in FY 1996 could be stronger than in the previous four years combined.

The emerging consensus regarding the economy's FY 1996 prospects represents a slight shift from a couple of months ago. For example, economic forecasts made by 48 private-sector Japanese organizations in anticipation of the government's economic outlook in December typically put real FY 1996 growth around 2 percent.

Most, if not all, analysts believe that the recovery remains fragile, however. Recalling how the upturn stalled last year, they offer a laundry list of reasons why it could happen again. Property prices appear to top many economists' lists, with dropping real estate values seen as having a variety of partly offsetting impacts. The National Land Agency's February 9 release of survey results of land prices in Japan's largest urban areas showed that in most locations the prices of commercial property appeared to fall in excess of 3 percent between October 1, 1995 and January 1. The prices of residential property typically fell between 1 and 3 percent on average, although in Tokyo they dropped in excess of 3 percent. The agency indicated that in some large cities, such as Tokyo, Osaka and Nagoya, the rates of decline appeared to be accelerating in comparison with the survey conducted three months earlier.

Real estate prices are related to economic activity in at least three ways. Analysts of late have stressed that continuing drops in property prices will tend to enlarge the extent of bad-loan losses incurred by housing loan companies (jusen); under a cabinet-approved plan the government will have to shoulder a share of these losses. An ongoing fall in real estate prices could cause the government bailout plan to unravel, which, these analysts say, could push the financial system into a perilous state. If so, this argument continues, banks will be unable to perform their traditional role as a conduit of monetary policy, jeopardizing the recovery. The validity of this argument depends on the unproven linkage between sick banks and a sick economy. In recent months Japan has offered evidence, as the United States did in the early 1990s, that the relationship can be overstated.

While the jusen argument sees falling property prices as bad for the economy, another common point of view sees this development as beneficial. Coupled with reduced interest rates, lower land prices potentially can make new home construction a more attractive proposition, thereby boosting aggregate demand. A less-heard argument even reverses the direction of causation. The fact that commercial property prices still are declining suggests that business executives are not falling all over themselves to seek land for capacity expansion. For that reason projections that capital spending is poised to rise significantly should be viewed with some caution.

All the potential land mines notwithstanding, within a few months politicians in Tokyo even may be able to hint — ever so subtly, given the sensitivities of coalition partners — that the experienced hands of Liberal Democratic Party officials have more or less fixed the economy that broke down under the opposition's watch. While that characterization would oversimplify the nature of recent coalition governments and ignore the historical reality that the recession began at a time of single-handed LDP control, it may have credibility with some voters. How the electorate would weigh this claim of good macroeconomic management relative to other issues such as the jusen problem remains to be seen, however.

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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