No. 8 — February 25, 2000

Feature Article

NEW DECADE, OLD PROBLEMS:
JAPAN STRUGGLES TO ACHIEVE SUSTAINABLE GROWTH IN 2000

Douglas Ostrom

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Summary

Although some bright spots were visible, 1999 was a disappointing year for the Japanese economy. In a sense, that outcome was an appropriate ending for a decade during which Japan's reputation for a consistently strong economic performance was completely shattered. The economy was relatively weak last year despite a lack of catastrophic events. Instead, its minimal showing reflected the difficulty of resolving the imbalances created during a nearly decade-long period when growth slowed dramatically or even disappeared.

More of the same appears to be in store for 2000. Japan's excess of both capital stock and employed workers implies that investment demand and consumer spending alike will remain weak. Depending on still-uncertain political developments in a year when politics will take center stage on both sides of the Pacific, Tokyo may or may not be willing to continue filling the hole in aggregate demand that these imbalances have tended to create.

Ironically, the strength of the economy of the United States, which not so long ago looked to Japan for guidance on certain economic problems, is a reason to hope that the Asian nation may experience a surge of growth early in this century through the adoption of new technologies that trigger a jump in productivity. However, this development, if it comes at all, will take a back seat to the difficult job of economic restructuring — a task that will suppress gains over the short to medium term. Japan's price-adjusted gross domestic product in 2000 is expected to expand less than 1 percent, which is close to the current estimate for 1999.

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A "Lost Decade"?

For years, Japan's economy was the poster child for growth. During the 1960s, for example, the price-adjusted expansion of gross domestic product averaged a whopping 10.1 percent a year. In the 1970s, real GDP increased at a 4.4 percent annual clip despite two oil crises. In the earlier decade, Japan's growth rate was more than double that of the American economy, the world's largest; in the 1970s, it was roughly 50 percent higher.

Based on that record, not a few analysts predicted that, in terms of real GDP per capita, Japan would pass the United States sometime in the 1980s. Even when growth slowed during the 1980s to 4 percent a year, the Asian nation remained at the top of the heap or nearby in terms of industrial-country performance. Its economic preeminence, while slower in coming than had been expected 10 years earlier, seemed to be only a matter of time.

The 1990s altered those views considerably. Japan's economy was sluggish compared with those of other industrial countries, particularly the United States toward the end of the decade. Analysts have taken to calling the 1990s the "lost decade" for the Japanese economy, a term originally coined to describe the slowdown that Latin America endured beginning in 1980.

The Japanese economy appeared to have lost its way by the mid-1990s, certainly in contrast to the heady early postwar decades or even the "bubble economy" years that had ushered in the decade. Nevertheless, the lost-decade depiction easily can be overstated. To be sure, a mountain of uncollectible debt was characteristic of Latin America during the 1980s as well as of Japan over the 1990s; efforts to deal with this problem contributed to a weak economic showing in both instances.

However, for all of its troubles, Japan did much better in the 1990s than Latin America did in the 1980s, hinting that the perception of a poor record comes primarily from a comparison with Japan's own history rather than the performances of other countries. Price-adjusted GDP declined in most Latin American countries over the 1980s; for instance, the economies of Argentina, Peru and Venezuela contracted at rates that exceeded 20 percent. Japan, by contrast, managed 1.4 percent real average annual growth from 1990 through 1999, assuming that GDP increased 1 percent last year. On a per capita basis in dollar terms, Japan even may have expanded faster than the United States. Certainly, Japan suffered nothing comparable to Latin America, where the economic problems of the 1980s were so severe that caloric intake often declined. By most accounts, Japan ended 1999 as the world's second-largest economy, exactly what it was 10 years earlier.1

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The Economy In 1999

Overall Performance - A year ago, Japan's economy seemed headed for another dreary performance. Although Tokyo had projected a real GDP gain of 0.5 percent for the fiscal year beginning April 1, 1999 (see JEI Report No. 1B, January 8, 1999), few analysts outside the government gave the economy much of a chance of doing even that well. Some thought that Japan was headed for the third consecutive year of shrinkage. In FY 1997, real GDP had dropped 0.1 percent. At the start of 1999, even the government expected the economy to contract 2.2 percent in FY 1998. That drop now is put at 1.9 percent. Among industrial nations during the 1990s, only a handful of small countries, most of them in Scandinavia, suffered through as many straight years of decline. By contrast, the United States registered a single year of shrinkage over the decade — in 1991, when real GDP slipped 0.2 percent.

Certainly, the final months of 1998 were discouraging for Japan's near-term economic prospects. The contraction registered in that period marked an unprecedented five straight quarters of shrinkage (see JEI Report No. 11B, March 19, 1999).

Going into 1999, few indicators suggested much in the way of a pickup. Analysts generally thought that the first-quarter GDP number would be flat. As such, the Economic Planning Agency's June announcement that the economy had jumped a price-adjusted, annualized 7.9 percent in the January-March period was a shock (see JEI Report No. 23B, June 18, 1999). Subsequent revisions trimmed the increase to 6.3 percent, although that gain still fell into the unbelievable category.

While some experts debated which set of numbers — the generally pessimistic monthly data released earlier or the more upbeat first-quarter GDP figure — better represented current reality, other economists went back to their spreadsheets and came up with much more optimistic scenarios for the medium term (see JEI Report No. 24B, June 24, 1999). The possibility that the economy might shrink in FY 1999 for the third straight year went out the window, particularly after EPA reported in September that real GDP had expanded by an additional 0.9 percent in the spring (see JEI Report No. 35B, September 17, 1999). In fact, even the official forecast of 0.5 percent growth began to look too pessimistic, as Tokyo acknowledged when it upped the figure in November to 0.6 percent.

The second half of 1999 was characterized by conflicting data and rising confusion about the economy's course. The news at the end of the year that real GDP had expanded 3.9 percent in the April-June quarter rather than the modest amount initially reported only added to the uncertainty. It did, however, temper worries about the parallel announcement that the economy had contracted 3.8 percent in price-adjusted terms in the July-September period (see JEI Report No. 46B, December 10, 1999). Fourth-quarter GDP data, to be released in March, could be just as bad (see JEI Report No. 7B, February 18, 2000).

With three quarters of GDP data in hand and some strong clues about the economy's performance in the October-December period, most analysts put 1999 growth around 1 percent. Predictions at this point in time about what the economy will do in FY 1999 are trickier since only six months of GDP information are out. While Tokyo's forecast of 0.6 percent real growth appears unobtainable, Japan likely will avoid the fate that a year ago generally was expected: more economic shrinkage. Thus, although the optimism of the first half of 1999 has faded and doubts about the sustainability of the recovery have expanded, uncertainty — rather than pessimism — is the prevailing sentiment in Japan.

Shocks, Foreign and Domestic - In contrast to 1997 and 1998, the economy was buffeted last year by relatively few unpleasant surprises at home or abroad. Perhaps most importantly, the financial system, while far from completely cured of its ailments and arguably still unable to perform its normal function of providing the credit that propels investment, was not the source of any high-profile bankruptcies. In previous years, the well-publicized problems experienced by Japan's financial system not only had raised questions about its viability but also had undermined foreign and domestic confidence in the nation's economic prospects.

The biggest surprises, in fact, were pleasant ones. Years after experts up to the level of the Federal Reserve Board chairman had expressed reservations about the sustainability of U.S. equity prices, the American stock market continued on an upward trajectory. Moreover, the astonishingly robust growth of the real U.S. economy led the expansion to a record for duration in February 2000. The 4 percent price-adjusted growth registered in this country last year, while the lowest since 1996, was far higher than initially had been expected.

Japan's East Asian neighbors, generally maintaining their recovery from the financial and economic crisis that had erupted in mid-1997, also were the source of surprisingly good news. South Korea, the focus of serious world concerns two years ago, currently is expanding faster than Japan. Its December 1999 unemployment rate of 4.7 percent approximated Japan's 4.6 percent figure. The International Monetary Fund now estimates that newly industrialized Asian countries like South Korea grew 5.2 percent in 1999, easily reversing the 1.8 percent shrinkage they had suffered in 1998 as a result of the crisis and much better than the 2.1 percent increase projected five months ago.2 These expanding economies are an important destination for Japanese exports and foreign direct investment.

Policy Initiatives - Despite the good news, the administration headed by Prime Minister Keizo Obuchi took nothing for granted in 1999. It remembered the experience of Mr. Obuchi's predecessor, Ryutaro Hashimoto. Believing that a series of upbeat statistics demonstrated that the economic slowdown that had begun in 1991 was at an end, Mr. Hashimoto's government increased a variety of taxes and levies in 1997, including implementation of a long-planned 2 percentage point hike in the consumption tax in April. These moves were seen as necessary if Tokyo was to rein in its fast-widening budget imbalance.

The economy's weak performance in 1997 had indicated to most observers that the Hashimoto administration's actions were premature. As if in acceptance of that interpretation, one of Mr. Obuchi's first acts after taking office in late July 1998 was to present a ¥23.9 trillion ($217.3 billion at ¥110=$1.00) stimulus package (see JEI Report No. 44B, November 20, 1998).

In mid-November 1999, the Obuchi team unveiled an ¥18.1 trillion ($164.5 billion) follow-up package (see JEI Report No. 44B, November 19, 1999). NEEDS, an arm of Nihon Keizai Shimbun, Japan's leading economic daily, calculated that the plan would limit the drop in nominal public works spending to 5.1 percent in the fiscal year that begins April 1, 2000. Absent the extra money, NEEDS projected a whopping 15.9 percent fall. In other words, Mr. Obuchi appears to be stretching out — but not eliminating — the transition to fiscal rectitude envisaged by Mr. Hashimoto.

The Bank of Japan has a similar mind-set. In recent years, it has adopted what on paper is among the most accommodative monetary policies ever employed by the central bank of a leading country. For example, since February 1999, it effectively has engineered a drop in nominal short-term interest rates to zero. Critics note, though, that BOJ is not as generous as it appears. With the rate of inflation below zero by many measures, borrowers are obligated to repay loans with funds worth more than those they borrowed.

The yen's 14.9 percent average appreciation in 1999 (see JEI Report No. 3B, January 21, 2000) reflected a combination of factors. For example, the currency continued to be affected by the apparent actions of speculators. In 1998, they rather suddenly had decided that borrowing at very low cost in yen and lending the funds in dollars no longer was a safe way to riches, the potential bump in the road being the possibility that the yen would increase in value and expose the speculators to higher costs when their loans in yen came due. As these positions were unwound, the supply of dollars and the demand for yen rose, creating upward pressures on the Japanese currency. The fear of a more expensive yen became a self-fulfilling prophecy.

Fiscal policy tended to reinforce the move toward a stronger yen. Three big stimulus packages in the space of roughly 18 months lifted Tokyo's borrowing requirements, thereby putting upward pressure on interest rates and providing another reason for foreigners to avoid yen-denominated borrowing. The subsequent drop-off in outbound capital flows reduced the supply of yen in world money markets, lifting its value.

Restructuring - In 1999, important decisions regarding the economy increasingly were made far from the government offices centered in Kasumigaseki in downtown Tokyo. Years of losing market share to foreign rivals, coupled with low profitability or even staggering losses, led a lengthening list of companies to declare that, in their organizations at least, it no longer would be business — Japanese-style — as usual. Executives implied that venerable management principles, such as permanent employment and a deemphasis on profitability per se, were to be cast aside as outmoded and counterproductive.

Nissan Motor Co., Ltd. exemplifies this new thinking (see JEI Report No. 41B, October 29, 1999). Under Brazilian-born President Carlos Ghosn, controlling owner Renault S.A.'s man in charge, the number-two Japanese vehicle builder announced plans in October to close three assembly plants and two engine factories in Japan and to cut its global payroll by about 21,000 people, or 14 percent, by March 31, 2003. The decision made headlines not because it meant a dramatic action by global standards but because, regardless of the magnitude of the problems, corporate Japan has tried to avoid shuttering factories or trimming payrolls — even by attrition.

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What To Look For In 2000

Baton Passing? - The major question that Japanese policymakers will be asking this year is whether it is time to take the "patient" off the artificial life support that has come in the form of nearly a decade of fiscal stimulus, particularly by means of public works spending. The November 1998 pump-priming package probably contributed to the strong first-quarter 1999 GDP number and the less spectacular but still-encouraging expansion of the economy in the spring. At the same time, a fear that the good news would not last led to last fall's economic package as well as to the relatively generous general account budget for FY 2000 unveiled late in the year (see JEI Report No. 1B, January 7, 2000).

In recent years, fiscal stimulus has played a major if not entirely predictable role in sustaining what little growth Japan has managed. The fiscal thrust measure shown in Figure 1 uses the concept of the structural deficit calculated by the Organization for Economic Cooperation and Development. Unlike the more widely employed financial balance, the structural deficit abstracts from increases (decreases) in the budget deficit caused by downturns (upturns) in economic activity. As such, it focuses attention on the causal linkage running from deficits to the economy's performance. Increases or decreases in the structural deficit (measured as a percentage of GDP) are the basis for positive or negative fiscal thrusts, respectively. Figure 1 compares the fiscal thrust so defined with the rise or the fall in GDP one year later, reflecting the lag from budgets to real economic activity.

The Figure shows a less than perfect but unmistakable linkage between fiscal stimulus — lower tax rates and/or higher government spending — and growth. For example, the fiscal contraction in 1997, mainly from higher taxes, was reflected in the economy's shrinkage in 1998. Conversely, the extensive stimulus provided in 1995 may have been a factor in the unusually big increase in real GDP that occurred in 1996, although the even larger amount of stimulus supplied in 1993 had little impact on growth the following year.

Overall, every year that the structural deficit increased, the economy expanded the next year. This outcome is consistent with traditional Keynesian economics, which predicts that growth will follow stimulus and a contraction will take place when the stimulus is removed.

The OECD data imply that the fiscal thrust in 1999 was 1.6 percent of GDP, virtually unchanged from the 1.5 percent figure for 1998. To the extent that the relationship holds, the economy's expansion in 2000 should be nearly equal to that in 1999, which the OECD estimates was 1.4 percent. Not surprisingly, the OECD pegs 2000 growth at exactly 1.4 percent.3

The Figure also highlights the dilemma confronting policymakers. If ever-greater — not merely continued — structural deficits are a necessary condition for growth, eventually the budget deficit will become impossibly large. OECD data indicate that the structural deficit relative to GDP already is larger for Japan than for any of the other 19 industrial nations for which the organization has calculated this measure. Japan first achieved its dubious distinction in 1997, replacing Greece and Italy. It is expected to maintain this ranking through 2001, if not longer.4

Over the very long term, virtually all observers agree that Japan's current stimulus policies are unsustainable. Not only will the resultant debt eventually become unmanageable, but the use of resources in wasteful public-sector activity will become increasingly costly in terms of growth to the extent that those resources are diverted — as they would be in a full-employment economy — from more productive private-sector uses.

In short, to borrow a metaphor much beloved by Japanese analysts, the government must stand ready to pass the baton to the private sector. Of course, having Tokyo run an extra lap is preferable to dropping the baton when no one shows up to take it. Moreover, the government debt — while a problem that will have to be faced at some point in this decade — is not an issue that Tokyo needs to address within the next year or two. In other words, the government could run another lap if really necessary, even though a marathon would be deadly.5

The Political Dimension - Various government officials have said in recent months that Tokyo has done all the pump-priming that it is going to do. Put another way, these policymakers are eager to get on with deficit reduction and baton passing. This position should not be taken as final, however. In fact, Finance Minister Kiichi Miyazawa told reporters in mid-February: "Even if the economy were to improve steadily in 2001, I do not think that we could plan to reconstruct Japan's fiscal position as early as 2002."

Mr. Obuchi does not appear to share the ideological commitment to balanced budgets of some of his predecessors. Moreover, he remembers Mr. Hashimoto's apparently premature decision to take a step in this direction. In addition, the Clinton administration seems to spend equal time crowing about its own successful deficit-reduction efforts and urging Tokyo not to follow suit. This gaiatsu (outside pressure) is not likely to change even with a new administration in Washington.

Lastly, and most importantly, the politically astute Mr. Obuchi and his Liberal Democratic Party will have to face the electorate no later than October 19. Should the economy be in trouble at the time, the LDP would be better off if the prime minister could point to something like a stimulus package to indicate that his government is aware of the problems continuing to dog a recovery and is dealing with them aggressively. Public works projects also are goodies that Mr. Obuchi can dangle before voters, particularly those in rural districts, which remain disproportionately represented in the Diet.

Electoral politics will come into play in other ways as well. Should Mr. Obuchi end up leaving office for some reason — perhaps because he is blamed for a subpar showing by LDP candidates in the lower house elections — he easily could be replaced by a prime minister who takes a harder line on deficit reduction. Indeed, a new premier might use this issue to differentiate himself or herself from Mr. Obuchi. In a situation that then would be dominated by deficit hawks in both the cabinet and the Ministry of Finance, Tokyo might well decide to tough it out, regardless of the state of the economy or what Washington might say.

In an election year, the LDP may see pressure on the Bank of Japan as a relatively risk-free tactic. Some party leaders already are urging BOJ to adopt an inflation target for monetary growth. Under this strategy, which has the support of certain American economists, the central bank would attempt a monetary policy so ambitious that today's deflation would be replaced by the targeted rate of inflation.

This strategy faces two problems. First, BOJ might not have tools powerful enough to accomplish the objective, and its failure to do so would reduce its credibility. The second risk is that the tools might be hard to control and could create more inflation than anyone wants. Indeed, the whole idea of deliberately creating inflation normally would seem bizarre, but BOJ's existing policy stance of zero short-term nominal interest rates also is bizarre.

However, today's highly unusual economic setting is matched by an equally rare political situation. On paper, the relatively new Bank of Japan Law gives the central bank greater independence from the Finance Ministry. Politicians might be tempted to test the limits of the new environment at BOJ by attempting to exploit the vacuum created by the central bank's autonomy from MOF.

Restructuring: The Labor Market and Consumer Spending - Mr. Obuchi's job, not to mention that of BOJ or Japan watchers in Washington, would be made much easier if the private sector got its act together. After all, it is the designated baton recipient — or so goes the conventional wisdom. In this view, consumers are supposed to get out of their funk and go out and spend money.

However, restructuring implies the need to reduce redundant employees, estimated by various analysts to have numbered between 3 million and 7.8 million in 1999. The latter figure equaled 11.6 percent of total employment,6 suggesting that firms could trim their personnel rosters even if demand picks up. Fewer jobs, in turn, would mean less willingness to spend on the part of people who either have lost their jobs or fear that they might. Alternatively, companies could maintain employment levels but reduce wages and salaries, overtime pay, bonuses or some combination thereof. Still another option would be to shift more employees to part-time or temporary status.

Japanese firms appear to be employing most or all of these measures. Not only have payrolls been cut back, but overtime and bonus payments also were reduced starting in 1997, and regular wages were trimmed in 1999. Ministry of Labor data for firms employing five or more people show that total nominal worker compensation fell 1.1 percent in 1998, the first drop in postwar history,7 and another 1.7 percent in 1999.8

Most analysts believe, however, that restructuring remains in its infancy in Japan. If companies were to reduce labor compensation in 2000 enough to offset the low-end estimate of redundant employment, then the total wage bill would fall about 5 percent, not the 1.7 percent registered last year. Given that consumer spending was 62.3 percent of nominal GDP in the July-September 1999 quarter, a cut in personal consumption proportional to this larger wage reduction would come to 3.1 percent of GDP. The drag on economic output might well be even bigger since people who still had jobs and earned the same salary probably would increase their precautionary savings in response to what they quite logically saw as greater uncertainty.

Restructuring: Capital Spending - Firms also are believed to have significant surplus capacity. Estimates run as high as a full year's worth of capital spending, which in the third quarter of 1999 equaled 13.6 percent of nominal GDP. This degree of excess might imply a restructuring effort that would completely eliminate plant and equipment outlays for a year, were it not for obsolescence and shifts in industrial structure. In any case, the overhang casts doubt on the likelihood of any significant pickup in business investment.

In short, the arithmetic of restructuring is discouraging for the economy's short-term outlook. The government stands ready and eager to pass the baton to the private sector, but the two most obvious candidates to take it up — consumers and businesses — are likely to remain on the sidelines. Together, these two groups of economic actors, which accounted for 75.9 percent of GDP last summer, may be the source of declining — not rising — spending in 2000. If the public sector, which was 18.2 percent of the economy, retires from the field, that leaves sectors generating 94.1 percent of aggregate demand shrinking or stagnating.

Most of the remaining 5.9 percent of aggregate demand is provided by exports in excess of imports. Although Japan's major trading partners are likely to do well in 2000, the strong yen will work against export expansion and encourage imports. In any case, the foreign sector is too small to reverse strong trends in the rest of the economy. In 1997, it accounted for 1.4 points of the 1.6 percent overall rise in GDP, but that contribution was the largest since 1980, when the figure was a full 2 points. More typically, net exports add less than a point, as happened in 1998 (a 0.5-point input), and often have trimmed growth, especially when the yen has been strong.

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Forecasts

In light of all these constraints and question marks, public and private forecasts for Japan's economy in FY 2000 are, if anything, optimistic. In the outlook it adopted in mid-December, Tokyo penciled in 1 percent real growth (see Table 1). Consumer spending is expected to match exactly the rise in GDP, accounting for most of the increase in aggregate demand. The foreign sector is projected to trim growth by 0.2 point, while plant and equipment investment is predicted to rise modestly.

Table 1: Government's FY 2000 Economic Outlook

Original
FY 1999
Outlook

Revised
FY 1999
Outlook

Initial
FY 2000
Outlook

(percentage change)

Real Gross Domestic Product

0.5%

0.6%

1.0%

-- Consumer Spending

0.4

1.6

1.0

-- Housing

6.7

6.0

-1.6

-- Plant and Equipment Spending

-5.2

-6.1

1.4

Nominal Gross Domestic Product

-0.5

-0.4

0.8

Wholesale Prices

-0.9

-1.0

-0.1

Retail Prices

0.1

-0.3

0.3

(in billions of dollars)

Current Account Surplus

$143.3

$110.5

$108.3

Trade Surplus

128.2

122.2

122.5

Note:Dollar-denominated current account surplus and trade surplus projections were not included in the economic outlook. For purposes of illustration, yen-denominated figures were converted using an exchange rate of ¥111.3=$1.00 for FY 1999 and ¥105.3=$1.00 for FY 2000.

Source: Economic Planning Agency

Private-sector forecasts are all over the map, particularly if those of foreign analysts are included (see Table 2). The average projection of 1 percent price-adjusted growth in FY 2000 duplicates that made by the government. Consumer spending predictions are similar as well, but analysts differ widely as to whether any of the expected expansion will result from capital spending or from additional public works. Generally, those analysts who are relatively pessimistic about the economy's prospects appear to assume greater government spending. For example, Nomura Research Institute, Ltd., one of Japan's best-known forecasters, predicts only a 0.7 percent rise in real GDP, accompanied by a decline in capital spending. To buttress the expected increase in consumer spending, NRI projects that government investment will jump 3.9 percent over FY 1999's elevated level.

An extreme example of the pessimistic view is provided by Morgan Stanley Dean Witter & Co., which believes that the economy will shrink 1.1 percent in both calendar 2000 and FY 2000. Like NRI, Morgan Stanley predicts weak business investment and strong public works spending, only more so. In addition, the Wall Street securities firm is unique in expecting a drop in consumer spending in the calendar and the fiscal year alike. Morgan Stanley's forecast appears to result from confidence that restructuring will, in fact, proceed, with negative consequences for wages and consumer spending.

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Effect Of U.S. Stock Market Correction

Even in the absence of a drop in consumer spending resulting from restructuring, the Japanese economy could fare significantly worse than the forecasts in Table 1 and Table 2 indicate. One possibility has gotten by far the most attention. What if the high-flying U.S. stock market crashed? Since analysts agree that elevated equity prices in this country have created a "wealth effect" that has lifted consumer spending, the impact of such a correction would be felt at the aggregate-demand level in the United States as well as in its trading partners, Japan included.

The IMF and the OECD have addressed this question with similar results. Both simulations assume a 30 percent drop in the U.S. stock market and half that in foreign markets. In the IMF model, the first-year adverse impact on American GDP is 1.9 points against 1.1 points in Japan.9 The comparable figures for the OECD study are minus 0.5 point in the United States and minus 0.6 point in Japan.10

In both instances, the repercussions for Japan occur through a sharply higher yen that reduces net exports and aggregate demand. The OECD's estimates of the fallout are smaller in part because it assumes that central banks would respond to the meltdown with more relaxed monetary policies. By the OECD's measurement, the impact of this hypothetical event initially is greater in Japan than in the United States because Tokyo is assumed to have less room to ease a monetary policy that already is very loose.

The results of the OECD stimulation over a five-year period are shown in Figure 2. The U.S. stock market correction is assumed to occur in the first part of 2000. Eventually, Japan would reap the benefits of a strong currency through greater imports and grow faster than in the absence of the shock, but the difference in expansion rates from the baseline level disappears entirely after four years. In contrast, the crash would have a consistently negative impact on the American economy. In other words, Japan may end up with a small net benefit in terms of economic output and the United States with a small net loss. In any event, the numbers are tiny considering the cataclysmic event hypothesized.

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An Assessment

The stock-market correction scenarios suggest that even an event of this magnitude would be manageable for Japan. However, that prospect should not be generalized to the conclusion that the economy is out of the woods. Since the forecasts in Table 1 and Table 2 were developed, typically last December, Japan's economic outlook appears to have worsened. Analysts are virtually unanimous at this juncture that real GDP shrank in the fourth quarter of 1999. In fact, Tokyo's revised expectation of 0.6 percent price-adjusted growth in FY 1999 appears to be virtually out of reach.

The Obuchi cabinet's prospects have worsened as well in the last few months, in part because its economic strategy does not seem to be working. If the current administration is replaced, the effect, as noted above, could be less government stimulus. In other words, pessimists' forecasts of weak capital spending may be correct at the same time that their assumption that Tokyo will pick up the slack is wrong. Moreover, restructuring could restrain consumer spending. Therefore, the rise in real GDP in FY 2000 could end up between 0.5 percent and 1 percent.

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A Look At The Long Run

Bluntly stated, 2000 and beyond are fraught with peril for the world's second-largest economy. Over the long run, Japan's performance will be better in inverse proportion to how things go in 2000. If corporations restructure and the government trims its gaping budget deficit, the impact on the economy would be terrible this year. However, these developments could set the stage for rapid growth several years hence when the economy regains its efficiency and when funds available to the private sector increase as government crowding-out becomes less of a problem.

Over the longer term, another factor also might come into play. Japan, like the United States,could develop a "New Economy." An increasing number of analysts claim to have discovered a New Economy in this country. It is characterized by higher productivity gains that lead, in turn, to a faster rise in GDP, lower unemployment, less inflation and other benefits.11

In apparent support of this idea, the Council of Economic Advisers pointed out in its most recent Economic Report of the President that the U.S. economy has benefited since about 1995 from an increasing rate of productivity improvement at a stage in the business cycle when such gains typically start to decline or even disappear.12 In fact, according to data too new for inclusion in the report, the rise in U.S. labor productivity in the fourth quarter of 1999 jumped to 5 percent on an annualized basis. Coupled with a slower expansion earlier in the year, the increase for 1999 as a whole came to 2.9 percent.13

The Internet, with its advantages of cost savings and better-quality services over traditional information and distribution systems, exemplifies the kinds of new technologies that arguably are bringing big gains to this country. It eventually could do the same for Japan, where labor productivity growth until last March was negative on a year-to-year basis and now appears to be increasing only as expected in light of the tentative, off-and-on recovery.

One possible silver lining in the lingering cloud from Japan's sluggish economic performance could be an expanding backlog of new technology from abroad that has been too difficult to introduce under the current circumstances. Just as happened in the immediate postwar years when it tapped into the technological stockpile that had accumulated due to war-imposed isolation, the Asian nation could catch up very quickly and create a New Economy early in this century that would spur growth. But this favorable outcome, if it comes at all, will follow an extremely difficult period of economic adjustment that is likely to last at least another couple of years.

Kanako Yamada provided research assistance.

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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Notes
aaa

1aa Some calculations that adjust official data put the People's Republic of China in second place behind the United States on the basis of purchasing power parity conversions of national currencies. See Douglas Ostrom, "Asia's Locomotive: Japan's Potential And Limitations," JEI Report No. 20A, May 22, 1998, p. 3. Twenty years ago, the Soviet Union was widely believed to have a larger economy than Japan — a claim that now looks ridiculous even allowing for the collapse of economic output and the disintegration of the country into such components as Russia and the Ukraine. Current estimates put Japan's economy at roughly 68 times the size of Russia's, suggesting the perils of figuring the size of such economies as the former Soviet Union and China, where market prices are far from universal. In China's case, further privatization and exposure to world trade would permit the calculation of numbers that showed the extent of the underestimation of China's GDP relative to that of Japan. Return to Text

2aa International Monetary Fund, World Economic Outlook (Washington, D.C.: October 1999), p. 2. Available at http://www.imf.org/external/pubs/ft/weo/1999/02/1099ch1.pdf. Return to Text

3aa Organization for Economic Cooperation and Development, OECD Economic Outlook 66 (Paris: 1999), p. 1 and p. 4. Return to Text

4aa Ibid., p. 223. Return to Text

5aa This argument is spelled out in Douglas Ostrom, "Government Deficits And Debt: Tokyo's Dilemma," JEI Report No. 2A, January 14, 2000, pp. 15-16. Return to Text

6aa Cited in Organization for Economic Cooperation and Development, OECD Economic Surveys: Japan (Paris: 1999), p. 47 and p. 229. See also Douglas Ostrom, "Unemployment In Japan: How Serious Is The Problem?" JEI Report No. 2A, January 15, 1999, pp. 6-7. Return to Text

7aa Ibid., pp. 34-36. Return to Text

8aa Calculated from Ministry of Labor data. Available at http://www.mol.go.jp/info/toukei/english/1112/fu1112pe.htm. Return to Text

9aa International Monetary Fund, World Economic Outlook (Washington, D.C.: April 1999), pp. 103-106. Available at http://www.imf.org/external/pubs/ft/weo/1999/01/index.htm. Return to Text

10aa OECD (Economic Outlook), op. cit., p. 33 and p. 37. Return to Text

11aa The term "productivity" here refers to labor productivity, not to the more appropriate concept of total factor productivity, for which timely data are scarce. Labor productivity sometimes rises simply because workers get more capital with which to work. If, as Japan discovered during the bubble period of the late 1980s, investment in capital stock earns low returns, an increase in labor productivity can be an indication of problems down the road. Return to Text

12aa Council of Economic Advisers, Economic Report of the President (Washington, D.C.: Government Printing Office, February 2000), pp. 34-35 and pp. 40-41. Available at http://w3.access.gpo.gov/eop/. Return to Text

13aa Department of Labor, Bureau of Labor Statistics data. Available at http://www.bls.gov. Return to Text

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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