Japan in Its Third Lost Decade?

Japan in Its Third Lost Decade?

The Economist, in 2012, put out an article detailing how Japan was behind behind both Western Europe and the USA despite the 2008 crisis affecting Europe and USA the most. Japan was once much ahead of Western Europe and North America bar the USA in terms of wealth before the 1990s bubble crash. Today, after five years ‘Abenomics’, Japan still lags behind most of its European counterparts in terms of per capita GDP.

The 1990s in Japan was characterized by crashing property values, falling interest rates, rising unemployment, declining and stagnant GDP and the worst demographic profile of any major economy.

In the early 2000s, the term "lost decade "started to be used to refer to the Japanese economy. And with the onset of the Great Recession in the West in the late 2000s, economic growth remained stagnant with a continuous deflationary pressure (To give you a hint: Only in 2010 did its economy regain a level of income last attained in 1995). Economists then extended the term to the "Lost score" or "Lost 20 years".

As Shinzo Abe begins his second term as PM, critics are debating whether Shinzo Abe, who came to power in 2012, has been able to avoid a third lost decade or not.

There are a number of negative signs to believe the latter. Japan faces a problem of deflation and hence it is essential that we judge the health of an economy which has been plagued by stagnant prices and wages on a few spending related parameters.

The Bank of Japan left its key short-term interest rate unchanged at -0.1 percent at its October 2017 meeting. Policymakers trimmed inflation forecast to 0.8 percent for fiscal 2017 from 1.1 percent, against the targeted rate of 2%, as firms' wage and price-setting stance has remained cautious. Economist Paul Krugman has argued that Japan's lost decade is an example of a liquidity trap.

Despite low (even negative) interest rates, consumer spending seems to never pick up. Since January 2016, Japan's household spending has contracted in all but three months. Consumer prices rose by only 0.7% in the year to September. It was the highest inflation rate since March 2015, mainly driven by a faster rise in the cost of food, well short of its 2% target.

One thing to keep in mind while looking at Inflation and household spending figures is that they are being calculated on a very low base on account of negative growth over the past two decades. Therefore, these hardly positive figures are because of a low base which does not depict the real picture, which is even worse.

Another negative aspect of the Japanese economy is stagnant wages. Although base pay (excluding bonuses and overtime) has stopped falling in the past two years, it increased by only 0.2% in 2016.  Wages for the permanent workers have remained stagnant primarily because of lack of bargaining power of the workers.

These permanent workers are neither easily fired nor easily quit as it would reduce their status (blame it on the work culture in Japan) leading to a loss of bargaining power. Moreover, an inflation rate of close to 0 percent gives no incentive to trade unions to bargain for higher wages. Moreover, increase in a number of women, elderly and foreigners in the workforce has increased labor supply further ensuring wages do not rise.

Adding on to the labor market problems is the work culture of Japan. Cases of "karoshi" - the Japanese term to describe death attributed to overwork, a phenomenon which started in the 1960s- keep coming up now and then.

Nearly a quarter of Japanese companies have employees working more than 80 hours overtime a month, often unpaid, a recent survey found, and 12% have employees breaking the 100 hours a month mark.

The government has introduced schemes like Premium Fridays- encouraging firms to let their employees out early, at 3 pm, on the last Friday each month. However, a survey found only 4% of Tokyo workers utilized the provision of Premium Fridays in February, which hints that the problem is not of an ageing population dependent on few young workers who have to work longer, but about a work culture which has been created through the course of the hardworking decades post the Second World War.

The fact is that work as a social symbol is hurting Japan on both the wages and work culture fronts and changing hanging this social mindset will take more than some legislation.

However, there is still some good news―the female labor force participation rate has increased to 50.4% (as of December 2016), compared to 47.8% when Abe took office in December 2012. Japan now hosts more than 1m foreign workers, up from 680,000 in late 2012. More importantly, the number of women and elderly men in work has increased by more than 2m over that period.

Further, there has been a proposal to increase the upgrade the definition of ‘elderly' to 75 years of age from the current 65. Add on to it an unemployment rate of 2.8%. This means that Japan has been able to neutralize the effect of the world's fastest aging population by adding on to its workforce.

Even though this means stagnant wages in the short term, Japan is not compromising on its productivity. Moreover, as the labor market tightens in the medium term, an increase in wages should become imperative. After all, can wages (or prices) be stagnant for more than 30 years? As of November 2017, Japan had over 1.5 job openings for every applicant, which should have an inflationary effect.

Other good news includes the fact that residential property prices have been rising since FY 2013. Japan has had a trade surplus bar just 4 months since 2012. The Yen is now about 30% cheaper in dollar terms than it was in November 2012, which has further helped boost exports, and the Nikkei 225 stock market index is up by more than 150%, symbolizing investor confidence.

Even though debt, expressed as a percentage of GDP, is at approximately 240% which is the highest level of debt of any nation on earth, Japan owes most of it to the Central Bank or Domestic financial systems. To default would mean to default on itself. It would simply have to recapitalize the institutions.

Also, given Japan is the largest international creditor, there is little doubt that Japan may default or investors may panic. Further good news is that IMF forecasts debt to remain stable at 232 % of GDP till 2022. Moreover, inflation meeting the 2% target will also help the government in paying some of its debt back more easily.

As the Yen is cheapened (it was 109 to the dollar one year ago, compared to 113 today), there are chances of inflation to push up due to increasing cost of imports. Depreciation coupled with an increase in oil prices due to production cuts by OPEC may also be a blessing in disguise for this deflated economy which imports oil.

Japan's economy has expanded for seven quarters in a row in the longest period of growth in more than a decade. Gross domestic product (GDP) grew at an annualized rate of 1.4% between July and September. The expansion of nominal GDP, which makes no adjustment for inflation, is even more striking. It was almost 11% higher in the third quarter of 2017 than it was five years earlier, the fastest pace of growth for over two decades.

Japanese manufacturing purchasing managers index (PMI) has been above 50, i.e., manufacturing has expanded, throughout 2017. Corporate investment, which fell enormously (22% of GDP) during the 1990s, has grown by more than 18% in nominal terms over the past five years and by almost 15% at constant prices.

Tax revenues are up by six percentage points of GDP since 2000. All of this means that Japan may well be on a long term recovery trajectory. The recovery was delayed by the 2008 crash but with no major economic meltdown in sight, and the global economy recovering as a whole, the outlook on Japan remains positive.

It is a tough task to balance a deflating and stagnating economy, with increased expenditure on healthcare due to an aging population. And Shinzo Abe has done pretty well by bringing in positive growth and sentiment, along with stabilizing the debt. The only thing that remains to be addressed is deflation- and Abe’s re-election gives him the mandate to take steps to do so.

Abe demanded a 3% pay rise to drive Japan's economy after his election win. If a law is made regarding the same (Abe has a two-thirds majority in Parliament) and if wages do pick up enough to spur inflation then there will be a downward pressure on the Yen.

This will generate a virtuous cycle for the economy, exports will benefit, imports will become expensive, and inflation expectations will rise further. However, PM Abe should be careful not to raise the sales tax to pay off country's debt like he did in 2014 — from 5% to 8% — which throttled consumption and sent the country into a recession.

One may almost feel sorry for Japan given its recovery after the Second World War and so many natural disasters. A few years ago it seemed Japan will never be able to come out of its spree of lost decades.

Today, however, the sentiment is positive which has been boosted by Abe's re-election. Abe has promised to continue on a spending spree to boost inflation and exports.

Japan, however, has to be careful of some of its neighbors in the event of something blowing up: Global economy does not have space for bleeding hearts.


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