The Japanese Economy: 2005 and Beyond
Toyoo GYOHTEN (President, Institute of International Monetary Affairs)
2004 was the year Japan's economy finally broke out of the stagnation that lasted for a decade after the collapse of the bubble. The stagnation was initially caused by corporations becoming unable to repay their superfluously expanded debts incurred during the bubble after the value of their assets tumbled. This brought about managing crises at banks as lenders had to register sharply increased amounts of bad assets on their books. Accordingly, cleaning up the aftermath of the bubble meant first that banks had to decrease their bad assets and that corporations had to rationalize their operations to cut costs by decreasing debts and achieving financial health. It also should be remembered that during the 1980s when Japan was enjoying the bubble bacchanalia, the world was experiencing rapid globalization. Corporations in industrialized countries were struggling to survive and win globalized and intensified competition by boosting productivity through utilizing dramatically advanced IT technology in every facet of management. Japan's economy lagged behind in this respect also. Thus "Japan as No.1" became "Forgotten Japan."
The recovery that began in 2003 indicated that Japan's economy had finally overcome these burdens and had begun to take new steps on the route to catch up with the rest of the world. The financial strengths of Japan's financial institutions are recovering at a pace that has awed international observers. The ratio of bad assets that surpassed 20% has come down to less than 5%, and reform of financial institutions is progressing at a speed and magnitude far exceeding expectations. Corporations have returned to their status as "excellent companies" in the global sense through efforts of managers who realized their backwardness and activated necessary measures for restructuring, cost reduction, technical innovation, and modernization of equipment. Factors that supported such success were, first, strong will of competent managers; second, the stance of the government to advance reform as a policy agenda priority; and third, the favorable global economy lead by the U.S. and China.
Japan's economy slowed down somewhat during the latter half of last year. Some express fears of returning to recession. But I do not think it is necessary to become so pessimistic. The slowdown was a minor and expected repercussion of the unpredicted rapid expansion of the economy during the 4Q 2003 - 1Q 2004 period. Another factor was a slowing of pace of growth in the U.S. and China, which are Japan's major destinations of export. IT-related industries have reached their inventory adjustment phase, which also had a slowing down effect on the economy. Thus, the period-over-period rate of growth for the coming year is expected to be moderate.
As domestic demand such as personal consumption and capital expenditures are strong, and the economies of the U.S. and China are expected to regain strength toward the latter half of this year, Japan's economy should continue to recover without slumping into recession. Increase in oil price is a negative factor, but because Japan is energy-efficient and has its own refinery facilities while the price of the yen is appreciating, the impact should be smaller than in other industrialized countries.
Difficult International Issues
Still, there are quite a number of difficult issues that need to be dealt with for Japan to cast off the after effects of the collapse of the bubble and to re-experience the golden age. From the international aspect there is the persistent appreciation of the yen against the U.S. dollar, which has been going on for more than two years. The exchange rate, which used to be on the order of 130 yen to the dollar, is now near 100, and market experts foresee further depreciation of the dollar. The largest factor for the lower dollar is the current account deficit of the U.S. The deficit of 135 billion dollars in 1997 grew more than fourfold to over 600 billion dollars in 2004, and is still increasing.
Many market participants fear that the rapid pace of deficit buildup cannot be sustained, and a meltdown of the dollar and grave economic downturn in the U.S. is inevitable. If that fear materializes it would be a serious blow to Japan, which owns huge amounts of U.S. dollar denominated assets, and whose economy is heavily dependent upon exports to the U.S. The basic reason for the current account deficit of the U.S. is that the country imports a lot, and that is because its domestic demand, especially the volume of personal consumption, is huge. The other side of the coin is that the large volume of consumption in the U.S. is the factor supporting the exports of Japan and other countries, which in turn is fueling the growth of the world economy. There are only three ways to decrease the deficit of the U.S. First is for the U.S. to decrease its personal consumption and budget deficit. Second is for Japan and other trading partners of the U.S. to increase domestic demand and decrease reliance on exports. And the third is to devalue the dollar and improve the trade balance of the U.S. It must be well noted that the process to decrease the U.S. current account deficit would not only be painful to the U.S. but also impose significant strain on its trading partners. A rapid and drastic reduction of the deficit would be a severe blow to the whole global economy. What is necessary, then, is to decrease the U.S. current account deficit, but do it gradually and in an orderly manner. Japan, which depends heavily on the U.S. economy, must be prepared to share the burden in the course of resolving this global issue.
Another important international issue for Japan is the course of the Chinese economy. China has become the closest partner for Japan's economy next only to the U.S. The Chinese economy is experiencing fast growth but at the same time is becoming a large destabilizing factor for the world, especially in terms of supply and demand of international resources such as energy consumption, environmental destruction, observation of international rules as in protection of intellectual property, and the foreign exchange systemís treatment of the yuan. China must become a stable and respectable leader in the international economic system not only for China but also for the world, especially Japan. Japan, through both official and private channels, must endeavor to improve and strengthen ties with China and support its economy to grow steadily.
On the domestic front, economic reform has advanced significantly in the past few years. But further and more thorough reform is imperative if Japanese people wish to maintain the current high and stable standard of living. Protections and restrictions extended to specific sectors of the economy are still abundant and widely practiced, and must be eliminated to promote competition domestically as well as internationally if various types of business and individual companies are to acquire genuine competitive power in the global economy. The strong will of politicians to pursue further reform in the direction truly desirable for Japan's economy is critical, and there must be a policy that provides a safety net to care for those unavoidable casualties caused during the pursuit.
In the medium and long-term perspective, there are truly serious issues such as coping with declining population and restructuring of public finance. These issues need to be addressed with a consistent long-term policy, while persistently attending to the necessary measures step-by-step.
The stagnation period following the collapse of the bubble was loaded with good lessons for Japan. As the fruit from those lessons are to beginning to ripen, Japan is expected to fully recognize that the surrounding world is ever evolving. Accordingly, in order to protect its affluent life style, Japan must acquire the strong will and determination to self-reform by constantly going over the constraints and experiences from the past. The coming ten years will be a critical period for Japan to see if its economy can accomplish a true revival.