Japan’s economy had a relatively good showing in the first quarter of 2016.The nation’s gross domestic product (GDP) grew an annualized 1.9% (or 0.5% on a quarterly basis), effectively rebounding from the previous quarter’s economic shrinkage to avoid consecutive quarters of negative GDP growth: a recession. National private consumption, which is responsible for over 60% of the nation’s GDP, carried much of the load with 2.3% growth, namely with higher spending on recreation and dining. Public consumption, accountable for about 20% of GDP, also chipped in with a 2.6% climb. While these numbers appear on the up side, the leap year of 2016 provides a little fluff to these end figures. As trivial as it may sound, that extra day in February provides Japanese consumers with some extra time to spend their money and keep the economy ticking, providing a bit of reality to these Q1 numbers.
The news of Japan’s recent economic progression is furthered soured when taking the previous quarter’s results into account. In the fourth quarter of 2015, Japan’s economy contracted 1.7%, even worse than previous estimates of a 1.1% decrease. The major culprit for the quarter’s disappointing performance was, predictably, faltering private consumption. Consumers simply did not have as much confidence to dig into their wallets, as private consumption fell by almost a percentage point. Combined with a sizable drop in public investment, an unwanted level of economic hesitation and inactivity stymied any hope for growth.
The antipodal performances between these two most recent quarters can be seen as a reflection of Japan’s volatile economic performance since the start of the decade, still in the wake of the 2008 global financial crisis. From 2010 onwards, the economy experienced twelve different switches between quarters of economic expansion and contraction; the economy battled three recessions during that same time span.
Many link Japan’s underperformance to Prime Minister Shinzō Abe and his policies, affectionately known by many as “Abenomics.” They have traditionally been characterized by a trifecta of fiscal stimulus (also known as “government spending”), monetary easing, and expansionary structural reforms, in an effort to revitalize an economy that has struggled to find its footing. Within weeks of his December 2012 re-election, Mr. Abe immediately charged up the fiscal defibrillator by announcing a massive stimulus bill of ¥10.3 trillion (or $116 billion), with ¥3.1 trillion ($34.9 billion) intended to encourage private investment. In terms of monetary policy, 2014 saw the Bank of Japan initiating sizable quantitative-easing, in which the national bank would make annual purchases of ¥60 trillion to ¥70 trillion ($68 billion to $79 billion) in bonds, increasing the nation’s money supply. Later that fall, the Bank of Japan doubled down on its efforts by increasing its annual bond purchases to ¥80 trillion ($90 billion), with the goal of driving down its currency value and driving up market liquidity. Outside of government spending, Abenomics looked after the private sector by lowering the corporate tax rate by 3.3% in 2015, with the goals of achieving greater corporate profit margins, private spending and investment, and new job hirings. Abe sought to systematically reinvigorate multiple players of the economy, and in most eyes, he went to extreme lengths to do it.
An important indicator to judge economic health is inflation. Although commonly misconstrued as a bad thing (and certainly, hyperinflation is something to be avoided), healthy inflation is associated with stable economic growth, especially when paired with encouraging growth in wages. Since the “Lost Decade” of the 1990s however, Japan has been struggling to approach that level of healthy inflation; the majority of 21st century Japan has seen inflation levels below zero, and GDP growth has been riding close to the zero line right along with it. The Bank of Japan has set its sights on a 2% target inflation rate to work towards in the coming years, similar to the Fed’s inflation target.
Over the last four years, the yen has depreciated against the U.S. dollar by a staggering 41%. Many would expect a less-valuable yen to result in rising prices for Japanese goods, especially given that the U.S.’ currency is more expensive and its exports would be less competitively priced, providing more breathing room for Japanese manufacturers. Inflation would be expected to follow.
So the question remains: Why hasn’t it?
Many of Abe’s initiations, while ambitious and far-reaching, have failed to yield the intended results most likely due Japan’s structural deficiencies. The economy has not been performing up to its capabilities since the 1990s, as indicated by the nation’s output gap, a measure of the difference between the economy’s actual output and its output at full-potential. This market inefficiency still accounts for -1.6% of national GDP according the Bank of Japan. Closing that gap is paramount to translating market inputs such as a competitively-priced currency, into a 2% inflation rate.
Whether or not the Japanese economy is in the midst of a solid and substantial recovery will be dependent on a few other things. Japanese legislators have to create an economic climate that encourages more private and public consumption, which, as illustrated before, has been a major component of the nation’s GDP. Prime Minister Abe seems to understand this as he has recently decided to push back an increase the country’s sales tax until 2019. A higher sales tax rate, while providing government more revenue and a way to lower any national debt, results in lower household wealth and less consumer willingness to purchase things. Unfortunately, the effects were already seen in 2014 when a premature tax hike stifled consumer spending and played a role in a mid-year recession. As Japan’s economy is presently constructed, plans for progress rest largely on the shoulders of consumers and spenders.
Hopes for Japan’s economic growth also fall on its exporters, and much of that has to do with the yen’s movement for the months to come. The yen has already appreciated 14% against the U.S dollar so far this year, which is the biggest gain among the currencies of developed nations (the recent Brexit certainly didn’t improve things, as investors scrambled to the safer yen, further spiking the up currency). Correspondingly, the Tokyo Stock Exchange Tokyo Price Index has fallen over 20% year-to-date as Japanese exporters battle with a rising yen and falling profits abroad. Some however don’t see the yen’s recent climb as an indication of the currency’s future performance. Economists at the Goldman Sachs Inc. Group is looking for the yen to make an about-face and soften to 115 per dollar by August, and 125 per dollar within the next 12 months. Analyst belief stems from Mr. Abe and the Bank of Japan’s desire to spark inflation by cheapening the yen and cutting interest rates. Of course, there are at least two sides to every exchange rate. The JPY/USD rate is also the product of the U.S.’ economic performance and Fed policies, both of which are largely out of Japan’s control. The Fed’s slowly approaching decision to pull the trigger on the second interest rate hike is widely expected to result in a stronger dollar, as the higher rate pulls in foreign investors and increases demand for the greenback (especially if other large players maintain their expansionary policies.) In addition to the U.S., the currency movements of Japan’s other trading partners (particularly China) are something to keep an eye on. Japan would benefit, structurally, from opening its economy to more trade communication and competition with these partners, which would bolster the nation’s export economy (currently the fourth largest in the world). Abe has an opportunity to move in the right direction with Japan’s involvement in the still-pending Trans-Pacific Partnership.
Japan’s government also has to contend with yet another major issue: its shrinking population. According to the national census, Japan’s population has shed nearly a million individuals within the last five years, a rather considerable figure when taken within the context of current population of 126.6 million. Japan’s population is also aging quickly, adding insult to injury. Over 25% of the current population is above the age of 65, giving Japan the world’s highest percentage and blowing away the global percentage of 10%. If left unabated, Japan’s population can fall to as low as 83 million by 2100, with the percentage of people age 65 and above reaching 35%. This has large implications for the economy, as a shrinking working-age population eats away at overall national productivity. Both of these issues require major immigration and social reforms, and Abe has pledged to raise the birth rate from 1.42 per woman to 1.8 (a very tall order according to experts) through expanding childcare opportunities and making it easier for women to take maternity leaves from work.
It will require a lot of time, and perhaps some missteps, but with the right combination of fiscal policy and structural reform, Japan’s monetary policy can start to yield greater dividends towards supporting healthy inflation and jumpstarting real growth that Japan has long waited for.