Scott B. MacDonald
there has been considerable discussion about the “beating” that
Prime Minister Koizumi’s Liberal Democratic
Party (LDP) took in the July 11th upper house of
the Diet elections, the economy is in about the best
shape it has been since the 1980s. The restructuring
of the banking sector (as reflected by the UFJ and
Bank of Tokyo-Mitsubishi merger) is moving ahead.
Economic growth looks sustainable. This was reflected
by the government’s upgrading its real GDP
growth forecast to 3.5% from its previous estimate
of 1.8% for the year to March 31, 2005. Moreover,
Japan’s economy expanded at an annualized rate
of 6.1% in the first three months of the year, the
strongest among major industrial countries.
We think the current growth pattern is
sustainable – at least through next year.
Beyond that our outlook is more cautious. The
Japanese economy initially gained momentum from
exports. It then benefited from corporate capital
investment, with personal spending providing the
last stimulus for growth. Ongoing strength in world
trade and steady increases in domestic demand as
well as some improvements in the labor market should
provide the foundation for next year’s expansion.
It will also help bring deflation to an end.
Yet, Japan still faces substantial challenges. These include the fall in
land prices (still going on outside of Tokyo), weak bank lending, the ongoing
challenged nature of many regional banks, and the potential for the Chinese
economy to hit a hard landing. The last is important considering that China
is a major factor in the strong expansion of exports, accounting for two-thirds
of the rise in 2003. There is also the problematic nature of government’s
finances – the fiscal deficit was 8% of GDP in 2003 and is expected
to decline to 7.1% in 2004. Public sector debt reached a massive 144% of
GDP in early 2004.
Considering the pluses and negatives of the Japanese economy, it can be said
the short-term is positive, but the long-term is harder to forecast. Government
finance is a major concern. According to the Organization for Economic Development
and Cooperation (OECD), public sector debt is projected to surpass 160 percent
of GDP this year. Related to this is the ability of the Koizumi government
to continue its economic reforms. There remains considerable work – deregulation
of agriculture, medical services and education, reform of the postal bank
system and restructuring regional banks.
Ongoing and broadening economic growth means an eventual return of inflationary
pressures. In turn, the Bank of Japan will at some point have to abandon
its zero interest rate policy and raise rates. If done too quickly, a number
of large companies that are struggling would be plunged into having serious
problems. If so, that could once again cause problems in the banking sector.
Koizumi (and the return of global growth) have helped put the Japanese economy
on the right track, but much more work is required. That requires strong
political will. Along these lines, we fully agree with the OECD’s assessment: “Over
the longer term, failure to press ahead with structural reforms would limit
Japan’s growth potential.” More significantly, failure will limit
Japan’s future, holding the door open to a possible major economic
crisis linked to massive public sector debt. Having survived the July 2004
elections, Koizumi has a window of opportunity to push ahead over the next
two years, which should be free of any new electoral challenges. The stakes
of making further reforms could not be higher. We wish Prime Minister Koizumi