Mounting gloom

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Sep 15th 2008
From the Economist Intelligence Unit ViewsWire

Japan faces problems as the world economy slows


Mounting economic gloom is combining with political turmoil in Japan. New data show that the country's economic decline in the second quarter of 2008 was larger than originally estimated. Real GDP contracted by 0.7% quarter on quarter in the three months to June, according to the government's Cabinet Office. This compares with the Cabinet Office's previous estimate of minus 0.6%. On an annualised basis, the revision is even starker, with the economy now estimated to have contracted by 3% compared with 2.4% previously.

The main reasons for the downgrade, published in the Cabinet Office's second preliminary estimate of GDP on September 12th, are revisions to the data for private-sector business investment and exports. Private non-residential investment contracted by 0.5% in seasonally adjusted quarter-on-quarter terms, the government said. This is down from the 0.2% decline in the Cabinet Office's first preliminary estimate of GDP, published on August 13th. Meanwhile, exports of goods and services contracted by 2.5% quarter on quarter, a slightly larger decline than the 2.3% reported before.

Exports have been one of the main drivers of the Japanese recovery in the past few years, not only directly contributing to growth but also stimulating business investment and, indirectly, consumer spending. The fact that both exports and corporate investment are now in decline points to the difficulties Japan faces as the slowdown in the world economy and the commercial uncertainties arising from the global credit crunch are reflected in weaker demand for Japanese exports.

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The LDP leadership race has highlighted divisions between camps that support pump-priming (more spending), those that favour fiscal consolidation (for example, a higher consumption tax), and advocates of pro-growth structural reform (the so-called "rising tide" camp). Of the candidates to become LDP president (and thus prime minister), the front-runner, Taro Aso, has come out most clearly in favour of increasing spending—and therefore of delaying the proposed return to primary fiscal balance.

The weak GDP data will also fuel the debate on monetary policy, although here again the options are limited. Interest rates in Japan are already so low that there is only minimal room for the Bank of Japan (the central bank) to cut them further. Although speculation in financial markets about a rate cut has grown, the economic response to such a move would be very muted given that real interest rates are already negative.

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The problem is particularly acute because the other main pillar of demand—private consumption—seems in no position to take up the slack. Private consumption contracted by 0.5% in the second quarter, a rate unrevised from the first preliminary estimate. Political turmoil, rising inflation, sluggish wage growth and concerns over job stability are all affecting consumer sentiment, which in July fell to its lowest level ever recorded since the introduction of the Cabinet Office's consumer confidence index in 1982.

The outlook for Japan's economy in the third quarter is for further weakness, and economic concerns have risen to the top of the political agenda. The turmoil affecting the government has also increased the attention that economic policy issues are receiving. Following prime minister Yasuo Fukuda's announcement of his resignation on September 1st, pressure has increased on his would-be successors to articulate plans to revive the economy, while also taking into account the structural constraints the country faces (most notably, its poor fiscal position and ageing population).

Unfortunately for the five candidates running for the leadership of the ruling Liberal Democratic Party (LDP)—the election for which will take place on September 22nd—the policy options for restoring the economy to a more robust footing are limited. Japan's very high level of public debt means that there is little scope for substantial fiscal stimulus, although just prior to Mr Fukuda's resignation announcement the government did unveil plans for a ¥11.7trn (US$110bn) stimulus package. However, the true level of new stimulus in the package is only about ¥2trn, and the impact on GDP growth is unlikely to be dramatic. Moreover, Japan's well-documented past attempts to promote growth through public-works spending have been ineffective—as well disastrously expensive.