Japan’s Econimic Policy Essay, Research Paper
The Current Economy and Medium-Term Growth Prospects Summer 1999 brought several indications that the recovery is slowly starting to gather momentum. Public investment, the zero interest rate policy, and an easy lending stance backed by government credit guarantees has clearly had an effect. Full-scale private sector restructuring has also helped put corporate profits back on an uptrend and this is having a major macroeconomic impact. The authorities have recognized that the rejuvenation of industry at the microeconomic level is necessary for revitalization at the macroeconomic level, which has led them to combine traditional demand stimulus policies with efforts to make business more competitive through, for example, the Law on Special Measures for Industrial Revitalization. But when will the economy start to recover under its own steam and what is the medium-term growth trajectory? Under given conditions, we would expect real GDP to grow at 0.9% in FY99, increasing to 1.9% in FY00 as the economy enters a self-sustained growth path. We would also expect actual growth to exceed the potential rate of growth fromFY01 onwards. These conditions relate to the policy measures that would need to be implementedwithin a macroeconomic context of ongoing structural reform designed torevitalize Japanese industry. Our medium-term forecast is based on the assumption that the authorities will give priority to self-sustaining economic recovery and maintain their ultra-easy monetary policy stance at least through 2000. The zero interest rate policy is not a necessary condition for economic recovery but until such time as private demand takes over from public demand, and most particularly until such time as private capex starts to pick up in earnest, we expect the ultra-easy monetary stance to be maintained. We assume the government will not reassign priority away from economic recovery back to its fiscal consolidation program for the time being, although the restructuring of public finances is likely to become a major political theme once the recovery gets fully under way. Under these conditions, we expect capex to start to expand again in FY00 and to drive economic growth in the medium term. However, given the deflationary gap between potential and actual growth, unemployment is expected to remain close to 5% for some time yet, falling only gradually over time. Slow job growth is thus likely to cause the economic recovery in 2000 to be a ‘jobless recovery’. Thereafter, unemployment will start to decline gradually but will probably remain in the 4% range — high by Japanese standards — due to a higher labor participation rate and the continuing mismatch between the supply and demand for labor. It seems the economy would have to grow more quickly than is predicted in the current forecast if unemployment is to be further reduced. From a different standpoint, however, the continued labor market adjustment pressure could equally be seen as part of the process by which business is regaining profitability. Labor’s share, which started to increase in 1989, has grown more or less steadily throughout the 1990s. This reflects the modest rate of employment adjustment that prevailed from FY91 through FY98 when the economy grew by just 0.9% a year on average. The flow from/to the labor market is becoming flexible, and there exists substantial excess labor. In the next few years, business ought to be able to keep labor costs at a comparatively low level while at the same time increasing profitability. This should, in turn, enable a gradual reduction in labor’s share, which is currently abnormally high. There also remains widespread pessimism about Japan’s economic future, as symbolized by the ongoing problems of over-capacity, surplus labor, and excessive debt. With land and general prices still falling, the risk of another economic downturn has not been completely eliminated. However, destabilization of the financial system, the Asian economic crisis, and the unusually steep decline in the propensity to consume, all of which fueled the sharp economic downturn of 1998, are in the process of being eliminated or normalized, and the government’s fiscal and monetary policies are starting to show effects, resulting in the conditions for economic recovery falling into place. Following the failure of a number of financial institutions in November 1997, concern over the stability of the financial system contributed to the development of a downward spiral whereby the contraction of bank credit led to a fall in the demand for investment funds. However, a solution was proposed in the Financial Reconstruction Bill of October 1998, and in March 1999 the problem was more or less resolved by the injection of approximately Y7.5 trillion of public money into the private banking system. The future injection of public funds into financial institutions on the verge of failure has thus been made less politically sensitive and the economy finally released from the threat of a systemic failure of the whole banking system. At the same time, the situation whereby uncertainty was dampening consumer spending and severely depressing the propensity to consume also resolved itself in 1999. In other words, despite the continued existence of problems such as rising unemployment, it may reasonably be assumed that for all practical purposes the economy has been in the preliminary stages of recovery since the beginning of 1999. How then are we to understand the problems of over-capacity, surplus labor, and excessive debt that are apparently now blocking the road to recovery? Japan’s economy is undoubtedly under pressure to restructure and large numbers of companies are pressing urgently ahead with programs designed to strengthen their organizational structures. As a result, there are still those who take the view that the economy cannot fully recover until the problems of over-capacity and surplus labor have been resolved, or that capex has been reduced further to improve the macroeconomic efficiency of capital and regenerate the economy. There are also those who maintain that the expected growth rate, which is said to have fallen further, should first be extrapolated into the future, and capex cut and the economy reduced to a lower macroeconomic equilibrium in the medium term until such time as it falls back into line with expected growth. From the stock adjustment point of view, industries in which there is a strong perception of over-capacity are unlikely to undertake fresh investment even when inventory levels have been fully adjusted and capacity utilization is rising once again. The flaw in this argument for further structural adjustment is that its proponents have apparently failed to distinguish between those facilities for which demand fluctuates in line with the business cycle and those that are in structural over-supply and will not be required even when the economy recovers. They also fail to grasp that questions relating to the retirement of surplus capacity are of a different order from whether or not capex subsequently recovers or corporate balance sheets improve.