Section 1 Toward Economic Growth Based on Private Demand
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A recovery in the Japanese economy has been continuing since the beginning of 2002. The recovery has been on solid footing since the latter half of 2003 with increases in exports and capital investment due to the acceleration of overseas economies' growth. In the business sector, in addition to progress in the reduction of excessive employment and debts as a result of restructuring carried out thus far, corporate profits are increasing as a result of the effect of increases in revenue generated by higher sales, and a virtuous cycle in which the increased profits promote capital investment can be seen. The business sector, which is exposed to severe competition, is still cautious in the increase in employment and wages. Hence, increases in employment and wages are slightly lagging compared with recovery phases in the past. However, there has been a halt in an increase in unemployment resulting from corporate restructuring and bankruptcies, and the employment situation is improving compared with before. Meanwhile, in the household sector, consumer confidence has been improving, partially as a result of the improving employment situation, and private consumption has become relatively steady, propping up the economy. Regarding prices, prices in the upstream sectors such as raw materials have started to rise, partially as a result of tight conditions in the international commodity market, but the current impact on the prices of final demand goods and consumer prices has been limited. With regard to future course of the economy, although there are factors of concern such as trends in overseas economies, a steady economic recovery can be expected. Section 1 looks at the characteristics of the current recovery phase.
Emergence of recovery led by private demand
The first characteristic of the current economic recovery is that private demand such as capital investment is driving the recovery with restrained government sector spending including public works projects. Real GDP grew by 3.2% in FY2003, and the majority of this growth was shouldered by private demand, with domestic private demand combining private consumption and residential and non-residential investment contributing by 2.9% along with the contribution of external demand of 0.8%, while government spending including government consumption and public investment adversely contributed by -0.6% (Figure 1-1-1).
Figure 1-1-1 Private Sector Demand Leads Recovery
The second characteristic is that the realization of the recovery led by private-sector demand results partly from the fact that the financial condition of companies is getting stronger as a result of adjustments made over the past several years. Specifically, with progress in the disposal of non-performing loans in the banking sector, uncertainty regarding the financial system is reduced, and the excessive debts of the business sector as a whole are narrowing, demonstrated by the reduction of debt in sectors with excessive debts such as real estate, wholesale and retail, and construction industries (Figure 1-1-2 (1)). Companies have significantly reduced their labor costs in the process of restructuring over the past several years, and as a result, the labor share declined and the proportion of compensation of employees over nominal GDP in the first quarter of 2004, for example, was on the same level as it was in the early 1990s (Figure 1-1-2 (2)). In addition, reorganization of companies such as through M&A was activated, and as a result, profitability in the business sector is increasing (Section 2). In terms of policies, legislation and tax systems relating to corporate reorganization are being developed, and the development of legislation for the corporate revitalization is moving forward in order to help the corporate sector strengthen its financial condition.
Figure 1-1-2 (1)). Companies have significantly reduced their labor costs in the process of restructuring over the past several years, and as a result, the labor share declined and the proportion of compensation of employees over nominal GDP in the first quarter of 2004, for example, was on the same level as it was in the early 1990s (Figure 1-1-2 Business Sector Trends in Employment and Debt
The third characteristic is that the current recovery of the business sector partly reflects the fact that Japanese companies are benefiting from their progress in developing original products in the areas in which they have an advantage. Specifically, Japanese companies are demonstrating their high capability in technological development as seen in areas such as digital electronics, computerization-related capital goods and hybrid vehicles (vehicles equipped with a combination of a conventional internal-combustion engine and an electric motor), as well as their strong competitiveness in areas which require methods for commercializing new technologies. Also, they tend to locate their plants in domestic sites with the need of these high-level technologies for production (Appended Figure 1-1).
Basically, the realization of the economic recovery led by private demand thus reflects the fact that the business sector, through its independent efforts without reliance on the government, is strengthening its profit structure by reducing excessive debt and labor, as well as increasing its competitiveness through the utilization of unique high-level technologies such as in digital electronics, while recoveries in economies overseas continue to have a favorable impact. Meanwhile, government policies are supporting this self-sustaining recovery of the private sector.
Broadening of recovery in the business sector
A characteristic of the current recovery phase in the business sector is that, while recovery in the previous cycle from 1999 to 2000 was narrowly based on the IT industry, improvements this time can be seen in a wide range of manufacturing industries and are extending to some non-manufacturing industries.
Looking at this in terms of corporate profits, profits in the electronics industry, which increased significantly in the last recovery phase, have still recovered to only 70% of their level in 2000, while profits for transportation equipment, steel, chemical and other industries have recovered to levels higher than those in 2000 (Figure 1-1-3). The profits of some non-manufacturing industries such as real estate, retail and wholesale, transportation, and communication also recovered to levels higher than those in 2000.
Figure 1-1-3 Extension into Improvement in Corporate Profits and Capital Investment
As such, this apparent broadening to various industries in the current recovery phase reflects the fact that 1） with the simultaneous advance of global economic recoveries, exports in particular to countries such as China, which is experiencing high economic growth, have increased significantly, and this is affecting not only manufacturing industries, but also materials industries, and 2） with continued relatively steady increases in private consumption, the recovery of profits is extending to non-manufacturing industries. The share of exports to China (in value terms) rose rapidly from 10.3% in FY2002 to 12.4% in FY2003. Looking at exports by item, exports of general machinery, electronics and other items increased by the same amount as during the previous recovery, and exports of materials such as iron and steel, and chemicals, which contributed significantly to exports to China and Asia, increased more than during the previous recovery (Figure 1-1-4 and Appended Table 1-2).
Figure 1-1-4 and Figure 1-1-4 Export to China Increased Significantly
With the significant increase in the profits of companies, capital investment of companies is also increasing. Regarding the broadening among industries, capital investment is currently increasing, centered on manufacturing industries such as for general machinery, electronics, precision machinery and steel, while the growth rate of business investment in the non-manufacturing industry as a whole has not been as high as those in the manufacturing industry (Figure 1-1-3). However, capital investment in some non-manufacturing industries such as real estate, transport and service, according to FY2003 figures, is about the same level as in 2000.
Section 2 covers the background to these positive trends in the business sector including the significant reduction of excess labor, debt and equipment in the business sector, the rise in the profitability of companies due to factors such as M&A (corporate alliances through mergers, acquisitions, the transfer of operations and capital alliances, etc.) and reductions in labor costs. Section 2 also looks at the fact that companies have remained cautious about the future direction of the economy, and while capital investment and debt repayment is continuing backed by increased cash flow, the growth of production capacity is being restrained as a result of the elimination of old equipment.
Lagging recovery in jobs and income
The recovery in employment and income was lagging a little compared with the recovery in the business sector. Comparing the current recovery with the previous recovery periods, which started from 1999 and from 1993, the number of new job offers has been recovering since a relatively early stage, while the number of employees stayed almost flat from 2002 to 2003 before it finally started to increase in 2004 (Figure 1-1-5). This phenomenon, in which employment did not recover as significantly as new job offers did, was also seen during the previous recovery period, and this aspect differed from the earlier half of the 1990s. With regard to new job offers, however, the composition of the job offers has been changed, demonstrated by an increase in job offers from contracts and dispatches, for which the probability of filled vacancies is low(1). It is likely that the problem of not creating more employment could have been a structural matter since the latter half of the 1990s.
Figure 1-1-5). This phenomenon, in which employment did not recover as significantly as new job offers did, was also seen during the previous recovery period, and this aspect differed from the earlier half of the 1990s. With regard to new job offers, however, the composition of the job offers has been changed, demonstrated by an increase in job offers from contracts and dispatches, for which the probability of filled vacancies is lowFigure 1-1-5 Comparison with Past Situation of Job Offering and Employment
Meanwhile, although a decrease in the unemployment rate was not observed during the previous recovery phase, in the current recovery phase, the unemployment rate peaked in January 2003 at 5.5%, and fell to 4.6% in May 2004 (Figure 1-1-5). A decomposition of this into detailed factors reveals the fact that the number of persons employed in FY2003 was for the most part flat compared with the previous year, while the unemployment rate fell as a result of a continuous decrease in the labor force population since FY1998 due partly to advancement of the aging society (Appended Figure 1-3). The unemployment rate decreased in the first quarter of 2004, however, with increases in the number of both persons employed and the labor force population as a result of the economic recovery.
With the employment situation mentioned above, the decrease in nominal income growth has moderated, reflecting an increase in overtime hours, and income growth became for the most part flat in 2004 (Figure 1-1-6). On the other hand, while consumption increased at around 1% in real terms from FY2000 to FY2002, it began to accelerate in the latter half of 2003, resulting in a 1.6% increase in real terms in FY2003. The savings rate (SNA basis) fell significantly from FY2000 to FY2001, dropping 2.6% points. Following this, the savings rate in FY2002 fell 0.3% from the previous year and bottomed out at 6.2% as a result of narrowing in the difference between the growth of real consumption and that of real disposable income (Appended Figure 1-4). According to the official figures for FY2003 which indicate a 1.6% increase in real private consumption spending and a 0.8% increase in real employee compensation in FY2003, it appears that the savings rate continues declining gradually. The growth of consumption in FY2003 was thus supported by this bottoming out of income and gradual decline in the savings rate. It is possible, however, that the somewhat stronger consumption since the latter half of FY2003 reflects a further increase in consumption propensity (a further decrease in the savings rate) due to a recovery in consumer confidence as a result of the improved employment situation such as a decline in the unemployment rate.
Figure 1-1-5). A decomposition of this into detailed factors reveals the fact that the number of persons employed in FY2003 was for the most part flat compared with the previous year, while the unemployment rate fell as a result of a continuous decrease in the labor force population since FY1998 due partly to advancement of the aging society (Figure 1-1-6 With Improvement in Consumer Confidence, Slight Strengthening of Consumption from Latter Half of 2003
Section 3 shows that stagnant job creation reflects the fact that, with the sustained loss of jobs in the manufacturing industry, job creation capacity is not as strong as it was before even in some sectors in tertiary industry in which employment has continued to grow. Section 3 also argues that the recent fall in unemployment reflects a halt in corporate restructuring. The section also discusses that the low growth of wages results from rapid increase in the proportion of part-time workers over the past several years and the change in the traditional wage system. Regarding consumption, the section shows that significant drops in the savings rate, as seen in 2001, are partially in reaction to previous restraints on consumption, and the decrease in the savings rate became gradual beginning in 2002 in line with long-term trends reflecting the aging of the population. The section also shows that strong consumption since the latter half of 2003 possibly reflect the fact that demand is being stimulated by new products including digital electronics in addition to improved consumer confidence.
Continued mild deflation
Reflecting the continuing worldwide economic recovery, the international commodity market has been tightened and domestic corporate goods prices have risen slightly as a result of an increase in material prices, etc (Figure 1-1-7). A decomposition of corporate goods prices by demand stage shows that, despite the rise in raw material prices and the prices of intermediate goods, the prices of final demand goods are continuing to fall slightly. Thus, even though the input prices of companies are rising, its impact on output prices is still limited. Although consumer prices have been flat since the middle of 2003, they have been pushed up by a temporary rise in the price of rice and institutional factors, such as a higher co-payment of medical insurance, and mild deflation is continuing (Figure 1-1-7).
Section 4 shows that given intense competition between companies in Japan and abroad since the 1990s, rises in material prices have hardly been translated into consumer prices. The section also argues that the economic recovery results in tightening of the supply and demand while the negative impact of supply side factors including technological progress and of increases in imports on prices is narrowing. Section 4 states, however, that with fragility remaining in financial factors, the risk of deflation is still not completely gone and efforts to overcome deflation are still only halfway done.
Figure 1-1-7). A decomposition of corporate goods prices by demand stage shows that, despite the rise in raw material prices and the prices of intermediate goods, the prices of final demand goods are continuing to fall slightly. Thus, even though the input prices of companies are rising, its impact on output prices is still limited. Although consumer prices have been flat since the middle of 2003, they have been pushed up by a temporary rise in the price of rice and institutional factors, such as a higher co-payment of medical insurance, and mild deflation is continuing (Figure 1-1-7 Domestic Corporate Goods and Consumer Prices
Rising stock prices reflecting economic recovery
Although short-term interest rates have remained close to zero with continued quantitative easing by the Bank of Japan, the yen has been appreciating against the dollar since the latter half of 2003, and this is having a slight tightening effect on the financial conditions (Figure 1-1-8). Although long-term interest rates rose from summer through autumn 2003, the rise in stock prices remained for the most part on the same path, which is basically thought to reflect an economic recovery (Figure 1-1-9). Long-term interest rates were relatively steady since the latter half of 2003, partially as a result of the Bank of Japan's clarification of the conditions for continuing its quantitative easing policy, and began to rise again since June 2004 onwards. The rise in stock prices since April 2003 coincided almost exactly with the recovery of the economy and has been continuing into 2004. This rise in stock prices is being driven by foreign investors who consistently bought stocks on balance from April 2003 through April 2004 (Appended Figure 1-5).
Figure 1-1-8). Although long-term interest rates rose from summer through autumn 2003, the rise in stock prices remained for the most part on the same path, which is basically thought to reflect an economic recovery (Figure 1-1-9). Long-term interest rates were relatively steady since the latter half of 2003, partially as a result of the Bank of Japan's clarification of the conditions for continuing its quantitative easing policy, and began to rise again since June 2004 onwards. The rise in stock prices since April 2003 coincided almost exactly with the recovery of the economy and has been continuing into 2004. This rise in stock prices is being driven by foreign investors who consistently bought stocks on balance from April 2003 through April 2004 (Figure 1-1-8 Trends in Exchange Rates of Local Currencies Against the US Dollar
Figure 1-1-9 Trends in TOPIX and Long-term Interest Rates
Section 4 looks at the movement toward normalization of financial markets including a halt in the hoarding of cash, partially as a result of a reduction in anxiety over credit. Section 4 also argues that the Bank of Japan is continuing quantitative easing even though the economy is currently stronger, judging by the conditions of prices and GDP gap, than it was in 2000 when the Bank of Japan lifted its zero interest rate policy, and there is a possibility that this is suppressing expectations of an early interest-rate increase and leading to steady long-term interest rates. The section also states that in the period of overcoming deflation, it is important for the Bank of Japan to clarify its policies for conducting monetary policy and gain the confidence of the market regarding these policies.
Increased current account surplus
The current account surplus in FY2003 rose 29% from the previous year to around 17 trillion yen, and this reflects a higher surplus in trade and a lower deficit in the balance on services (Figure 1-1-10). The increase in trade surplus was partially as a result of continued high growth in Asian economies centered on China and increased worldwide demand for digital electronics which pushed up not only exports of finished products but also exports of parts to Asia (Appended Table 1-6). The lower deficit in the balance on services was partially caused by lower deficits in the travel account and the transport account as a result of a decrease in the number of Japanese people who traveled abroad due to severe acute respiratory syndrome (SARS), and the first surplus in royalties and license fees since statistics began. In addition, the capital and financial account, which until FY2003 had continued to be at a deficit, moved into a surplus (excess inflow) of over 20 trillion yen, reflecting an inflow of funds from the overseas branches of foreign banks, which expect an appreciation of the yen, in addition to a surplus in net inflow of inward stock investment from foreign investors. Meanwhile, changes in foreign reserve assets rose to over 34 trillion yen in FY2003 from 8 trillion yen in FY2002, reflecting increased intervention in the foreign exchange market by monetary authorities.
Figure 1-1-10). The increase in trade surplus was partially as a result of continued high growth in Asian economies centered on China and increased worldwide demand for digital electronics which pushed up not only exports of finished products but also exports of parts to Asia (Figure 1-1-10 Trends in Balance of Payments