Annual Report on
The Japanese Economy and Public Finance
- Japanese Economy Heading for New Growth Era
with Conditions for Growth Restored -
Government of Japan
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The prolonged economic recovery
The Japanese economy has continued to recover for more than four years since early 2002. This is a special phase never experienced before and in the sense that the economic recovery has lasted for a long period in spite of deflationary, continually declining prices.
The current economic recovery not only has followed the basic behavior of past business cycles but also differs from the traditional economic recovery models in the sense that it has been accompanied by the structural adjustment dissolving excesses in employment, production capacity and debts, aftereffects remaining from the burst of the economic bubble.
The progress made in this structural adjustment has not only enhanced firms efficiency and profitability, but productivity is seen as recovering as well if viewed from the overall economy.
The current phase of the economic recovery is remarkable also for the long duration of the economic recovery. It is a phase of the economic recovery which has lasted for more than four years, and though briefly interrupted with a condition of leveling off for two times, it is classified as being relatively long in duration compared to the average business cycles after the World War II. The long duration of the economic recovery, the fact that the Japanese economy has increased its flexibility, through the progress made in structural adjustments (as has just been described) is raised as one of its contributing factors. However, the average growth rate for the period has been no more than in the 2 percent range, if compared to the two-digit growth rate recorded during the Izanagi boom which set the longest-ever economic recovery in the past. During the Izanagi boom, the Japanese economy achieved high growth along with various changes in the social structure, but regarding the current economic recovery, as there is the feature of a mature economy returning to a normalized condition through the structural adjustment, it might be necessary to understand the diversified features of the economy from various viewpoints other than the duration of the economic recovery.
If a comparison is made to the business cycles of foreign countries since the beginning of the 2000s, the magnitude of fluctuation has narrowed amid an increasing mutual correlation. Such a behavior is inferred to be an attribute to factors such as an increasing co-movement of the world economy, including the financial aspect and the growing accuracy of macro-economic policy management.
Impact of the economic recovery spreading from the corporate sector to the household sector
As the current economic recovery has been accompanied by the structural adjustment under deflation, its initial phase was mainly a course of convalescence for the corporate sector. Because of this, compared to the behavior of the corporate sector, the impact of the recovery spread to the household sector at a slower pace. Judged from the household sector which lacked in a real impression of economic recovery, the severe economic situation has still continued. Nevertheless, as the employment situation recovered amid the prolonged economic recovery, the household sector, too, finally started to be benefited from the economic recovery, such as with an established trend of increasing consumption caused by the recovery of household income. The fact that consumption has played an increasing role in the economic recovery is also a feature of the current economic recovery and one of the contributing factors propping up a stable, sustaining economic recovery. Judged from the overall economy, too, this has become an economic recovery led by private demand, one in which consumption, investment and foreign demand, while recovering, have kept a well-balanced relationship with each others.
An economic recovery achieved under deflation
The current economic recovery has been a recovery under an environment of deflation since the second half of the 1990s. Theoretically, deflation is thought to have a negative impact on economic activities, due to factors such as an increasing outstanding balance of real debts, rising real interest rates, and downward rigidity of nominal wages. The reality that factors like the corporate sector's improving management amid improvement in the deflationary condition have offset the negative impact of deflation since 2000 is also pointed out to be in the background of why an economic recovery has been possible under deflation.
Furthermore, factors such as a strong underlying tendency of the world economy towards recovery, the avoidance of increasingly apparent financial instability through efforts of financial revitalization, the maintaining of an environment with a low interest rates through monetary policy management (accompanied by quantitative easing as already pointed out) and the formed the environment that has propped up the current economic recovery.
Escaping from deflation
Changes are also noted in the behavior of prices which have so far continued to drop over a long period amid the continuing economic recovery, continuing the progress being made in ending deflation. Among various statistics indicating price conditions, the year-on year change in Consumer Price Index has been in the neighborhood of zero percent, if petroleum products and other special factors are excluded.
In order to assess pressure for price increases from the aspect in the real economy, it is an effective method to examine the conditions of various supply-demand gaps and the behavior of costs like wages. Recently, these indicators have showed steady improvement but there are still variations. There has already been the impression of a tight supply-demand condition in the goods market and the labor market viewed from the corporate sector, and the GDP gap, too, has risen above zero. At the same time, unit labor cost is still continuing to grow negatively, though with a narrowing magnitude of decline.
While there are strong expectations that the economy will move away from deflation to return to a normal condition, it is also necessary to note changes in the economic environment accompanying this. Under normal conditions where concern over deflation has been dispelled, monetary policy will be normalized and interest rates will return to the positive level. This means an increase in interest rates, compared to the condition where short-term interest is zero. It will have an economic impact on the household, corporate and fiscal sectors. So long as such an increase in interest rates is a natural movement in keeping with the economic recovery, its impact on the overall economy will not work as a force to retard a trend of recovery excessively. However, as all of the sectors of the Japanese economy, such as the household, corporate and fiscal sectors, have so far adapted themselves to economic activities in the prolonged environment of zero interest rates, they need to response to the new circumstance wherein the interest rates are at a positive level.
Restructuring and adjustment of the economic structure viewed from the corporate sector
Under the current economic recovery, firms have made serious efforts to reduce excesses in employment, in capacity and in debts. In pushing forward active restructuring in employment, firms have also made efforts to recover their business footing by striving to repay interest-bearing debts while curbing capital investments. To some extent, such behavior may probably appear to have departed from the typical action take n by Japanese firm s, but in fact, this can be understood as a result of the optimal action taken by firms based on the principal of profit maximization.
In fact, the economy has entered a stage where it will soon get out of deflation amid the continuing recovery, causing changes in corporate activity. With prospects of debt compression looking brighter for firms, a forward-looking behavior has finally started in capital investments as well.
The trend of corporate restructuring has appeared as a phenomenon of diversification in employment styles, as viewed from the household sector. It has caused concerns that under deflation, employment would rapidly increase due to the downward rigidity of nominal wages. But in fact, a serious situation arising from increasing unemployment was avoided. This is attributed to the fact that the increase in unemployment was eased due to declining average wages for non-regular employees rose in addition to wage cutbacks for full-time worker (and also a reduction in employment of regular employees). Judged from employment styles, during the initial phase where restructuring was under way, particularly the ratio of part-time workers rose and this, too, is considered to have worked as a force to push down average wages.
But, as has been just described, the favorable impact of recovering business performance in the corporate sector has spread also to the household sector in the continuing economic recovery. In terms of employment, full-time workers have increased and the size of the decline in the number of regular employees has narrowed. Viewed from the macro level, this behavior has appeared as an underlying trend of increasing compensation of employee and increasing household consumption.
International competition growing increasingly fierce and the possibility of Japanese style management
Japanese firms have become more efficient through the structural adjustment, and judged from the behavior principle in capital investments and the financial aspect, there is not a very large difference from American and European firms. However, it is necessary to note that compared to overseas firms, Japanese firms' ROA has remained at a lower level. Regarding this, it has been pointed out that pressure of supervision from shareholders is weaker in Japanese firms. Further in recent years, capital efficiency has also been rising amid an increasing stance of attaching more importance to shareholders.
Phenomena like the internal organization built in with the lifelong employment system and seniority-based wage system, corporate governance centering on intra-firm managerial executives and banks, and long-term transaction relationships among firms are raised as the so called feature of "Japanese style management" if firms are viewed from the perspective of management. Even after firms underwent the structural adjustment, to a great extent, such feature s can still be confirmed to be the common feature among many Japanese firms. If Japanese firms are judged from the perspective of international competition, it can be said that they have been exhibiting their strength in industries like highly technology-intensive manufacturing industries. The key to such a condition lies in well-developed human resources within the firm along with a competitive edge of technical strength.
Viewed from the relationship between Japanese style management and firms ' actual results, firms adopting Japanese style management, those firms which pay more attention to employees have showed a high capital efficiency as well. Japanese style management tends to be seen relatively often in such mature firms. As the economy moves out of deflation to return to a normal condition, it is expected that an increasing restructuring, along with a debt compression, these firms, too, may be benefited by the advantages of traditional Japanese style management.
Change in the economic environment and the economic disparity in the household sector
In the initial stage of the current economic recovery, firms have made serious efforts of restructuring, and on the other hand, it took a long time for the effects of recovering corporate earnings to spread to the household sector; consequently, there occurred increasing arguments about the economic condition of those who were in employment difficulties.
Regarding this trend of the economic disparity, it possible to deepen its understanding by interpreting it as a mid- and long-term structural phenomenon, instead of limiting it only to the duration of the current business cycle. Judged from the trend of the income disparity from such a viewpoint, statistical indicators showing the economic disparity in the Japanese society as a whole in the past twenty years were on a rising trend. However, the widening of the historical income disparity is considered to have been attributed to a large extent to the change in the population structure, i.e., ongoing population aging. The higher an age bracket is, the larger the economic disparity viewed from the income distribution is, and as the ratio of elderly people becomes higher due to ongoing population aging, such disparity works as a force to push up the disparity of the whole society. On the other hand, no great changes have been seen in the degree of the disparity within the same age bracket.
As economic indicators showing the economic disparity have their respective statistical property, it should be noted that there is the necessity to assess the trend of the disparity by examining various indicators in a comprehensive manner. Statistical indicators showing the economic disparity such as the Gini coefficient and the poverty rate can also vary in level and behavior based on which statistical base they are calculated from.. It is expected that statistical indicators related to the disparity will be further refined.
Regarding the evaluation of the disparity, there are also cases where it is difficult to make pure comparisons, e.g., the narrowing of the disparity amid a declining average income and the widening of the disparity due to increasing income of the higher income group. The issue that should be addressed as a policy concern is how to take measures for those economically disadvantaged people, and caution will be needed if the narrowing of the disparity indices, i.e., statistical indicators, itself is set as the policy target.
The widening disparity among young generations which should be addressed
Even if the widening disparity in terms of households is attributed mainly to an aging population, there are results of analysis available suggesting that the disparity has been widening as far as young generations are concerned. Even if actually the economic disparity among young generations cannot be clearly confirmed to have widened in terms of households, there is a possibility that this may lead to a disparity for which corrections will be difficult in the future, and consequently, adequate policy responses will be highly recommendable as well. Nevertheless, that would not be to eliminate the disparity through pure income compensation; but what would be considered as advisable is a proactive employment adjustment and support measures which provide help for young generations get employed.
Challenges towards the strengthening of human potential
As a countermeasure to a declining population resulting from the declining birthrate and a growing proportion of elderly people, one hopes that labor quality can be enhanced through the improvement of the human potential. From the viewpoint of enhancing human resources, education is an important element, and the acquisition of more advanced capability through universities and professional schools along with the steady acquisition of basic scholastic abilities has always played an important role.
At the same time, vocational training of various types experienced by workers in workshops after the y enter the workforce also plays a big role in enhancing the human potential. In firms that have so far attached more importance to Japanese style management, there has been a strong tendency to emphasize and utilize on-the-job training in workshops.
Increasing non-regular employment has become an established trend amid stringent restructuring by firms. As a reflection of this, some firms have become less inclined to take the responsibility for implementing intra-firm vocational training. There is a strong trend by such firms that expect workers to master vocational skills on their own responsibility. Such behavior means that non-regular employees will face a severer environment.
If the ratio of regular employees can recover, as the economic recovery continues, and deflation is overcome with the economy returning to a normal condition, then there will be a possibility for firms to change their attitude towards vocational training. On the other hand, individuals who make active efforts aiming to enhance their own human potential are increasing as well. To provide these strongly motivated individuals with ample opportunities for vocational training will be an important policy purpose that could well lead to the vitalization of the overall economy.
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