Intelligence

Still The Wrong Answer In Japan

Milton Ezrati

Chief Economist

World media, once riveted on Japan, has long since lost interest. The rise of China and disappointing decades since the Japanese economy’s heyday of the 1980s have understandably turned heads elsewhere. Japan nonetheless warrants attention.  It is, after all, the third largest economy in the world and the second largest in Asia. And of late, its economy seems to have faltered yet again, suffering because it still depends heavily on exports, and its largest market, China, is suffering.  Japan need not live with this vulnerability. It need not remain dependent on exports and so on China.  It would, in fact, serve its aging population better if it were to abandon its continued emphasis of production for export and pursue a more balanced economy that depends more on domestic sources of demand.

At the moment economic indicators look ominous. According to the latest report of Japanese purchasing managers, manufacturing activity shrank in February, for the first time in two-and-a-half years. Business confidence also soured for the first time in six years. Orders figures point to sharper future sales declines. Machinery orders overall fell 5.4 percent in December, the most recent period for which data are available, while overseas orders recorded their biggest drop in more than two decades. Government data showed an 8.4 percent drop in Japan’s January exports, the worst performance in two years. Exports to China, Japan’s biggest trading partner, fell 17.4 percent. Exports to the United States, mostly cars, expanded some 6.8 percent, but imports from America, mostly oil, rose at a faster 7.7 percent pace. Signs of weakness look serious enough for the Bank of Japan (BoJ) to announce an immediate turn to stimulus. BoJ Governor Horuhiko Kuroda, while denying that the economy is in recession, announced support for growth, pledging to keep long-term bond yields at zero and short-term interest rates at minus 0.1 percent.

Most commentary on the sudden loss of economic momentum lays the blame on China’s economic problems and connects them to the incipient trade war with the United States.  China’s economic slowdown is definitely an immediate cause of Japan’s export problems but the U.S. tariffs are only part of China’s and hence Japan’s problem. At least as significant is the departure of the industry from China. In part, these firms are trying to avoid the tariffs, but they are also in search of lower-wage labor than they can now get in China. Theoretically, these new operations outside China, largely elsewhere in Asia, could source their equipment in Japan as they did when they were in China, but in these new, less advanced locations, management has less need for cutting edge machinery.  And then there is the fact that China has entered a new, slower stage of development. When China first emerged economically late in the last century, it had many obvious projects that vastly and easily increased economic efficiencies and capabilities.  As it has realized those opportunities, the pace of growth has naturally slowed. China has battled this fact for some years, trying to simulate that earlier stage of development by engaging in dubious, grand projects.  Rather than help, this effort has only created a debt overhang that now further impedes Chinese growth.

With all these other factors in mind, it is clear that China’s problems and hence Japan’s export difficulties will not dissipate as easily as some suggest. Even a favorable trade deal between China and the United States, one that lifts all the tariffs, will not necessarily return China to the fruitful destination for Japanese exports it once was. Yet, Japan could have avoided all this, if it had abandoned its export-oriented growth model in the 1990s when it first showed signs of breaking down.

It was clear even then that Japan no longer had the youthful, low-wage population that had once fueled export-oriented growth. Japanese wages had long since risen to some of the highest in the world. The population had become far from youthful. As of today, fully one-quarter of the country’s population is over 65.  The economy has barely over two people working age for every retiree. This is hardly a demographic basis to aim to remain the workshop of the world. Rather, it suggests that Japan look for growth in a more balanced economy that depends less on production for export and more on domestic sales, particularly consumer spending. Japanese business has long since pointed the way, relocating production to low-wage areas of Asia, China initially but also elsewhere, in Taiwan and Indonesia, as well as the Philippines. But the government has shown less insight. It has continued to discourage consumption and spend on support for industry and exports. It had actually planned a consumption-crushing sales tax hike until this recent bad economic news prompted a rethink.

Japan may never again grow as fast as it did in the heyday of its export-driven model. Those double-digit real rates of expansion are now part of a world long past. But with a shift toward consumption, the policy can serve the county’s population better and importantly end the economy’s vulnerability to China. Japan need not give up on production. It just needs to do the producing overseas among low-wage, youthful populations. Japanese engineering and quality control are transferable. Ownership and management will enable Japan to bring home much income and wealth from what others produce under Japanese guidance. With a change in government emphasis, Japan could support a consumer-led economy that produces goods and services for its people, particularly its aging population.  The economy in this way can find stability and growth that elude it under its current export-oriented policies.

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