Japan is poised to slip back into recession. Quite staggeringly, this would be the sixth recession since the start of the 1990s. June quarter real GDP rose a tepid 0.2% but the partial indicators since then are pointing to a contraction in the September quarter with sharp falls in industrial production and weak retail spending.
In yet another blow to hopes of a turn in global economic activity, the dismal state of the Japanese economy points to more downside risks to commodity prices and, as Australia’s second largest export market, more problems for Australia’s export sector.
Japan is the world’s third largest economy — marginally smaller than China but around 50% bigger than Germany and about 110% bigger than France, which is the fifth biggest economy. What happens in Japan still matters for the global economy even if it no longer grabs the headlines in the that China, Germany, Spain or Greece now do.
The problems in Japan are multifaceted and do not appear to be able to be corrected. According to IMF data, net government debt is estimated to be 135% of GDP in 2012 and that on current projections, government debt will reach 164% of GDP in 2016.
The overwhelming majority of the debt on issue is held domestically given the still high level of savings, which means there is little immediate concern about Japan’s ability to finance these record high levels of debt.
Remarkably, that is the good news. Japanese government bond yields are incredibly low. All bond yields, out to 10 years, are below 1%; the 30-year bond yield is 1.9%. So clearly, there is no funding threat to the government’s budget deficit, which this year is estimated to be about 9.5% of GDP.
Demographic factors are a long-run structural issue holding back growth and the ability of the economy to expand. Over the past decade, annual population growth has averaged less than 0.1% per annum and in recent years, Japan’s population has stopped growing at all. This matters because it means that the construction sector, for example, will continually be depressed. There is little need to build new roads, houses, offices and shopping centres, for example, because there is effectively no net increase in population to move into those houses, work in the offices of go shopping in any new shopping centres.
In countries such as the US, by way of contrast, population growth is about 0.7% per annum — which translates to about 2.5 million people per annum that need services and will add to the labour force and support economic growth.
The demographic factors in Japan are even more troublesome when account is taken of the ageing population. Already, almost one quarter of the population is aged 65 or older and this proportion is forecast to climb steadily towards 40% by 2050.
These trends are a severe handbrake on economic activity. The older age cohorts have a low propensity to consume, which will suppress consumption spending. The working-age population is also shrinking and the so-called dependency ratio, which measures the proportion of the population that is working relative to children and older retirees, is falling. In other words, the proportion of the population in employment, that have the highest productivity, that pay taxes that fund education, health and aged care, is falling.
These depressing economic times have entrenched almost two decades of deflation. Since 1994, the GDP deflator has fallen by a cumulative 18% — a fall without precedent. This ongoing fall in prices is poison for the economy — consumers and business continually postpone the purchases knowing that the item they wish to purchase will be cheaper in six or 12 months.
The Japanese stock market and the wealth destruction from the market crash is also another constraint on confidence and spending. This morning, the Nikkei will open at 8870 points, some 75% lower than the peak level in 1990.
This protracted economic gloom and deep deflation in Japan has provided a model for the rest of the world. It has prompted the rapid implementation of near-zero interest rate policy throughout most of the G7 countries as the global crisis hit and quantitative easing is now a viable policy for the US, the eurozone and the UK.
In Japan, there seems no policy framework to kick-start the economy. The Bank of Japan has had interest rates at zero for more than a decade. Fiscal policy is ineffective and constrained by the massive debt levels. Demographics are unhelpful and will remain a problem. Japan, it seems, will have another decade of low, deflationary economic growth. It is hard to see what policymakers can do to prevent this from happening.