The sequential traumas that Japan has been experiencing, while serious and dramatic in their own right, should bring into focus underlying issues that that have been building since her equity and real estate bubbles burst in the late 1980s. From the ashes of World War II, the Japanese economy became a global power house by exporting quality consumer electronics, cars and other merchandise. Many of us are old enough to remember the Japanese purchase of trophy properties during those heady days. Since the bubble burst, the Japanese economy has never regained its former vigor. The Bank of Japan reduced interest rates to zero and government embarked on massive stimulus programs. Yet, the economy stagnated and suffered occasional bouts of deflation. During deflation, prices fall so even zero interest rates do not discourage saving in favor of consumption. Japan’s government debt/GDP (on a net basis) rose from 11.7% in 1991 to 120.7% in 2010 and is currently the highest among the G-7 (including Italy). Despite 20 years of slow growth and periodic recessions, Japan is still a wealthy country. Her per capita GDP is still greater than that of France, Germany, the U.K., and Italy.
The high Japanese saving rate has been a reliable source for large deficit spending and high debt/GDP levels. Until now. The population is both falling and aging. Fertility rates at 1.2% are the lowest of any developed country. The percentage of people over 65 is growing the fastest in the developed world. The Japanese have the highest life expectancy, too. Not only do older people save less, improvements in old-age pensions and long-term care insurance are encouraging younger people to save less. The saving rate has dropped from double digits in the 1990s to 2.7% last year. For the time being, corporations have been a substitute source for savings. Capital spending has been falling while exports, particularly of capital goods, have been increasing. They have accomplished this without increasing capital spending. This process will not work forever.
Increased domestic consumption has not increased economic growth. Exports have been the one area of strength in Japan’s economy. The government announced a campaign last year to increase exports of capital goods, such as nuclear reactors and high speed trains. But as global growth slows (China, US), Japan’s current account will be affected. Recent events will only aggravate this trend. Imports will increase as exports decline. The purchasing managers’ surveys for March were the first taken after the big earthquake and tsunami and showed sharp drop offs in the manufacturing and service sectors. GDP was already struggling in the first quarter. So, we should expect the economy to experience a deep recession with some improvement once reconstruction really begins.
Unemployment increased from 2% in the early 1990s to 4.9% just before the recent earthquakes. Because of the destruction and dislocation caused by recent events, unemployment will likely rise above 5% from what is already considered high by Japanese standards. Consumer confidence, already lagging, will likely suffer further. On balance, there will be upward pressure on inflation as some necessities rise due to shortages, while prices of prices of discretionary goods and services may fall due to a lack of demand. GDP will probably fall by 1.5%.
No one doubts the industriousness of the Japanese people. Rebuilding will require imports of energy, steel, cement, and food. A real danger exists, however, should the current account turn negative. In that case, Japan would be importing, not exporting, money. In a lackluster economy, with few attractive investment opportunities, interest rates would have to rise to attract capital, complicating already high deficits and debt financing costs. Such a scenario would force the government to reduce spending elsewhere, adding additional stress to the economy. Debt rating agencies may revisit Japan’s credit rating, putting further pressure on interest rates.
Beyond Japan, auto makers have had to close plants in the US and Europe because of earthquake related disruptions of all sorts of critical supplies. Customers will be looking to diversify sources of supply. Even Japanese companies are accelerating plans to move more production offshore. This trend was already in place, with 40% of manufacturers previously considering shifting R&D and production abroad due to high costs within Japan. The tsunami and multiple earthquakes are severely aggravating unfavorable structural issues that having been building for many years.