Japan’s Economic Woes for 2020 Goals
As its economy grew by 1.2 percent during the last quarter of 2016, Japan experienced four consecutive quarters of growth for the first time in a decade. Although welcomed, this rate of growth is smaller than in previous quarters and falls considerably short of what is required to achieve Japanese Prime Minister Abe’s goals for the economy. In the short and medium term, the Japanese economy faces key challenges— weak domestic demand, unsustainable public finances, and geopolitical risks— that Mr. Abe would be well advised to address.
Earlier last year, Mr. Abe revealed his target to increase Japan’s gross domestic product (GDP) from ¥537 trillion to ¥600 trillion ($5.32 trillion). In order to achieve this target, Japan must grow by 2 percent in the next four years, with an inflation rate of 1 percent. Last quarter’s growth rate of 1.2 percent, while well above Japan’s long-term growth trend of 0.5 percent, falls 1.5 percentage points short of Mr. Abe’s target. Macroeconomic challenges for the Japanese economy might slow Japan’s growth rate even further.
Firstly, the recent growth figure underlies a strong export performance but weak domestic demand. In the last quarter, exports grew by 2.5 percent, largely due to increased semiconductor shipments to China and car sales in the United States. As a result, net exports contributed a full percentage point to this quarter’s growth. However, consumer spending, which accounts for 60 percent of GDP, fell by 0.01 percent, reflecting weak domestic demand. Since domestic demand accounts for more than half of Japan’s GDP, increase in growth rate is unlikely to be substantial unless Japan can boost its domestic product.
Secondly, Japan’s already strained public finance limits the extent to which Mr. Abe can attempt to boost domestic demand by borrowing further. In the recent years, the Japanese government has borrowed heavily to stimulate domestic demand and consumer spending. This unprecedented borrowing, coupled with low growth, has increased Japan’s debt as a percentage of GDP from 93.8 percent in 1995 to 246.6 percent in 2014, making Japan the most heavily indebted advanced economy. Even Greece, the second most heavily indebted advanced economy, has a debt-to-GDP ratio of only 179 percent. The International Monetary Fund (IMF) estimates that, if the current trend continues, by 2030, public debt will rise to 300 percent of Japan’s GDP.
Experts fear that such a high level of debt-to-GDP ratio might be unsustainable in the long run. Japan already spends 43 percent of its tax revenue on debt servicing costs. In the coming years, Japan’s government will have to pay half of its annual tax receipts on debt obligations. Such high level of indebtedness leaves Japan with little fiscal room to stimulate the economy by borrowing further.
Lastly, the current geopolitical environment does not bode well for Japan’s export-dependent model of growth. Japan’s dependence on export leaves the economy particularly vulnerable to global macroeconomic risks. Japan’s largest export market, China, is showing clear signs of a credit bubble, leading experts to fear that its growth model is close to having run its course and that its bubble might burst in the coming years. According to the IMF, the Chinese economy will slow down to 6.5 percent in 2017 and below 6 percent by 2020, dampening the outlook for Japan’s export-led growth.
There are also concerns that the United States, Japan’s second largest export market, will impose trade barriers. President Trump accused Japan of unfair trade practices, particularly in auto industries where Japan enjoys a trade surplus with the United States. Given the importance of the auto industries to the Japanese economy and its growth, such trade barriers would pose a significant challenge to the Japanese economy.
Given these key challenges, there are a number of steps that Mr. Abe can consider. While Japan has little fiscal room for further monetary stimulus, there are significant structural reforms that Japan could undertake. In fact, structural reforms have been the weakest of the three prongs of Abenomics: fiscal expansion, monetary easing, and structural reform. Although the Abe administration has successfully reformed Japan’s agriculture, its success in other sectors—especially labor market and tax reforms—has been limited.
In particular, Japan’s labor market suffers from key structural weaknesses, including a two-tiered system that creates a gulf of opportunity and pay gap between temporary and permanent workers. The two-tiered system particularly affects young people entering the work force and women, who find it significantly more difficult than other groups to find permanent jobs. According to the IMF, Japan should reform its two-tiered labor market, in addition to improving labor market flexibility and encouraging greater labor force participation, particularly from the youth and women.
In light of Japan’s economic challenges and its integral role in the global economy, policy makers should not become complacent by Japan’s recent growth. If Japan is to reach Mr. Abe’s 2020 goals, it must undertake key reforms and heed the global macroeconomic risks that Japan faces. A weak Japanese economy would be unfortunate not only for Japan, but—given its importance to United States, the European Union, and China—also to the global economy.