Recent economic news from Japan has been good, so much so that it has people talking about a renaissance and a return to strong growth. The Bank of Japan is even raising interest rates.
Japans GDP growth for the fourth quarter of 2006 came in at a startling 4.8%. Investment and exports were very strong. Even more surprising was that real (inflation-adjusted) consumer spending, was up by more than 4% at an annualized rate, and some are pointing to this as early evidence of a consumer renaissance.
Unfortunately, it came on the heels of a big drop in consumer spending in the third quarter. For the entire year, real consumption spending rose by only 0.7%, a big deceleration from 2.7% in 2005. Retail sales are essentially flat in the past year, and the Bank of Japan is only cautiously optimistic about the consumer outlook.
Other Japanese economic indicators are more reassuring. Industrial production growth has been averaging more than 5% in the last six months. Business confidence has risen for the past three quarters in a row. Exports are up 11% from a year ago, and so are imports. Obviously, there is a lot going on with companies, but consumers are not fully participating, at least not so far.
This all suggests that the enthusiasm now being expressed by some about the Japanese economy is overdone. Japan has been muddling through for years, and looks like it will keep doing so. Japans monetary and credit data support this interpretation bank lending is up only 1.7% in the past year, and money supply by around 1%. These are not characteristics of a strong economy, and that is why the yen has been weakening these past few months, particularly against the euro. In Europe, the case for an economic renaissance is a little more compelling.
The Bank of Japan is gradually raising interest rates from zero, signalling growing confidence that the worst is over. True, but at 0.5% the level of rates is still very low and extremely stimulative. Fact is, Japans problem with deflation is not over. The GDP deflator declined by 0.5% in the fourth quarter, although that was the smallest decline in two years. The CPI is essentially unchanged for the past two years. Falling prices can trap an economy in stagnation, because consumers know that by waiting to make their purchases they will see their purchasing power increase. All to say that Japanese interest rates are likely to continue to rise only very gradually.
And then there is the demographic problem.
Japans population has actually begun to shrink. This means that GDP growth can even be negative while maintaining Japanese living standards. Long-term growth expectations need to be scaled back accordingly. It will be very difficult for economic growth to go much above 1.5-2% for any length of time. Indeed, given the economys now-modest underlying growth potential, above-2% growth would result in inflation pressures, prompting even higher interest rates and a return of growth to somewhere around a 1.5-2% trend.
The bottom line? Japans economy is doing better now than it was three or four years ago, perhaps because people are learning to adapt to persistent deflation. But it is important not to lose sight of the growth constraints that Japan still faces and keep the enthusiasm in check.
Stephen Poloz is Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada. His column on trade-related issues appears weekly on www.ctl.ca.