Japan's Economy.

Economics Coursework Amit Sodha

Japan’s Economy

Over the past twelve years, Japan has experience the good and the bad of its economic cycle. The GDP was at its highest and balance of payments was at an overwhelming surplus during the late 1980’s, strongly competing with the American economy. More recently, towards the end of the 1990’s, the economic climate has experienced a complete alternation in performance in different aspects.

The Gross Domestic Product (GDP) is the value of the total output actually produced in the whole economy over some period, usually a year. Graph 1 below shows the varied performance for Japan

Graph 1

According to economic theories, in the long run, all economies experience an overall growth. The Japanese economy has complied with this theory but has also experienced deflation.

The bullish growth during the 1980’s was mainly led by consumer demand and exports of high technology products. The weak yen to the dollar (graph 2), due to the low interest rates in the mid-1980s (graph 3), considerably helped the growth. Thereafter the rise in interest rates and a stringent fiscal policy decreased inward capital investment and lowered consumer demand, which partly helped to shrink GDP in the early 1990s. Other reasons to blame for the falls in growth were; the collapse of the corporate sector; fierce competition from other foreign exporting firms (which increased unemployment to 4.8% in early 1990s) and the decreasing confidence in the Japanese economy.

Graph 2

Graph 3

From 1991, as can be seen from graph 4 below, the rate of growth was very slow so the Bank of Japan (BoJ) and the Government employed less strict fiscal and monetary policies to drive the economy upwards. BoJ lowered interest rates from 5.5% in 1990 to 4.5% in 1991 and the government elevated public spending, which all contributed to the domestic-led economic recovery. In 1992 the economy barely avoided zero growth, falling to 0.5%. The private sector was confronted with the need to slash excess machinery and staff, which is one of the reasons why Japan has a recessionnary output gap. By 1993, the BoJ was forced to cut interest rates to 1.75% - one of the lowest in its history. The continually lowering of the interest rates till 1995 to 0.5 % and the increased government spending on public sector services helped to push up GDP, gut at slower rates. A possible reason for this was that a lower interest rate distorts confidence in the economy, which reduces investing by Foreign Direct Investors. Fall in GDP from 1997 to 1998 was accompanied by a significant rise in the unemployment rate and a considerable fall in the Consumer Price Index (CPI). The government, again, tightened its fiscal policy by soaring tax rate to help pay its large debts from previous years. This increases in taxes reduced consumer spending as the disposable income fell, which as a result led to fall in GDP.

Graph 4

The upward movement in the Japanese economy in 1999 was due to the ‘government spending’ element in Aggregate Demand. The government spending rose by 10.3% in the 1st quarter in 1999. The monetary policy also contributed by lowering the interest rates to below 0.5%. However, these short-term policies were not enough to save the economy.

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Graph 4

Luckily, portfolio investors were able to augment the circumscribed fiscal stimulus and thus sustain the Japanese recovery. The strengthening signs of the economy caught the eye of investors who poured money in Japanese stock market firms. As a result, the Nikkei average rose from 13500 points in 1998 to 18000 points in 1999. The monetary policy adopted was very lenient. By pushing short-term rates down to almost zero, the BoJ forced many Japanese individual and corporate investors into the potentially more fruitful stock market. Also, this helped to counter the dangerous downward spiral of land, real estate and stock prices. This was until 2000. In this case, it was consumer demand and investment that raised the GDP.

Graph 2 shows the trend of the yen against the dollar. The low ratio during the early 1980s again helps to explain why growth (in the form of exports) was high, the rising value of the yen from 1990 onwards can help to explain why the rate of growth of GDP was low (illustrated in graph 4). The massive drop in exchange rate in 1998 triggered huge foreign investment into Japan. As the aggregate demand rose in terms of investment, demand for the yen also rose drastically which resulted in the yen to soar. The high yen threatened exports, which negatively affect the growth rate of GDP. All that was left for the BoJ to do was to increases the supply of the yen in order to lower the exchange rate. This is because the interest rates were low enough.

Graph 6 shows the line of best fit, which represents the potential GDP for Japan. We can see three main diversions from the line. From 1992 to 1995 there was a recessionnary gap (when production is below the potential due to inefficient use of resources) for the reasons explained above. There was growth but at very slow rates. The unemployed labour, due to the economic slowdown in early 1990s, was the “spare capacity” not used from 1992 – 1995. Unemployment rates fluctuated from 4% to 5.5% during this period.

There was an inflationary gap between the end of 1995 and the end of 1997. The reason for this are explained above. The easing up of the monetary and fiscal policy and the lower exchange rate are the main reasons.

After the recovery from depression, in 1999 the economy followed on by achieving slower growth mainly just because of the investment in the stock market. At present, the stock market is at a 20 year low.

Graph 5

The changes in the CPI reflect the actions taken by the government and BoJ in the form of the fiscal and monetary policy. For example, the increases in CPI from 1996 to 1997 caused the government to strengthen its fiscal policy in terms of increasing taxes. The falling CPI from 1999 onwards is accompanied by the falling interest rates close to zero (including the negative rates very recently) and the high exchange rates from 1998 to 2001.

As a result of this economic disaster, unemployment has risen by considerable amounts (see graph 6). It should also be noted that as although the working population decreased over time, the number of unemployed increased, which again emphasises the severity of the unemployed recourses in this period. This combination of reasons helps to justify the resultant output gaps.

Graph 6

The future of the Japanese economy will be partly determined by the use of fiscal and monetary policies. However, these short-term policies need to be accompanied by long-term structural reform programmes for effective progress.

The banking system has chosen to revitalise its poor situation by properly disclosing information about its clients to determine their credit worthiness. Many bad loans had to be accounted for during the falls of investment and recession.

The Cabinet Office of Japan has outline seven policies it aims to follow to accomplish economic and political stability. The first policy is to maximise the use of the private sector by deregulating and exposing the fields of health, nursing care, social welfare and education to the free market economy. Although the Cabinet wishes to achieve economic efficiency, it may do so at the expense of disregarding equality.

The second programme is called the “ Support Challenger” program. This targets to enhance systems that encourage growth, for example it will help the development of support for IT education, business start up and creation centres and Fair Trade Commission.

The third, forth and fifth programmes are primarily designed to promote better standards of living and lifestyles through improvement in social services, credits for pensioners to buy medicine and improving the general safety in the country. It also targets to develop the human capital by encouraging private sector firms to channel funds into universities to produce future employees for their firm (scholarships).

The sixth strategy is to empower local governments to the maximum. They hope to achieve this by developing particular cities by capitalising on their unique character for example directing funds into improving a harbour if that is the town’s main feature. They also wish to reduce involvement in local governments issues.

The final plan is dedicated to targeting resource allocation into areas of minimum opportunity cost and maximum gains. They aim to plan a budget to take into account more long-term views.

The limitations of the policies are that they collide and contradict each another and that it will take time to implement them and then actually experience the outcome. However, they are very specific so its success can easily be measured.

Along with the policies mentioned above, the fiscal and monetary policies can be used to keep Japan on track for economic reform. The interest rates should be kept low enough to derive a low exchange rate to push up Japanese export, and the money supply should increase to bring in steady inflation. The Government should play the central role in gathering funds to pay of international debts (through maintaining a steady taxation system) and they should also direct spending into other sectors in manufacturing (other than high technology equipment) to effectively compete with the other growing Asian nations.

Although Japan has promising capabilities, the highly vulnerable Asian economy creates an uncertain short-term future.