Source:IMF, World Economic Outlook database, September 2004
Government budget deficit
The government have been investing in public infrastructure in order to help stimulate the economy. The government budget deficit is currently over 160% of the GDP of Japan, which is the highest value in the OECD area. Therefore, in the long run the government will need to raise taxes to increase its revenue or reduce the level of spending. Although, the Japanese government aim to have a budget surplus by 2010. However, this will depend on the growth rate, interest rates, inflation and the fiscal policy.
Source:IMF, World Economic Outlook database, September 2004
Also local government spending has also sharply increased over the past few years, from around 15% of GDP in the 1990s to 40% in 2003. The local governments in Japan operate decentralised from the central government and have completely control over their own expenditure. The ‘Trinity Reform’ plans to reduce local government’s spending by decreasing earmarked grants, reform equalisation grants, and increase local taxes.
Labour Force
There is currently a worrying rate of unemployment rate amongst the 15-24 year old group, which currently stands at 10%. This figure is almost twice the national average. Several hundred thousand unemployed youths are neither in education or actively searching for jobs. Also, there is a high number of the workforce in temporary jobs. This does allow flexibility for both the workers and the company, but also decreases wage rates for these types of workers.
This causes two main problems for the Japanese economy; the human capital acquired by workers will be relatively low in the long term, which may affect future economic growth. Much of a worker’s human capital is gained from employment and not solely from academic training. Also, it is easier for a person in their youth to learn skills and adapt to technological changes. Therefore the youth unemployment problem is likely to have a serious negative impact on human capital formation on the Japanese economy in the future. The other problem is that this will affect the future pensions of these youths because many are not contributing to the pension system. The pension system operates as a pay-as–go method where by the working generation contribute a pension fee that is then distributed to the retired generation. This may cause a possible breakdown in the pension system in the future.
The Japanese labour force is also shrinking due to the aging population and a low birth rate. It will increase the inter-generational income transfers, which will burden the working generation with higher pension contribution rates in order to support the older generation. This will also lead to slower economic growth, which will affect government spending such as social security as more people will require pension payments.
Trade
The Japanese economy is an open economy, meaning that it trades globally. Japan has no natural resources and therefore it must trade with other countries. China (including Hong Kong) has replaced the United States (U.S.) as Japan’s largest trading partner. The Japanese government announced recently that Japan's trade with China in 2004 totalled ¥22,200 billion ($211 billion), up 17.0% from 2004. For the first time China has exceeded Japan’s trade with the U.S., which was valued at ¥20,480 billion ($195 billion), up 1.1%. China accounted for 20.1% of Japan's total trade with the world in 2004. However, in China's worldwide trade, Japan's relative importance has declined. Japan was China’s largest trading partner, but since 2003 it has dropped to third place after the U.S. and the European Union.
Source: Research Institute of Economy, Trade and Industry
Japan's exports to China in 2004 amounted to ¥11,830 billion ($112.6 billion), an increase of 17.2% over the previous year. Imports from China were valued at ¥10,370 billion ($98.8 billion), up by 16.7%. Overall, Japan has a trade surplus of ¥1,460 billion ($13.9 billion) since its exports are greater than its imports.
Structural Reform
When Prime Minster Junichiro Koizumi assumed office in April 2001, he has campaigned for implementing structural reforms aimed to overhaul Japan’s economy. One public company soon to be privatised is Japan Post, which is the national postal company and also the primary savings bank and insurance provider for millions of the Japanese population. Privatisation of the company will hopefully boost competition in these markets. It will take place in stages and the company will broken up into four separate companies under one holding company. It is believed that the company is inefficient, and this overhaul will improve services and cut costs. It will also allow Japan Post to control its own assets and therefore weaken the influence of Ministry of Finance officials, who have used the company’s resources to invest in government bonds, road building and other unnecessary infrastructure projects.
The government had also proposed changes to the tax system, where by special zones will be created which will allow some businesses to operate free from specific regulations. Since April 2003, 328 such zones have been created, with tax cuts of ¥1.8 trillion and a fall in public works spending. This policy is aimed to boost private consumption and have so far been successful. It is hoped that the economy will achieve nominal growth of more than 2% by 2006. In April 2003, the government established Industrial Revitalization Corporation of Japan. It used ¥10 trillion of public funds to purchase bad loans from financial institutions. It hopes to revive the business activities of around 100 corporate borrowers within the next five years.
The Extent Government Policy and Free Market Forces have affected this economy
There are two main forces that affect an economy; the central government and the free market. The extent to how these factors have affected the Japanese economy will now be discussed.
Government Policy
The central government’s decision to loosen the monetary policy during the 1980s greatly hindered the Japanese economy as it led to the crash of the entire economy. Since the economy’s crash, the government has attempted to revive it using a series of fiscal policies. In 1980s, Japanese fiscal policy was generally designed to reduce aggregate demand. Conversely, from 1992 to 1996 it was used to stimulate demand. In 1997, when the Asian Crisis broke out, it was clear that Japan was heading towards a major slowdown, and the fiscal policy was tightened sharply in response. In 1998, the Japanese government announced a package of fiscal stimuli, along with financial support to weak institutions. However, this was not enough to stop Japan entering a recession. The budget deficit rose to 8 percent of GDP, but this was mostly because of lower tax revenues as output slowed growth. Nevertheless, the government debt has continued to rise with little sign that it will stop.
Structural reforms, as mentioned previously, are helping to boost the economy. These aim to boost private consumption, by increasing the competition in some sectors. This gives the consumers more choice as well as lowering prices. The government has been maintaining a low exchange rate against the dollar. The exchange rate system for the yen operates under a managed float. As a result, the government can only influence the exchange rate is by purchasing U.S. Treasury bonds and driving the value of the dollar up. It has allowed Japan to remain competitive with U.S., as its exports are therefore cheaper to the Americans. The government have also been trying to eliminate deflation. Due to the vast amount of debt, inflation will dilute the real value of these debts, making it easier for corporations to repay their debts.
Free Market
As previously mentioned, Japan’s trade with China has been significantly growing in the past few years. This has boosted Japan’s production output and helped the country’s economy to recover, purely through private sector consumption. However, it may also lead to companies relocating abroad to China, where cost are cheaper and these companies will be closer to its customers. If companies move abroad, the opposite effect will occur. More people will be unemployed and there will be less investment within Japan. It may also lead to technology being copied and an increase in cheap competitors, making it difficult for the Japanese companies to compete.
It should be noted that a triangular pattern of trade is emerging between Japan, China and the U.S. This means that Japan is extremely dependant on its two largest markets-China and the U.S., which may pose as future problem to Japan. If China’s investment boom were to burst, Japan’s exports of steel, chemicals and construction machinery would be affected.. However, if the U.S.’s economy slowed sharply, it will have a greater impact on Japan’s economy. There would be an indirect impact on business confidence, stock markets and trade within the whole Asian region would be much more serious.
Corporate debt is a major issue for Japanese companies, which has also affected the economy. However they have been performing better in recent times, mainly because of demand from China, cost cutting and a recovery in the domestic market. The surge in profits has helped to reduce corporate debt. This has led to increases in share prices, which then allows the companies to sell cross equity holdings and also repay their debt. Once companies are financial healthier, debts will become less of an issues and many will be confident about the outlook for the economy. They may decide to plough more of their profits into new investments or they might even start borrowing to invest, consequently improving the country's economy and bring Japan out from its long deflationary period.
Overall, a combination of government policy as well as free market forces are required to ensure Japan’s economy will recovery in the long run, which will take time. It is up to the government to monitor the economy and to take the necessary steps to ensure that the country does not slip into another recession.
Total word count: 2000
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Bishop, M (2004), Essential Economics, Italy: Profile Books Ltd.
Chrystal, K.A. and R. Lipsey (1995), Positive Economics, 8th Edition, Oxford: Oxford University Press
Bank of Japan
Economic and Social Research Institute of Japan
(article)
Foreign Press Center Japan
http://www.fpcj.jp
IMF
OECD Economic Report of Japan 2005
Research Institute of Economy, Trade and Industry
The Economist website
