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Monday, April 6, 2009
Demand-supply gap is driving Japan's precipitous slide
The Japanese economy is stuck in a tailspin. With industrial output sinking 10.2 percent in January and 9.4 percent in February, economic activity could drop to half in another six months.
With interest rates close to zero, the Bank of Japan is trying to increase money liquidity by buying commercial paper and subordinated debt from financial institutions while the government is expanding quotas for credit guarantees to small and medium-size businesses as their business years close. But these measures aren't expected to provide much more than short-term relief.
As a result, hopes are growing for more steps to boost demand through Keynesian-style public spending. In fact, it almost looks like Japan, the United States, China and other major economies are competing to see how much sheer stimulus they can muster.
In Japan's case, however, legislative debate is stuck on money and politics, and discussions on how best to stimulate domestic demand seem to go nowhere.
One of the problems with Japan's efforts to boost demand is that it is already mired in public debt, an amount that has expanded to a globally unparalleled level of 1.8 times gross domestic product. The debt is growing because policymakers and politicians are still giving in to the excuse that issuing debt-servicing bonds is inevitable in times of crisis.
As the latest political scandals indicate, the public debt is mounting because corporate "expenditures" aren't leading to an effective increase in investment. Politicians' money problems continue to be regular fodder for news programs because the revisions to the Political Funds Control Law were, unsurprisingly, ineffective. To put an end to these problems once and for all, the mind-set of the voters themselves must change. We need to keep reminding ourselves of this fact as we discuss what kinds of stimulus efforts will be needed to deal with the recession.
A second factor behind the sliding economy is Japan's heavy reliance on exports. Japan and other economies that rely on exports for growth — South Korea, Taiwan, China and oil-producers like Russia — are facing the prospect of taking severe damage from the global crisis.
According to the Japan Automobile Manufacturers' Association, domestic auto production in February fell 56.2 percent from a year ago as vehicle exports fell 63.9 percent for the fifth month straight.
Imports normally tend to fall in bad economic times, alleviating the impact on GDP by reducing the fall in net exports. Japan, however, is a country that produces a wide variety of goods, ranging from instant noodles to ballistic missiles. Since it relies very little on imports beyond its necessities in energy and natural resources, this buffer function doesn't work much in times of recession. Thus what is behind Japan's current plight is not an overall shortage of demand, but an excess of supply.
Measures to stimulate demand are still needed, of course, including tax incentives to promote solar energy and to encourage the elderly to pass their assets on to their children while they are alive, which might stimulate consumption and the housing industry. But unless Japan ends its excessive reliance on exports, there is no way the economy will recover without a resurgence in overseas demand.
The current crisis is often compared with the depression triggered by Black Thursday in 1929. One of the reasons Japan was badly hurt by the Great Depression was that, in addition to lingering damage from the 1923 Great Kanto Earthquake, 90 percent of Japan's raw silk exports — which accounted for 40 percent of all its exports — were sold in the U.S. market.
The third problem is the public's perception of prices. While salaried workers are either facing wage and bonus freezes or pay cuts, consumers have generally embraced reductions in power and gas charges as well as expressway tolls. Land prices are also continuing to fall.
But Japanese land prices are still extremely high on an international basis, and the current decline merely reflects that they haven't fallen enough since the bubble economy imploded in the late 1980s. So this trend is not indicative of deflation, but disinflation, and the ongoing process of resolving a bubble situation. When you look at prices, you should not only look at whether they're going up or down, but also at whether they are at appropriate levels by international comparison.
As we confront the challenges of a falling birthrate and an aging population, Japan needs to shift away from its export-led model and promote new products and services in medicine and nursing care. The key to Japan's recovery lies in the correction of its supply side mismatch.
Teruhiko Mano is chairman of the Mano Economic Intelligence Forum.