The Future of Japan's Economy

Where will Japan be in 20 years?

SUMMARY

Long-term economic forecasting is still as difficult as ever. Typical previous long-term forecasts have proved to be on average out by as much as 33%. In the present day unsettled political and economic climate forecasting economic future of a country has become even more difficult.

Japan‘s economy declined during 1998-2003 period, making the economic pundits wonder if Japan would be able to revive its economy. Significant growth during the last two years shows that Japan’s economy cannot be written off that easily.

Japan has many economic factors supporting the likely hood of Japan’s continued economic growth over the next 20 years. On the other hand emergence of China as the third largest economic power, its increasing share in world economy, Japan’s declining working population, huge domestic debt, rising energy prices and unstable world politics could jeopardize the economic growth.

Japan need to modify its tax structure and reduce the burden of debts. Recent elections over the decision on privatization of the postal system shows that Japan is prepared to make tough decisions to keep its economy on track.

It appears that Japan is already preparing to be a part of the success of the newly emerging economic superpowers. The inter-dependence of the economies will ensure that Japan will continue to make economic progress. An economic development rate of 1.8% over the next 20 years appears to be certainly achievable for Japan.

INTRODUCTION

The post war years allowed Japan to concentrate on economic development. With nearly no defense expenditure, Japan was able to devote nearly one third of its GNP to investments during 1953-63 [Angus Madison, 2005]. The government policies of investment in education, industry and research and development started bearing fruit and the average annual growth rate during 1960s remained around 11% per annum.

The government policies favored encouraging savings, promoting investments, supporting newly emerging industry and promoting exports. Between 1965 and 1970 average growth rate was 11.1% (Financial statistics of Japan, Ministry of Finance, 2005)

GDP Growth in real terms**

GDP Growth %

1960 8.8

1965 9.2

1970 11.1

1975 4.5

1980 2.8

The steady growth rate of almost 10% per annum helped Japan overtake Federal Republic of Germany in terms of GNP by 1968 to become 2^nd only to United States of America. The 1973 oil crisis came as an economic shock to Japan. The second oil price increase of 1979 meant that the oil prices which were around $12.75 a barrel in 1974 increased nearly by 300% to $34 a barrel in 1981 [Nakamura, 2005]. Japan, being almost totally dependent on imported oil reacted quickly by adopting a policy of monetary constraints and improved its energy efficiency to stay competitive and the decline in exports in 1980-2 were recovered by 1984 proving that Japan has the ability to bounce back.

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The two decades following the Japan’s meteoric rise were the years of globalization. 1980-2000 were the years when the economic development suffered a slow down all over the world. [Weisbrot et al, 2001] call it the period of diminished progress. The 2^nd oil price increase of 1979, globalization and flow of capital to third world countries and economic mismanagement have all been blamed for the decline [Weisbrot et al, 2001]. The IMF figures of real per capita GDP (in constant 2000 US$) shows that when compared to 1960-80, almost in all cases per capita GDP declined during the two decades 0f 1980-2000. For the top GDP bracket (which includes Japan), the annual rate of GDP growth fell by 1%.

Reference: [Weisbrot et al, 2001]

In this global period of economic decline, Japan’s economic also went through a period of recession. When everyone was expanding Japan to continue the economic miracle, Japan’s economy had to face a number of financial crises, some of which in the hindsight appear to be of their own making. [Agarwal, 2004] believes that the liberalization of financial system, the deregulation of banking sector, interests and capital flows were carried out without proper assessment of their impact on the domestic financial markets. Many financial institutions came to the verge of bankruptcy and most of these had to be bailed out to prevent an economic crisis.

Some analysts [in Agarwal& Agarwal, 2001] believe that unlike United States which stepped into to save the economy from ‘Savings and Loan’, Japan’s Ministry of Finance failure to intervene and making the financial institutions sell their assets to account for hundreds of billion dollars worth of non performing loans is responsible for the economic crisis of Japan during the 1990s.

In addition to the financial problems and banking sector near insolvency, the economic experts identified Weak economic activity, low productivity and high prices as some of the reasons for stagnation of economy. Japan’s dwindling working age population means that there will be fewer workers available for economic activity.

The domestic financial policies, a reduction in exports due to a global economic down trend resulted in an average growth rate of 1.7% during 1990s [CIA Economic Report, 2005]. In the aftermath of September 11 crisis, the slowing down of US, European and Asian economies has not helped the export based Japanese economy and during 2000-3 Japan’s economy stagnated during this period.

During the first half of 2004 Japan’s economy began to show the sign of recovery. It was the first time that the economic figure gave reason for optimism for Japan’s economy during almost a decade; Japan declared a growth rate of 5.25% (seasonally adjusted annual figure). This figure was largely due to the new economic factors now emerging in the world economy, the fast growing Chinese economy. Slower growth in domestic machinery demand and reduction in orders from China resulted in an overall growth rate of 2.25%. Suddenly the economic pundits have become extremely optimistic about Japan’s economic growth in the forthcoming years. The earlier estimates of 3.4% growth for 2005 have now been upgraded by International Monetary Fund (IMF) to 4.5% [IMF Predicts, 2005].

Economics believe that due to pressures of being a democracy, Japan chose not to make hard choices; the banks were forced to hide the non recoverable loans and were obliged to throw good money after bad to appear to be solvent. The government borrowed heavily from the public and now the debt stands at 160% of GDP [CIA Economic Report, 2005]. Japan opted to ignore the option of writing off bad debts and using inflation to overcome the problem and used monetary tactics of accumulation of capital, which to most economist has cost them a longer than expected period of economic decline. The position now is that the banks are in a strong financial position and are generally solvent. The economic recovery from now on can be expected to be on a sound footing [Jerram, 2004].

ECONOMIC FORECASTING

The science (or Art) of forecasting the economic future of a country especially a long term forecast is still an uncertain art. The parameters required for the input can and do change over the forecast period. [Artis, 1996] analyzed the economic forecasts error in pre-1983 and post-1983 period to show that the forecasting has not significantly improved during the two periods. While the economic parameters for most of the developing countries are not available in the required detail, for the developed countries it is normally not a major problem, yet the accuracy of the forecast varies by about 1% which is almost 30% out when we recognize that actual growth rate is around 2.75% [The difficult Art of Forecasting, 1996]. It has to be appreciated that some of the factors involved in economic growth are so unpredictable that they cannot be possibly included in economic forecasting, factors such as oil price shocks, unification of two Germany, September 11 terrorist attack, natural disasters like floods in New Orleans and Kashmir earthquakes cannot be factored into economic forecasts. The error of 1% in predicting economic trends is an average, in many cases IMF and OECD have been quite accurate in their predictions and the economic forecasting continues to have the confidence of economic planners to use it as a basis of international business as well as for providing planning information to the national economies.

METHODOLOGIES OF ECONOMIC FORECASTING

[Clements and Henry, 2002] and [Mizon, 2002] present excellent reviews of economic forecasting techniques. [Clements and Henry, 2002] give a detailed explanation of statistical modeling and techniques for generating forecasts. Reasons for errors in macroeconomic forecasts are also covered as also are methods of evaluating forecasts generated by different methods. The reasons for forecast failure are explained in a non-technical language by [Hendry & Ericsson, 2001].

[Arsham, 2005] is an excellent reference manual available online for economic forecast modeling. The Forecasting method covered by [Arsham, 2005] include Economic Indicators, Economic Projections, Compound Growth Rate, Time Series Projection, Time Series using Ordinary Least Square (OLS) Method, Visual Time Series Projections, Forecasting with Smoothing Techniques and Forecasting with Econometric Models.

JAPAN ECONOMY IN 20 YEARS

Japan’s economy has overcome the difficulties of the last decade. The growth rate from 2004 is expected to be a healthy 3%. In 2004 Japan achieved a growth rate of 2.25%. The IMF forecast for 2005 and 2006 is an economic growth rate of 4.5%. The worse appears to be over but for future economic growth, Japan has to ensure that its national debt is reduced, the impact of demographic factors is minimized and its exports and overseas production interest are maintained.

DEMOGRAPHIC FACTORS

One of the major factors being identified as potential hazard to future economic development of Japan is its aging population. Japan has an excellent health care system. The life expectancy in Japan is among one of the highest in the developing countries. According to the population statistics 20% of Japan’s population is now 65 years or over.

The problem is that the Japan’s population is not being replenished by the new births at the required rate. The fertility rate has dropped to 1.3 children per woman which is well below the replacement level. The concern that Japan’s economy weakened by the recession of more than a decade may be overburdened by the problems of manpower shortage, paying old age benefits to the high percentage of senior citizens. The labor force is likely to shrink by 0.7% [Campbell, 2003] a year between 2000 and 2025 and may well seriously effect the economic development during the next 20 years. The problem is that the life style Japanese have got accustomed to does not encourage child bearing to have the hope of making up the present shortfall in foreseeable future. A survey of Japanese women showed that only 7% of Japanese women saw child bearing is a satisfying experience compared to 60-70% women in other countries [Campbell, 2003]. This means that Japan’s population is likely to continue its trend of declining working age group and an increasing population of 65 years and over.

The fiscal implication of the aging population would require a change in the pension system. The present system of pay-as-you-go would mean that “pure aging effect on public finances for 2000 to 2030 could be debt equal to 190% of 2000 GDP [ ]

The United Nation Population Development calculations estimate that if the present situation does not improve, by 2025 Japan will have an average age of 50 years. The population of 65 years and over will be 30% of the total population. The NUPD paints a bleak picture where due to decline in birth rate the proportion of children under 15 will be the same as those of people 80 years and over. This is stark statistics indeed and there is no doubt that Japan will have to take steps to encourage population growth rate to around 3% per annum. However, most social scientists believe that this doom day forecast can be avoided. In the near term Campbell [ ] argues that the gradual decline rate of 0.7% is manageable and the economy can cope with this without undue strain.

Campbell [ ] contends that older people will not be a burden on state, the pension premium for the working population may have to be increased to support the pension schemes but it is unlikely to impede the economy. He points out that United States spend 13% of GDP on health care while Japan spent 7.8% for providing a better degree of health care to its population.

Usui [ ] believes that women are still not participating in the economy to the extent they could and in case of labor shortage they would play a more active role in the labor market to remove the labor shortage. She also points out to the useful role senior citizens play in upbringing of their grand children releasing parents for a more active economic role. The population growth rates can thus be achieved without removing women from the workforce for an extended period.

The demographic dilemma is certainly a cause for concern for Japan’s economy but it appears that Japan will be able to cope with the shortage during the next 20 years. Japan has not been very receptive to the ‘guest workers’ for meeting its manpower requirements but a future shortage may change that situation. Increased productivity, late retirement, more participant of women in work force and possibility of using foreign workers are some of the options that can be used to meet the manpower requirement of the economy. Japan has the highest number of robots in use in the world [CIA Report on Japan Economy, 2005, the automation is another solution to the manpower shortage.

However, the real solution in the long term is to encourage population growth through incentives and child support. Negative population growth is a problem in many developed countries and solutions are being found to prevent it from holding the economic development.

CHINA AS AN ENGINE FOR JAPAN’S ECONOMY

Japan’s economic miracle was greatly helped by the exports to United States. As Japan’s economy developed it was able to find additional partners in Middle East, Europe and in developing countries. The global economic decline during 1980-2000 reduced the pace of economic development in Japan. China’s ‘economic miracle’ during the last few years has been largely responsible for the revival of Japan’s economy.

India is also posting impressive economic growth rate during the last few years. Japan’s technological advantage, its competitiveness and its participation in ASEAN places Japan in an advantageous position in helping develop these economies [News Item, 2004]. The recent revival of Japan’s economy has in part been attributed to its exports to China. At present the main exports to China are of high-tech parts. Many of the Japan’s giant corporations are building new facilities in Japan to make products for China and other markets.

China has made tremendous progress since a change in its political system. Its foreign trade has grown by double digits for many years. China is now the third largest trading country in the world and its exports to United States were around $150 billion last year putting China ahead of Japan in the list of countries exporting to USA [Herman, 2005]. Many observers believe that this might be a threat to Japan’s economy. But China and Japan, at least for now see this as a window of opportunity for developing their economies. China needs Japan’s technology and Japan recognizes China as an opportunity to reduce its production costs by using cheap labor available in China.

China will perhaps welcome Japan’s investment even more than investment from US as Japanese investment does not come with a dose of speeches urging China to reform its political system! China is encouraging direct investment from developed countries and Japan has already built plants in Japan to lower its labor costs and stay competitive in the international markets. Japan-China cooperation in the economic filed appears to be in the interest of both countries. China has an advantage in labor costs and for the foreseeable future China will need the advance Japanese technology to meet its development goals.

China is now the second largest market for Japan’s export and it appears that for the next decade or two China- Japan trade will continue to grow for their mutual benefit. China’s GDP of $1.7 trillion is only 13% of that of United States and about one third of that of Japan [Wang, 2005]. China has a population of more than a billion and it is clear that the scope of development in China is enormous.

After China agreed to the one-country two-system policy and Hong Kong came under its political control, countries like Singapore, Korea and Japan built considerable production facilities to China to benefit from the cheap labor costs. Hong Kong, of course being a political part of China moved many of its labor intensive industries to China. This has benefited China in boosting its exports. It has been estimated that 60% of Chinese export in 2004 came from the foreign invested enterprises. The profits of Japanese enterprises in China, of course benefit Japan too. It is clear that both China and Japan are using trade to each other’s advantage. What is not well known is that China is not only the fastest growing market for Japan but also for the United States.

The Kyoto protocol agreed to keep India and China out of the developed countries list and as such they are not expected to limit green house gases. Although United States has also not agreed to the Kyoto Protocol, it appears that Chinese economy can continue to develop, at least for the time being without the worries for limiting green house gases. Absence of application of Kyoto Protocol would also be advantageous for Japanese companies working in China.

JAPAN’S DEBT AND FUTURE DEVELOPMENT

The total debt of Japan is nearly 160% of its GDP [CIA Economic Report on Japan, 2005]. Most of Japanese debt is however internal. Us Foreign debt is already approaching the internal debt of Japan and it has been estimated that by 2010 US will owe as much to the international lenders as Japan owes to its internal lenders, Japanese people. Although the difference in economic sizes of the two countries is enormous and it is not correct to compare Japan and US on the same economic scale but it does give us an idea that the debt that Japan built during the recession years may not hold it from future development. The demography, the huge debt problem and rise of competitive China are some of the factors Japan will have to contend to make economic progress.

As the editorial in Rediscovering Japan Dec 2003 said that with the revival of Japan’s economy economic pundits are once again discovering that Japan has the competitive strength to bounce back. The editorial said that that Japan is still the world second largest economy and it has streamlined itself to meet the emerging challenges from Korea and Japan. It urges US CEOs to be not influenced by media misperception and to take Japan seriously. Japan is far too important to be ignored, it said.

THE ECONOMIC FORECAST FOR NEXT 20 YEARS

The Editorial from Rediscovering Japan is perhaps the best note to conclude this article. Japan has the potential to develop and compete with the new emerging economies; it had the ability to become energy efficient to stay competitive after the energy crisis of 1973 and 1979 and the new energy prices will probably be more of a headache for gas guzzling economies of the west. Japan has invested in its people and while other countries might build plants to manufacture Japanese cars for the present, Japan has the foresight to invest in the research and development for energy efficient vehicles possibly electric to stay ahead of the competition.

[Suzuki, 2004] presented medium term economic forecast for Japan (2004-2010), estimating the economic development rate to remain in the range of 2% per annum. Their forecast is however based on an oil price estimate of $28 per barrel, which we now know is more than twice that. Their assumption regarding improvement in export was also rather conservative. The economic forecasting is poor in estimating up and down turns. Suzuki analysis had projected 2% growth rate for 2004 and 2005, which was actually 2.25% for 2004 and 4.5% estimated for 2005.

[Kosai and Ito, 1999] estimate that the economy growth rate for the period 2000-2025 will be 1.8% and as the economic forecast for such a long period of a habit of being out by an average 1% we can safely expect Japan to develop during the next 20 years.

Japanese have proved themselves capable of meeting economic challenges presented to them. No one would have believed that Japan had the capability of bouncing back from the ravages of the 2^nd World War and develop to an extent where it is seen as a threat to the other economies. One thing is certain Japan is too important to be ignored and is likely to remain so for the next 20 years and beyond.

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