International Finance
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Debating Japan’s brilliant rebound

IFM_ Japan’s brilliant rebound
Foreign visitors to Japan increased by more than 1,600% from COVID-affected levels a year earlier, amounting to roughly 2.1 million in June 2023

Japan’s economy grew at an annualised rate of 6% in the second quarter of the 2023-24 financial year, one of the best results the world’s third-largest economy has undergone since the middle of the 1990s and good enough to make it the best performer among major global economies. The GDP growth rate was more than twice what economists had predicted.

Additionally, it wasn’t a true boom in many ways; rather, a post-COVID-19 spike assisted a technical boom. However, after years of stagnation, Japan’s economy is starting to gather steam. The results were also convincing enough to compel analysts to revisit their spreadsheets; private-sector expectations for growth in the March-ending fiscal year now range between 2.0 and 2.5%, virtually double earlier projections.

Since the middle of the 1990s, Japan has served as the paradigm of a struggling economy. It has been trapped in a rut, with growth often flatlining at 1.0–1.5%, weighed down by deflationary forces. While a significant portion of this was due to the drag of steadily declining asset values for the majority of the previous 30 years, it also highlighted Japan’s position as the top “mature economy,” an uncomfortable club that now includes the majority of its G-7 peers.

Since more affluent people spend a smaller percentage of their income, and the large infrastructure spending necessary to create an industrialised economy has already occurred, these economies are characterised by slower development than developing economies. This is because there is less room for future expansion. A declining population that includes fewer young people makes this worse for Japan and other nations.

Even if the Japanese economy was, in some respects, stagnant, life wasn’t all that horrible. Growth as a concept began to lose its appeal, but the government kept public infrastructure at a high standard, and businesses demonstrated their willingness to keep employees even when business was slow. In 2002, unemployment reached a high of 5.5%. As the population inevitably declines, there are currently 1.3 jobs for every job seeker, bringing the unemployment rate down to only 2.7%.

In sharp contrast to their Chinese counterparts, college graduates in Japan have no concern about getting full-time staff positions when they graduate. They do not have to deal with the uncertainties of the gig economy because they have high job security, required health insurance, and other benefits from a staff job. It may not come as a surprise that Japan isn’t innovating if the need is the mother of invention.

What is fuelling the increase in activities?

Several technical aspects of the technique used to calculate the GDP contributed in part, but some encouraging indicators for the future also played a part.

According to the most recent data, a surge in exports and a drop in imports were two of the main factors driving growth. Imports are counted as a negative within this, whereas exports are counted as a positive. According to a traditional paradigm, a country imports goods at a cost and then exports goods with a higher value, increasing the country’s wealth.

Therefore, there would typically be a timing issue between Japan’s Q2 export growth of 3.2% and Q2 import growth of 4.3%. Imports will eventually need to increase once more to replenish the merchandise that has been sold overseas. Statistics from a single quarter can be especially misleading in this situation.

But for Japan, something that doesn’t seem to be an export—the entrance of thousands of foreign tourists—plays a significant role in the export column. Foreign tourists are back with a fury, as any traveller in Tokyo’s chic enclave of Ginza can attest. Foreign visitors to Japan increased by more than 1,600% from COVID-affected levels a year earlier, amounting to roughly 2.1 million in June 2023. That is four times the amount when Japan began a significant drive to promote tourism abroad in 2012. Japan is now a bargain on the global market because of an approximately 33% decline in the yen’s value over the past ten years.

Since the figures exclude China’s August 10 decision to once again permit tour groups to visit Japan, there is still plenty of room for growth. However, a fresh row over Japan’s decision to release wastewater that was used to cool the Fukushima nuclear power plant has put that back in jeopardy. Chinese travellers made up the largest percentage of foreign tourists before the COVID-19 outbreak and were among the top spenders per person.

The decline in consumer spending, which has a significant impact on overall domestic demand, was identified by economists as a weakness. The recent (and long-needed) rise in inflation, which is currently hovering around 3%, is partly to blame for this. However, the picture is ambiguous.

Other official statistics demonstrate that during the last eight months, consumer confidence has been increasing and is currently at its highest level since December 2021. Additionally, the GDP numbers demonstrate that as employees demand higher wages, salary rises now appear to be catching up with price increases. Real salaries saw their first increase in more than two years, rising by 0.6% from the prior quarter.

Is the Japanese economy operating as usual or undergoing a fundamental transition? Economists are divided on this issue.

“The story of de-risking from China is a long-term one, but for now, we are not seeing any impact on the data, to be honest,” said Kentaro Koyama, the chief economist for Japan at Deutsche Securities.

Positively, investment is increasing due to a weaker currency, solid infrastructure, and surprisingly low labour costs that make it more alluring to both Japanese and foreign businesses. The fact that Japan is not China (which American businesses are increasingly decrying as “uninvestable”), but rather a strategically advantageous nation in East Asia with a sizable amount of government funding accessible to aid, adds to the appeal of investing there.

The restoration of Japan’s once-dominant high-tech manufacturing base is a top aim for Prime Minister Fumio Kishida as part of his “new form of capitalism.”

Government payments of 476 billion yen ($3.2 billion) to chip powerhouse Taiwan Semiconductor Manufacturing Company (TSMC) for the construction of its first Japan factory and a second facility are among the subsidies that have been provided.

Officials from TSMC claim in confidence that the Japanese factory is on schedule and within budget, in contrast to a similar facility in Arizona that is running late and over budget due to higher-than-anticipated labour costs.

More people are joining. While U.S.-based Micron Technology will invest up to 500 billion yen ($3.4 billion) in Japan over the next few years, including expansion at its Hiroshima plant, and semiconductor equipment maker Applied Materials has recently announced plans to hire over 800 new engineers for its Japan operations, Sony is currently building a new image sensor plant close to the TSMC facility.

More significantly, Japanese businesses are now focusing inward. “Japanese corporations have made relatively little capital investments in Japan over the previous 20 to 30 years, particularly in the manufacturing sector. However, the scenario has shifted amid a change in the geopolitical environment,” according to Koyama of Deutsche, who pointed out that, according to data from the Bank of Japan, big Japanese companies expect to boost their capital spending this year by 13.4%, which is more than they anticipated just three months prior.

Japanese economists concur that the rate of future wage rises, particularly those resulting from union discussions in the 2024 spring, will play a significant role in boosting future domestic demand and preventing growth from fizzling out.

“Consumers anticipate that wages will rise higher in the upcoming year,” claimed Takahide Kiuchi, a former member of the BOJ policy board who is currently working for the Nomura Research Institute in Tokyo. However, if pay growth is underwhelming in 2024, then expect a drop in consumption.

Another significant challenge for Japan is opening up a labour market that is still heavily skewed toward lifetime employment. Again, claiming that businesses won’t raise salaries for workers who aren’t at risk of leaving, the government has started yet another scheme to promote labour mobility.

Even though millennials in Japan exhibit some of the carefree attitudes observed in millennials elsewhere, it is unclear whether this new campaign will be any more successful than the long list of past projects dating back a decade. Mid-career job moves continue to be unusual as employees choose security over increased income.

China, however, presents numerous hazards to the expansion of the Japanese economy. The possible impact of China’s stalled growth on Japanese exports is the most urgent problem. Even though the government advocates for onshoring and de-risking, China continues to be Japan’s largest trading partner, receiving 20% of all exports from that country.

In the long term, geopolitics and the potential for a Taiwan war can become the main risks. This could have an impact on shipments to Taiwan, which is Japan’s fourth-largest export market, in addition to possibly harming exports to China.

The disruption to the supply chain that would result from a halt in Taiwan’s semiconductor manufacturing is an additional factor. According to Kiuchi, this alone would reduce Japan’s GDP by 3%.

There may be more to come. Given the military logistics that have brought war to Japan’s doorstep, the country will be drawn into the battle. If this happens, commerce with the rest of Asia—which accounts for 50% of all of Japan’s trade—could be in jeopardy.

According to Kiuchi, the potential harm to the Japanese economy in the event of an incident in Taiwan “could be unprecedented.”

The future, he believed, is genuinely promising if all of this can be prevented.

“Japan’s economic share has been falling for many years, but the government has adopted a high-growth policy, and that gives Japan the opportunity to improve its presence in the global economy,” the expert concluded.

While there are concerns about the sustainability of Japan’s growth story and potential risks to the island country’s economy, the government’s high-growth policy and investments in key industries are promising.

Japan’s unique position, with a highly educated workforce, advanced infrastructure, and government funding available to support businesses, makes it an attractive destination for investors.

By addressing challenges such as labour market reform and increasing domestic demand, Japan has the potential to continue its economic resurgence and play a more prominent role in the global economy.

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