Nouriel Roubini's Global EconoMonitor

Why Japan’s Downturn May Not Be So Mild After All

Until last week, some analysts still believed Japan would escape recession, but the release of the Q2 GDP numbers forced most to change their tune – real GDP in the second quarter (Apr-Jun) fell -0.6% qoq (-2.4% yoy). Consequently, the consensus now seems to be that Japan is experiencing a shallow, short-lived recession, with recovery expected sometime in the first half of 2009. While Japan’s downturn may yet be mild, it’s important to keep in mind that considerable downside risks exist to this scenario. Given the risks detailed below, there’s a strong likelihood analysts will have to revise down their forecasts further.

Before we get into the downside risks, here’s a look at some forecasts:


Already Anemic Consumption Likely To Deteriorate Further

Private consumption has been anemic in recent years and there’s no sign of any improvement on the horizon. If anything, private consumption – which currently accounts for about 55% of Japan’s GDP – looks set to drop off further, as my fellow blogger Claus Vistesen has noted.


Source: Japan’s Ministry of Health, Labour and Welfare

In recent years, consumption has been hurt by stagnant real wages (which have been essentially flat as can be seen in the chart above) and Japan’s deflationary environment (which fostered thinking of “Why buy now when the price will soon be lower?”). Now Japan is experiencing inflation, but this is nothing to cheer about, as I detailed in a recent blog post.


Source: Japan Statistical Office

Flat real wages remain a key contributor to sluggish consumption, but now consumers are facing the double whammy of stagnant wages and rising food and fuel prices. So consumption will likely get even more anemic than it is now (note the almost flat trend line in the chart above). Highlighting consumers’ troubles, Japanese consumer confidence dropped to the lowest level ever recorded in July and summer bonuses dropped for the first time since 2002. While headline inflation may be rising, core inflation (excluding energy and food prices) is essentially zero, coming in at 0.1% in June yoy. What this means is that Japan has barely shaken off deflation. Meanwhile, this cost-push inflation and weak consumer sentiment is hurting companies’ bottom lines (see next risk below), which in turn could push wages even lower – not a pretty cycle.

See: Where Are Japan’s Consumers? Japanese Inflation: Not Much To Cheer About

Companies Not In As Great Shape As Some Press Reports Suggest

A recent Lex column in the Financial Times pointed to Japanese companies as an economic bright spot, suggesting they look well-equipped to weather a downturn with their ‘robust’ balance sheets.

The problem is that the cost-push nature of Japanese inflation, in addition to eroding consumers’ real income, is also eating away at corporate profits. Input costs have soared, but companies are having trouble passing on those costs. In a sign that companies are not all that robust, the number of corporate bankruptcies has risen, particularly among small enterprises, as Kazuhiko Ogata of Alliance Bernstein recently noted.

Residential Investment Not A Growth Savior

A rebound in housing investment was expected to help sustain Japan’s economic growth in 2008. However, GDP data showed housing investment fell an unexpected 3.4% for the three months ended June 30. It’s not surprising house hunting is less en vogue as households are being pinched by stagnant wages and rising food and fuel prices. Hiroshi Shiraishi of Lehman Brothers says residential investment is unlikely to recover much further in coming quarters.

See: How Will The Housing Sector Affect Japan’s Growth?

Gloomy Export Outlook

Earlier this year, many analysts were optimistic that Japan could weather a U.S. economic slowdown as exports to emerging markets more than offset falling exports to the U.S. As recently as late July, Daniel Citrin – the IMF’s mission chief for Japan – said exports to Asia and other non-U.S. markets should help the economy avoid recession. While Japanese exports rebounded in July, rising 8.1% yoy after decreasing 1.8% in June yoy, many analysts are skeptical the rebound is sustainable (see Danske and Mitsubishi UFJ).

The reasons Japan’s export machine is waning include: weak U.S. demand, the slowing global economy, and yen appreciation (notwithstanding recent strengthening against the USD).

See: Japan’s Export Machine: Is July’s Recovery Temporary?


Sources: Japan’s Ministry of Finance, “The Summary Report on Trade of Japan”; Bank of Japan, “Corporate Goods Price Index”

Most importantly, exports to East Asia (which, including China, accounted for 46% of Japan’s real exports in 2007) are unlikely to permanently offset those lost from the U.S. and EU slowdowns. That is because intra-Asia trade seems unable to offset Asia’s slowing exports to the G-7 economies since most of it is actually for final exports to the G-7, which my colleague Arpitha Bykere noted in a recent post. This point is underlined by the fact that almost 60% of Japan’s exports to China consist of parts and components, rather than finished goods, according to Fitch. Basically, decoupling seems like wishful thinking at this point.

Adding to the export machine’s woes, Japanese companies are facing sharp increases in the import prices of raw materials, but are having difficulties passing on these increases to export prices.

Economic Ramifications Of Japan’s Political Stalemate?

The opposition Democratic Party of Japan (DPJ) won control of parliament’s upper house in July 2007. Prior to this, Japan was effectively a one-party state with the Liberal Democratic Party holding power for all but one year since 1955. The political stalemate between the LDP and DPJ over the last year has at times had economic ramifications. For example, dissonance between the two parties on suitable Bank of Japan nominees resulted in a three-week leadership vacuum at the BOJ earlier this year, which unsettled investor sentiment. While that particular kerfuffle was eventually resolved, the uncertain political environment – and the risk this poses for economic spillover effects – should continue, especially in the run-up to Lower Hous
e elections, which are due no later than September 2009.

See: Political Stalemate in Japan: Early General Election?

Bright Spot: Healthy Financial System

Not all is doom and gloom. Japanese banks’ performance has steadily improved since 2001. Moreover, they have been mostly unscathed by losses related to subprime mortgages. As Ogata notes, Japanese banks’ healthy performance is reflected in the modest level of their excess reserves at the BOJ, as financial instability tends to cause a surge in excess reserves when banks hoard liquidity amid fears of a credit crunch.

See: Health Of Japan’s Financial Sector: Still Room For Improvement?

Bottom Line

The downside risks listed above undermine the consensus view that Japan will only experience a shallow, short-lived recession. In sum, current growth forecasts for the Japanese economy seem overly rosy when these risks are considered.

5 Responses to “Why Japan’s Downturn May Not Be So Mild After All”

DJCAugust 26th, 2008 at 9:35 am

There are alot of problems in China, but because China is so vast in territory size, one must not draw conclusions from any particular province. Generally, there is a huge disparity in incomes between regions of China. Some cities like Shanghai, Shenzhen, or Beijing are ultra-modern. Other interior provinces such as Guizhou, Gansu, and Ningxia are dirt poor. Generally wealthy areas are less polluted. Polluting industries are moving inland. For instance, Beijing capital steel is being kicked out of the city.Contrary to popular belief, China isn’t so dependent on the US Economy anymore. Inter-regional Asian trade exceeds trans-Pacific trade. Europe is now China’s largest trading partner. And the fastest growing export markets for China are the developing nation markets of India, the Middle East, and Africa. Direct Sino-US trade probably accounts for around 2-3% of China’s current GDP. If just the US falls into recession, it isn’t serious for China’s economy. If the rest of the world falls into recession, then it is very serious.The Beijing region accounts for 4-5% of China’s GDP. While $40 billion was spent on the Olympics, most of the spending went into infrastructure including a new airport, subway lines, highways, wind turbines that supplied 20% of Olympics electricity, and sewage systems. Around $1.8 billion was spent directly on the new stadiums. NBC paid $900 million for USA broadcast rights alone so the stadiums are already paid off. The Olympics water cube was entirely donated by overseas Chinese. Just as there was minimal economic impact after the Atlanta Olympics in 1996, there won’t be a significant impact after the Beijing Olympics.

tyaresunSeptember 2nd, 2008 at 11:09 am

Is Japanese GDP computed differently from US GDP? Is the Japanese GDP deflator series behaving the same way as USA?

Mary Stokes Mary StokesSeptember 3rd, 2008 at 6:22 am

Thanks for your question Tyraesun!Unlike the U.S., the GDP deflator in Japan has been negative for the past decade. For Japan’s current fiscal year through Mar 2009, the Cabinet Office forecast the full-year GDP deflator will decline 1.0%.But as we have recently seen in the U.S., Japan is experiencing a divergence in trends between the CPI and GDP deflator. Consumer prices in Japan have been rising sharply in recent months, with core inflation (excluding fresh food, but not energy) hitting 2.4% yoy in July – a decade-high for Japan.So why this divergence in the case of Japan between the GDP deflator and the CPI? As the BOJ notes in a 2003 brief, “close attention should be paid to the fact that when import prices increase due to the ‘rise’ in crude oil prices, the GDP deflator ‘falls’…when, as is the case of Japan, the rise of oil prices is not immediately passed on to domestic prices.”Basically, the GDP deflator is heavily influenced by the terms of trade, which have worsened considerably for Japan this year with the sharp rise in oil prices, as the brief makes clear with this equation:GDP deflator = domestic prices + a*export prices – b*import pricesHere’s the link to the brief if you’d like more information:

GuestMarch 31st, 2009 at 10:31 pm

Coming extremely late to this thread, but Japan’s GDP deflator is indeed rather odd…It has gone up rather sharply in recent months. Oil prices have gone down, which should bring DOWN other prices. Since a rising GDP deflator is basically a function of rising prices, I can’t understand why the Japanese GDP deflator is going up! Thoughts?