Priorities for the Japanese Economy in 2018 (January 2018)

Japanese Economy Likely to Remain Calm and Uneventful on the Surface

GOTO Yasuo
Research Associate, RIETI

Japan is enjoying a long spell of economic growth, which has exceeded the length of the Izanagi boom, the symbol of the postwar high growth period. What will happen to the economy in 2018? With few seeds of trouble in sight, at least on the domestic front, my view is that the Japanese economy will generally remain calm and uneventful.

Few negative factors observed on the domestic front

On the domestic front, factors working to prop up the economy are more visible than seeds of trouble. Those positive factors can be divided into two broad categories, namely, policy factors and cyclical factors (i.e., the self-correcting mechanism of an economy including the momentum of the economy), with the former further divided into fiscal and monetary policy factors.

First, take a look at the proposed government budget for FY2018 to examine fiscal policy factors. As it appears, the budget shows few signs of austerity with expenditures as a whole continuing on an upward trend. As a broadly defined fiscal policy factor peculiar to this year, we expect to see a boost in construction demand in association with the forthcoming Tokyo Summer Olympic Games. One study estimates that the hosting of the Olympic Games has a cumulative effect of boosting the host country's real gross domestic product (GDP) by about 10% over the period between the announcement of the host country and the hosting of the event (Brückner and Pappa 2015).

Meanwhile, the monetary policy will likely remain accommodative as Japan has yet to remove deflationary pressure. It may be difficult to take impactful monetary easing steps comparable to the so-called "Kuroda Bazooka," a sequence of extraordinary monetary easing schemes introduced by the Bank of Japan (BOJ) since 2013 under the leadership of Governor Haruhiko Kuroda. At any rate, however, this is no time for the central bank to consider tightening monetary policy. It is thus hard to imagine that any step taken by the BOJ will become a trigger to suppress the economy.

Next, when we look at cyclical factors, consumer spending—which is the biggest component of GDP and holds the key to sustaining the ongoing economic growth—shows no signs of dampening. With both wages and employment likely to maintain positive trends, it is expected that household income, a key determinant of consumption, will also follow a generally upward trajectory. Prime Minister Shinzo Abe and his government might be getting frustrated with the existing state of the corporate sector, as companies appear reluctant to raise base pay despite posting record earnings. Still, the current situation bears no resemblance to the grim situation that continued until the early 2000s, in which Japanese companies came under massive restructuring pressure and many workers suffered pay cuts.

As such, we see very few, if any, domestic factors that may cause a dampening effect on the economy. What about overseas factors? Overseas economies are not as solid as Japan and are embedded with a number of risk factors. Among the major risk factors are the conduct of U.S. monetary policy—which is a focus of global attention—and its impact, as well as the future course of the Chinese economy, which is already plagued with overcapacity. Developments in Europe, where the United Kingdom is to exit the European Union (EU) and southern EU member states continue to struggle under the weight of massive debt, are another source of concern. Each region has potentially destabilizing factors. For Japan, geopolitical risks posed by North Korea are a potential flashpoint. However, the Japanese government has long been aware of all of those risks (except for the geopolitical risks) and their potential effects on the economy. With significant policy efforts made to prevent them from materializing, concerns over the risks are not as strong as they used to be.

"Lukewarm water situation" will likely continue

All of these observations taken together point to the following conclusion: Although overseas economies remain subject to downward risks, the Japanese economy will likely continue to expand with few negative policy or cyclical factors on the horizon at home. However, despite the continuing expansion, there is little possibility for the economy to overheat, mainly because household income is likely to increase only moderately. When income growth is modest, a significant boost in consumption is hard to come by.

There are two major factors suppressing growth in income. One is Japanese companies' wariness of raising wages. Although listed companies are expected to churn out record profits for the current fiscal year ending March 2018, they generally maintain a cautious stance when it comes to raising base pay levels, citing uncertainty over the future course of the economy. Against this backdrop, labor unions are demanding relatively modest wage hikes. The Japanese Trade Union Confederation, or Rengo, is demanding a 2% hike in base pay and a 4% hike including annual increments based on age or the number of years in service. The requests remain unchanged from those made in the Shunto annual wage negotiations held in spring 2015.

The other major factor weighing down on income growth is an increasing fiscal burden imposed on taxpayers. Changes to the individual income tax proposed by the ruling coalition in their 2018 Tax Reform Outline would reduce household disposable income by almost 100 billion yen (Note 1). The expected impact would not be so large as to dampen the economy, but the potentially consumption-suppressing effects of reduced income are non-negligible. In fact, the fiscal burden on corporate taxpayers—including the portion of social security taxes borne by employers—has been continuing to rise in recent years, working to suppress wages (Oshima and Sato 2017).

The picture we have here is that while there are few factors pouring cold water on the economy and the upward trend is continuing, downward pressure on income continues to weigh heavily, particularly among the working generation. As a result, the "lukewarm water situation," one in which people find themselves in moderate comfort but fall short of feeling the momentum of economic growth, will likely continue in 2018.

Cost of uneventfulness

We must take careful note of the fact that the ongoing calm and uneventful economy is a product of significant policy compromise. In April 2018, Kuroda's term will end. Who his successor will be is a matter of the greatest concern for the financial market. Whoever it is, however, the central bank will likely maintain its ultra-easy monetary policy, given the current macroeconomic situation including prices of goods and services. Japan's monetary policy has gone way beyond its normal boundaries, venturing into experimental territory to try out unconventional schemes. It is hard to tell what long-term effects this will have on the Japanese economy and society.

The enormity of the government's budget, maintained despite limited tax revenue, is another potentially big risk. Japan's fiscal condition, the worst among advanced economies, has long been subject to concerns over the possibility of losing public and market confidence. This will be an important year, in which the government will decide whether to go ahead with the planned hike in the consumption tax rate in October 2019.

Faced with two contradictory goals, i.e., keeping the size of fiscal spending while giving due consideration to the need to restore fiscal health, the government tends to collect more taxes where it is relatively easy to do so, targeting working taxpayers belonging to certain income brackets. Since any attempt to reform social security and other income distribution systems can easily provoke political and social friction, the government has long shied away from discussing the matter in a full-fledged fashion. However, the reform of income distribution systems is a top priority issue that we cannot afford to avoid if we are to revitalize our economy and society.

Even if the Japanese economy continues to cruise uneventfully, considerable doses of potentially harmful policy measures have been taken underneath the calm surface. Some people say that Japan's post-bubble economy, popularly referred to as the "lost two decades," is now becoming the "lost three decades." In order to avoid turning it into the "lost four decades," Japan needs to address key policy issues by taking advantage of the gradually increasing leeway. From a long-term historic perspective, this year can be seen as a critical juncture that determines the success or failure of Japan in this endeavor.

January 4, 2018
  1. ^ "Kojin Jiku-ni 2,800-oku-yen Zozei: Hojinzei wa Zogen Zero [Tax Increase Worth 280 billion yen to Impose Greater Burden Mainly on Individuals: Overall Burden on Businesses Will Remain Unchanged]," Nihon Keizai Shimbun (Electronic Edition), December 14, 2017.
  • Brückner, M., and E. Pappa, 2015, "News Shocks in the Data: Olympic Games and Their Macroeconomic Effects," Journal of Money, Credit and Banking, Vol. 47, pp. 1339-1367.
  • Oshima, Keiji and Tomohiko Sato, 2017, "Kakei Chosa-to kara Saguru Chingin Teimei no Riyu: Kigyo Futan no Zodai [Reasons behind Sluggish Pay Growth as Seen in the Family Income and Expenditure Survey, etc.: Growing Burden on Businesses]," Chapter 9 in Yuji Genda (ed.), Hitode Busoku nanoni Naze Chingin wa Agaranainoka [Why Wages are Stagnant Even When Businesses are Understaffed], Keio University Press

February 15, 2018

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