Priorities for the Japanese Economy in 2021 (January 2021): Using the COVID-19 Crisis as a Chance to Revive the Japanese Economy

Highly Uncertain Prospects for the Japanese Economy and Policy Challenges

President, RIETI

Highly Uncertain Prospects for the Japanese Economy in 2021

The government's economic growth forecast for the next fiscal year was announced in late December. According to the forecast, Japan's real gross domestic product (GDP) will record positive growth of 4.0% in fiscal 2021. At the same time, for fiscal 2020, a forecast of negative growth of 5.2% was announced, and this would mark the largest negative growth to be recorded since the end of World War II. If the new forecast realizes, the figure would represent the largest-ever negative forecast error of 6.1 percentage points compared with the initial forecast (in other words, the initial forecast had an upward bias of 6.1 percentage points), exceeding the previous record forecast error posted in fiscal 2008, when the economy took a sharp downturn because of the impact of the global financial crisis. Naturally, as the current economic downturn was caused by the novel coronavirus (COVID-19) pandemic, an unforeseen shock, forecasts by private-sector economists and international organizations were also revised significantly from the initial figures.

The corporate sales forecast was also revised sharply downward. According to annual sales plans (on an all-industry basis) in the Bank of Japan's "Tankan" survey report on short-term business outlook, sales in fiscal 2020 were forecast to record a slight increase of 0.1% in the March survey but a drop of 8.6% in the December survey. The profit forecast was also revised downward sharply, from a fall of 2.5% to a plunge of 35.3%.

On the other hand, the government's forecast in fiscal 2021 of positive growth of 4.0% in real GDP is the highest initial growth forecast in the past 30 years and is somewhat higher than the average forecast among private-sector economists (Note 1). However, the economic growth rate may rebound strongly after a steep decline in some cases, so the government's forecast is not entirely unrealistic. Still, as the economic situation in fiscal 2021 depends on how the COVID-19 pandemic will unfold, there is very high uncertainty over the prospects for the economy.

As I am writing this article, the number of COVID-19 infection cases continues to increase across Japan, so various measures have been taken, including the suspension of the "Go To" financial incentives for travel, eating out and event attendance, and requests for eating and drinking establishments to cut back on opening hours. Outside Japan, measures such as stay-at-home orders are spreading once again in Europe, and it is difficult to foresee how long this situation will last. On the other hand, as the development of vaccines is making rapid progress, the speed of diffusion of vaccines will also affect economic activity. If vaccination proceeds smoothly worldwide, economic activity may rebound more strongly than is currently expected.

Effects of Uncertainties and Response

In a highly uncertain situation like this, the realistic approach is to provide a confidence interval of forecast instead of a point forecast. If we mechanically forecast an economic growth rate in fiscal 2021 as a 95% confidence interval based on past data regarding the ex post forecast errors of the government's economic growth forecasts in the 1990s through fiscal 2019, we come up with a growth rate range of minus 0.2% to plus 6.4%. In other words, the possibility cannot be ruled out that GDP may record a negative growth rate for the three consecutive years (Note 2). As this is based on information for past years, and includes a wide range of economic periods from recessions to boom years, it may be better to apply a wider confidence interval to the forecast for fiscal 2021.

While there is still uncertainty over whether the Olympic and Paralympic Games in Tokyo will be held, as they have already been postponed for one year, this factor is not considered to have a significant impact on the growth rate at the macroeconomic level. As I mentioned in a previous column (Morikawa, 2017), fundamentally, any increase in consumption expenditure during the Olympic-Paralympic period is expected to be very limited if a substitution from other consumption items and negative factors to reduce consumption are both taken into consideration.

It is well known that when uncertainty heightens, forward-looking corporate activities, such as capital investment and research and development investment, are curbed as a result of the "wait-and-see" behavior of putting off long-term decision-making until the uncertainty recedes. As recruitment of new employees is a long-term investment, it is also affected in a similar manner. There is also a study showing that the decline in GDP due to the COVID-19 pandemic can be explained in large part by increased uncertainty (Baker et al. 2020a, b). Although little can be done about uncertain factors that are difficult to eliminate, such as when the COVID-19 pandemic will be contained, it is desirable at least to implement economic policies in as predictable a way as possible to avoid creating an additional source of uncertainty.

Challenges for a Post-COVID-19 World

From the medium- to long-term perspective, the issue will be whether COVID-19 will become a factor of long-term economic stagnation. This depends on how strong the irreversible negative "hysteresis effects" of the COVID-19 crisis will be. In addition to the decrease in investments that may lead to improve productivity, such possible effects include an exit of workers who lost jobs due to the COVID-19 crisis from the labor market, a deterioration in those workers' skills, the impact of school closures and a shift to online education on the skill development of younger generations, and the retreat of globalization. On the other hand, there are also factors that may raise productivity after the containment of the COVID-19 crisis, including the diffusion of new digital technologies, business efficiency improvements and regulatory reform measures, such as simplification of the authorization process and the abolition of the stamping of seals, and the "cleansing effect" arising from an exit of companies with low productivity from the market (Morikawa, 2020).

Amid the COVID-19 crisis, unconventional fiscal and monetary policy measures have been taken around the world. The average ratio of government debt to GDP among developed countries is forecast to exceed 125% by the end of 2021, with the ratio for Japan rising above 250% (IMF, 2020). Under the present circumstances, it is unlikely that the heavy debt burden will immediately lead to inflation or fiscal collapse. However, the high level of government debt is a critical future risk factor and could affect growth potential in an economic recovery phase by pushing up interest rates, for example. To ensure economic growth after the containment of the COVID-19 crisis, the question of how to normalize the emergency fiscal and monetary policies will also be a significant issue.

Looking back at the Japanese economy since the bursting of Japanese economic bubbles in the early 1990s, we have frequently experienced great negative shocks, including the Japanese financial crisis in 1997-1998, the global financial crisis in 2008-2009, the Great East Japan Earthquake in 2011 and the ongoing COVID-19 crisis. We must bear in mind that in the future, Japan will continue to face the possibility of unforeseen events, including large-scale natural disasters and political and economic shocks coming from abroad, and that the country should further develop its capacity to deal with such contingencies.

December 25, 2020
  1. ^ According to the ESP Forecast Survey (Japan Center for Economic Research), the average forecast of the real GDP growth rate in fiscal 2021 among economists is plus 3.4%.
  2. ^ According to recently published GDP data using 2015 as the base year, the real GDP growth rate in fiscal 2019 was minus 0.3%.
  • Baker, Scott R., Nicholas Bloom, Steven J. Davis, and Stephen J. Terry (2020). "COVID-Induced Economic Uncertainty," NBER Working Paper, No. 26983.
  • Baker, Scott R., Nicholas Bloom, and Stephen J. Terry (2020). "Using Disasters to Estimate the Impact of Uncertainty," NBER Working Paper, No. 27167.
  • International Monetary Fund (2020). Fiscal Monitor: Policies for the Recovery, October.
  • Morikawa, Masayuki (2017). "Consumption-boosting Effects of the Tokyo Olympics and Paralympics: Whose consumption expenditures will increase in net terms?" RIETI Column (August 1, 2017).
  • Morikawa, Masayuki (2020). "The Coronavirus Crisis and the Japanese Economy," Kobayashi, Keiichiro and Morikawa, Masayuki (eds.), Economics of the COVID-19 Crisis—Proposals and Analysis, Nikkei Business Publications, Inc., pp. 5-24.

February 18, 2021

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