The Economist on Japan 7

The Economist on Japan 7

Pitching for growth

Nov 9th 2006 | TOKYO
From The Economist print edition
Shinzo Abe—and the economy—may be more vigorous than they look

THE school of Japan-watchers that keeps an eye on the country's economy chiefly out of a morbid interest in terminal decline has stopped dwindling. It has even taken on new adherents of late. For signs are mounting that the recovery that began in 2002 has slowed—or even, some say, gone into reverse.

The chief worry is that what started as a recovery driven by exports (chiefly to China), and then expanded to one led by business investment, has failed to spread to households, whose spending remains sluggish. Prices still flirt with deflation (see chart). And some economists predict that figures published on November 14th will show that the economy actually shrank in the third quarter.

This exacerbates a deeper unease: a belief that the new prime minister, Shinzo Abe, has more interest in foreign affairs than in tackling the domestic rigidities that constrain Japan's potential to grow. The belief was reinforced by his energetic diplomacy over North Korea in his first month in office. But he was being written off even before that, either on the grounds that he lacked the reformist instincts of his predecessor, Junichiro Koizumi, or that he lacked the authority to push through unpalatable reforms, with important upper-house elections due next July.

Is this growing uneasiness justified? Mostly not. Take the economy first. Certainly, its anaemic performance marks this recovery as out of the ordinary, but then it follows long years of extraordinary distress. Habits are hard to change. So even though households now have more income—because companies are hiring more, and raising overtime and bonuses—this has not shown up in consumer spending. Alarm mounted last week when the main survey of household spending recorded a plunge in September of more than 6% compared with a year earlier. Yet this fall is too big to be credible; the survey (like early GDP numbers and other Japanese statistics) is notoriously unreliable.

Meanwhile, expectations are rising, even if habits have not yet caught up. Households' estimates of future inflation and property prices have climbed since the spring. People are not spending gaily, but they are starting to remove money from risk-free havens and invest it again. Deflation had killed the appetite for risk. There are other signs that the recovery is still broadly on track, even if it has, as in 2004, hit a soft patch. The latest bank lending figures seem to confirm this: though growth slowed in October, the year-old recovery in bank lending is still intact.

On November 7th the Bank of Japan's governor, Toshihiko Fukui, gave warning that it would not wait for a build-up in inflation before raising interest rates, now at 0.25%. Many economists think that the central bank is itching to raise rates, so risking undercutting a weak economy. “Core” inflation—including energy but excluding fresh food—is just 0.2%. If energy is excluded, as it is in other countries' measures of core inflation, prices are actually falling. So a rate rise this year would probably generate more controversy than the central bank is ready for. Meanwhile, with interest rates low and the yen weak, monetary conditions are exceptionally loose. The economy might confound downbeat expectations in the coming months.

Ditto, with luck, the prime minister. For Mr Abe is throwing out hints of wanting to bring about more far-ranging structural change than his predecessor managed. After he had cleaned up the banks' bad loans, so setting the stage for economic recovery, Mr Koizumi's great—some would say, only—passion was for privatisation of the postal-savings system, which lunged at the heart of Japan's money politics. Mr Abe, by contrast, has strengthened economic policymaking within the prime minister's office, and reinvigorated the key body of the early Koizumi years, the Council on Economic and Fiscal Policy, stuffing it with reformists.

One of its members, Takatoshi Ito, of Tokyo University, says the ideas spilling out of the council point to a new stage of change for Japan. The aim is to tie the country more deeply into the global economy by seeking more free-trade agreements (including even with China and America) and boosting pitifully low levels of foreign investment in Japan. A priority is to address Japan's so-called “dual” economy. The competitive exporting industries are not matched in agriculture and services, which are shielded from competition, lack economies of scale and are backward in their use of information technology. To boost investment, the government is mulling a cut in corporate income tax and other tax changes. Deep reforms to pensions and health care are also expected.

Japan's demography, says Genichiro Sata, the minister for regulatory reform, demands higher growth, and it is the Abe government's intention to impart deep structural change—including even a wholesale restructuring of government, by crunching Japan's 47 prefectures into a handful of American-style states. These are early days. Mr Abe has given little sense yet of his priorities, and many of the proposals are hardly vote-winners. Reformist achievements are yet to be seen. But the charge that Mr Abe has no reformist intentions is getting harder to make.