BOUNCING BACK
The stagnant Japanese economy seems to be finally getting buoyant after decades of inert prices, wages, and interest rates.
Japan’s economy has long stood apart from other developed economies. Most notably, since the late 1990s, it went through years of stagnation and deflation, an economic crisis referred to as Japan’s “Lost Decade.” For years, Japan had the dubious distinction of being the only advanced economy with near-zero inflation, interest rates, and wage growth.
Finally, it appears that the Japanese economy is emerging from this period of market troughs as prices and wages rise, raising hopes for growth. Japan's central bank raised interest rates for the first time in 17 years, marking a significant pivot from its long-running aggressive, easy monetary policy.
Is Japan at a turning point, on the verge of transitioning to a more “normal” economy?
An Economic Trajectory to Envy
It is common knowledge that as of August 1945, Japan and Germany had no economy or industry to speak of. The might of the American firepower had literally sent them back to the Stone Age as starving millions dug through the ruins of their once-great cities seeking sustenance.
In the decades following World War II, Japan's economy grew rapidly, mainly due to a peak in industrial production and aggressive exports. Japan's export-oriented economy flourished on global markets by keeping exports cheap, particularly by depreciating the currency. The thriving post-war economy of the U.S. and the reconstruction wave in Europe acted as ideal markets to absorb Japanese products.
Before World War II, products made in Japan were considered shoddy and cheap rip-offs of those made in the West. After eliminating militarism from the Japanese political and social scene in the 1950s, Japan focused on achieving quality. As a Japanese engineer said, “Not by an inspection system that takes out defective items on an assembly line but a concerted effort to get it right the first time, and every time!”
In this, they were helped by the work done by W Edwards Deming and Joseph Juran, the acknowledged pioneers in quality management in the industry. Deming is better known for his 14 points for management and Juran for the 'trilogy of quality planning, control and improvement." In the 1970s, the Japanese tried to implement all the thumb rules these experts propagated sincerely.
Some efforts to adopt western quality control methods had been in practice in Japan since the 1920s, the most notable being 'Taylorism.' This system of scientific management emphasised 'time discipline' as advanced by Frederick Winslow Taylor. Today, the world stands in awe of Japan’s strict adherence to this management mantra.
The country developed a diversified manufacturing and services economy and became one of the leading producers of motor vehicles, steel, and high-tech goods – notably consumer electronics. The growth curve peaked in the 1980s with the world's highest per capita gross national product. The standard of living rose to a level comparable with that of developed countries.
Japan’s incredible growth since the 1960s seemed so unusual to Nobel Laureate economist Simon Kuznets that he categorised it as a unique kind of economy distinct from under-developed or developing economies; he broadly grouped economies into under-developed, developed, Argentina, and Japan.
In the late 1980s, a loose monetary policy resulted in increased speculation and high stock and real estate valuations. The asset bubble burst at the start of the 1990s, setting off an economic downturn – the Lost Decade. Even though the country remained wealthy, it fell into deflation and growth rates crawled at a snail's pace until the global financial crisis in 2008 and continued till the Covid-19 pandemic in 2020. Japan's chronic deflationary pressure and its near-zero or negative interest rates and wage growth further set it apart from other major economies.
The Japanese government persisted with a highly easy monetary policy, aiming to stimulate the economy by making borrowing and spending cheaper for consumers and businesses, injecting funds into the economy and providing tax breaks.
A Transition to “Normal”?
Prices began to rise in early 2022 after the pandemic and Russia's invasion of Ukraine. In 2023, the world's third-largest economy seemed to stir from its decades-long slumber, witnessing its fastest price rise in over 30 years after stagnant wages since the 1990s. Annual inflation remained above the Bank of Japan's (BOJ's) two per cent target for 18 consecutive months. In February 2024, Japan's core inflation (excluding volatile food prices) was up by 2.8 per cent year-on-year.
Global supply shocks like the Ukraine war sparked the sudden trend of rising prices and wages. The turmoil caused escalated import prices and pushed Japanese companies to raise prices, encouraging the practice of price-setting in an economy long accustomed to keeping prices low. Wages and markets have responded: the country's biggest employers agreed this year to raise wages by an average of 5.3 per cent, which would be the biggest pay rise since 1991. In February, the Nikkei stock index exceeded its last peak 34 years ago. Witnessing two years of mild inflation and an emerging cycle of rising wages and prices, the central bank raised interest rates.
The BOJ's hitherto ultra-easy monetary policy has been controversial and criticised for majorly contributing to the yen's rapid depreciation against the dollar. While the weak yen made exports more competitive, household purchasing power took a toll. Tourists visiting this pristine island paradise came back shocked at the cost of even basic items.
This monetary policy has set it apart from most central banks, which have hiked interest rates in recent years to combat inflation sparked by the pandemic, the Ukraine war, and supply chain pressures. Japan was not immune from this global trend: inflation in Japan hit its highest in more than 40 years in 2023. Still, it was substantially below inflation levels that afflicted countries across the globe in recent years and upped living costs.
The policy pivot makes the BOJ the last central bank to end negative interest rates, possibly marking the end of an era where governments and central banks sought to propel growth through easy lending.
Experts opine that Japan is slowly transitioning towards a "normal" direction and that the central bank may eventually be able to implement a regular monetary policy. Japanese central bankers and government officials second this expectation of renewed economic growth. Investors like Morgan Stanley reckon Japan is finally emerging from its economic stagnation.
Premature Celebrations?
The “cycle” of rising wages and prices is yet to manifest tangibly. This would be indicated by real wage rises (actual purchasing power of wages based on price levels), the resilience of households to wider price rises, and new consumption, saving, and investment patterns. Only then could we ascertain if the Japanese economy is really pivoting towards sustained growth rather than just a passing phenomenon. Japan’s other long-running structural issues like demographics (an ageing and diminishing population) and high public debt persist, particularly due to increased social spending that an ageing population necessitates.
Additionally, an expanded defence budget in response to looming regional geopolitical risks stands to burden state funds further. The defence budget 2023 ($52 billion) saw an unprecedented hike of 26 per cent from 2022, the largest year-on-year nominal increase in planned military spending since at least 1952, per the respected SIPRI. There are indications that Tokyo is committed to nearly doubling its defence spending by 2027, a marked departure from its long-established practice of limiting its defence budget to about one per cent of the GDP.
These inherent challenges prompt many to question the feasibility of a series of interest rate hikes, as witnessed in Europe and the U.S.
Critics contend that the economy isn't ready for major changes yet. Consumption remains weak, while the yen has depreciated to the lowest in 34 years. It is uncertain whether the wage hikes by major companies will percolate down to small and medium enterprises, which employ the majority of the workforce and have less capacity to invest in improving productivity and human resources or raise wages.
More importantly, wages remain behind inflation, and consumption will not increase until people feel more secure financially. Some consider the BOJ's decision premature, arguing that Japan's business cycle is still stagnant, citing falling numbers for public works, machinery orders, and new construction. Inflation could face resistance in a society that is not accustomed to continuously rising prices, a norm that populations in most countries take for granted.
Moreover, foreign investors’ increased interest in Japan is not just anticipation of its new growth but also to do with its relative stability in a volatile geopolitical climate. Japan is reaping the benefits as investors increasingly consider China a less reliable investment destination.
Shifting Social Tides
On a more positive note, a shrinking workforce has pressured employers to raise pay in recent years to attract and retain workers. It has also made room for more women to enter the workforce.
Gradual generational and cultural changes are taking place in Japan’s workplaces. Economists posit that behavioural shifts in Japanese company culture evidence a potential pivot to “normality” and growth. Companies are more willing to hike the prices of products and services. It is a momentous shift in a nation that has long sworn by low prices and cheap currency as the winning formula – even if it meant low wages and purchasing power. Labour shortages are propelling employees to become more confident and slowly changing employer-employee relationships. These socio-structural changes have the potential to translate into more long-term change across a span of five or ten years.
Prime Minister Kishida Fumio's proposed "new form" of capitalism promises to encourage growth while incentivising companies to distribute their profits better as wages. This initiative may be a way to set himself apart from his predecessor, Shinzo Abe's long-running Abenomics, which was criticised as being economics for the wealthy.
The programme will focus on re-skilling and improving labour mobility to enable individuals to move into high-growth sectors. In light of Japan’s workforce crunch, investing in human resources has become key.
Assessment
It is
yet too early to say with any degree of certainty
that
Japan’s
new cycle of rising prices and wages is here to stay and that it will transition into normal economic growth and result in material benefits.
As global markets continue to yo-yo between crests and troughs, we must wait and watch how this Asian economic powerhouse navigates through its challenges.
Shifting company mindsets (like price-setting) and employment dynamics contribute to improved wages, encouraged by a scarce labour supply.
However, whether management measures can sustain the growth without ground-breaking fiscal and financial measures remains to be seen.
Globalisation and market equilibrium are hinged on the geopolitical situation of an export-dependent economy. Sadly, this is one factor that remains extremely fragile at this moment as the Gaza war refuses to come to any conclusion, and Russia and the West seem determined to wage a war of attrition that will drain both sides. The tension across the Taiwan Straits may put paid to all efforts of Japanese economists to bring back the good old days.
