Japan: D Day Approaching?

Well there is a lot of attention being focused on the 2 day meeting of the Bank of japan which started today. Will tomorrow be Decision Day? Certainly the equity markets are nervous. Dave Altig at MacroBlog had a timely post yesterday about some of the possible pitfalls ahead, and Martin Wolfe has a piece on Japan in today's FT:

Japan is back. After almost one and a half decades of disappointment, growth is strong, deflation is vanishing and confidence is returning. Is this then the reward for Junichiro Koizumi's reforms? "Exactly the opposite" is the answer. If the prime minister had done what he initially proposed – pursue structural reform and cut fiscal deficits – the result would have been a catastrophe. Fortunately, wiser counsels prevailed.

In what way then is this an unreformed Japanese economy? It is still a Japan whose growth depends heavily on exports and investment, whose private sector saves far more than it can profitably invest at home and whose corporations waste capital. Japan is not recovering because it has a brand new economy: what has been achieved is a partial clean-up of the legacy of the bubble years.

As Martin Wolfe also points out:

Between the fourth quarter of 2001 (the last deep trough in gross domestic product) and the fourth quarter of last year, the economy expanded by 9.9 per cent, in real terms. Net exports generated an astonishing 30 per cent of the increase in demand, investment 18 per cent and government consumption a further 14 per cent. Private consumption generated a mere 39 per cent of the increase in demand.

The sharp improvement in net exports had two principal explanations: the depreciation of the real exchange rate; and China’s demand for Japanese technology. Between December 1999 and February of this year, Japan’s real broad exchange rate depreciated by almost 30 per cent, according to JP Morgan. This was not an accident: Japan’s foreign currency reserves rose by $547bn between December 1999 and the end of last year. Meanwhile, exports to China accounted for 30 per cent of the increase in Japan’s total exports between 2001 and 2005.

Japan has, in short, continued to derive much of its dynamism from external demand. It also continues to rely heavily on corporate investment. That may not seem surprising until one realises how overcapitalised the economy is by global standards.

The share of Japanese corporate investment in GDP is far higher than in other high-income countries (see chart). Most recently, it has been 40 per cent higher than in Germany or the US.

Overall, investment ran at 24 per cent of GDP in 2004. That such high investment has generated little growth in the recent past (and is expected to generate little growth in future) is evident. But what would have happened without it? Without some other offset, the result would have been not stagnation, but a depression.

Today’s new Japan is essentially the old Japan. It continues to rely on competitive exports, a sizeable current account surplus and wasteful use of its people’s savings to keep demand expanding in line with its disappointing potential rate of growth.