The Japanese economy has been picked up and hurled off a cliff. Such a steep decline in GDP over the past two quarters -- a quarter-on-quarter contraction at an annualised rate of 15.6% in the January-March quarter and a 12% annualised quarter-on-quarter decline in September-December 2008 -- is probably unique in the lifetimes of professional observers of any major economy.
No country within the Organisation for Economic Cooperation and Development (OECD) has suffered such a fall in key economic values as Japan. Over the course of this latest decline, industrial production reverted to 1992 levels, exports fell over 70% in the first quarter from the previous year, knocking 15 percentage points off GDP growth, and private capital expenditure slumped 36% in the same period.
The figures are chilling and place doubt over the economic policies started under former Prime Minister Junichiro Koizumi and his equally committed economics and finance minister, Takenaka Heizo, in 2001.
Koizumi came in with the promise to fight vested interests and make Japan's economy more efficient and dynamic, using the privatisation of the Post Office and the national road corporations as his symbols. In his recent book on Japanese politics, Governing Japan, Arthur Stockwin said: "Koizumi was ideologically committed to globalisation in the sense of cutting through obstacles to market capitalism that existed in Japan's managed economy."
In particular, Koizumi attacked the practice of banks supporting loss-making companies. By cutting off unconditional bank lending, he made the corporate sector more responsive to market signals. In sum, he was a 'supply-side' ideologue in the same vein as Margaret Thatcher and Ronald Reagan. That basically means that demand takes care of itself, as long as firms and individuals are given the freedom to maximise profitability. The state essentially withdraws from the market.
Japan's blue-chips took full advantage of Koizumi's special labour legislation in 2003, which enabled large manufacturing firms to hire non-regular labour for the first time. Such firms have reclassified much of their workforce as casual labour: paid by the hour, employed through intermediaries with short-term contracts, and easy to fire. The changes helped Japan's blue-chips in particular, since the small- and medium-size enterprise (SME) sector was never in a position to offer lifetime employment in the first place. In 1990, 'non-regular' workers made up 18.8% of the labour force. Today, they make up 33.4%, according to the Japan Institute for Labour Policy and Training (JILP).
The downside of this restructuring was that the Japanese corporate sector became a force for social fragmentation, in clear contrast to its previous role of creating social cohesion and spreading wealth. In other words, economic benefits have begun tob be spread far more unevenly between management and labour. Standard and Poor's estimates that Japan's labour share of GDP has decreased by 10 percentage points since the early 1990s, and now hovers close to US levels. The JILP also calculates that average monthly cash earnings were ¥341,898 ($3,500 at today's exchange rate) in 2003, but just ¥271,711 in April 2009.
Initially, the Koizumi strategy worked wonders for Japanese companies, helped by an export surge on the back of a cheap yen to China and the US from 2002 onwards. Companies cut costs and fattened margins. Investors (increasingly foreign) got better dividends, and benefited from new techniques like share buy-backs, but employee compensation generally lagged.
The strength of Japan's corporate sector is undeniable: Japanese car firms have a 30% global market share, Japanese companies making industrial robots have a 40% market share, and Japanese silicon wafers for use in high-tech components have a 74% market share, according to Japanese government publications.
That sounds impressive, but recent events show the vulnerability of the new model during an export downturn: corporate profitability at Japanese blue-chips is down by 80% year-to-date , according to UBS. And that is the very sector the Koizumi's reforms were meant to help. SMEs, which are far less protected and have far less fat to cut, are much worse hit. Even elite full-time employees are being cut back at companies like Sony and Toyota. Investors are losing out, too, as dividends get slashed. Non-regular employees, of course, are seeing further reductions in income.
Still, Takahira Ogawa, Japan economist at Standard and Poor's in Singapore, denies that the Koizumi administration was bad for Japan. "The banking sector was extremely fragile when Koizumi came to power, but was greatly strengthened during his time as prime minister. The fiscal consolidation which occurred under Koizumi also means that today's government is in better shape to launch stimulus packages," he told FinanceAsia.
He agrees, though, that the process whereby Japanese companies simultaneously are able to cut back on their workforces, although individually rational, has a detrimental overall effect on domestic demand. When export demand collapsed following the current crisis, there was less ability to substitute this with domestic demand from the private sector. Lower salaries and the prospect of unemployment have put the brakes on consumer spending -- and with consumption representing 60% of GDP, even a relatively small change can have a big impact on GDP. Ogawa is forecasting a 6.5% decline in Japan's GDP in calendar year 2009, the worst performance since World War II.
"Japanese companies spent all the money they saved on employment on expanding capacity, not thinking that economic circumstances might change. That money was somewhat wasted, in retrospect," Ogawa said. That over-capacity also means private capital investment won't contribute to GDP growth for a while.
Some parts of the system are slowly swinging around to adjust to the new reality. Unemployment benefits, for example, are grudgingly being increased, with workers now able to apply after a six-month hiatus, rather than a year (compare this to the UK, where financial support is available immediately). Since April, the government has also been rolling out more public works projects, although these do not have a good record. But Koizumi-era cost-cutting policies are still turning up, such as the recent decision to cut child benefits for low-income families.
For Ogawa, there is no turning back. For him, the main problem is that Koizumi's reforms did not go far enough. "In the US, the flexibility exists for new forms of employment creation to occur, like the IT revolution. Such industries take over from sunset industries and ensure future growth. We have energy saving and environmental technologies, but they do not seem to have the same powerful impact (on growth, income and employment) as innovation in the US."
Interestingly, Ogawa's points bear little relation to Koizumi's supply-side strategy to get the economy on track. Ogawa's suggestions are strictly demand-side. This is by no means new. Deficient domestic demand has plagued Japan since the end of high-speed growth in the 1970s, according to Hiroshi Yoshikawa, a Tokyo University academic, who says that is when Japan first began to rely on exports. Japanese households had caught up with the West by then, and had acquired all the consumer durables they needed.
Unfortunately, the only strategy the government could come up with was to sell those same items abroad. When the US balked at the flood of Japanese goods imported into the US in 1986 and forced up the value of the yen, the Japanese government created a disastrous asset bubble to compensate, which ended up bankrupting its banking system.
Yoshikawa believes the government has failed consistently to come up with genuine wealth-creating demand-side initiatives. (Demand side initiatives could comprise a government-built sports centre, which encourages further private sector investment, like food concessions. Any kind of well-planned infrastructure upgrade can have the same effect.)
Policies, such as those conducted by Koizumi, which impoverish large parts of a country's population, are hardly conducive to demand growth. You can substitute foreign customers for a while, but not for long if they are leveraged to the hilt and no longer able to pay -- which is unfortunately the case of the US consumer base. Given the poor state of government finances, it seems Japan has no choice but to to seek ways to raise the incomes of its citizens if it wants to boost demand, just as Prime Minister Taro Aso did several months ago, with his unorthodox $200 cash hand-out to every citizen. It looks as if the era of supply-side economic restructuring is well and truly over in Japan.
