25 November 2005

Arrows Tokyo Stock Exchange Market Centre

Economic historians are increasingly likely to look on 2005 as the year in which Japan emerged from 15 years of economic stagnation. Three factors underpin this conclusion: the breadth of the current upturn; the addressing of long-standing structural problems; and the lifting of the burden of deflation. Since the beginning of the long downturn in 1990 there have been a number of temporary upswings, but all were short-lived, because all rested on narrow foundations. For domestic demand, they depended on government-led initiatives; for export demand, on other countries' appetite for imports. Domestic demand from companies and consumer spending remained weak. The result was that the upswings did not last long and were felt mostly in areas other than the private sector.

This time, however, it is the private sector that is actually leading the expansion. Particularly noteworthy are the record profits in the corporate sector following a period of drastic restructuring. These in turn are leading to healthy levels of investment. In addition, the rise in personal incomes, though modest, is starting to stimulate consumption. For the first time since 1990, the recovery has become self-sustaining. This recovery has been visible since January 2001, and in September this year it officially became Japan's third-longest period of growth, after those of 1965-70 and 1986-91.

Second, the measures designed to tackle structural problems that have hamstrung the private sector in the past are taking effect. A telling example is non-performing loans. This issue, one of the major causes of Japan's longest recession since the war, has now been largely resolved. The Koizumi administration's goal of halving the volume of such loans in the three years from March 2002 had been far surpassed by March this year: over this three-year period, the percentage of non-performing loans declined from 8.4% to 2.9%. Furthermore, the overstaffing which used to plague some sectors of industry is now scarcely an issue. In March 2005, the Bank of Japan's Tankan survey of the short-term economic outlook showed that for the first time in 13 years, more companies were reporting labour shortages than an excess of staff, while the number of companies planning to recruit new graduates is rising sharply.

Third, the long-standing burden of deflation seems close to being lifted. The consumer price index has recently been touching zero, and in October the Bank of Japan forecast that price movements would enter positive territory this fiscal year for the first time in eight years.

These trends have led to changing perceptions of the Japanese economy overseas. In the IMF's World Economic Outlook published in September, Japan stood out: while for other industrial countries the projected economic growth rates for this year were revised down because of factors such as rising oil prices, for Japan the figure was revised up to 2.0%, from the 1.2% forecast made in April. Strong demand for stocks is another indicator of optimism. Share prices have risen substantially, with the Nikkei 225 index up 17.5% from the beginning of January through the end of October, supported by a sharp rise in investment from overseas.

Japan's economic prospects look brighter than they have done for 15 years. There are undoubtedly tough issues still to be dealt with - not least the need to reduce the level of public debt, and demographic trends such as the declining birth rate and the ageing of society - but the economy clearly appears to be on course for further growth.