Signs of Hope in 2012?

The year 2012 got off to a poor start under the heavy pressure of the ongoing fiscal and financial crises in Europe. Elections and leadership changes are scheduled this year in many countries, including the United States and China. Because of the severe economic climate and the uncertainties in the political sphere, the world economy faces a variety of risks.

Pessimism can easily take hold in such a situation. Certainly, I would not deny that the world economy faces a number of perils. But this is precisely why it is worthwhile to step back from a “doom and gloom” outlook to look around for what else the future might have in store for Japan and the rest of the world.

The linchpins of the global economy are the United States and China, which are first and second in the world, respectively, in terms of gross domestic product. People are watching to see whether the struggling US economy can smoothly recover and the overheated Chinese economy can avoid a hard landing. Unfortunately, European economies are in such dire difficulties that the best we can hope for is that they do not sink into a deeper financial quagmire.

Rays of Light in the United States

We can begin by looking at the United States, where the latest economic indicators convey good and bad news. These statistics reflect a situation in which the US economy is poised to take the path of either growth or further stagnation. The business environment is bleak, with consumer spending in a slump, employment improving only slowly, and housing battered by a deep drop in prices. Still, there are some positive signs. Most of the damage resulting from the collapse of real estate prices, in the wake of the subprime mortgage fiasco and collapse of Lehman Brothers, has been limited to the household sector. Meanwhile, the corporate sector got through the crisis in relatively good health and now has a wealth of funds at its disposal.

Plummeting housing prices and soaring unemployment have harmed the household sector, but the slump in consumption has had the positive effect of encouraging a structural adjustment. The economic downturn in the United States was caused by the collapse of a bubble inflated by excessive spending. If families instead put a somewhat larger portion of their income into savings, rather than spending, the demand would shift in the direction of exports. This is precisely the sort of change that US President Barack Obama is seeking to bring about through his administration’s economic strategy.

The declining value of the dollar and the slowdown in consumer spending occurred within this context. The United States now simply needs to wait for its exports to begin expanding, fueled by the weak dollar. Such an adjustment is admittedly a painful process. If the negative effects of the drop in consumption became too pronounced, the US economy could slow down even further. A look at the recent economic indicators, however, suggests some favorable developments since the beginning of the year, including a better employment picture. Let us hope that these developments gain momentum.

The Might of the Chinese Mandarins

After the demise of Lehman Brothers touched off the global financial crisis, the Chinese economy quickly regained its footing, bolstered by bold economic policies implemented by Beijing. At the same time, this policy response heightened concerns about extreme overheating. Like other emerging countries that have been hit by currency and financial crises touched off by collapsing bubbles, China faced the danger of a hard landing. Judging from the developments over the last half year, however, I believe that the Chinese government has successfully cooled down the economy and piloted it to a soft landing.

The Chinese economy’s greatest strength is the government’s capability to manage the economy. The authorities in Beijing have a treasure house of fiscal funds at their disposal, and they have headed off financial crises in the past by injecting massive doses of capital into financial institutions. It is hard to say how long the Chinese mandarins will be able to effectively implement this interventionist economic policy, but I hope it will continue to work for a while.

The IMF’s World Economic Outlook for 2012

Source: “World Economic Outlook Update” issued by the International Monetary Fund on January 24, 2012.

Reconstruction Demand Will Prop Up Japan

In macroeconomic terms, the outlook for Japan is not that unfavorable. This is because of the demand that will be generated for rebuilding the northeastern area of Japan that was laid low by the March 11, 2011, earthquake and tsunami. The Japanese economy, which has been plagued by insufficient demands after a decade-plus of deflation, will be getting a powerful boost from reconstruction projects. Talk of reconstruction demand usually calls to mind fiscal spending by the government, but we should not overlook the private-sector demand from reconstruction activities in the corporate and household sectors.

What we need to keep our eyes on among the movements in the domestic economy is not so much the short-term business outlook as the response of Japan to medium- and long-range structural tasks. Prime Minister Noda Yoshihiko is firmly resolved to restore the health of public finance through a number of measures, most notably a hike in the consumption tax. Fiscal soundness is of great import for the Japanese economy, but tax hikes are politically difficult to push through, which has meant that most administrations up to now have postponed the decision. It is encouraging that Noda’s government is proactively tackling this issue, without further delay, but given the administration’s lack of strong support there is a risk that political disorder could result from the tax-hike effort, further postponing the drive to get public finance onto solid footing.

The value of Japan’s government bonds is holding steady, due to the huge amount of savings flowing into the financial markets amidst the ongoing deflation, but their value could plummet if the political situation becomes turbulent and the market loses confidence in the government’s ability to get its budget back into balance fairly quickly. We will need to review the situation at key dates on the political calendar, including March, when the budget for fiscal 2012 (April 2012 to March 2013) will be adopted, June, when the National Diet’s regular session will close, and September, when an extraordinary session is to begin.

Local Stimulus Effects of Electricity Supply Reform

The major structural tasks Japan must tackle include dealing with the nuclear power disaster and reforming the electricity supply system. After the accident in Fukushima, many nuclear power stations were shut down, and they have not been restarted. As things stand, electricity supply is going to be extremely tight. We should note, however, that there have been some favorable moves with regard to long-term electricity supply. Japan has 10 electric power companies, and until recently they had close to a monopoly in their respective regions, each vertically integrating all operations from electricity generation to transmission, distribution, and retailing. This is a supply setup slanted toward distribution, with electric power charges set according to a total cost method. The result is that Japan’s electricity rates are among the world’s highest.

The nuclear power accident has sharpened the debate on reconfiguring the electricity supply system. An argument has been made that power transmission and distribution should be separated from power generation, and that deregulation should be actively pursued both in the upstream generation sector and in downstream retailing. It is likely that the debate on reform will further intensify in the months ahead. If Japan is able to follow the lead of the United States and Europe in introducing distributed networks and utilizing a market mechanism, the changes would probably stimulate the country’s regional economies in a variety of ways.

A Growth Strategy Promoting Innovation

Finally, let me touch on the accelerated pace of global operations among Japanese corporations amidst the strengthening yen. If corporations in such industries as automobiles and household appliances engage even more actively in offshore manufacturing, concerns about domestic employment will intensify. The shift to overseas production has had a particularly harsh impact on Japan’s regional economies, where many plants are located—including those operated by subcontractors.

Looking at the overall situation, however, we can appreciate that overseas operations bolster the competitive strength of Japanese corporation, and are thus necessary for energizing Japan’s economy. Consequently, instead of viewing the loss of manufacturing jobs negatively as a “hollowing out of Japan,” we should see it as an element of a major transition in the industrial structure. In the midst of this larger trend, we will need to look for ways to preserve jobs in regional communities and enhance the dynamism of the domestic economy.

Other key topics that Japan needs to address include designing systems to incorporate the economic growth in the Asian region, expanding employment in such fields as medical and nursing care in response to the graying of the population, and coming up with a growth strategy to promote innovation aimed at fostering successor industries to the automotive and consumer electronics industries. Those topics will have to be addressed elsewhere, however, because there is not enough space to treat them in detail here.

(Originally written in Japanese in January 2012. Photographs by Katō Takemi.)