Can a changing Japan meet the productivity challenge in the long-run?

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Can a changing Japan meet theproductivity
challenge in the long-run?
Japans Economy Recovered
Canadian Embassy Tokyo April 2006
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Overview

• Current Outlook and Issues
• Macroeconomic situation, regional economies,
  business, banks and labour, monetary policy
  normalisation
• Strengths
• Size, wealth, technology, manufacturing, Asian
  integration
• Productivity challenge
• Demographics, LT structural change, efficiency,
  bureaucracy
• Assessment
• Is Japans economy recovering?
• What does this mean for Canada and the world?

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Current trends and issues

• Current macro outlook
• Regional economies
• Business resurgence
• Financial sector revival
• Labour market upturn
• Hot topic monetary policy normalisation

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Economic growth Real GDP growth strong in 2005

• 2.7 growth in 05
• After 2.3 in 04
• Strong end to 05
• 05Q4 5.4 q/q annualized
• 05Q4 4 over 04Q4
• 06 and 07 forecast
• quite robust
• Consensus of Japanese forecasters (for fiscal
  year ending in March)
• FY05 3.4
• FY06 2.6,
• FY07 2.4
• Note in 2005, Canadas economy grew
• 2.9, with much faster population growth.

Source Cabinet Office, Japan
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GDP Growth More sustainable now

• Private and
• Domestic
• Growth stimulus
• Domestic final sales (private cons. invest. net
  of inventory changes) now growth driver
• Unlike 90s, public demand is weak sharp cuts in
  public works
• Modest net
• export growth
• Economy firing on all cylinders

Tech bubble
Real GDP
Source Cabinet Office, Japan
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Recovery by city and region Boom centered on
industrial heartland, urban areas
Recovering strongly robust growth overall very
tight labour market industry, services, real
estate increasingly buoyant
SAPPORO Northern centre at heart of agri-food
tourism region
Recovering firm growth tightening labour
market industry and services solid
Recovering mildly growth picking up labour
market, Industry and services recovering,
although picture is uneven
Signs of a turnaround growth remains
slow. Labour market slack remains modest pickup
in some industries
Stagnant/Recession no regions in this category
at this time
HIROSHIMA Dynamic regional centre
FUKUOKA modern city with growing ties to NE Asia
TOKYO-YOKOHAMA growing financial and economic
metropolis worlds biggest city with economy
larger than Canadas
NAGOYA booming manufacturing centre
OSAKA-KYOTO-KOBE re-emerging second urban
region of Japan

Source Cabinet Office, Embassy estimations
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Deflation Easingending?
Change in prices (y/y)

• CPI inflation
• now mildly positive
• Core CPI 0.5 y/y Jan 06
• Corp. goods prices ?
• GDP deflator ?
• import prices key factor
• BoJ has called
• end of deflation
• Quantitative easing over
• BoJ now targetting 0 interest rate
• Interest rates will stay at or near zero this
  year
• BoJ wants CPI at 0-2

0
Source Bank of Japan
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Business sector recovery

• Restructuring paying
• off, debt bubble gone
• Corporate debt/GDP ratio now below 1980 level
  (HSBC)
• debt repaid by non-financial corps 40 of GDP!
• Liab. / bal.sheet ratio lowest in 50 yrs. (Morgan
  Stanley)
• Non-financial firms may
• be in best shape ever
• Profitability at 50-year highs
• Q405 14th consecutive Qtr. of y/y profit growth
• Longest period since 1960s
• Confidence, return on equity at post-bubble high

Non-financial firm profitability (current
profit/sales - 4Q moving average)
Property bubble
IT Bubble
Source Ministry of Finance
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Banking sector revival

• NPL problem fixed
• Takenaka plan to halve 2001 NPLs by 2004
  exceeded
• Capital adequacy, quality improved
• Banks repaying pub. funds
• Profit recovery is
• less certain
• FY05H1 saw highest profits on record, but spreads
  tight and loan growth slow
• Key fee-based financial services
• Rising interest rates will help bank profits

Source Bank of Japan
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Labour market upturn Recovery may finally be
spreading to the labour market

• Restructuring job cuts
• Aging-driven labour force decline
• excess labour throughout 1990s
• Full-time jobs up again
• Growth had been in part-time jobs, full-time jobs
  were falling. This trend has reversed.
• Latest unemployment rate 4.1
• Offers/applicant ration 11!
• Firms now perceive labour shortage
• Rising incomes key to
• recovery, deflation end
• Nominal employee compensation rose 2.6 in 05Q4
  over 04Q4

Source Bank of Japan
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Hot topic monetary policy What will the impact
be of normalisation, rising i-rates?

• ?overall in Japan ? Household (HH) assets 4X HH
  debts
• consumption boost offsets profit impact banks
  benefit from better spreads
• BUT govt has to pay higher interest book value
  of bondholdings fall, overseas assets may suffer,
  possibly gold

What if rates increase?
1 Source Nomura securities
2 Source Goldman Sachs
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Japans strengths

• Size, wealth
• manufacturing productivity
• technology
• Asias rise and economic integration

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Size and wealth 2nd biggest economy biggest net
creditor

• Japans GDP
• larger than rest of Asia
• equal to the combined economy of all US states
  west of the Mississippi

Individual financial assets in Japan CAN 17
trillion (280 ofGDP) 4 times household
liabilities
Despite govt debt, net foreign position was CAN
2.2 trillion (What Japan is owed) (what Japan
owes) (Canadas annual GDP X 2)

• KantoTokai
• GDP larger than Germanys
• but Tokyo-Nagoya distance is less than
  Montreal-Toronto

KANTO
GDP larger than Chinas, twice Canadas
(Tokyo Metro Region)
TOKAI
GDP larger than Indias or Brazils
(Nagoya-Shizuoka Region)
KANSAI
GDP larger than Mexicos or Koreas
(Osaka-Kobe-Kyoto Region)
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Strengths Manufacturing productivity, leading
industries

• Leader in manufacturing productivity
• Japanese manufacturing productivity is 20 higher
  than in US
• This partly explains Japans trade surplus with
  the world.
• Growing lead in key industrial sectors
• E.g PAX TOYOTA it can be argued that Japanese
  automotive empires are dictating terms of
  global auto industry
• Result is growing prosperity in the imperial
  capitals, the Japanese design and manufacturing
  centres (eg Nagoya)
• Leadership brings obligation to maintain peace,
  avoid trade friction
• Strong investment in key markets, notably NAFTA
• Some restraint in pricing strategy to avoid
  crippling US cos
• Strong leadership in others sectors Japan HQs
  global finance and tech hubs, from chemicals to
  electronics

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Strengths Technology and RD

• Japan is RD leader
• Highest RD/GDP ratio in G7 (over 3 in 2001)
• Canada 3rd lowest in 2001 (lt2)
• Japanese RD
• Total investment in Canada

Source OECD Note For Italy, the graph is
based on the latest available data for 2000

• Result is tech leadership
• Old industries have gone high-tech (eg chem.,
  steel)
• Final assembly no longer key to value-added
• eg digital appliances according to METI
• Made in Japan (ie final assembly in Japan)
  products 27 of global market
• BUT, Japan supplies 51 of global high-tech parts
  and semiconductors, 54 of manufacturing devices,
  and 65 of high-tech materials
• Higher energy efficiency than competitors (eg
  US, Korea, China)

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Strengths Japan a player in Asias rise and
integration

• Japan key to Asia growth pole
• On the surface, USEU becoming less important in
  Japans trade
• Japanese aid and FDI historically top source in
  many Asian countries
• China, ASEAN process
• Japans exports to US, EU also
• products for Japanese market
• Asia buys Japans tech. and capital
• Japan trade surplus with China, Korea
• Japans firms drive processing trade
• Dynamic means US growth still has twice impact on
  Japan as Chinas
• Chinese export growth key to Japan
• Will Japans firms reach the
• new Asian consumer?

Source Ministry of Finance, Japan
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Japans productivity challenge

• Population decline
• Productivity acceleration?
• Long-term structural change
• Capital allocation improvements
• Remaining policy challenges
• Decline or opportunity?

Photos Nikkei Weekly
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Population decline The demographic imperative for
faster productivity growth

• Japans population is now falling
• 2005 saw first slight overall pop. decline
• By 2050
• Down to 100M
• 30 million less people of working age (15-64)
• 10M more people age 65 and over

Source Ministry of Internal affairs and
communications
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Productivity acceleration? Is the increase
structural or temporary after slowdown?

• GDP/hour y/y growth slowed after bubble
• GDP/hour y/y growth slower in 94-03 vs. 85-93
  (OECD)
• Has productivity growth picked up again?
• GDP/hour y/y growth was well above trend in 2005
• Key question is Japan different than during
  post-bubble period in a structural way?

Embassy Calculation based on Cabinet Office and
Ministry of Labour data
Source Cabinet Office
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Long-term change Despite stagnation -- major
structural shifts occurred

• Like in all advanced
• economies, the
• tertiary (services)
• sectors share is
• growing
• The share of services in GDP increased 10
  between 1990 and 2002
• The share of manufacturing has fallen by 9 of GDP

Source Cabinet Office
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Increased openness to trade Japanese markets are
becoming more contestable

• Share of trade in economy is growing
• Asian integration growing two-way trade with
  China and other Asian economies
• Long term may see a trade deficit
• Recovery and aging savings down, cons. up
• current acct will stay positive foreign inv.
  income

Source Cabinet Office
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Capital allocation improving Big problem in 1990s
was poor allocation of capital

• Overall, Japan is investing less as a share of
  GDP
• Less total investment
• Significant decrease in public investment
• Trend suggests I/GDP ratio is edging up
• Due entirely to strong growth in private
  investment
• Firms increasing their capital, productivity, to
  meet growing demand, face labour shortages

Source Cabinet Office
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Areas for further improvement Capital market,
services, agriculture

• Capital market
• efficiency is improving
• Households 50 in cash but interest in risk
  assets is rising
• Corp. fin was too bank-led
• Now Cos borrowing less, issuing more stock,
  bonds
• Lending down from peak (-20), but may be
  on rise again syndicated loan boom
• Corp. control more market-driven, arms-length
  investors now lead
• MA, private equity booming
• Efficiency was postal reform key motive

• Services need further reform
• lag US productivity up to 40
• Competition weak, but reforms progressing prices
  falling (e.g utilities)
• OECD Japan ahead on privatization, limiting
  financial interventionism, lags in dereg

• Agriculture too protected
• Protection among highest in OECD
• Govt too slow to reform ag.
• BUT, ag trade opportunities may spur new openness
  (eg apples)

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Government Debt, deficit and bureaucratic
inefficiency

• Rising debt, large deficit
• 95 of debt held in Japan
• Deficit 5-6 of GDP
• balance not likely until 2010s
• Taxes among lowest in OECD
• Aggressive cuts are risky
• At odds with anti-deflation drive
• Govt small, but inefficient
• Red tape barrier to growth
• privatization accomplished, but deregulation a
  work in progress
• Reform better govt, not smaller
• public works cuts, govt FI reform
• Rising social security costs
• govt will get bigger (G/GDP)

Source IMF
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Aging and population decline Demographic
challenge or opportunity?

• Aging or greying a milestone of social progress
• Older people living longer healthier lives
• Japan asking what is place/role of elders beyond
  dependency?
• Low birthrate (1.29) challenge, but also
  opportunity
• Challenge women not participating fully in paid
  economy
• Men participation rate highest in OECD women
  among the lowest
• Can demog. decline mitigate social costs that
  plague Japan?
• crowding, env. pressure, resource dependence
• Key policy priority reform to boost output,
  taxes per worker
• social security costs will double in the next 20
  years
• Capital reallocation tech can increase
  productivity (labour,TFP)
• Demog. decline does not mean lower living
  standard
• per capita GDP growth gt GDP growth (eg GDP 2
  pop 0.5)

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Assessment

• Are Japans economic woes over?
• What is the long-term future of Japans economy?
• What does this mean for Canada and the world?

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Are Japans economic woes over?What is Japans
long-term economic future?

• Japan recovered, resilient, but LT challenges
  remain
• Shift from export-led growth to domestic demand
  well underway
• Last short-term challenge is to normalize
  monetary policy
• Falling population and fiscal constraint means
  Japan needs to boost its productivity growth
  again the reform imperative remains
• Sudden change not Japanese way, but Japan is
  evolving
• at an accelerating pace
• China factor, Asian integration Asia is Japans
  new strategic focus
• Demographic change and new generation with
  different values
• Stronger private sector, a government forced to
  change by finances, households taking risks once
  again
• The future will not be like the past
• If handled right, the Japan that evolves will be
  fundamentally stronger than the bubble economy
  that was so feared in the 80s Japanese firms may
  already be in the best financial shape ever

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Short-term outlook main risks

• Downside Global economy, the US dollar and
  global
• imbalances, higher oil prices
• Chinese economy stumbles hard and cuts off export
  growth
• US looks good, but housing bubble bursting is a
  risk
• US dollar fall would cause rapid yen rise and
  slow exports
• Japan is energy efficient, so direct effect of
  high oil is lessened, but may slow growth in key
  export markets
• Upside stronger than expected consumer revival,
• productivity growth
• Labour market tighter companies are increasing
  bonuses, dividends and starting raise wages
• Domestic demand may continue to surprise to the
  upside
• Improved capital allocation, labour shortages
  more productive investment and rising
  productivity is possible

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AssessmentWhat does this mean for the world?

• Japan is contributing to global growth again
• The worlds second largest economy is integral
  part of Asian growth pole, and imports are
  gaining as a share of GDP
• Emerging Japan-US-China economic triangle
• Imbalance or a deepening of global integration?
  
• Japan a big market, but is increasingly hub of
  investment and tech.
• How does Canada plug in to the network?
• Japanese government must change its relationship
• with its people, but also with the world
• less aid, more trade applying both at home and
  abroad
• Chequebook politics and diplomacy too expensive
  now Japan will seek influence through other means

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AssessmentWhat does this mean for Canada?

• Opportunities for trade in traditional emerging
  sectors
• Resources, housing, agriculture
• Innovation and science partner IT, environmental
  technologies, nanotechnology, robotics,
  biotechnology, pharmaceuticals
• Investment partner
• Prospects for new partnerships in technology,
  services and investment, key areas of future
  growth
• Demographics mean significant change in
  consumption patterns, new opportunities
  particularly in services
• Canadian companies can take advantage of Japans
  central place in the booming Asian economy
• We must see Japan as Asias financial and tech
  hub, very much complementary to Asian high growth
  economies.
• New International Policy Statement recognizes
  this.

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The Canadian Embassy in Tokyo, Japan 7-3-38
Akasaka, Minato-ku, Tokyo 107-8503 Tel (81) 3
5412-6200 Web
http//www.dfait-maeci.gc.ca/ni-ka
Contact Laurence Blandford First Secretary,
Finance and Economy Email laurence.blandford_at_inte
rnational.gc.ca