When dying men arise and walk, people start to speak of miracles. So it is with Japan's recent economic recovery. Stunned by its suddenness, once jaded observers, inured to years of moribund performance, are turning into born-again believers. Some even envisage a day when Japan may again become a locomotive of the regional and global economy.
Not so fast. To be sure, the signs of life are real. For the first time in more than a decade, many indicators are reading positive. Industrial output, profits, wages, investment and bank lending are all on a rising trend. Deflation is gradually receding, unemployment is falling and deeply depressed property prices are firming.
However, euphoria is premature. Japan's recovery could still easily be blown off course. In the short term, its continuation depends on a number of unpredictable factors going right. Further ahead, prospects are clouded by serious structural problems.
The first risk is that the authorities will snuff out recovery by raising interest rates and taxes too soon. On their past record that possibility cannot be ruled out, particularly as the social security budget is chronically in deficit and public debt of more than 160 per cent of gross domestic product limits scope for further borrowing. Second, the upturn is still narrowly based, being largely due to higher capital expenditure. However, household spending, the essential underpinning of a stable and sustained recovery, remains subdued and fell by 1.3 per cent in August. In the near term, that leaves the economy still heavily dependent on continued export growth.
The optimistic view is that steadily rising employment and growing numbers of free-spending retired people will revive consumption. But Japan's low household savings rate of only 3.0 per cent suggests there is little pent-up consumer demand. Furthermore, consumers may choose to use any increase in income to rebuild depleted financial assets.
The longer-term outlook is overshadowed by the rapidly ageing population and shrinking labour force. One-quarter of Japanese are aged over 60 today and by 2040 the proportion will be almost double, among the highest in the world. The problem is made worse by a declining rate of labour productivity increase.
As a consequence, the economic growth of as much as 3.0 per cent that some forecasters now predict for this year may prove a short-lived bounce. The Organisation for Economic Co-operation and Development (OECD) puts Japan's potential medium-term growth rate at only 1.3 per cent, the lowest of any industrialised country. Given the growing burden of caring for the elderly, that spells deepening fiscal problems. The OECD estimates that public debt could reach as much as 230 per cent of GDP and take 15 years to stabilise. Debt service costs would amount to 2.0 per cent of GDP, necessitating hefty tax rises and depressing economic performance.
Prospects could brighten if Japan raised its potential growth rate by getting serious about structural reform. But the chances do not look promising. Junichiro Koizumi's government achieved few economic reforms in its first term and, despite its landslide re-election, has given little reason to suppose its second will be much different.
This does not add up to a Japan that can tow others along strongly in its wake. While still the world's second biggest economy, its share of global GDP has shrunk to less than 11 per cent, barely half its level a decade ago. Although the value of its imports grew 12 per cent in the first half of this year, their volume stagnated, suggesting much of the apparent rise was due to higher oil and raw materials prices.
In sum, Japan no longer appears in danger of slipping ever deeper into an economic graveyard. But it still has to show that it is fit enough to throw away its crutches. Unless it can do so, it is unlikely to be able to offer much support to other economies, either.
FT Syndication Service