During the recent election campaign, Japanese Prime Minister Shinzo Abe called the country’s aging and shrinking population a “national crisis” — a proverbial can kicked down the road by Abe himself over the last six years of his mandate, continuing a decades-old practice of his predecessors and the formidable bureaucracy.
Abe — re-elected last week for a third consecutive term of office — pledged to “solve” that existential socioeconomic problem by allowing people to stay in the workforce after their retirement age of 65, and to decide for themselves when to begin receiving their pensions.
That, obviously, is unlikely to stop a reported 1.1 percent annual decline of Japan’s labor force. And neither will it stem Japan’s soaring health and welfare costs. Next year’s budget spending is projected to reach another record high of about $920 billion, with one-third of that needed to cover the projected health and welfare outlays.
All that is happening in a country whose gross public sector debt — currently estimated at 225 percent of the economy — is expected to keep climbing in the years ahead.
Exports are the key
As the Greeks and the Italians could tell the Japanese, the only way to stop that ominous debt trend is to begin running a primary budget surplus (budget balances before interest charges on public debt) of at least 3 percent of GDP. That’s a sort of mission impossible for Japanese authorities whose primary budget deficit last year stood at 3.3 percent.
There, of course, is no chance that Japan can grow out of that debt trap, but steadily increasing demand and output would help to raise government revenues and narrow unsustainably large debts and deficits.
Where could that steady growth come from?
Given Japan’s virtually free and abundant credit flows, one would expect that the economy’s interest-sensitive components — such as household consumption and residential investments, about 60 percent of GDP — would be the main growth drivers.
But that’s not the way the Japanese economy works. In spite of a continuing avalanche of virtually free money, private consumption in the first half of this year grew at an annual rate of 0.1 percent while activity in the housing sector collapsed at an annual rate of 7.1 percent.
Clearly, Abe’s reference to the “national crisis” — shrinking population and a long-standing problem of declining family formation — are at the center of all that.
It is also clear that Japan’s extraordinary monetary easing over the last six years had more to do with a weak yen, growing exports and cheap government financing than with classic policy prescriptions to end price deflation by stimulating domestic spending.
Exports, therefore, are the key — a starting point in a typically Japanese cyclical upswing.
Here is how that works: Exports in the 12 months to the second quarter of this year grew at an annual rate of 6 percent. Over the same period, that strengthening export demand led to a 3.5 percent increase in private sector investments as businesses moved to expand and modernize production capacities to meet rising overseas sales. That export stimulus was then diffused through the system, the GDP grew 1.5 percent, and the trade surplus contributed one-third of that economic recovery since the spring of last year.
The question now is whether Japan will be able to keep exports growing in its main overseas markets — the U.S., China and the European Union.
Abe’s tests in New York and Beijing
The Japanese expect a difficult meeting with U.S. President Donald Trump coming up in New York on the sidelines of the United Nations General Assembly. That’s quite possible because the U.S. is not making any progress on trade with Japan.
America’s $40 billion deficit on goods trade with Japan in the first seven months of this year is slightly above its year-earlier level, and $82.1 billion of Japanese exports to the U.S. are 5 percent higher than during the same period of 2017. On that evidence, it is very likely that last year’s $69 billion trade deficit with Japan will be exceeded as U.S. imports pick up to restock the shelves for the main retailing season in the months ahead.
Japan is facing a number of problems in its trade with the U.S. Most of its exports to the U.S. consist of automobiles, and any bilateral trade deals that Trump wants — and Tokyo resists — would force the opening up of Japan’s politically sensitive sectors, such as agriculture.
The key issue for Japan may be how much the automobile production can be stepped up in its U.S. factories to compensate for falling exports from Japan, and how fast Japanese businesses can redirect their exports to other markets.
Improbably, the EU could be a good candidate to take more Japanese exports after a free-trade agreement Tokyo recently struck with Brussels. The Europeans and the Japanese apparently found acceptable solutions for trading agricultural products, while settling for a seven-year transition period before customs duties are eliminated in the automotive sector.
At the moment, Japanese goods exports to the EU are growing briskly. In the first half of this year, they rose 9 percent, maintaining the same pace of advance observed in 2017.
Asia, however, offers Japan the best export alternatives to U.S. markets. That’s primarily the case of China and the 10 rapidly developing countries of the Association of Southeast Asian Nations.
Japan’s sales to China and ASEAN last year soared at annual rates of 20.5 percent and 14.4 percent, respectively. In the first half of this year, Japan’s export business in those markets has slowed, but it still grew at healthy 9 to 11 percent rates.
Trade with China remains a delicate issue, though. Abe will have a difficult task of rebuilding confidence with China’s leadership during his meeting in Beijing next month. That has been a stage Abe coveted over the last six years because he knows that China is a crucially important market for Japanese trade and investments.
Exports are the main driver of Japan’s economic growth. They are the beginning and the end of the country’s business cycle.
Faced with the crushing public debt of more than twice the size of the economy, overseas sales must keep the economy afloat. The fiscal policy will continue to struggle with the soaring health and welfare costs of an aging and shrinking labor force, while monetary policy keeps picking up the tab for the country’s huge debts and deficits.
The Bank of Japan currently owns nearly half of government bonds outstanding, and its expansionary policy stance will remain in place for the foreseeable future.
Watch Japan’s trade balance. Asia holds the key to Japan’s export diversification at a time when sales to the U.S. will have to be reduced and increasingly replaced by output in Japan’s American production facilities.
Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.