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Saturday, August 23, 2003

Good, or Bad, News From Japan?


A couple of interesting heterodox pieces on Japan. Michael Hann in the Guardian casts an extremely skeptical eye on what seems to be generalised 'spin' on the 'new tipping point'. Lehman Brothers is "encouraged by the fact that the main contribution to Japan's growth is coming from improved private-sector demand.........This is not simply an export-led recovery." However most of this increased private sector demand seems to have come from Japan's electronics makers producing high-tech toys such as digital cameras and camera-equipped mobile phones. Sharp for eg has said it will raise its capital spending by 20 percent this year, mostly for liquid crystal displays. Sony, meanwhile, raised its capital spending estimates late last month for the current business year by more than 10 percent to 350 billion yen ($2.93 billion), mainly to replace equipment and boost manufacturing capacity for semiconductors: all of which raises the question as to whether this capital spending is economically justified and will lead to real growth or is a 'risk' decision taken in anticipation of a global market which may not deliver. This latter scenario would not, of course, be a 'historic first' for Japan where project evaluation decisions seem to be made using rather different criteria to those commonly applied in, say, the US. (Of course, no sooner do I open my mouth than I want to correct myself. This distinction may well have been a lot more applicable in the past than today, since the tech sector both in the US and Europe is also now swimming in overcapacity. But the substantive point remains: in technology investment the argument risks becoming circular, enterprises invest in anticipation of demand growth, fine, but we can't then read this data off as evidence of coming growth. The expectation/decision may be a bad one, may be disappointed. In which case the outcome will be more deflation not more growth. This is why we still need to be talking about a New Economy dynamic characterised by increased risk, limited visibility, fundamental undertainty, compressed depreciation timescales (the creative destruction hurricane) and, of course, increasing returns. To the victor the spoils, but 'many are called and few are chosen'.)

Analysts at BCA Research in Montreal put out the word last week. Last Wednesday Canada's National Post reported that the firm had just released a report, The Japanese Bull is Set to Run, "advising clients that the Nikkei may be in the early stages of another monster rally, even if the country's economic fundamentals leave much to be desired". On Monday the 225-issue Nikkei Stock Average duly closed above 10,000 for the first time since August last year, 20% up on the index's spring low point.

"While hitting 10,032.97 may seem a feeble victory when compared with the assaults of yore on 40,000, it represents a remarkable turnaround for an index which in March fell near 7,500 as the threat of Iraq war quelled hopes of Japanese economic recovery after a decade of stagnation," said Sally Patten in the Times. "For 14 years after the bursting of the late-80s asset price bubble, the Japanese market has slid inexorably downwards," said Ruth Sunderland in the Daily Mail. "But a growing camp of foreign investors believes the tide has turned." The Wall Street Journal Europe noted the reasons for the change of heart: "Restructuring by corporate Japan is paying off. Companies have cut labour costs, and total corporate debt fell to �185 trillion (�980bn) last year from �354 trillion during 1994."

At Forbes.com, the website of the financial magazine, Lisa Hess was bullish. "Japan's long-awaited revival is getting under way. This is not another false start. Bad deflation is ebbing, business is reviving and the stocks are very cheap." For evidence, Hess pointed to the "Bank of Japan's recently released Tankan survey of business prospects, which covers 10,000 Japanese companies, large and small, [and] shows a meaningful increase in capital spending plans by large corporations. Businesses are not going to spend if executives think they can't turn a decent profit". However, as Sunderland pointed out in the Mail, "Japanese punters have ... largely steered clear of the [share] buying frenzy - perhaps for good reason." The good reason in question is the fact that deflation in Japan is running at 2%.

As the Lex column of the Financial Times pondered: "Should foreigners rush in where locals fear to tread? ... Recent real GDP data have been flattered by deflation - meaning that, in nominal terms, the economy remains flat. Moreover, a key reason for the Japanese investors' caution is that they have been burnt before. On several occasions in the 90s, the Nikkei surged amid a cyclical recovery and reform hopes. But these rallies subsequently faltered because the government backed away from implementing painful policy change, as a sense of crisis ebbed." No wonder the Japanese daily Yomiuri Shimbun - the world's bestselling daily paper - refused to get too excited by the Nikkei's revival. "One of the effects of looking at the world from the bottom of an economic ravine is that we tend to delude ourselves into thinking we have scaled the heights when we get such news, when in reality we have but inched a little higher." The paper criticised ministers for excessive jubilation over the Nikkei's rise and suggested, "the government should not take the rebound of stocks to the 10,000 level as an excuse to rest on its laurels. Rather, it should initiate bold measures to buoy the economy." The Yomiuri reckoned the current rebound was largely down to US economic measures having an impact overseas.
Source: The Guardian
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Which brings us to the real point, is the Japanes economy, as some would have it 'flat', or is it growing, as others don't hesitate to point out, at a reasonably attractive 2.2%. The answer, as always, is it depends (this habit I have of hedging is one of the reasons I try not to mix economics and politics, and try to avoid pronouncing too much on the latter. Big Arny is receiving a lot of stick at the moment for the emminetly reasonable 'never say never' - although of course I'm not saying that Big Arny is emminently reasonable. A politician, maybe, is someone who finds it easy to be sure about something, I only have doubts - even on the euro, honest, I think I'm right, but as they should say: once you stop doubting you're dead.

Anyway to get back on subject, is Japan growing? Answering this takes us back to an earlier debate I had with Dave (and here ) about the uses and abuses of data at current dollar prices. We live in a world awash with numbers, the real problem is what to make of them all. Churchill had it that there were 'lies, damn lies and statistics'. I think this is unduly cynical, but we do need to ask ourselves some important questions in each and every case when we use economic numbers. In particular we should ask why the data has been assembled the way it has. The issue in the present case revolves around the distinction between real and nominal values. Real values are the numbers economists use to compare time series data in terms of a common reference point: constant prices. They is important for constructing such things as consumer price indices and for making comparisons of economic performance between periods. But despite their name they are constructs, the real numbers are the 'nominal' ones. If we go back to my vision of the economic system as the man in the Chinese room interpreting the ticker tape signals fed to him, the data to interpret are the nominal prices, the economy as such doesn't operate through the mediation of a GDP price deflator any more than it matters whether the products exchanged are melons, mobile phones or phone numbers of potential clients (except wait a minute, wait a minute, we have this unfortunate problem of dualism, we have (let's stay Cartesian to keep it simple) brain and mind, so the economy is not a simple machine, we form part of the picture with our tastes and our expectations, and all this enters, economics is a social science. But, again, the main point holds: the real numbers are the 'nominal' ones). Think of the classic businessman's problem in times of deflation: falling stock values. Now is it of any consolation to tell the person who has just lost money that their stock in hand has actually risen in value 'in real terms'. They will just laugh at you, if they don't cry that is.

So getting back to Japan, this is the problem. Prices are dropping at 2%, the nominal value of GDP is roughly constant, so we can derive the idea that there is 'real' growth of 2%. This is true, and it is important, since if nominal GDP was falling the problem would be far worse, but it of little compensation to the Japanese businessman who wants to invest. This is why cracking deflation has to be Japan's number one priority, and the fact that it has not made any progress on this front has to be the most significant piece of information about Japan we have on the table right now.

One last point on the above mentioned Dave. There could be a ripost that with the rise in the value of the yen the whole Japanese economy is now worth more. No, no, no, wait a minute. This is a very complex question (Krugman did his doctoral thesis on just this problem if my memory serves me well), but this is an illegitimate comparison for all sorts of reasons. It is important to distinguish between the traded and the non traded sector. Now comparing the current dollar values of Japanese exports with US exports, Chinese exports, world trade or whatever is, it seems to me, a competely legitimate exercise since these are the numbers which move the economy in real time, viz these are the numbers that matter, and in this sense I feel that the kinds of comparison that Roach makes about world trade shares and growth in current dollars are interesting and legitimate, but maybe the whole idea of changing relative shares of Global GDP would be better left in the wardrobe, since we are never sure what we are comparing with what. Now for Susumu Saito to put some flesh on all this abstract argument:

Chairman Alan Greenspan of the U.S. Federal Reserve Board recently acknowledged the U.S. economy was at risk of suffering Japanese-type deflation and that Washington needs to learn important lessons from the Japanese experience. Japanese prices as measured by the implicit deflator of gross domestic product (GDP) have fallen almost 10 percent since 1994, and GDP at current prices, or nominal GDP, has been on a downward trend since 1997. Greenspan's concern is quite understandable as his ammunition of conventional monetary policy has been nearly exhausted, with the federal funds rate already at 1 percent. The response of the U.S. economy to the Fed's monetary easing has been much weaker than expected by most American economists, probably including Greenspan himself. After the Fed's unprecedented aggressive monetary easing in 2001, nominal GDP rebounded only at a 6-percent annual rate in early 2002 and quickly petered out thereafter. Past upturns showed rates of 8 percent or so. The Fed was obliged to ease monetary policy further last November, and in June of this year. For the past three quarters, however, the growth of nominal GDP has fallen to 3 percent levels.

So what have been the Japanese lessons in deflation?

Japanese government statisticians have been doing a fairly good job tracking the long-term trend in Japan's economic activity as measured in GDP. As many users of GDP statistics know very well, the ``estimates'' of GDP and its components usually have a margin of error of 1 to 2 percent or even larger. So it is not very meaningful for economists to read too much into the minor quarterly changes in GDP. GDP statistics, however, are a fairly useful tool to track economic activity in the long term, simply because it is very difficult for any group of statisticians to continue producing larger and larger margins of error over many years.

Recently, the Japanese government announced the economy had grown for the past six consecutive quarters. Indeed, real GDP (GDP at 1995 constant prices) is ``estimated'' to have increased by 3.4 percent from the first quarter of 2002 to the second quarter of 2003. In a long-term retrospect, however, the ``level'' of real GDP has been hovering marginally around 540 trillion yen for the past six and a half years since the first quarter of 1997. More important for businesses than real GDP is nominal GDP, or GDP at current prices, because businesses keep their books at current prices.

Especially when prices are falling, real GDP and the rate of economic growth derived from it sound like imaginary numbers. They appear far from the sentiments of business managers who have been hard pressed to maintain sales. Indeed, nominal GDP has remained almost flat for the past six quarters. Under more rigorous terms, the size of GDP minus ``imputed'' rent corresponds more closely to businesses' books and business managers' sentiments on sales and so forth. As a practice in estimating GDP, each homeowner is ``regarded'' to have paid rent at a market price. And such imputed rent is counted as personal consumption, or the largest category of GDP, even though ``transactions'' do not involve any cash or credit.

Misleading and false impression

This statistical practice is a good measure of ``housing services'' for homeowners. Personal consumption and GDP including imputed rent, however, give laymen a misleading and false impression on the level of business activity measured in money terms in two ways. First, imputed rent is very large and accounts for more than 10 percent of nominal GDP: 52.6 trillion yen from nominal GDP of 498.0 trillion yen at an annual rate in the second quarter of 2003. Secondly, imputed rent keeps rising because housing investment does not entirely stop even during a recession, and the resulting rise in housing stock is translated into an ever-rising imputed rent: from 41.5 trillion yen in the first quarter of 1994 to 52.6 trillion yen in the second quarter of 2003 at an annual rate.

After all, GDP minus imputed rent at current prices has been on a downward trend, except for a temporary pickup in the period of the IT bubble around 2000, shrinking by a staggering 6.9 percent to 445.4 trillion yen in the second quarter of 2003 from 478.3 trillion yen in the final quarter of 1997 when financial panic erupted in Japan. The latest figure of GDP minus imputed rent is actually lower than the corresponding figure in the first quarter of 1994. It is no wonder most Japanese businesses are still bothered by an ever-sinking feeling. Through 1997, however, both nominal and real GDP kept growing in Japan despite the crash in asset prices early in the 1990s.

Two factors in particular distinguish the pre-1997 period from the 1997-2003 period. The first is fiscal policy. Fairly expansionary fiscal policy, though insufficient in retrospect, supported the growth of GDP, nominal and real, in the pre-1997 period. Thereafter, public demand was frozen at around 120 trillion yen per year on a GDP account basis, and has been cut further in the latest three quarters. The switch in fiscal policy, of course, has worked as a powerful brake on nominal GDP. The second is the current financial restructuring plan that has forced Japanese financial institutions to sharply-and quickly-cut back their outstanding loans. The resulting credit squeeze quite naturally has shrunken aggregate demand, and hence, nominal GDP. Actually, the current financial restructuring plan is a major culprit in the acceleration of Japan's deflation. The greatest irony is that the switch in policies in 1997-2003 has not achieved its objectives. It has rather aggravated the problems it purported to alleviate. Fiscal austerity was intended to restore the balanced budget. But the shrinkage in nominal GDP has sharply reduced tax revenue, resulting in a much sharper deterioration in the budget balance. The shrinkage in aggregate demand due to the financial restructuring plan has actually made it harder for more Japanese companies to service their debt from banks. The resulting increase in bad loans has cornered more banks, and the vicious cycle goes on. It is no wonder that financial restructuring under the current plan does not appear to be drawing to an end.
Source: Asahi.com
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