Prospects for dissaving in Japan and inheritance tax

In the book "Dogs and Demons: Tales from the Dark Side of Japan", Alex Kerr notes that Japan has very high inheritance taxes relative to other developed countries. This could be a significant factor in Japan's public and private economic future, as larger numbers of Japanese pass away leaving substantial savings from their estates.

BusinessWeek identified the issue back in 1999 in an essay "Commentary: Inheritance Taxes Are Draining Japan's Lifeblood", providing examples of how this is a problem. The essay explains that:

"Many small and midsize companies cannot afford to expand and keep up with tax payments at the same time. Yet many cannot sell assets, since potential buyers are also scarce. And as Japan's population ages, more entrepreneurs are frustrated at their inability to hand their businesses over to their children without also sentencing them to lifetimes of tax payments."

and yet

"the government relies on inheritance taxes for $18 billion annually, or 4% of its budget, which runs a large deficit".

More recently (April 2011), researchers pointed out that the inheritance tax is still an issue:

"With its rapidly aging society, nowhere is inheritance tax more important than in Japan. Over the past decade, an unexpected segment of Japan’s population has been impacted. Although originally aimed at the wealthy, inheritance tax now impacts regular Japanese salary men and retirees who own land and whose other assets’ value has nominally increased over the years. The inheritance tax bill often comes as a shock to the heirs. As a result, any change to Japan’s inheritance tax regime is important not only to the wealthy, but also to the average Japanese homeowner."

Apparently reforms are being discussed in Japan's legislative body that would:

"promote the transfer of trillions of yen from the nation’s conservative, money-conscious elderly to the free-spending younger generation.

Beginning in April 2011, a reduction in the inheritance tax exemption will be effectively coupled with a change in the gift tax regime. The policy change would see a significant rise in inheritance tax, as well as a reduction of gift tax by almost half. This makes it attractive to give money away now, instead of waiting and having a future inheritance taxed at higher rates. The essence of the tax reform is encouraging elderly Japanese to gift their assets now instead of waiting to bequeath it in a will. As an economic stimulus measure, the success of this plan hinges on a hope that the younger generation will open their wallets and spend more freely than their savings-conscious parents or grandparents."

This is dis-saving as a policy tool. It is an open question whether reforms will take place and if so whether the impact will be significant to Japan's overall economy.

Recession returns

Japan's economy has fallen into recession again with two consecutive quarters of negative GDP growth. Gross domestic product contracted 0.9% during the January-March quarter, marking a 3.7% annualized drop, the Cabinet Office reported Thursday. A drop in domestic demand took 0.8 of a percentage point off growth last quarter. Business investment fell 0.9% and consumer spending declined 0.6%. GDP shrank a revised annualized 3.0% in the October-December period. Clearly the earthquake/tsunami/nuclear crisis had a major impact in Q1 2011, but it is intriguing that the drop in that quarter was not that much greater than in Q4 2010. It is very possible that the Q1 figure will be revised to an even greater decrease.

The eastern half of the country will have to deal with severe electricity shortages for quite a while, as electric power is difficult to shift from other parts of the country due to incompatible transmission systems as shown in this chart of the country's power grid from Wikimedia:


The New York Times nicely summarizes the impact of such shortages:

"Besides the dangerously disabled Fukushima Daiichi nuclear power plant, three other nuclear plants, six coal-fired plants and 11 oil-fired power plants were initially shut down, according to PFC Energy, an international consulting firm.

By some measures, as much as 20 percent of the total generating capacity of the region’s dominant utility, the Tokyo Electric Power Company — or an estimated 11 percent of Japan’s total power — is out of service.

Until all the lost or suspended generating capacity is replaced, economists say, factories will operate at reduced levels, untold numbers of cars and other products will go unbuilt and legions of shoppers will cut back their buying "

The power shortages may last quite a long time; some experts are predicting that
Japan's shortage of electricity may last two or three years and that production slowdowns will continue in many sectors such as automotive, semiconductors, electronics, special chemicals, machinery, and precision equipment. This seems likely to reduce the chances that GDP growth in Q2 2011 will be positive year on year.

In addition, it appears that turf battles and government inertia are hobbling the cleanup effort: Focus on local firms slows debris removal : National : DAILY YOMIURI ONLINE (The Daily Yomiuri)

"More than two months after the Great East Japan Earthquake, piles of debris created by the ensuing tsunami remain untouched throughout disaster-hit areas.

Municipal governments have consigned most removal work to local companies, a practice that disaster-management experts say is delaying cleanup efforts. Calls are increasing for the central government to play a more active role and for the debris to be removed more quickly."

It seems to me that the Japanese government has nothing more than ad-hoc responses to this crisis. They've never had any meaningful control of the nuclear crisis since day 1. There are too many simultaneous problems causing cascading additional problems. Their deliberative style of decision-making is a poor fit for a crisis that requires prompt action.

Japan's Economy Struggles For Air

With the arrival of the first real Japanese data since the Tsunami struck the immensity of the tragedy which Japan is passing through is only now gradually becoming apparent. Exports were down by a seasonally adjusted 7.7% in March over February, while imports were only fell by a much more modest 1.4%, with the inevitable consequence that the trade surplus which forms the lifeline for Japan's fragile economy shrank sharply. In particular car production was badly hit, with output at Toyota plunging 62.7% during the month, while Nissan reported a drop of 52.4% and Honda put the shrinkage in its Japanese domestic production at 62.9% adding that output would be at 50 percent of its former projections until at least the end of June.

In fact March output across the whole of Japanese industry fell at a record monthly pace of 15.3%, while household spending declined at the record annual rate of 8.5%.






Large as they are, however, these numbers were to some extent expected. More worrisome from the Japanese point of view is the fact that production may be many months getting back to earlier levels given supply chain problems and the fact that electricity generating capacity will remain problematic, leading to reductions in the level of power available. These delays in restoring production in Japan’s auto industry at a time of substantial economic growth in potential new markets raise the prospect that some of the damage may be permanent, as some part of the Japanese market share goes to the country’s main competitors. Indeed just this point was raised by S&Ps recently when they cut their outlook to negative for all three manufacturers along with suppliers Aisin Seiki, Denso, and Toyota Industries. In their report justifying the move S&P’s stated "The outlook revisions also reflect our opinion that extended production cuts may erode Japanese automakers market shares and competitive positions in the longer term."

Among companies who may well inadvertently benefit from Japan's ill fortune is the US company General Motors, who less than two years after declaring themselves bankrupt now seem poised to reclaim the global auto sales number one spot from their struggling rival Toyota. Japan's car manufacturers have also been hurt by the sharp rise in the value of the yen. After years of a weak yen boosting sales and corporate profits, the Japanese currency has steadily strengthened to 81 yen to the dollar from 112 at the end of 2007. What might have been seen as a temporary development now looks much more permanent, and strategic planning by Japanese corporates will undoubtedly be influenced by this when it comes to decisions on where to locate new plant and capacity. And in the meanwhile, they stand to loose market share in both the US and in the key growth market, China.

German manufacturing is also an indirect beneficiary of Japan's ills, and the German April manufacturing PMI once more revealed a very strong performance, underpinned by ex-European demand for capital and intermediate goods.



Obviously the substantial under-performance will continue, as was confirmed by the April manufacturing PMI which showed a second month of sharp contraction, with the indicator registering 45.7 reflecting a deterioration on the already sharp contraction (46.4) registered in March (50 marks the neutral, or no change mark on these indexes). And while after years of deflation and slow growth Japan’s economy may not be what it used to be, it is still the world’s third largest economy, so it should not surprise us if JPMorgan attributed a large part of the fall in their March Global Composite PMI (to a six monthly low of 54.7) to the Japan impact. Without the contraction in Japan, they suggest, the Global Output Index reading would have been in the region of 57.3.



On the other hand, since Japan is an export surplus country, and it is highly likely that the slack left by Japan’s export losses will be taken up by its main competitors, beyond a short-lived supply chain blip there is unlikely to be any major impact on Global economic growth in 2011 following from the disaster. The problem here is very much a Japanese one.

We also now have details of the first instalment of money allocated by the government for the reconstruction programme. As expected the initial spending is modest in relation to the extent of the damage, with an emergency budget of 4 trillion yen ($48.5 billion) while total costs have been estimated as lying more in the region of $300 billion. Further, the government have been at pains to stress that no new debt will be issued to cover this spending, and that the resources will be found from cuts in social programmes and from pension fund resources. In fact the package has been financed using 2.5 trillion yen from the country's pension funds plus money originally intended to increase payments to families with children. Ironically this money had been promised as part of a campaign to try to address the country's long term demographic shortfall, which is now playing a key role in generating the country's evident economic imbalances. In any event, these are hardly "stimulus" measures, although paying for the next round of reconstruction will be much harder without recourse to a new debt issue.

Significantly, no decision seems yet to have been taken on whether to increase consumption tax, since given the ongoing weakness in Japan domestic consumption the application of such a remedy in the current environment may create as many issues as it resolves. The reticence of the Japanese authorities to raise new debt is comprehensible given the fact that the IMF estimates that gross government debt will hit 229% of GDP in 2011 (and net government debt 128%) while the rating agencies are waiting in the wings waving imminent downgrade warnings. Subsequent packages are likely to prove far more challenging in terms of financing, and markets are liable to remain nervous.



It is now more or less universally acknowledged that Japan is in recession, and Bank of Japan governor Masaaki Shirakawa has confirmed this impression by asserting the Bank’s view that the economy will continue to contract throughout the first half of the year. In fact only last Saturday he described the country's economic outlook as "very severe" and asserted that the central bank was resolute in its determination to take appropriate action to support the economy. Most observers interpret this as meaning that the bank will ease further by increasing its asset purchase programme. The BOJ eased policy in the days following the tsunami by doubling to 10 trillion yen the funds it sets aside for purchases of a range of financial assets, such as government bonds and corporate debt, and despite the fact that a proposal from Deputy Governor Kiyohiko Nishimura to expand the programme by 5 trillion yen ($62 billion) was outvoted by the board, the mere fact it was discussed could mean that bank could loosen policy further as early as next month.

It is important to bear in mind that Japan’s recovery from the global crisis was always fragile, and that while post-Lehman growth resumed in Q2 2009, the economy contracted again in Q3 2009, and suffered a further relapse in Q4 2010. At the end of last year economic activity in Japan was still at the same level as in Q1 2006, and the short term impact of the Tsunami will only have served to blow it further back in time.

Thus while it seems pretty clear that growth in Japan will resume in the second half of the year, and that the rebound in manufacturing industry will be pronounced once a normal power supply is restored, the thesis that natural disaster shocks are invariably good for economies with a lethargic track record of pronounced under-performance seems rather questionable. It is entirely possible that Japan will turn into a reference-case-example of a country where this does not happen (particularly given the major differences in the demographic profile between Post WWII Japan and the country today). In addition, while additional government indebtedness and burden sharing from the private sector may well be short term growth positive, the stimulus will be short lived, since what Japan needs is not a “one off” push start, but major structural changes and in particular a new openness to immigration. Further down the road only lie major tax increases (which will surely slow the domestic economy even further) or (ultimately)debt restructuring, since surely, even in the Japan case, the sky is not the limit for sovereign debt, and while any Japan sovereign restructuring would have little external impact given that the Japanese are the main holders of their own debt, Japan's banks (who hold the lion's share) would hardly escape unscathed. But beyond immediate government debt-woe issues, the big question is the extent to which lasting damage is being done to demand for Japanese home-grown products, and whether or not this will make it more rather than less difficult to sustain in the longer term the external surplus the country so badly needs to underpin its fiscal survival.

Global Manufacturing Slips Back Slightly In March

Evidence which would enable us to assess the full economic impact of the Japanese earthquake and tsunami is still hard to come by. There is a lot of talk of supply chain disruptions, but little in the way of detailed evidence to back up assertions of the more anecdotal kind. Even the latest set of manufacturing PMI data has decidedly left the jury out on the topic.


Evidently in Japan there was a clear and substantial drop in activity, but that was only to be expected . The Japanese March PMI slumped to a two-year low of 46.4, down from February’s reading of 52.9, the largest one month drop on record.

Commenting on the Japanese Manufacturing PMI survey data, Alex Hamilton, economist at Markit and author of the report said:

“March PMI data provide the first indication of how output at small, medium and large sized Japanese manufacturers was affected by the events following the Tohoku earthquake on 11 March. The PMI slumped to a two-year low, suffering the largest monthly fall in points terms since the survey began in 2001, exceeding the drops seen after 9/11 and the collapse of Lehmans. The latest index reading is consistent with a decline in Japanese industrial production of around 7.0% on a 3m/3m basis".

“Suppliers’ delivery times lengthened at a survey record pace amid widespread disruption in the supply chain resulting from the disaster. These delays could affect production in coming months and drive input price inflation even higher than the two-and-a-half year peak seen in March.”

At the same time it is hard to disagree with this conclusion, presented by Nomura economist Richard Koo in a recent report on the subject:

Any analysis of Japan's position vis-à-vis the rest of the world needs to start with the question of whether Japan was running a trade surplus or deficit. A trade deficit implies the world has lost a customer: ie, demand: whereas a surplus would mean the world has lost a producer, namely, a supplier of products and intermediate goods. Inasmuch as Japan boasts the world's third-largest trade surplus after China and Germany, I think the world has lost an important supplier.


Supplier countries' products are typically in demand for one of two reasons: either they are cheap or they are essential. A key to distinguishing between the two is the exchange rate. When a nation's currency is cheap relative to those of its trading partners, its exports tend to fall into the first ("cheap") category, whereas exports from countries with a fully or over-valued currency tend to fall into the second ("essential") group.

The Japanese yen has been the strongest currency in the developed world since the Lehman-inspired financial shock. Its strength was reaffirmed when it surged into the Y76-77 range against the US dollar in the wake of the earthquake. Japan has continued to run one of the world's largest trade surpluses in spite of an extremely strong currency. Inasmuch as this is evidence that there are many businesses around the world that must buy Japanese products regardless of the cost, I suspect that many of Japan's exports cannot be easily substituted.

But elsewhere, at least on the surface, there was little sign that companies were being held back by any substantial shortage of components.

Digging a little deeper, while manufacturing output strength weakened slightly from February, survey respondents still indicated companies were raising output rapidly. On the other hand it is hard to sort the wood from the trees here, since global output could weaken for any of a number of reasons, most of them nothing whatsoever to do with Japan.

More significantly, manufacturing activity did slow in South Korea, and failed to really recover in China following the end of the new year holiday season. These two countries are among the most closely integrated with the Japanese economy.

Commenting on the China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC said:

“The Final March manufacturing PMI confirmed that the pace of manufacturing expansion has stabilised after slowing in February. This implies economic growth is only moderating rather than slowing too much. More importantly, price hikes also started to slow in March. All these confirm our view that quantitative tightening is working. So as long as Beijing keeps tightening for another three to four months, inflation should start to slow meaningfully in 2H2011.”

On the other hand, there has been plenty of earlier evidence that the Chinese economy may now be slowing somewhat, and this for its own domestic reasons. So it is hard to know what is attributable to a Japan impact here, and what isn't.

Certainly it does seem that economies in Asia are now slowing somewhat, and since the region has been one of the main drivers of the global economy, then this slowing will be noticed in those economies which are most dependent on exports.

Curiously, both in Europe and in China the final PMI reading was below the initial flash estimate, which could suggest that problems mounted a bit as the month advanced, with those responses which came in later being slightly less optimistic.

Either way, the big issue isn't the supply chain disruption one - since lost output can (in general) be quickly recovered in this context, especially given the degree of surplus capacity which still exists in the global manufacturing system - rather the question is one of where exactly we are in the current global cycle?

Many Emerging market economies have plenty of scope for continuing rapid expansion, as long as the markets are still willing to fund them. And risk sentiment doesn't seem to be an issue at the moment, although forthcoming monetary policy decisions at central banks in both the developed and the developing world make the mid term outlook rather more uncertain than it was six months ago.

Commenting on the India Manufacturing PMI survey, Leif Eskesen, Chief Economist for India & ASEAN at HSBC said:

"The momentum in India's manufacturing sector held up well in March, suggesting that growth is not an immediate concern. Output growth kept up the pace and the inflow of new orders accelerated, holding promise of a continued strong momentum in output in the months ahead. However, capacity constraints are tight as reflected in the increase in the backlog of works. Also, manufacturer's are facing ever steeper increases in input costs due to tight labour markets and rising material costs, which are increasingly being passed on to output prices. In turn, this calls for further tightening of monetary policy to tame inflation pressures."

Commenting on the Turkey Manufacturing PMI survey, Dr. Murat Ulgen, Chief Economist for Turkey at HSBC said:

“Turkish manufacturing sector performance eased somewhat in March from its record high level in the previous month, though it still remained comfortably stronger than past averages. The slight slowdown in the rate of expansion was caused by output and new orders, both of which also expanded at slightly lower, but still markedly strong rates. There was a solid slowdown in new export order growth, possibly reflective of uncertainties in the Middle East & North Africa region, while backlogs of work fell despite the weaker expansion of output. Employment conditions continued to improve as manufacturers continued to hire more workers to meet robust demand and production. There was a slight decline in stock of purchases in March due to shortages of raw materials, as reported by survey participants, that was also evident in the continued lengthening of supplier delivery times. While both input and output prices rose at slower rates than in February, they both continued to signal pipeline inflationary pressures in the manufacturing industry.”

In the Eurozone,where the headline PMI slipped from 59 in February to 57.5, the results followed a now familiar pattern, with Germany, France and Italy all showing quite robust expansions, while Greece, Spain and Ireland continue to struggle, even if in each case the performance was an improvement on earlier months. Of the three, only Greece continued to show a contraction in activity, even if this was at a slower rate than previously.

Chris Williamson, Chief Economist at Markit said:
“The Eurozone’s manufacturers continued to report buoyant business conditions in March. Despite the slight easing since February, the data are consistent with industrial production growing at a quarterly rate of 2%, spearheading the region’s recovery.

“National divergences are marked, however, with surging output growth driving record job creation in Germany, while weak or falling production led to ongoing job losses in Spain and Greece.

“The record jump in average prices charged for goods will further encourage the European Central Bank to increase interest rates sooner, rather than later, which may drive further divergences among member states as higher borrowing costs hit already weak demand in the periphery.”

Commenting on the final Markit/BME Germany Manufacturing PMI survey data, Tim Moore, senior economist at Markit and author of the report said:

“German manufacturing growth cooled during March, but the latest figures confirm an exceptionally strong performance for the sector across Q1 2011 as a whole. Firms continued to benefit from steep gains in inflows of new business during March, helped by the fastest expansion of export orders for ten months.

“The survey’s fifteen-year anniversary was marked by a series record rise in manufacturing employment levels, as firms continued to step up production capacity in response to steep improvements in order books.

“March data indicated higher levels of purchasing and stocks of inputs, reflecting concerns about lengthening supplier delivery times as well as greater production requirements. Strong global demand for raw materials was cited as the primary reason for supply chain delays, and only a small proportion of the survey panel cited the earthquake in Japan.

“Surging raw material and transportation costs meanwhile meant that factory gate price inflation accelerated to a level last seen in the wake of the January 2007 VAT rise.”

Commenting on the Spanish Manufacturing PMI survey data, Andrew Harker, economist at Markit and author of the report, said:

“The latest PMI survey indicated a continuing divergence between demand in domestic and foreign markets, with the latter proving the main source of new order growth. Meanwhile, a record rise in output prices was recorded, although the rate of charge inflation remains much weaker than that seen for input costs as firms struggle to fully pass on price rises to clients.

Phil Smith, Economist at Markit and author of the Greece Manufacturing PMI said:

“Waning domestic and international demand for Greek manufactured goods continued to hurt the sector during March. Crucially, firms were left with little choice but to absorb sharp input price inflation and find savings elsewhere. To some extent, this came in the form of rapid stock depletion. Hope, however, might be taken from the fact that business wins by surveyed firms fell at the slowest rate for ten months.”

But the issue this raises is that the global economy must now be getting somewhere near the peak of this cycle, at least in terms of manufacturing activity. Central banks across the globe are moving into tightening mode, and much of the low lying fruit has now been eaten, so the issue for the fragile economies on Europe's periphery (who are now totally dependent on movements in demand elsewhere for growth) is how they will fare, not during the highpoint, but as and when the current expansion slows.

In the US, the PMI index, compiled by the Institute for Supply Management, edged down from 61.4 in February to 61.2 in March, but stood at a level close to a 27-year high.



Norbert Ore, chairman of the ISM, said “the component indexes of the PMI remain at very positive levels and signal strong sector performance in the first quarter”. Despite the positive result this month, doubts remain about where exactly we are in the cycle at this point. Danske Bank's Signe Roed-Frederiksen thinks we may be near the peak, which doesn't mean a collapse in activity, but simply that from this point the rate of expansion may slow:

US ISM manufacturing declined from 61.4 to 61.2 in March. This was marginally higher than consensus expectations of 61.0 and our estimate of 60.7. However, details of the eport suggest that the ISM will continue lower over the coming months.

New orders dropped to 63.3 from 68.0 and although inventories declined as well, the drop was more modest. This means that the two order-inventory differentials declined further and continue to signal a downward correction in the ISM index. The ‘new orderscustomer inventory’ differential, which has proven the most reliable on short-term movements, suggests the ISM should decline to around 57. The ‘new orders-inventory’ differential suggests a more pronounced slowdown to 56.

New export orders weakened to 56.0 from 62.5 possibly reflecting the slowdown in Asian growth while supplier deliveries increased to 63.1 from 59.4, indicating a slower pace of deliveries. Prices paid rose further to 85.0 from 82.0 reflecting the increase in commodity prices and upward pressure on input prices.

That said, even a moderate decline from the current level would still leave the ISM index at a healthy level.

Globally, the headline PMI reading was 55.8, well above the historical average and the level of 50 that attempts to separate expansion from contraction, But down from the 57.4 registered in February, largely as a result of the slump in activity in Japan.

As David Hensley, economist with JPMorgan, put it: “There was little visible sign of supply-chain disruptions in the March surveys, but this effect is likely to be more visible in Asian emerging markets in April.”


The main concern expressed by the authors in their monthly report referred to the inflationary threat coming from a rapid rise in the prices of inputs and evidence that manufacturers were passing these on. Certainly, in this sense, the report will do little to deter decision makers at the ECB from raising interest rates when they meet on Thursday.