Risks for the economy

Japan’s gross domestic product for the January-March period increased 1.5 percent from the previous quarter or an annualized 5.9 percent — a pace of growth that exceeded the forecasts of private-sector economists. It was mainly driven by last-minute purchases by consumers ahead of the consumption tax hike from April 1 and robust capital investments by businesses.

After six straight quarters of growth, the nation’s GDP is expected to suffer a reactionary contraction in the April-June period, but the government says that the decline will be within the range of expectations and that the economy will enter a virtuous circle after recovering in the July-September period. Rather than be too optimistic, however, the government should be cautious about latent risks that may negatively impact the economy for years to come.

Consumer spending, which accounts for about 60 percent of Japan’s GDP, increased 2.1 percent in the January-March period thanks to strong demand for high-priced durable consumer goods, such as electronics, personal computers and cars. Sales of consumer durables as a whole grew 13.7 percent — faster than the 4.5 percent rise registered in the January-March period of 1997 just before the previous consumption tax hike. But the strong sales of those products are more a reflection of one-off consumer sentiments to buy before the tax hike than improvement in disposable income of households.

Although some major firms offered the biggest pay raises in years for their workers, such wage increases are confined to a limited portion of the economy.

The government should realize that many households continue to suffer net declines in wages due to the rising prices caused by the weak yen driving up the cost of imports and the consumption tax hike. The overall effect could depress consumer sentiment over a long period unless wage increases exceed price hikes.

Reflecting the improved earnings of many businesses, capital investments rose for the fourth straight quarter, climbing 4.9 percent. But the one-off factor of heightened demand before the tax hike is also behind the robust investments. The government needs to carefully monitor whether capital investments will remain steady.

What’s worrisome is the fact that the yen’s 20 percent decline against the dollar over the past year — the result of the Bank of Japan’s quantitative easing under the Abe administration’s economic policy — has not fueled much of an expansion in exports.

While exports increased 6 percent in the January-March period, imports grew faster at 6.3 percent. Consequently external demand pulled down GDP growth 0.3 percentage points — the third quarter in a row in which external demand was a negative factor for growth. The slow growth of exports remains a source of concern for the economy.

The picture of overseas demand is mixed. While the U.S. economy appears to be picking up, opaqueness continues to prevail in Europe and in emerging economies, especially China. Real estate investments that drove the Chinese economy in recent years are shrinking.

What could have a longer-term impact on the Japanese economy than the trend in overseas demand is the continuing relocation of the nation’s manufacturing operations abroad. Exports did not rise so much despite the yen’s fall because many Japanese manufacturers had already moved their production overseas during the long period of the strong yen, and they do not seem ready to shift their operation back home because they see more market potential abroad.

The hollowing out of Japanese industries seems set to accelerate in coming years.

It is imperative that the government take measures to help Japanese companies keep their manufacturing operations at home and attract more foreign investments.

To achieve this, the government is considering cuts to the nation’s corporate tax rates, which are higher than in other Asian economies. But it needs to carefully weigh the effectiveness of such tax cuts, given that the appetite of Japanese and Western companies to invest more in Asia’s emerging markets continues to be strong.

Such a course of action could end up reducing tax revenue without increasing investments in Japan.

The government hopes that increased public-works projects funded by the ¥5.5 trillion supplementary budget for fiscal 2013 and by front-loading spending under the fiscal 2014 budget will underpin the economy. However, serious labor shortage in the construction sector could hamper the implementation of such projects.

To lay a solid foundation for growth of the Japanese economy, the government should pay more attention to the rapid aging of society and decline in the working-age population. To reverse this trend, the government must implement policies that lead to the creation of jobs that provide the nation’s younger people with both decent pay and security so they can feel confident enough to marry and start families.

Until this happens, the nation’s birthrate will continue to be dismally low.

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