The Japanese society once proud of its post-war economic miracle and revolutionary manufacturing techniques became synonymous to economic dilapidation. Iconic companies such as Nissan went into a steady decline, their final capitulation sealed with their take-over by foreign firms.
Adjusting to a new reality in which “employment for life” was no longer guaranteed, the Japanese consumer retrenched exacerbating the economic depression. This decline not only inflicted economic pain, but also took its toll on the social fabric of Japanese society as suicide rates soared by 50 per cent.
Recently, Japan’s economic indicators have turned positive and it appears that the sun might finally be rising on its economy for the first time since 1989. The paramount evidence of this optimistic outlook has been the 52 per cent rally in Nikkei225 during the past two years.
However, there has been a false dawn for the Japanese economy before. For instance in 1996, its economy showed signs of an upswing but the positive momentum could not be sustained and thereafter the economic decline continued. So, what are the factors contributing to a positive outlook on Japan’s economy this time?
First, when the widespread malaise within Japan’s economy became apparent in early 1990s, its political leadership hesitated in initiating a “shock-therapy” of economic reforms. This reform strategy was implemented by various East-European countries and involved undertaking unpopular measures which are painful in the short-term but also hastened economic recovery.
Japan’s consensus driven culture was more amenable to slow and incremental rather than sudden change and therefore the recession was much longer than it would have been if the shock-therapy of reforms had been employed.
However, these incremental reforms have reached a critical level and are beginning to have a positive impact by reducing structural rigidities of the economy.
Labour market flexibility has increased with part-time employment constituting 30 per cent of the labour force compared to 18 per cent in 1990. This has improved flexibility and competitiveness of manufacturers. At the same time, non- performing loans have been cut down by a half and lending is freed from political interference, resulting in a more efficient allocation of capital.
The culmination of this reform process has been the recent election victory of Prime Minister Koizumi who fought the election on a reform agenda. His victory demonstrates that economic reforms are irreversible and command widespread public support.
Second, after years of wrangling, the Japanese parliament has finally approved privatization of Japan Post Office, the world’s largest financial institution. Its privatization will release a portion of $3.6 trillion into equity markets which are otherwise invested in time-deposits earning nominal interest. This huge inflow of funds will constitute a major boost to the stock market and could kick-start domestic consumption through rising disposable income of local investors as a result of gains on the stock market. Institutional investors have already been buying Japanese equity on the expectation that this massive inflow of funds will take place in the near future.
Third, Japan will benefit from the nine per cent plus growth of the Chinese economy. Except for the last 140 years of the past two millennia, China has been one of the foremost economic powers in the global economy. However, China’s status as the leading producer of global wealth will be reinstated over the next decades and Japan will be the greatest beneficiary of the Chinese boom. This is because the two economies are surprisingly complementary.
Japanese firms provide the luxury end of consumer goods as well as heavy industrial equipment that powers China’s production-lines, which in turn churns out goods at the cheaper end of product-spectrum. In spite of the raucous diplomatic spats between the two countries, the two economies are getting integrated and as China continues to power ahead, it will boost Japan’s manufacturing and export sectors.
A growing evidence of Japan’s economic recovery is in the investment flows into Japanese equities from hedge funds and private equity firms. These sophisticated investors tend to be the first to identify and profit from a trend. For example, hedge funds were the first to proclaim a positive outlook on Germany, often regarded as the sick-man of Europe, and started to invest in the country even when it’s political and macro economic news was largely disappointing.
Finally, their positive view was vindicated in late 2005 when German business confidence and economic data recorded a marked improvement. The hedge fund investors have been duly rewarded for their astute prediction by a 30 per cent surge in Germany’s DAX30 Index over last year. Investment in Japan by hedge funds is evidence of the underlying strength of Japanese economy and a precursor of favourable economic news in the future.
For four decades after World War II, Japan was a stabilizing force and a key engine of growth for the global economy. However 1990s saw the Japanese economy slump and therefore could no longer be relied upon to be a pillar of support for the global economic system.
Japan’s resurgence is a vital and favourable development for the global economy which has come to rely too heavily on the US consumer to power its growth. The last two years bear positive prospects for the Japanese economy and herald its return to being a major driver of global growth once again.