Japanese Economy in 2010: Three Growth Alternatives

Shuntaro SHISHIDO (Professor Emeritus, International University of Japan and University of Tsukuba)

1. Present Situation and Outlook

The Japanese economy appears to be recovering, due to export growth. In fact, this year's real GDP growth rate will be around 4% and nominal GDP will grow at 1.8%, while real export growth seems to be as high as 14% with the current account surplus/GDP ratio being 3.5%. In this export-led growth situation there is a bright aspect, that is technology balance (export-import ratio), which has reached 2.6 to overtake the U.S.

Next year, however, the outlook for the overall economy seems to be bleak. The real GDP growth rate will decline to 1-2 %, and nominal GDP is likely to show zero growth with real exports slowing down to 5-6%. Japan's government debt and weak labor demand will continue so long as the current restrictive fiscal policy is adopted. The huge current account surplus will also continue, creating the pressure on the yen's appreciation.

2. Structural Problems

Because of continuously restrictive public investment which tended to prevent the recovery of regional economies, a serious disparity is growing -- especially in Hokkaido and north-east regions, the Japan Sea coast, etc. Income disparity is also becoming more serious, causing the deterioration of social conditions resulting in growing crime rates and suicide. The fertility ratio is also falling, because of a gloomy income and employment outlook, exceeding the forecast by the government.

Current prevailing pessimism seems to be rooted in three aspects: (1) demographic sources, such as aging and rapidly falling fertility, (2) internationally high government debt ratio causing narrower policy actions, (3) over-emphasized capacity shortage of production linked with the necessity of structural reform, thus disregarding the urgency of aggregate demand promotion.

3. Need for Grand Design on Growth Alternatives by Using the Model

Our project on policy-oriented modeling was initiated in 2001 aiming at growth acceleration through structural reform and proper demand management on a multi-sectoral basis. DEMIOS (Dynamic Econometric Model with Input-Output System) was completed in 2003 after two years' data base building and modeling efforts on a 81-sector basis. The predecessor of the model is a 64-sector Japanese Long-Term Model, which was prepared under the collaboration of a US project on a multi-sectoral U.S. model of the University of Pennsylvania group headed by L. R. Klein and J. Adams.

DEMIOS, a Leontief-Keynesian model, is characterized by several points: (a) multisectoral specification for consumption, investment, capital stock, exports, imports, as well as output, employment, and total factor productivity, (b) sectoral prices for output, final demand, exports and imports, (c) flexible input-output coefficient matrix prepared by V-RAS algorism aiming at consistent estimation for each input, including primary factors such as employment and capital stock, and (d) comprehensive macroeconomic variables for financial block, government block (central, local, social insurance) and demographic block covering different age groups. As in major macromodels, the exchange rate and stock price index are endogenized.

With serious structural and macroeconomic problems in mind as mentioned above, we attempted to prepare three types of scenarios for the period 2004 to 2010: base line scenario, big push scenario, and big push plus consumption tax increase scenario.

3-1. Base Line Scenario

The present policy stance is assumed to continue by 2010. Government investment is assumed to grow at zero %, stopping six-year consecutive declines, however. Monetary policy is also assumed to continue the present low interest policy.

The results are featured by weak, real and nominal GDP growth despite a sound growth of exports. There are no indications of improvement in the present high unemployment rate and huge current account surplus. The present government debt-GDP ratio on a net basis tends to rise up to the level of 1.32, nearly doubling. Total population starts to fall after 2007.

Regarding cyclical trends, the economy tends to weaken during the first half, followed by a slight recovery during the last two years. The rate of utilization of GDP still remains sluggish in 2010. The trend of the yen tends to appreciate, since no government intervention is assumed.

3-2. Big Push Scenario

For accelerating economic growth, three channels are considered: government investment, business investment, and housing investment.

Regarding government investment, we assumed a 15% increase for 2004 and 2005 and 7% for remaining five years. In term of the accumulated sum this scenario is higher than the Base Line by \120 trillion. Government consumption is also assumed to accelerate from 1.5% to 3.0% in view of the growing importance of welfare expenses to the aging society. A big push to business investment is assumed to be accommodated by greater financial channels of the government for strategic important sectors such as those related to IT, biotechnology, nanotechnology, energy-saving and recycling sectors, airport, transport and communication industries, etc.

The results of simulation for this scenario are encouraging. Growth rate of real GDP accelerates at 4-6% for the first half and continues to grow at around 3% for the second half. The unemployment rate falls significantly and the rate of utilization of GDP reaches to a satisfactory level of 99%. The rise in prices and wage rate remain fairly modest. The long term interest rate tends to rise, but it still remains modest by the international standard.. The stock price index indicates a steady increase, having a greater asset effect on financial market which offsets rising interest rate pressures.

Regarding the government debt, the ratio to GDP on a net basis continues to rise, but it remains much lower than that of the Base Line Scenario. This is because of relatively faster GDP growth and the rapidly growing tax revenues as compared with the Base Line Scenario.

Current account surplus declines and the yen slightly depreciates as compared with the Base Line Scenario as a result of faster GDP growth. Finally total population continues to grow in a sharp contrast to the Base Line Scenario because the improvement of employment and housing conditions tends to raise the fertility rate with a certain time lag.

3-3. Big Push Plus Consumption Tax Increase Scenario

In view of the recent growing criticism on government deficit and debt accumulation we attempted to prepare another scenario on the basis of the Big Push Scenario. In stead of a hasty tax increase, our option is to first accelerate economic growth, followed by a gradual increase of consumption tax to 10%, now 5%, thus alleviating the pains caused by this government action. The rate is assumed to be 7% in 2007 and 10% during 2008 and 2010, without changing the Big Push Scenario.

The results indicate a slight deceleration of growth after 2003 and a rising tendency of prices, e.g. 1.7% point in consumer prices in 2010. Real consumption falls slightly by about 1.4% in 2010. Real gains, however, are noticeable in terms of primary balance of the government. Similar but less improvement is also observed in terms of the net government debt-GDP ratio. This scenario indicates that fiscal reform of the government after the full recovery of the economy tends to become much more bearable as compared with the hasty policy measures taken by the government in 1998. It seems always true that the farthest way about is the nearest way home in the case of government fiscal reform. There are many other alternatives, including ones that might be more ambitious about growth with longer postponement of fiscal reform after abundant tax revenues. These are a matter of our study in future research featuring DEMIOS (Dynamic Econometric Model with Input-Output System).