Economic Development of Japan - Essay Example

ANALYSIS OF JAPAN'S ECONOMIC STRENGTHS AND WEAKNESSES OVERVIEW Japan is located in East Asia, with a total area of 377,835 sq km, its land slightly smaller than the state of California. The country comprises of 3, 000 islands, the biggest of which are Honsh, Hokkaid, Kysh and Shikoku. Its estimated population is 128 million people and is known globally as a leader in high technology products and electronics (CIA World Factbook, 2006 and Economist Intelligence Unit (b), 2006). Its economy is the second largest after the United States in real terms and by far the largest in terms of GDP, set at an estimated $3.914 trillion and a per capita income of $30,700 in 2005. In terms of PPP, the Japanese economy is second to the People's Republic of China in all Asian economies. The country is also the largest in terms of foreign investment and has successfully sustained a trade surplus for more than five decades. As of 200, the Japanese state holds a sixth of the United States Treasury Securities, which represents about 3.5 percent of the United States' gross domestic product. It is notable that Japan's economic problems can greatly impact the global market (CIA World Factbook, 2006 and Economist Intelligence Unit (b), 2006). After the Second World War, much of Japan's industries were destroyed. Economic growth was achieved after the War with the strong work ethic of its labor force, sound economic policies and close ties between the government and business sector, efficient and technology-driven industrial methods resulted in one of the most spectacular growth rate averages of 10% in the 1960s. This trend continued in the 1970s and early to mid-1980s, posting average growth rates of 5% and 4% respectively. During the late 1980s, there was a noticeable increase in terms of real state and stock prices which was due to slackening of monetary policies in the middle of the decade and would later result to over-investment. When the Bank of Japan (Central Bank) tightened measures and increased interest rates to rein speculation of asset share prices in early 1990S, this resulted to an economic slump that would last until 2003, despite government revitalization policies and efforts. Another factor was a marked slowdown of the global economy (Economist Intelligence Unit (b), 2006). PAST ECONOMIC DEVELOPMENT Japan's economic development dramatically slowed down as an outcome of the 1990's asset price bubble. Because of the sharp decrease in the asset prices, the supply and demand mechanisms of the country were greatly impacted. From this period, the government's response to install economic reform was passive, overlooking the need to counter the effects of the surplus in capacity build-up after the bubble economic debacle which eventually led to the sharp cut in its total factor productivity. Monetary and fiscal policies were again alleviated to revive the economy. As a consequence, the fiscal balance shifted to close at three percent of 1991's GDP and proceeded to a deficit of eight percent in the year 2000. To make matters worse, its domestic debt have increased to 130% of its GDP in 2000. There was also a steady appreciation of the yen against the US dollar in the mid 1990s but this was lessened due to fiscal measures (Grimond, 2002). The languished state of the Japanese economy that continued for more than a decade since 1990 became the focused of other world economies, for it had stimulated the continued problems related to non-performing loans (NPLs) and add to the decline of world asset and consumer prices. From 1991, the real gross domestic product has only increased by a measly fourteen percent. In contrast, the GDP of the United States during the same period was pegged at forty-four percent (Grimond, 2002). While there was an increase of 3.7 percent in terms of its consumer price index (CPI) in the particular phase, its CPI continued to drop beginning 1998, a trend that was arrested only in 2003. Accordingly, there was a marked pronouncement of the deflation of asset prices. The country's Nikkei index was greatly affected, plummeting to seventy-nine percent as compared to its crest prices in 1989. Unemployment rate increased to its highest levels in the past twenty-five years, peaking at almost six percent. The scenarios during this bleak period are stumpy investment and consumer growth (EIU (a), 2003) The Japanese economy began to shake off the economic sluggishness it has been experiencing for almost a decade in 2002 mainly because of the combination of several factors: optimistic outside demand, corporate restructuring and aggressive economic reforms. In 2003, output has increased to 2% and 3.25% if public sector inputs are excluded. The surplus in the current account sector was pegged at 3.4% of the annual 2003 GDP and this improvement continued in the following year. This current account surplus was a direct result of extreme saving measures in the corporate sector. With regards to the savings obtained from the corporate segment of the market, the reserves were acquired from repayment of debts and loans while maintaining a conservative outlook in investments (EIU (a), 2003). On the other hand, there was a decreasing trend in the household sector's savings surplus. This contributed to the fiscal deficit of 7.3 of the GDP in the year 2003. The elevated deficit was also caused by a deficiency in tax revenue collections. In terms of trade, Japan continued to still maintain its surplus because of the demand of the Asian markets, thus constituting the major share in of the account surplus. Eventually, the surplus in trade decreased in response to realistic levels when the fiscal adjustments, deregulation of key industries, tax reforms and transition period to a domestic economy was finally completed. In 2003, GDP was at $3.575 trillion and this grew to $3.787 trillion by 2004. Comparatively, GDP per capita was $28,016 and $29, 664 in 2003 and 2004 respectively (OECD, 2006). Source : OECD Factbook 2006 With regards to inflation, price of consumer goods decreased by 0.5% in 2003 and continued to decrease by 0.6% the following year. Consumer price was projected to decrease until 2010. The goods factor of the CPI was not balanced with the ratios of its service component. Because of this, there has been widespread deregulation. Comparatively, the CPI also reveled that Japan's domestic goods are facing stiff competition with imports, resulting in declining prices (OECD, 2006). However, deflation was a recurring problem. . Inasmuch as deflation levels in Japan could be classified as moderate, ranging from -0.8 to 0.2% CPI and 1.5 to 0.6% in terms of deflator indicators (GDP). By 2003, economic indicators point that there was an easing of the deflation levels, in relevance to the CPI side, declining the inflation rates. In the first quarter of 2003, the exchange rates against the dollar swings from 116 - 120 to a dollar. This fluctuation however was not a result of a lessened confidence in the yen, but merely a reflection of the burgeoning US account deficit. By 2004, the exchange rate stabilized to and average of 116 (OECD, 2006). CURRENT ECONOMIC DEVELOPMENT Economic managers in Japan have reported a continuing positive economic recovery by the fiscal year of 2005. The BOJ revealed that 2005 have yielded a stronger economic activity than what was initially projected. In its economic outlook for fiscal year 2006 to 2007 released on the first quarter of 2006, the BOJ have projected that Japan will sustain its positive economic activity and will continue a sustained expansion. The central bank also reported that domestic/external demand as well as its corporate and household segments will continue to be balanced. The BOJ stated that it has isolated the continuing problem of oversupply and that the production gaps have been addressed. Notably, the assumptions of the BOJ were that the stability of the economy for the past four years is expected to reach its maturity and with such, the growth rate would also slowly ease in the direction of the projected growth rate. The central bank also pegged a growth rate forecast of 2.5% for this fiscal year. The BOJ have based its economic forecast on several fundamental assumptions and economic mechanisms: exports, corporate performance and a stronger household sector performance. The BOJ said exports are expected to be on an upward curve due to the ongoing development of overseas economies. The BOJ also noted that the strong corporate performance from fiscal years 2002 to 2005 will also increase. For this current fiscal year, profit to share ratios will exceed even the levels posted during the bubble economy period. However, many firms are cognizant of the rising worldwide competition and are careful in increasing their fixed investment and building capital stocks but this trend is expected to continue declining in deference to the capital stock cycle which reflects the long-term economic revival that Japan is experiencing. The continued strength of the corporate sector is also helping the household sector to gain momentum, augmenting the employment rate and increasing both wages and the stock market. With these developments, the BOJ said that there is a noticeable boost in private consumption. In contrast to these economic developments, the realty sector is only projected to undergo a modest growth for this fiscal year due to the expected increase of current interest rates. The rising prices of housing and land in the central Tokyo are one of the indications of this. In the next years, this is expected to improve, especially when many lending institutions are coming up with innovative financing schemes to attract investors and the falling interest rates of short-term finance mechanisms. Changes in price indicators will be gradual given this current economic outlook which could be attributed to resource utilization, closing of production gaps, increased wages and employment rates and better inflation outlook in short, medium and long terms. With regards to current inflation indices, the BOJ revealed that price of domestic goods exceeded the expectations assigned for fiscal year 2005, the biggest increase since the nineties on a year on year comparison. This change mirrored the weakening of the yen around the last quarter of fiscal year 2005 and the significant increase of world commodity prices. Oil prices and import prices will be significantly influenced by forex rates with its index expected to rise until the next fiscal year. The CPI conservatively moved in line with the previous fiscal year's projections, its changes became positive towards the end of fiscal year 2005 and surged towards the beginning months of 2006 and is expected to sustain the rate but will fall by the start of the next fiscal year; its projected decrease is pegged at below one percent. JAPANESE ECONOMIC POLICIES When its economic bubble burst in the late 1980s and early 1990s prompted the Bank of Japan to respond the beginning of deflation and weakening financial system by decreasing its call rate from 0.43 to 0.25% in the last quarter of September 1998. In March of 1999, the rates were further lowered to near 0%. The succeeding month, the BOJ assured that a zero interest rates will be maintained to dispel deflation concerns. This policy was best known as the zero interest rate policy (ZIRP). This measure allowed the economy to temporarily recover and grow to about 3.3% from the third quarter of 1999 to 2000. The BOJ then decided to lift the ZIRP, however the economy again went into recession brought about by a lowered requirement for high technology products that Japan produces. In 2002, the BOJ initiated the implementation of a Financial Revival Program. One of its agenda in restoring and maintaining a healthy financial sector is to reduce the NPLs of major banks to half by the first Quarter of 2005. So far there was improvement in NPLs of major Japanese banks as the ratios were decreased to only 7% by the target date. However, this improvement was dampened as new NPLs were added to the portfolio of the major banks, an indication of the loan quality deterioration during the economic recession and more stringent bank asset assessment mechanisms (OECD, 2006). The strategic measures that were implemented by the BOJ concentrated more on the creation of monetary alleviation results revolving on an interest rate policy that based on short term, zero rates. Through the ZIRP and revised similar policies, the BOJ aimed at forming a fundamental policy rule that was effective on a short-term basis. However, long-term effects of low interest rates were not given more consideration specifically in the areas of lending and fised investments, thus reducing the net worth of lenders and borrowers (OECD, 2006). Because of the economic slowdown in the early 1990s, the position of Japan's fiscal management is currently at its worst state. As an outcome of slower growth rates, tax revenues were greatly decreased, while on the other hand, there was a significant increase in government spending due to various interests and sectors, resulting in hefty budget deficits. By 1997, the government aimed at reducing the budget deficits and initiated the Fiscal Structural Reform but it was halted and in its place tax reduction and public budgetary outlay were implemented. This was caused by a shift in the political climate and an increased dampening of Japan's economic condition. A large number of government bonds were issued and yet the yields are significantly lower than expected, in fact lower than any G7 country (OECD, 2006). CURRENT MONETARY, FOREIGN AND FISCAL POLICIES The BOJ decided to change its monetary policy in lieu of the current economic projections for fiscal year 2006 to 2007. The bank assumed from the economic indicators mentioned earlier that the Japanese economy will continue to be robust and expanding while on one end continues to have a balanced domestic and external demand. Even with the risk of possible fluctuation of inflation rates resulting from bridging production gaps, the Japanese economy will still be likely to succeed in sustaining its positive growth rate through the implementation of new monetary policies to stabilize current and long-term prices (BOJ, 2006). After five years of implementation, the Bank of Japan concluded the quantitative easing policy on March, 2006. The BOJ modified the current system of using outstanding current account balances to an unsecured overnight call rate pegged at zero percent. Under this new policy, the BOJ decreased the volume of short-term funding facilities, in line with its decreasing outstanding balance of current accounts. Because of these changes in the monetary policy, Japan's short-term money market continues to be steady and there was a noteworthy increased activity in inter-bank transactions. To maintain the stability of its money market, the central bank also monitors the continuing conditions in order to level it towards the required reserves (BOJ, 2006). The aim of the BOJ in implementing the monetary policy changes is to ensure Japan's continued economic development through the stabilization of prices. Under the new monetary framework introduced, the BOJ declared to utilize two approaches in order to properly review its economic action and price movement: take into consideration the dynamics of medium-to-long term price stabilization and from the outcome of this evaluation, the central bank will draw the amendments that is needed to ensure an effective monetary policy (BOJ, 2006). . The monetary policy changes also impacted Japan's foreign exchange market. In the late 1990s, the Bank of Japan placed its foreign exchange market under constant intervention. At the time, Japan is still reeling from the residual effects of the financial crisis brought about when its bubble economy burst. Interventions are usually undertaken by central banks during financial turmoil, but it the case of the Japanese economy, it was also carried out during the time of financial tranquility. Foreign exchange intervention was initiated on a daily basis by BOJ from January 1999 to March 2004. The BOJ intervention was on a large-scale and jacked up in 2003, selling more than twenty trillion yen to exchange for the US dollar - exceeding all recorded foreign exchange transactions in any given country. Considerable market intervention still continued until the first quarter of the 2004 fiscal year, selling an additional fourteen trillion against the USD (Otani, 2006). In 2005, due to a stronger economy and foreign placements and partly due to international currency movement, the weaker yen ignited a rally against the US dollar and pushing its Nikkei index into a five-year high. With the conclusion of BOJ's five-year quantitative easing policy, the central bank announced that it will now tighten the supply of the Japanese yen in the world market without upsetting the revitalized Nikkei and the improving real estate sector. The BOJ also hopes to limit its intervention this current fiscal year until the next (Otani, 2006). . When the government debt ratio peaked at 157% in 2003 implemented further measures to stabilize its spending ratio and bring it closer to its revenue ratio. Ending the BOJ's quantitative easing policy and restraining the supply of yen are among the ways to curb government spending. For fiscal year 2006, the government is still focused in the implementation of the Structural Reform and Medium-Term Economic and Fiscal Perspectives, aimed at restraining its expenditure at a maximum of 38% of the gross national product. With the strong economic performance it is experiencing, Japanese economic managers are optimistic that the government will meet its fiscal target. In addition, budget deficit are expected to decline by 4% for this year due to a robust economic performance and expansion (Von Hagen, 2006). RECOMMENDATIONS To mitigate another recession, analysts have stated that it would be prudent for the BOJ to implement a new and more transparent monetary policy, as the 0 to 2% rates proved to be ineffective in lowering deflation. Furthermore, they stressed that the central bank should also be careful in the implementation of any interest rate hikes in the future. According to them, it would also be more beneficial in the economic future of Japan to opt for measures that will increase interest rates on a long-term basis, as this is can also prove to be advantageous in easing the fiscal situation and bettering the state of the banking sector. However, the economic analysts warned that the BOJ should also be aware that significantly increasing the prevailing interest rates in the market a tad early or too hefty than what the economy could manage at the moment pose risks in the long-term economic and fiscal management of the country (Grimond, 2002) Currently, the monetary and foreign exchange policies that are being implemented should be enhanced. With regards to its foreign exchange, Japan should be cautious in the future since the BOJ, in averting a volatile market in the late 1990s, have flooded the banking system with more than the required yen reserves. Slowly removing the excess yen to only about six trillion is no easy feat and required careful study. To do this, Japan should use the model of Greenspan, tighten its rates without unsettling the newly-invigorated stock and real state markets (OECD, 2006). Japan really needs to focus on making its fiscal position sustainable. The sober status of its fiscal position is limiting its capacity to support its social and poverty alleviation programs (OECD, 2006). On the other hand, unwarranted spending and ensuing fiscal deficits are products of poor coordination in the preparation of the national budget. A cohesive political system is vital in ensuring that a fiscal crisis is mitigated. Similar cases in handling fiscal problems, particularly in the EU have yielded positive outcomes (Von Hagen, 2006). For Japan, budget construction should be all-inclusive; covering the entire government's spending allocations. There should also be an accord among all concerned parties regarding fiscal targets and budget allocation with accompanying accountabilities and responsibilities. It would also be beneficial to focus more on limitations of the budget rather than increments or supplementary budget allocations, ensuring that all parties have a clear understanding of the fiscal position of the country. The Finance department should also have a control mechanism among all government spending. With these, Japan should adopt a firm and concrete fiscal rule and implement subsequent fiscal reforms (Von Hagen, 2006). . CONCLUSION The prevailing economic policies and outlook of the government in the mid 1980s to early 1990s were ill prepared in handling economic imbalances that took effect. Have its then account surplus been managed through corporate restructuring or overseas investments, the government then would have enough stability to counter market forces and Japan would have enjoyed a respectable growth rate. However, counteractive policies and possibilities were never surveyed, as economic managers then misunderstood the need for economic reforms. In the early part of 2000, economic vigor was stalled because of hesitancy and self-interest of its economic managers: miscalculation and preference for a stronger yen by the BOJ while apposing Ministry of Finance managers did nothing to level monetary levels at par with its real savings and employment rate. The same thing could be said of the politicians and other government sectors (Katz, 2005). Excessive corporate investment during the bubble economy pushed Japan to deep financial crisis, its domestic debt swelling to levels that was not aligned to its economic growth. Economic problems were followed by an erosion of public confidence which its government, prompting the public to be wary to take advantage of lowered interest rates being offered. Aggressive economic reforms were pushed in 2002 and by 2003; the economic outlook began to improve, posting a significant growth rate after thirteen years. (Katz, 2005). The introduction of a new monetary and foreign exchange structure and the scrapping of its five-year quantitative easing policy by the BOJ after a continuing economic growth in the past four years have enhanced and revitalized a formerly sluggish economy. With its stock, real estate, production rates on a positive note, Japan still have to face increasing inflation rates (BOJ, 2006) and more importantly managed its government's debt-spending ratios. The adoption of valid fiscal management policies will assure that the economy's performance shall continue its progressive trend (Von Hagen, 2006). REFERENCES Asher, D. and Robert H. Dugger , "Could Japan's financial Mount Fuji blow its top," MIT Japan Program Meeting Proceedings No.1, Cambridge (MA): MIT Press, 2001 Bank of Japan (BOJ). (2006). Outlook for Economic Activity and Prices. Japan. Bank of Japan (BOJ): Institute for Monetary and Economic Studies (IMES). Broda, Christian, and David Weinstein. Happy News from the Dismal Science: Reassessing Japanese fiscal policy and sustainability, Columbia University Press , August, 2004. CIA World Factbook, "Japan Economy", November 17, 2006. https://www.cia.gov/cia/publications/factbook/geos/ja.html Doi, T. and T. Ihori, Fiscal reconstruction and local interest groups in Japan, Journal of the Japanese and International Economies, 2002, vol.16, no.4, pp.492-511. Grimond, John . What Ails Japan - A Survey of Japan, The Economist, 20 April 2002 Hutchison, Michael M. and Fatum, Rasmus. (2006). Evaluating Foreign Exchange Market Intervention (Working Paper). University of California: Santa Cruz Center for International Economics. Katz, Richard. Japanese Phoenix: The Long Road to Economic Revival, Social Science Japan Journal.2005; Vol. 8, No. 2: 155-157 Nagahata, Takashi and Toshitaka Sekine. The effects of monetary policy on firm investment after the collapse of the asset price bubble: an investigation using Japanese micro data, Bank of Japan Working Paper Series, 2002. No. 02-3, Bank of Japan. Organisation for Economic Co-Operation and Development. Economic Survey of Japan. OECD Policy Briefs. 2006. Otani, Akira et al. (2006). Revisiting the Decline in the Exchange Rate Pass-Through: Further Evidence from Japan's Import Prices. Bank of Japan (BOJ): Institute for Monetary and Economic Studies (IMES). The Economist Intelligence Unit (a). Japan Country Report 2003. EIU Country Report, 2003 The Economist Intelligence Unit (b). Japan Country Report 2005. EIU Country Report, 2005. Von Hagen, Jrgen. (2006). Fiscal Rules and Fiscal Performance in the European Union and Japan. Bank of Japan (BOJ): Institute for Monetary and Economic Studies (IMES). Read More