January, 2006

 

－FY2005-FY2006 Economic Situation Report－

 

Outlook of the Japanese Economy in FY 2006 (A follow-up)

 

We presented the "Forecasts for the Japanese Economy in FY 2006" in the final section of "Report of the Economic Situation, FY2005-FY2006" issued in October last year. This follow-up is based on changes in the economic situation since then, including the extensive revision of the underlying statistical data and the finalized government budget draft for fiscal year 2006.

 

 

1. State of the Economy

 

In the first half of fiscal 2005, the Japanese economy picked up from a sluggish second half of the previous year to post strong real economic growth of 4.1%. If the economic expansion phase that began from a bottom in January 2002 continues to January 2006, it will mark 48 consecutive months of growth, far exceeding the averaged growth period of about 33 months since World War II. If this trend continues, in April this year it will reach as long as the bubble economy (51 months) and in October as long as the so-called Izanagi expansion period (57 months), the longest period of postwar growth.

 

Despite the prolonged economic expansion, corporate revenues and incomes continue to improve. The economies of the United States and China, Japan's major export markets, continue to grow and there are no visible threats to the economic trend predicted in October last year, despite rising crude oil prices. Thus, the Japanese economy looks set to grow further in the second half of 2005. Throughout FY2005, the economy is expected to achieve a rapid real growth of 2.6% over the previous fiscal year.

 

Nevertheless, we expect the nominal economic growth rate to remain low owing to the expansion of the nominal import amount, and the GDP deflator will decline steadily contrary to the trend of domestic corporate goods prices. Wages have just started to recover, while corporate labor costs have stayed remarkably low compared to current profits (Figure 1). As a result, labor's share dropped by fiscal 2004, to a level that was lower than during the bubble economy. This level remained flat (Figure 2) in fiscal 2005 perhaps affected by the expansion of atypical employment and the accumulated effects of wage revisions that do not reflect improved productivity. On the other hand, most of the current profits were used to compensate for special losses. The process of disposing of non-performing loans is almost complete and companies' net income has reached extremely high levels (Figure 3). Corporate assets of some companies exceeded the total market value of own stocks and they are pursuing ambiguous capital policies in order to prevent hostile takeovers. Companies which are holding on to excessive profits should distribute them to household income to ensure stable general economic growth.



2. Outlook for FY 2006（Attached Table：Economic Model Simulation by RENGO-RIALS）

 

The economic outlook for fiscal 2006 remains largely unchanged since last October's announcement. We consider that the spreading effect of further depreciation of the yen since then will boost the economy through the end of the next fiscal year. The labor participation rate now seems to be recovering and the labor force and number of employed persons are expected to grow accordingly next year. As mentioned above, prospects are slightly brighter than at the time of the last announcement.

 

As the prospects largely depend on the results of wage revisions again, we provide below two potential cases.

 

(1) Wage revision reflecting improved labor productivity to be achieved (Case A)

If the wage revision properly reflects the rate of increase in labor productivity (i.e. approximately 3% pay raise), the economy will expand steadily with greater investment and consumption, while overcoming the effect of a steep rise in crude oil prices. We will achieve real growth of 2% or more. The unemployment rate will be lower than 4% through the second half of the fiscal year, reflecting tighter supply and demand of the workforce. Continuous expansion of individual consumption will contribute to stronger demand in local districts and for small and medium-size enterprises whose share of consumption goods is large, thus helping to resolve problems relating to regional as well as company-scale differentials. The supply-demand gap, which widened during the prolonged stagnation, will be narrowed. The GDP deflator data suggests that deflation will end and the nominal growth rate is set to exceed the long-term interest rate. A higher nominal growth rate is particularly important for long-term sustainability of the Japanese government finance. Labor's share will improve slightly.


(2) Delayed improvement of household income (Case B)

However, if the wage revision is restrained to as low as 1% or so, the real growth rate will remain low compared to fiscal 2005. Due to the buoyancy of the economy in fiscal 2005 and the expected growth of exports driven by the lower yen, a relatively high growth rate of 1.6% may be achieved throughout the year, but consumption will lose the support of income again in fiscal 2006. As analyzed in Part 2, Chapter 1 of the Report on the Economic Situation, the current level of consumption is maintained mostly by a rise in consumption propensity of the household. Accordingly, even if the consumption level in FY2006 remains almost at the same level for some time owing to the ratchet effect, the level cannot be sustained if incomes do not catch up. Partly because of the situation, the economy will surely stall toward FY2007, and may even turn toward recession. When the economy enters such a sluggish phase, the GDP deflator will remain negative (-0.2%). Even after experiencing a fairly long period of expansion, the GDP deflator will not turn positive which is required for financial sustainability. Thus, the economy will enter recession and labor's share of national income will fall again.

 

The Japanese economy has almost come out of the long tunnel. However, to resolve the accumulated negative assets including the huge amount of outstanding public bonds, as well as the unemployment of young people and jobless or NEET people, the benefits of the economic recovery should not be limited to the corporate sector. We must distribute the benefits to households to achieve stable growth both in real and nominal terms. An appropriate wage revision reflecting labor productivity must be achieved at the spring labor offensive in FY2006 as the first step towards that goal.

 

 

(Note) Outline of the revision of statistics

In December 2005, the Cabinet Office changed the base year of the GDP statistics from 1995 to 2000. Accordingly, the actual figures of GDP-related statistics have changed. The real GDP growth rate was 1.9% for fiscal 2004, but was adjusted downwards to 1.7%. Adjustments of figures were not always downward, and the sizes of the changes were small in most cases. What is noteworthy, however, is the downward adjustment of labor's share. The current share, as calculated by dividing nominal employee remuneration by nominal GDP, was a little higher than the level during the bubble economy according to the 1995 standard, but was reduced to the lowest level of the bubble period according to the 2000 standard.

The data of total cash pay and total actual work hours were taken from establishments employing 5 persons or more, not 30 persons or more in the previous standard.

 

In addition, we changed the data for the model of Rengo-Soken (RENGO-RIALS (TUC Research Institute for Advancement of Living Standards)) for prediction according to the change of GDP statistics which had been in progress since the last fiscal year to the chain index method and made estimates without changing the mathematical functions. This reduced the estimated time taken how the change of household income affects private final consumption.