Report of the Economic Situation, FY2005-2006
"A Path toward Improved Life and Stable Growth"
－Forecasts for the Japanese Economy in FY2006－
RENGO-RIALS released its Report on the Economic Situation in FY2005-2006
at its 18th forum on October 26, 2005. This paper introduces the "Forecasts
for the Japanese Economy in FY2006."
1. State of the Economy
The Japanese economy continued to fluctuate between growing and retreating
due to stagnant exports as well as consumption in the latter half of 2004.
The growth of private non-residential investment also receded. However,
corporate profits remained high during the period and private non-residential
investment has regained strength since early 2005. Wages, which had continued
to decline owing to the swelling share of part-time workers, have now started
to increase accompanying the rise in employment, and employees' income
has started to rise. Private consumption has also started to grow.
Domestic corporate goods prices have been higher since mid-2004 compared with the same month in the previous year, because of a steep hike in the prices of primary products centering on crude oil, and the trend looks set to continue for some time. Affected by the narrowing gap between supply and demand in general and increasing prices of petroleum-related products and relevant charges, consumer prices are expected to rise by the end of the year.
The world economy grew strongly in 2004, overcoming the price rises of crude oil and other primary products, and since early 2005 the economy has been steadily expanding in general. Reflecting global inventory adjustments in the IT industry, Japan's exports were sluggish from mid-FY2004, but as IT-related inventory adjustments have ended and triggered by the expanding world economy, exports from Japan are expected to rise again gradually. However, affected by some factors including a hurricane, which hit the southern part of the US at the end of August, there is great concern over a further steep rise in the price of crude oil.
Under these circumstances, the economy in FY2005 is expected to continue to expand centering on domestic demand such as private non-residential investment and private consumption. Meanwhile, the nominal growth rate is expected to decline by the expanding nominal import amount due to the soaring crude oil price, and the GDP deflator will continue to decline in contrast to domestic corporate goods prices.
2. Situation of FY2006
As the economy enters a recovery phase, the real economic growth rate
is recording an annual average of 2.3%1) , slightly beyond the potential growth rate. However, overheating is not perceived for the economy as a whole, and the high growth rate can be maintained for the time being. The break-even point ratio is declining as well, as the financial situation of companies improves. In the coming fiscal year, the booming corporate sector is expected to drive the Japanese economy forward by expanding private non-residential investment.
In addition, an increase in household income will strengthen the purchasing power of consumers, although increased taxes and a heavier social security burden will dampen consumption. A halving of the flat-percentage tax cut is already included in this year's budget and the temporary tax cut is set to be abolished entirely in next year's budget, which will absorb a significant portion of the growth of household income that would otherwise have materialized. Accordingly, disposable income is not expected to increase unless wages increase substantially. While the wage raise this year is held to a small 1.7% even including the regular pay raise, the flat-percentage tax cut may decrease tax revenues by about 3.3 trillion yen, according to the government's estimate. This amount equals 1.3% of employees' income. Therefore, a higher wage raise is necessary next year to maintain the steady expansion of household consumption.
Furthermore, although the world economy is expected to be favorable in general, there are some major uncertainties for the future. Concerning crude oil prices, there are no signs of the tight supply and demand situation easing. Moreover, there are some concerns that the prices of other primary products will rise. The world imbalance of current accounts is not likely to improve, and there are growing fears of a drastic adjustment accompanied by sharp currency fluctuations. There were many uncertainties at the time of drafting the present forecasts, relating to the hurricane, including how long the high gasoline prices will continue and how large the reconstruction demand will be in the U.S. The possible bursting of the housing bubble mainly in the US is another concern. Although the Chinese economy may avoid stalling owing to increased exports, it requires a slowing-down.
3.Forecast for FY2006（Attached Table：Economic Model Simulation by RENGO-RIALS）
As stated above, FY2006 also will see economic expansion according to published economic data available so far, although there are major uncertainties regarding the world economy. However, our economic forecast may greatly differ depending on the wage revision level which will be determined during next year's spring labor offensive. Here, we assume the following two scenarios.
(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. A real growth rate of about 2%, exceeding the potential growth rate, will be attained. The unemployment rate will be below 4%. 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.2)
(2) Delayed improvement of household income (Case B)
If the wage revision does not progress but remains at about 1% rise, the
real growth rate also will be lower than the rate in FY2005. Even if a
relatively rapid growth of 1.7% is recorded owing to generally buoyant
business in FY2005, individual consumption will not be supported by the
income level again in FY2006. 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 overcome the accumulated problems of huge outstanding public debt and the unemployed or NEETs among young people, an appropriate balance must be kept between each economic sector -- enterprises, household income and government finance -- to attain stable economic growth. An appropriate wage revision reflecting labor productivity must be achieved at the spring labor offensive in FY2006 as the first step towards that goal.
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1) The average between the first quarter in 2002 and the second quarter in 2005.
2) Even if balance is restored for basic public finances, outstanding debt will increase due to the payment of interest. However, if the nominal GDP growth rate exceeds the nominal interest rate, the growth of the nominal GDP will exceed the increase in debt balance, leading to a lower ratio of debt balance to nominal GDP.