The DPJ’s difficult task ahead
The DPJ is in power but is it really a chance? Japan is facing one of the worst recessions in decades and the government has very little room to implement reforms. It is agreed among economists that Japan is facing four big problems: growth has been poor, deflation is back, demographic are bad and public finance are terrible.
The current economic situation is looking somewhat like the 1990’s with a pick up in the inventory cycle after the trough of 1Q09. The rebound should stay through 2010 and beat most of GDP growth expectation but it is only a short term recovery with many difficult quarters that will follow. Right companies’ profit forecasts are on the rise since visibility has reappeared somewhat in the market.
Like the 1990’s the cyclical upswing is just a technical rebound after a period of strong fear from market participant and companies. However, growth is not expected to pick up over the next few years given the very high unemployment rate and the high level of countries’ debt, which will have to be reduced through fiscal policy probably.
Macquarie’s economist, Richard Jerram, raised his concerns with the DPJ’s political strategy: “The DPJ seems less encouraging in terms of growth, deflation and public finances. The intention seems to be to continue to re-regulatory drift of the past few years, and we are particularly concerned about the talk of labour market regulation that will further reduce the flexibility of the labour force. Environmental policy and government intervention in credit allocation are also areas that may hurt growth. On deflation, it is hard to see much changing. The large (albeit shrinking) output gap combined with the BOJ’s tolerance of moderate deflation implies another multi-year period of falling prices.”
The high net debt to GDP ratio (close the 100%) is set to rise in coming years. It is probably the most troublesome issue the DPJ will face, especially since the decrease of the debt level was one of the important promises the DPJ told his supporters. Taxes are at a very low level versus GDP but historically an increase of taxes during a recession (or a difficult economic time) faces strong headwind in general. Therefore, it will take a few quarters before the new government can increase taxes.
If taxes cannot be increased, then the DPJ should hope for strong economic growth to decrease the debt level. But can Japan really enjoy a long period of strong growth? Over the past 20 years, Japan has struggled with an average Real GDP Growth of 1.2% and there has been no nominal growth for the past 17 years. What really poses a threat to GDP growth is demographic. It was demonstrated that population growth accounted for two-thirds of the US GDP growth the past two decades. Thus, if Japan does not change its political view on immigration, it is unlikely the country will enjoy a long period of GDP growth.
In conclusion, the DPJ is facing a difficult task. The country is under the threat of deflation and there is little flexibility for the government to use either fiscal policy or monetary policy. 2010 will tell us if the DPJ has what it takes to revive Japan’s power on the international scene.