Japan’s GDP Bump Is Real but Fragile

Japan’s economy roared ahead in the second quarter, posting growth at an annualized 6 percent rate, one of the best figures that the world’s third-largest economy has seen since the mid-1990s and good enough to make it the top performer among major global economies. The GDP growth rate was more than double the estimates by economists and seemed too good to be true.

And in some respects, it was a technical boom with some help from a post-COVID-19 bump, rather than a real one. But in other ways, Japan’s economy is picking up wind after decades in the doldrums. The figures were also good enough to send economists back to their spreadsheets, with private-sector estimates for growth this fiscal year ending in March now around 2.0-2.5 percent, roughly double previous forecasts.

Ever since the mid-1990s. Japan has been the poster child for an underperforming economy. Dragged down by deflationary pressures, it has been stuck in a rut, with growth generally flatlining at 1.0-1.5 percent. While much of this was caused by the drag of slowly but steadily falling asset prices for much of the past 30 years, it also reflected Japan’s role as the leading “mature economy,” an unenviable club that now includes most of its G-7 partners.

Such economies are characterized by slower growth than developing economies, since more affluent people spend a lower percentage of their income and the big infrastructure spending needed to create an industrialized economy has already passed, creating more limited room for future growth. For Japan and the others, this is exacerbated by a declining population with a diminishing number of young people, typically the biggest discretionary spenders in any economy.

And yet, stagnant as the Japanese economy was in some ways, life wasn’t so bad. Even as growth faded away as a concept, the government continued to keep public infrastructure at a world-leading level and companies, while slow to hire new people in good times, also showed they would not fire in bad ones. Unemployment peaked at 5.5 percent in 2002. Today, the jobless rate is just 2.7 percent, and there are 1.3 jobs for every one of the (declining) number of job seekers as the population inexorably shrinks.

College graduates in Japan, in stark contrast to their Chinese counterparts, have little to fear about finding a full-time staff position when they graduate. With high job security, mandated health insurance, and the other perks from a staff job, they do not have to wrestle with the uncertainties of a gig economy. If necessity is the mother of invention, then perhaps it’s no surprise Japan isn’t innovating.

So, what was behind the apparent surge in economic activity? Part of it was several technical factors within the methodology used to compute the GDP—but some positive signs for the future also played a role.

One of the biggest drivers of growth in the latest data was a boom in exports coupled with a decline in imports. Within this, exports are counted on the plus side, while imports are a negative. In a classic model, a country imports items at a cost and then exports things of higher value, adding to the wealth of the nation. Therefore, Japan’s Q2 rise of 3.2 percent in exports coupled with a 4.3 percent fall in imports would normally be a timing issue. At some point, imports will need to go up again to restock the items that have been sold abroad. This is where a single quarter’s statistics can be particularly misleading.

But for Japan, a big factor in the export column is something that doesn’t seem to be an export, namely the arrival of thousands of tourists from overseas. As any wanderer in the fashionable neighborhood of Ginza can tell you, foreign tourists are back with a vengeance. The number of foreign tourists in Japan shot up more than 1,600 percent from COVID-hit levels a year before, reaching nearly 2.1 million in June. That is four times the level when Japan launched a big overseas tourism push in 2012. A roughly 33 percent fall in the value of the yen over the past decade has made Japan an international bargain.

There is considerable room for further growth, since the numbers do not include China’s Aug. 10 decision to again allow tour groups to travel to Japan, although a new spat over Japan’s decision to release wastewater that has been used to cool the Fukushima nuclear power plant has put that back at risk. Before the COVID-19 pandemic, Chinese visitors made up the largest share of international tourists and were also among the highest spenders per person.

Lower consumer spending was a weakness cited by economists, a figure that has a sizable impact on overall domestic demand. Part of this is due to the recent (and long-sought) resurgence in inflation, now running at around 3 percent. but here again the picture is mixed. Other government data shows that consumer confidence has been rising for the past eight months and is now at its highest since December 2021. In addition, the GDP figures show that wage increases finally seem to be catching up with rising prices as workers demand more money. Real wages were up 0.6 percent from the previous quarter, the first gain in more than two years.

The bigger question is whether all this represents business as usual for the Japanese economy or a fundamental shift, and on this, most economists are of two minds.

“The story of de-risking from China is a long-term one, but for now, we are not seeing any impact on the data, to be honest,” said Kentaro Koyama, the Japan chief economist at Deutsche Securities.

On the positive side, investment is rising, both among Japanese and foreign companies as a weak yen, good infrastructure, and surprisingly low labor costs make it more attractive. Adding to the appeal of investing in Japan is the fact that it is not China (which U.S. firms increasingly condemn as “uninvestable”), but still a well-situated country in East Asia with a healthy dose of government cash available to help.

Prime Minister Fumio Kishida has made the return of Japan’s once-powerful high-tech manufacturing base a priority as part of his “new form of capitalism.” Subsidies have included government grants of 476 billion yen ($3.2 billion) to chip powerhouse Taiwan Semiconductor Manufacturing Company (TSMC), to build its first Japan plant, with a second facility in the works. TSMC officials say privately that while a similar facility in Arizona is behind schedule and over budget with higher-than-expected labor costs, the one in Japan is on schedule and at the projected cost.

Others are joining. Sony is building a new image sensor plant near the TSMC facility while U.S.-based Micron Technology will invest up to 500 billion yen ($3.4 billion) in Japan over the next few years, including expansion at its Hiroshima plant, while semiconductor equipment maker Applied Materials has recently announced plans to hire over 800 new engineers for its Japan operations.

More significantly, Japanese companies are also looking closer to home. “For the past 20-30 years, Japanese companies’ capital investment into Japan was relatively low, especially for manufacturers. But recently the situation has changed going forward amid the change in the geo-political situation,” said Deutsche’s Koyama. He noted that data from the Bank of Japan shows that major Japanese firms plan to increase their capital spending by 13.4 percent this year, a higher figure than they planned on just three months before.

There are, of course, potential storm clouds on the horizon. Japanese economists agree that the pace of future wage increases, especially next spring’s union negotiations, will be a major factor in improving future domestic demand to keep growth from sputtering out. “Consumers expect that wages will increase further next year. So that kind of expectation is supporting consumption,” said Takahide Kiuchi, a former BOJ policy board member, now with the Nomura Research Institute in Tokyo. “However, if the wage growth is disappointing next year, that could mean a decline in consumption.”

Another key issue for Japan is in opening up a labor market still dominated by lifetime employment. Here again, the government has launched yet another program to increase labor mobility, arguing that companies will not raise wages for people who are not at risk of leaving. While millennials in Japan demonstrate some of the free and easy approach seen in millennials elsewhere, it is not clear that this new program will succeed any more than the string of other initiatives dating back a decade. Mid-career job changes remains the exception with workers opting for security over higher paychecks.

The other gorilla (or dragon) in the room is China, which poses multiple risks for Japan’s economic growth. The most pressing issue is the potential impact of China’s stalling economy on Japanese exports. Even as the government promotes onshoring and de-risking, China remains Japan’s biggest trading partner, accounting for 20 percent of all Japanese exports.

In the longer term, the risk shifts to geopolitics and the chance of a military conflict over Taiwan. Not only would this likely hit exports to China, it could also affect exports to Taiwan, which is Japan’s fourth-largest export market.

Added to that is the supply chain chaos that would come from a stoppage in Taiwan’s semiconductor production. Kiuchi estimated this would alone cut 3 percent off Japan’s GDP.

It may not stop there. If Japan is dragged into the conflict, which appears increasingly possible given the military logistics that put war on Japan’s doorstep, trade with the rest of Asia could be threatened, a risk to 50 percent of all of Japan’s trade.

“In case of an incident in Taiwan, the possible negative impact on the Japanese economy could be unprecedented,” Kiuchi said.

But if all this can be averted, the outlook is actually bright, he reckoned. “Japan’s economic share has been declining for many years, but the government has implemented a high-growth policy, and that offers the chance for Japan to improve its presence in the world economy.”