Home truths in Japan's fall from grace

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The Independent Online
TOKYO - Friday was a good day, or maybe a bad one depending on your point of reference, to be in the Ministry of Finance in Tokyo. On the wall of the office of one of its top officials was a large electronic panel showing what was happening on the markets. As we spoke, the Nikkei index had plunged to below 13,000, its 5 per cent fall the worst performance this year - and that after a fall on Thursday, despite a cut in Japanese interest rates.

Elsewhere in Tokyo, the statistics for the economy in the three months to end-June were published: minus 3.3 per cent at annual rate. That follows a decline of 5.2 per cent the previous quarter and a smaller one the quarter before.

Will things get better now? Well, also on Friday the Bank of Japan, not an organisation known for excessive gloom, said in its monthly economic report that the economy was likely to continue to deteriorate. Conditions were insufficient for a recovery in domestic demand. There were also a raft of dismal company developments, including a warning by Toshiba that the collapse of semi-conductor prices would force it into loss, and that it was cutting some 6,000 jobs as a result.

My attention, however, was drawn to a rather different number on the screens: the yen. It had risen by 3 per cent against the dollar. That was a cause for clear satisfaction. The MoF, it was made very clear to me, would like a weaker dollar, not just against the yen but more generally. It does not see yen depreciation as a way of pulling Japan out of its present slump. What it wants most, it seems, is lower dollar interest rates. Its outlook for the economy is similar to that of the Economic Planning Agency, which does the official forecasting in Japan. Its forecast is for zero growth in this fiscal year, the one that runs to the end of April 1999, plus or minus 0.5 per cent.

Surely there is a bigger risk on the downside, I asked? But no, The MoF thinks it should be all right. The last fiscal stimulus should be starting to have a direct effect on the economy, and the tax cuts to come would soon have an indirect effect on demand, too, it thinks. Meanwhile, the authorities were soon to tackle the problems of the banking system - in particular the problems of the big bank most under threat, the Long-Term Credit Bank.

The MoF is right there; the rescue plan was being blocked by the opposition, which controls the upper house of the parliament. But just this week it relaxed this position on the grounds that the threat to the banking system was so serious that action had to be taken immediately. So it will allow the government to go ahead with a rescue - while taking no responsibility for whatever the government chooses to do.

On the wider issue of the economy, though, the doubts rise. The trouble with the MoF's relatively sanguine view of an economy that stays flat and does not fall further into recession is that no one seems to believe it.

For a rather different perspective, I went across town to the offices of a specialist economic consultancy, Nakamae International Economic Research. Its founder, Tadashi Nakamae (whom I should acknowledge is a friend and collaborator), has been stunningly right on his recent forecasts for the economy and the yen. He has called both the scale of the recession and the collapse of the yen with remarkable accuracy.

So what will happen next? Forget about the zero growth: Mr Nakamae expects minus 2.5 per cent growth this year and minus 2.5 per cent again in 1999. Since the economy also declined last year, he is predicting three years of decline.

We are looking at a recession both longer and deeper than that which Britain experienced in the early 1990s. The risks, he believes, are on the downside; things are more likely to turn out worse than the forecast, not better.

To many people this will all seem something of a puzzle. The yen has fallen sharply and Japan is devastatingly competitive, being not only the world's largest creditor nation, but adding to that surplus every month at a record rate. Why can't it use a combination of increased exports and cuts in interest rates to engineer a boom, as we did in the early 1990s?

The trouble is two-fold. Exports overall are doing perfectly all right, though exports to East Asia have been pretty dreadful. But exports are only 10 per cent of GDP, less than half the proportion in the UK. Because we see so many Japanese exports on the streets and in our homes we tend to forget that they constitute a very small part of the economy. So it is not big enough to pull the whole economy along.

The second problem is that you cannot cut rates as they are already close to zero. There was that cut in the Bank of Japan lending rate this week. But with money market rates of a quarter per cent or so, and even the mortgage rates of only 2.5 per cent, that is still not enough to pull things up. That 2.5 per cent rate might sound wonderful, but it is not if home prices are falling by 10 per cent a year.

Deflation - falling prices - is demonstrating how Japan has been investing far too much and accordingly investing it unwisely. Mr Nakamae points out that the peak investment rate, reached in 1991, was 20 per cent of GDP. It has now fallen to 14.4 per cent of GDP, and should fall, on his calculations to about 10 per cent. Once that happens, there is the basis for recovery.

The good news - and there is light at the end of the tunnel - is that a sound recovery should take place in Japan in the year 2000, though for that to happen there will also have to be tax reforms - cutting rates and closing loopholes - and a banking reconstruction. Non-financial businesses in Japan make up nearly two-thirds of the economy and they are mostly in very good shape. That two-thirds will pull everything else up, once the backlog of past financial errors has been worked off. Sadly, that will take time.

Meanwhile, what does this mean for the rest of the world? The root of Japan's economic problems are particular to the country; we have not over- invested in the same way (we may even have under-invested) and our banks are in good shape. But understanding the odd paradox that a rich country with enormous overseas assets and wonderful companies can have the weakest economy of the G7 nations is important to us for three reasons:

First, Japan is not going to be able to help much in the short term to get the rest of East Asia back on its feet. Even if the official forecasts were right, it would not be of much help - and they do look too optimistic. That is disturbing.

Second, we should not underrate Japan in the medium-term. It has enormous underlying economic strengths which tend to get overlooked on a day like last Friday.

Third, its experience of falling prices is enormously important to us, for we may well be heading down the same road in a few years to come.