international analysis and commentary

Japan’s economy a year after: post-disaster and post-growth?

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The triple disaster of March 11, 2011 in northern Japan resulted in more than 19,000 deaths and roughly 340,000 displacements. A year after the earthquake, tsunami and nuclear meltdown, the country is still coming to grips with its huge losses; furthermore, it is confronted with the burden of reconstruction and rebuilding, estimated at $238 billion.

In the wake of the tragedy, the fate of Japan’s economy remains uncertain. On the one hand, protracted negative growth, deflation, an ageing society and its high debt burden leave little hope for economic recovery. On the other hand, Japan’s current account is in surplus, the country can raise its consumption tax significantly and it has a comparative advantage in global growth industries such as green technologies and bio-health.

Japan seems to be at a fork in the road. This triple crisis could be a catalyst for a widespread societal upturn, affecting not only economics and politics but the entire Japanese civilization. As the British historian Arnold J. Toynbee argued, “when a civilization responds to challenges, it grows.”

However, Japan’s pressing problems remain vivid. The full decommissioning of the Fukushima Nuclear Power Plant and the decontamination of affected areas will take months and years. With little credibility left after the government’s response to the natural disaster, revitalizing the economy has become a political battleground.

In the last twelve months, public confidence in government has plummeted. Not only because of the inadequate response to the Fukushima crisis but because of political bickering between the ruling Democratic Party of Japan (DPJ) and the Liberal Democratic Party (LDP), which has led to the ouster of former Prime Minister Naoto Kan, and his replacement by Yoshihiko Noda. The structural inability of the government to make decisions because of a “twisted Diet” – the Upper House is controlled by the LDP and the Lower House by the DPJ – exacerbates the public’s disillusionment with Japan’s ruling class. To cite just one example: the supplemental budget to deal with the crisis was not passed until autumn and the Recovery Agency (Fukkouchou) was only opened in February 2012.

In light of this, the testing ground for Noda’s success will be in reinvigorating the economy. Last year’s economic performance was clearly affected by the disasters, with real GDP loss of around 0.9% and the first recorded trade deficit in more than 30 years. Exports, which increased 24.2% in 2010, increased just 0.02% in 2011. The strong yen, the floods in Thailand and a shrink in demand caused by the European debt crisis also had a negative impact on Japanese exports. 

However, Japan’s key economic constraint are its public finances. The country already had a high national debt – running at 200% of GDP prior to the disasters – and that has been further inflated by a $175 billion budget for recovery. On top of this, Japan has a very low fertility rate and the highest life expectancy in the world, severely straining its welfare state system: as pension contributions increase the debt burden expands further. The positive note is that Japanese debt is almost entirely held by Japanese individuals and institutions, preventing any significant speculative attacks from international financial markets. Thus, although Japan’s debt is unsustainable in the long run, it is somewhat insulated from the risk of default akin to those orchestrated by creditors in Greece and Italy.

To reduce this unsustainable debt burden, the government will necessarily have to undertake fiscal consolidation and impose higher taxes. Already, there are signs that the Noda government will seek to push through a much needed tax reform by raising the current consumption tax from 5% to 10% by 2015. This tax hike will be fought over in the Diet, and some suggest that the outcome of this battle will determine the Prime Minister’s political future.

On top of reforming public finances, the government’s economic priorities must lie in continuing to open up Japan’s economy, by increasing trade, by creating incentives for growth industries such as agriculture, biomedical healthcare, education and by securing safe energy supplies.

To open up Japan’s economy and increase trade, Prime Minister Noda’s decision to tentatively join the negotiations for the Trans-Pacific Partnership Free Trade Agreement (TPP FTA) is a step in the right direction. Although the negotiation process will take years, it might have the valuable effect of urging other major trading blocks such as the EU or even China to consider creating a free trade agreement with Japan. Should indecision and risk aversion continue to reign in Tokyo, however, Japan will lag behind its Asian counterparts in terms of economic openness. As Japan is an integral part in the so-called Asian supply chain, it is paramount for the Japanese economy to create a favorable trade environment.

The Japanese government has also launched a “rebirth strategy” centered on strategic sectors such as education, nursing care, agriculture and energy. A policy to reform the university calendar, for instance, intends to bring Japanese schools in line with universities of the northern hemisphere: this should help attract more foreign students and internationalize Japan’s universities. Moreover, policies have also been adopted that aim to increase environmental sustainability and green energy practices, such as promoting smart grids, smart meters and hybrid cars.

Of course, one of the greatest challenges Japan faces is that of securing a stable and affordable energy mix. A nuclear-free future in Japan is not as obvious as it may seem, especially if the electric utilities’ regional monopolies (like TEPCO) are not broken up. Increasing use of liquefied natural gas (LNG), investments in large-scale solar and offshore wind farms, and geothermal energy are the alternatives Japan has if it wishes to decouple itself from the volatile global energy market.

Overall, Japan’s economy is fundamentally solid and resilient albeit with a debt burden that needs to be addressed. The immense disasters of a year ago may fuel a new “post-growth economy”, but what form such an economy may take remains to be seen.