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Figure 10. Saving-investment balances by sector

Figure 10. Saving-investment balances by sector

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Macroeconomic developments and key economic challenges



37



corporations was covered by household savings of around 6 per cent of GDP. With

total private-sector saving exceeding the small government deficit, Japan

recorded a current account surplus averaging 2.4 per cent of GDP in the first half of

the 1990s. The external surplus remained at around the same level during the

second half of the decade despite dramatic changes in saving patterns. First, as

noted above, the government budget deficit widened considerably, averaging

nearly 7 per cent of GDP between 1996 and 2001. Thus, there was a deterioration

equivalent to 6 per cent of GDP. Second, this was nearly matched by the decline in

net borrowing by the non-financial corporate sector to zero as it reduced

investment.12

Prospects in the short and medium term

With a 2.8 per cent rise in output in the first half of 2003 (seasonallyadjusted annual rate), the economy has recorded six consecutive quarters of positive growth. The pick-up in growth was accompanied by an exceptionally large

decline – more than 7 per cent at an annual rate in the first half of 2003 – in the

deflator for business investment. If the decline in the deflator were overstated, it

would exaggerate the rates of growth of both business investment and GDP.13 The

key question is whether this upturn will prove to be more durable than that

of 1999-2000, which recorded only six quarters of positive growth before the recession

of 2001. One positive factor is the pick-up in the world economy since mid-2003,

which is boosting Japanese export growth. Further increases in corporate profits

are likely to sustain business investment, while the one-third rise in the stock

market since its trough in March 2003 reduces the risk of instability in the banking

sector. Moreover, it may provide a positive wealth effect for households and reduce

fears of further declines in employment. The wealth effect, combined with further

gains in real disposable income should sustain private consumption. In sum, output

growth is expected to reach around 2¾ per cent in 2003, the highest since a similar

rate was achieved in 2000, with the upturn continuing into 2004 (Table 2).

However, the weakness of the non-manufacturing sector in Japan’s dualistic

economy may limit the improvement in the labour market, slowing the pace of growth

to around 1¾ per cent in 2004 and 2005. Moreover, investment growth may slow in the

latter half of 2004, in line with the long-run declining trend in the investment rate,

while the effort to reduce the budget deficit requires cuts in public investment. Nevertheless, the further narrowing of the output gap may help to reduce deflation, as

measured by the GDP deflator, to around ½ per cent in the second half of 2005. There

are a number of risks, though, that could limit the pace and durability of the expansion. A sharp appreciation of the yen could slow growth while strengthening deflationary pressure. The outlook for the Japanese economy will depend importantly on the

strength of the rebound in world trade. Other risks include the emergence of larger

risk premia in interest rates and other strains associated with rising public debt.



© OECD 2004



OECD Economic Surveys: Japan



38



Table 2. Short-term outlook1

2003

2002



Demand and output (volumes)

Consumption

Private

Government



2003



2004



2005



1.1

1.8



1st

half



1.1

0.7



2004



2nd

half



1st

half



2nd

half



0.4

3.4



1.3

1.6



1.2

1.5



1.1

1.9



1.0

2.0



5.0 –1.1

4.0 –13.4

0.4 –0.8

6.2

3.3



–1.1

–8.4

–2.0

1.8



0.3

–1.7

–2.0

1.4



0.6

–1.0

–2.0

1.5



0.2



0.1



0.1



1.3

2.3



1.1

1.6



1.1

2.0



Gross fixed investment

Public2

Private residential

Private non-residential



–4.7

–4.9

–4.8

–4.7



4.4

–7.0

–1.9

10.3



0.2

–8.3

–1.4

3.5



Stockbuilding3



–0.4



0.2



0.1



0.1



0.0



–0.3



Total domestic demand



0.0

5.6

–3.5 –10.3

–2.0 –3.1

1.5 14.0



2005



0.3



1st

half



2nd

half



–0.5



2.3



1.1



1.0



2.2



1.8



1.0



0.9



1.1



1.2



Exports of goods and services

Imports of goods and services

Net exports3



8.1

2.0

0.7



7.5

4.5

0.5



9.5

5.2

0.7



9.8

5.1

0.8



6.3

1.1

0.6



6.0

5.7

0.2



10.9

5.0

0.8



10.1

5.0

0.8



9.8

5.2

0.8



9.7

5.2

0.8



GDP



0.2



2.7



1.8



1.8



2.8



2.0



1.8



1.6



1.8



1.9



–1.7

–1.6

–1.5



–2.5

–2.2

–1.4



–1.3

–1.3

–0.6



–0.8

–0.7

–0.4



–3.0

–2.7

–1.5



–0.8

–1.0

–1.1



–1.6

–1.4

–0.5



–1.1

–0.9

–0.4



–0.7

–0.6

–0.4



–0.5

–0.5

–0.3



5.4

–3.2



5.3

–1.9



5.2

–1.5



5.0

–1.0



5.4

–2.0



5.3

–1.8



5.3

–1.6



5.2

–1.4



5.1

–1.1



5.0

–0.9



Inflation and capacity utilisation

GDP deflator

Total domestic deflator

Private consumption deflator

Unemployment rate

Output gap

Memorandum items:

Net government lending

(% of GDP)

Gross debt

Net debt

Short-term interest rate

Long-term interest rate

Current account (% of GDP)



–7.1 –7.4 –6.8 –6.9

147.3 154.6 161.2 167.2

71.8 79.1 85.7 91.7

0.1

1.3

2.8



0.0

1.1

2.9



0.0

1.7

3.6



0.0

1.8

4.3



1. Assuming an exchange rate of 111.2 yen to the dollar.

2. Including public corporations.

3. Contribution to GDP growth.

Source: OECD, OECD Economic Outlook 74 (November 2003).



Japan’s growth prospects over the medium term appear mediocre as its rate

of potential growth has slowed from 4 per cent in the second half of the 1980s to

around 1 per cent at present (Figure 11). One key factor in the slowdown was the shift

of labour inputs from a positive to a negative contribution since 1991. This reflects a

reduction in hours worked and a fall in employment since 1998, which resulted in a

higher unemployment rate, despite a declining working-age population. A second,



© OECD 2004



Macroeconomic developments and key economic challenges



39



Figure 11. Potential growth

Per cent



Per cent



5



5

Labour productivity

Labour input

Potential growth



4



4



3



3



2



2



1



1



0



0



-1



1982



1984



1986



1988



1990



1992



1994



1996



1998



2000



2002



2004



-1



Source: OECD.



more important factor has been a deceleration in labour productivity growth from a

peak of almost 4 per cent to around 1½ per cent in recent years.

Looking ahead, there is unlikely to be any significant pick-up in labour

input that would boost the rate of potential growth over the medium term.

Indeed, the working-age population is projected to continue falling, at a rate of

0.4 per cent annually (Table 3). This may be largely offset by a continued trend

rise in labour force participation, even though Japan’s rate is already 3 percentage

points above the OECD average. However, working hours, which remain 10 per

cent above the OECD average,14 are likely to decline further. The net effect is a

negative contribution of 0.3 percentage point to output growth during the

period 2003 to 2008. If labour productivity continues to rise at its current pace of

around 1½ per cent a year, Japan’s potential growth would remain the lowest in the

OECD area at 1.2 per cent over the next five years.

Key challenges facing Japan

Japan faces a number of serious and interrelated problems, notably weak

growth prospects, entrenched deflation and an increasingly large public debt

problem. Its disappointing performance over the last decade has contributed to

concern about its ability to address these problems. Indeed, Japan’s output per

capita, measured in purchasing power parity terms, has declined from 83 per cent

of the US level in the mid-1990s to under 75 per cent at present (Figure 12). Japan

has thus gone from being one of the richest OECD countries to around the average.



© OECD 2004



40



Table 3. Potential output growth over the medium term

Annual average, percentage points

Potential GDP

growth =



Potential labour

+ Potential labour

productivity growth

input growth (hours

(output per hour

worked)

worked)



Contributions to labour input growth

Working-age

population



Trend participation

rate



Change in NAIRU



Hours worked per

person



1996-2002 2003-08 1996-2002 2003-08 1996-2002 2003-08 1996-2002 2003-08 1996-2002 2003-08 1996-2002 2003-08 1996-2002 2003-08



1.2



1.2



2.0



1.5



–0.7



–0.3



–0.1



–0.4



0.4



0.3



–0.2



0.0



–0.8



–0.2



Australia

Austria1

Belgium

Canada

Denmark



3.7

2.3

2.1

3.3

2.4



3.7

2.0

2.1

3.1

2.1



2.0

1.9

1.8

1.5

2.0



2.4

1.9

1.8

1.8

2.0



1.6

0.4

0.3

1.8

0.4



1.3

0.1

0.3

1.3

0.1



1.4

0.3

0.1

1.2

0.2



1.2

0.0

0.4

1.1

0.1



0.1

0.0

0.6

0.2

–0.1



0.0

0.1

0.2

0.2

0.0



0.2

0.0

0.2

0.2

0.3



0.1

0.0

0.0

0.0

0.0



–0.1

..

–0.6

0.1

0.0



0.0

..

–0.3

0.0

0.0



Finland

France

Germany

Greece

Iceland



2.9

2.1

1.5

3.0

2.9



2.3

2.0

1.5

3.5

2.9



2.5

2.0

1.8

2.3

1.7



2.4

1.7

1.6

3.0

1.8



0.3

0.2

–0.3

0.7

1.2



–0.1

0.3

–0.1

0.4

1.1



0.3

0.3

0.0

0.2

1.3



0.2

0.4

–0.2

0.1

1.0



0.1

0.4

0.4

0.5

0.0



0.1

0.1

0.3

0.2

0.0



0.3

0.2

–0.1

–0.1

–0.1



0.1

0.1

0.1

0.1

0.1



–0.4

–0.7

–0.5

0.0

0.0



–0.4

–0.2

–0.3

0.0

0.0



Ireland

Italy

Netherlands

New Zealand

Norway



7.5

1.8

3.1

3.0

2.8



4.8

1.8

1.8

3.2

2.0



4.7

1.6

1.8

1.4

2.3



3.5

1.5

1.7

1.9

1.6



2.6

0.2

1.3

1.6

0.5



1.3

0.3

0.2

1.2

0.4



1.8

–0.1

0.4

1.2

0.7



1.1

–0.1

0.4

1.1

0.5



0.8

0.3

0.9

0.2

0.1



0.3

0.4

0.3

0.1

0.0



1.0

0.2

0.4

0.3

0.2



0.1

0.1

0.0

0.0

0.0



–1.0

–0.2

–0.4

–0.1

–0.5



–0.3

–0.1

–0.6

0.0

–0.1



Spain

Sweden

Switzerland

United Kingdom

United States



2.9

2.4

1.3

2.5

3.4



2.8

2.3

1.2

2.4

3.1



1.1

2.1

1.0

2.1

1.9



1.0

1.9

0.8

2.0

2.1



1.8

0.3

0.4

0.4

1.4



1.8

0.4

0.4

0.4

1.0



0.6

0.4

0.4

0.4

1.3



0.3

0.6

0.4

0.3

1.1



1.0

–0.3

0.0

0.1

0.1



1.1

–0.2

0.0

0.1

–0.1



0.2

0.1

0.1

0.2

0.0



0.4

0.0

0.0

0.0

0.0



0.0

0.1

–0.2

–0.2

0.0



0.0

0.0

0.0

–0.1

0.0



Euro area

Total OECD



2.1

2.6



2.0

2.4



1.8

1.9



1.6

1.8



0.3

0.7



0.3

0.6



0.2

0.7



0.1

0.5



0.5

0.2



0.3

0.1



0.1

0.1



0.1

0.0



–0.3

–0.4



–0.1

–0.2



1. On a per worker rather than per hour basis.

Source: OECD.



OECD Economic Surveys: Japan



© OECD 2004



Japan



Macroeconomic developments and key economic challenges



Figure 12.



41



Per capita income in Japan is falling relative to other OECD countries



USA = 100



USA = 100



100



100

Japan

Canada

Australia

EU



90



90



80



80



70



70



60



1990



1991



1992



1993



1994



1995



1996



1997



1998



1999



2000



2001



60



Note: Based on current purchasing power parities.

Source: OECD.



Extrapolating this trend would reduce Japan’s per capita income to half of the

US average – the level of Portugal and Greece today in relative terms – by 2030.

Reversing the relative decline in Japan’s living standard will require measures to

bring deflation to an end (Chapter II), achieve fiscal sustainability (Chapter III) and

enhance growth prospects through reforms to strengthen competition (Chapter IV)

and the implementation of additional structural reforms (Chapter V).

Ending deflation

The challenge of achieving price stability is complicated by entrenched

deflationary expectations. With the price level declining since the mid-1990s,

households and firms expect prices to continue falling, as reflected in long-term

bond yields, which remain low despite the increase during the past few months.

The overall price decline – 10 per cent in the GDP deflator since 1994 and 3 per

cent in the consumer price index since 1998 – is relatively mild compared to the

experience in the 1930s, when prices fell by about a quarter over a four-year

period in both Japan and the United States. Nevertheless, declining prices have

become pervasive throughout the economy, as noted above, probably influencing

spending decisions of firms.

The growth-inhibiting effects of deflation have limited the impact of positive demand shocks, such as fiscal stimulus, in achieving sustained growth which

would, in turn, bring deflation to an end. The negative impact of deflation on

growth prospects operates through several channels. First, deflation tends to slow



© OECD 2004



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Figure 10. Saving-investment balances by sector

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