Recent economic performance

Gross domestic product — The economy was in recession most recently (as measured by year-over-year gross domestic product) from the second quarter of 2001 to the third quarter of 2002. However, key sectors of the economy and especially domestic demand have been depressed even longer. There are signs that the domestic economy is finally turning around even though the overall economy is still very much reliant on the growth in the U.S. and China, the country’s two largest export markets.

Japan was plagued by dismal economic performance for over 10 years. The recovery has been erratic and volatile. After robust first quarter 2007 growth — GDP was up 0.7 percent when compared with the previous quarter and 2.5 percent on the year — second quarter GDP weakened materially and edged down 0.4 percent on the quarter. However, the economy grew 1.5 percent when compared with the same quarter a year ago. Preliminary third quarter GDP rebounded with quarterly growth up 0.6 percent and a gain of 2.2 percent on the year. Japanese data are notoriously subject to large revisions and a better picture of the economy’s growth status will eventually emerge. The GDP price deflator continues to be negative (down 0.3 percent on the year) while other price measures are barely positive.

Industrial production — Industrial production data are watched closely given the economy’s dependence on manufacturing exports to grow. This is in contrast to industrialized economies such as the UK and the U.S. who rely on the consumer to stimulate growth.

Consumer spending — Consumer spending has been the Japanese economy’s Achilles heel. Despite improvement in the economy elsewhere, the consumer continues to be reluctant to spend. Besides retail sales data, an important measure of consumption is worker household spending. This indicator continues to lag in recovery and is perhaps an indication of lagging wage increases as well.

Deflation or Inflation — Whether Japan has beaten deflation depends upon which measure of price change is used and which version. According to the ‘old’ version of the CPI, prices had increased for six months. However, the ‘new’ CPI which was released for the first time in August 2007 showed increases for only three months. This reinforced the belief of some government members that the Bank of Japan increased interest rates prematurely. Some also think that the GDP deflator should be used to measure whether the economy is truly no longer in deflation’s grip (See the first graph in profile). The financial system has stabilized, the corporate sector is more resilient, labor markets have become more dynamic, and fiscal consolidation is under way. As a result, the economy appears to have recovered from deflation. For those who borrowed, deflation was a nightmare because the burden of debt becomes heavier as time passes. For consumers, deflation is a delight: the purchasing power of money grows when it is not spent. But that encourages consumers to save, not spend, and makes it more difficult for debts to be repaid.

Another picture emerges if one looks at the corporate goods price index, a measure of producer price inflation. The CGPI has been positive since 2004 when compared on the year. However, these price increases have not boosted consumer prices because demand has been too weak to pass them on. However, the CGPI’s recent path perhaps reflects higher crude oil and commodity prices.

Unemployment — The unemployment rate returned to 4 percent after dipping to 3.6 percent in July, a nine year low. Despite the relatively low level of unemployment, consumers continue to be reluctant to spend because wage gains have been weak.  

The unemployment rate hints that the aggressive job cutting by many Japanese companies has done its job and there are signs that companies are again beginning to hire new employees. Many of the earlier job cuts were made at overseas operations, reflecting the cultural reluctance to dismiss domestic staff in Japan. Employees at larger companies generally stay with the same firm throughout their careers.

Merchandise trade imports and exports — Japan is not particularly open to foreign trade. As a percentage of GDP, the value of Japan's 2001 two way foreign trade was just 16.8 percent while in Germany, for example, was 57 percent. The closed nature of Japan's economy is also apparent in comparisons with other countries in Asia such as China, which saw foreign trade reach 42.4 percent of GDP. This is largely owing to official and unofficial restrictions on merchandise imports. These remain in place despite pressure from the United States and other trading partners in order to protect less efficient sectors of the economy. This lack of openness to foreign trade has often been cited as one of the reasons for the persistence of the structural problems in the country's economy in general and the poor productivity of companies in the non-tradable sectors in particular.