Japanese Economy: Has the Sun set in the Land of the Rising Sun?

The Japanese economy is in a state of coma. Japan’s biggest problem, according to experts, is its huge public sector debt, which has grown to nearly twice the GDP. But that is least of its worries. Far more pressing is the deflation crisis that it faces today.

Many would argue, that, how could deflation be harmful to an economy? After all, low prices would mean a low cost of living. That is a grave misunderstanding. But many miss the point that the downward spiraling prices signify low demand, which would mean lower production and simultaneous decline in wages. Sadly enough for Japan, neither its administration nor its central bank has a shown a sense of urgency in tackling the deflationary curse. Complacency and deflationary pressures are juxtaposed in the present situation of the country.

Captious questions might be asked about Japan’s tendency to play with fire, repeatedly. The Bank of Japan’s(BoJ) habit to put the country’s financial fundamentals through extreme stress has proved to be its undoing. Earlier, during the period of 2001-06, the spurge of liquidity unleashed by BoJ had created quite a scare. Just because deflation did not spiral downwards then doesn’t guarantee a safe journey now. A few years ago, the world economy was bullish and Japan could export its way back to health. The prices in Japan may not be falling drastically but deflation is deeply entrenched in the economic system. As the prices fall, Japan could feel the burden of debt growing, leading to retrenchment in households and financial firms. The deflationary pressures have the potential to put brakes on Japan’s incipient recovery.

Of late, official statistics seem to suggest that Japan’s tryst with its crippling deflation is almost over. But the financial pundits beg to differ. The mechanism used to calculate inflation statistics has been found to miss several crucial indicators, important in determining the actual health of the economy. Research confirms Japan’s tendency to overstate its inflation figures, making a mockery of the actual cost of living index. A realistic and a more sophisticated methodology, as in US, suggests that inflation figures in Japan are at least overstated by at least 1 percentage point. It means during the period 1999-2006, the deflation in Japan was probably double the official figure. The outdated mechanism has been used by Japan without thinking about its possible ramifications. The environment of gloom is here to stay, a bit longer.

They say, desperate times call for desperate measures. This is the time when the rest of the world economies would look up to Japan to disentangle itself from the clutches of deflation. The government and the BoJ may be facing their worst crisis ever, but the people of Japan would be eyeing them in anticipation, for them to promulgate some assertive reforms. BoJ’s earlier attempts to revive the economy was met with flaky success.

In brief, Japan needs a big shake-up in its financial system, to bring the economy back to life. An aggressive BoJ will do a lot of good to investor’s confidence. Its laidback attitude is painful. It should kickstart public programmes to re-inflate the economy. Those may include increasing government bond purchases, or setting a fiscal target based on not only a positive inflation rate but also a strong growth of GDP. It could also consider negative interest rates on bank balances, which would discourage money hoarding in banks. Such measures could surely weaken the Yen, but that would be a small price to pay if one wants to come out of the deflationary mess.

The government led by Mr. Yukio Hatoyama has to take a mentor’s role in the situation. It should stop depending on BoJ and stand up for its own responsibilities. The ruling Democratic Party of Japan has often been accused of being myopic in its future goals for the country. Prevarication is passe. To boost growth, the government has to take decisions in phase with the world economy. That means boosting productivity through labour market reforms, immigration policies and incentives in trade partnership. There is huge room for improvement, in areas like agriculture. Also the DPJ has to do away with union-friendly wage control systems. The administration has to increase funding for the Japanese statistical agencies, so that the outdated method of calculating inflation and CPI undergoes a major revamp. That should be foremost on its agenda.

The period of recession has brought about an era of parity in the economic systems of the world.US was brought down to earth, and the gap between the developed and developing countries was bridged. Everyone realized that to tide over the crisis, one would need every help possible. At this juncture, we can ill afford the failure of one of the biggest economies of the world, Japan. If they drown, they will take the whole world down with them. Japan has to put aside its inhibitions and work for the greater good of the world economy. Let’s