1

Japan’s Economic Prospects

Richard Katz

The Oriental Economist Report

© 2008 rbkatz@ix.netcom.com www.orientaleconomist.com

NYU

March 4, 2007

2

I.

Without Productivity Revolution,

Potential Full-Capacity Growth Limited to 1.5% per year

(optimists say 2%)

3

Working Age Population Shrinking

1.2%

0.8%0.9%

0.8%

0.3%

-0.2%

-0.5%

-0.7%

-1.1%

-0.8%-0.7%

-1.0%

-1.3%

-1.8%

-1.5%-1.4%-1.4%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

1975 1985 1995 2005 2015 2025 2035 2045 2055

An

nu

al ra

te o

f ch

an

ge in

po

pu

lati

on

15-6

4

4

…Faster Than Total Population

-0.5%

-0.7%

-1.1%

-0.8%-0.7%

-1.0%

-1.3%

-1.8%

0.1%

-0.9%-0.8%

-0.7%-0.6%

-0.4%

-0.3%

-0.1%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

2005 2010 2015 2020 2025 2030 2035 2040

An

nu

al ra

te o

f ch

an

ge in

po

pu

lati

on

15-6

4

15-64

Total

If the labor force falls 0.7% a year and the total population falls 0.1%, then even if per worker GDP stays the same, per capita GDP will fall 0.6% a year

5

Productivity Sole Source of Growth

50556065707580859095

100105110115120125130

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

1990

=100

50556065707580859095100105110115120125130

Work Hours

GDP

Productivity

6

Productivity Figures Are Cyclical

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Yea

r-o

n-y

ear

gro

wth

(2-

qtr

MA

)

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

GDP

Productivity

Average productivity growth 1991-2007: 1.6%

In slumps, GDP falls faster than hours; in recoveries the reverse is true. Recent claims of productivity acceleration neglect this factor.

7

No Trend Hike in Productivity

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

-3.0% -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5%

GDP (year-on-year growth, 1991-2007 (2-qtr MA)

GD

P p

er h

ou

r (y

ear-

on

-yea

r g

row

th, 2

-qtr

MA

) 2005-07

1991-2007 Trend Line

1991-2001 Trend Line

1991-2007

8

ROA: Big vs. Small

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Ret

urn

on

ass

ets

(RO

A)

Big firms

Small firms

93-06 average (all firms)

9

Japan's Manufacturing Productivity 30% Below US Level

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

Mfg

. P

rod

ucti

vit

y %

of

US

1998 2005US level

10

Japan Grows More Slowly Despite Investing More Than Others

12%

15%

18%

21%

24%

27%

30%

33%

1992 1994 1996 1998 2000 2002 2004

Inve

stm

ent:

GD

P R

atio

Japan G7 ex-Japan

11

Competition and Firm Mobility Breed TFP Growth

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Holland(1.9%)

France(0.9%)

AVERAGE(2.5%)

Italy (5.3%)

Finland(2.8%)

UK (1.8%)

% o

f T

FP

Gro

wth

Due to shifting market share

Due to exit of old f irms

Due to entry of new firms

12

In Japan, Entry and Exit Play a Minor Role In TFP Growth

0%

10%

20%

30%

40%

50%

60%

70%

80%

Due to incumbentimprovement

Due to shifting marketshare

Due to entry and exit offirms

Shar

e of

impr

ovem

ent i

n TF

P, 1

995-

2001

13

Japan Firm Mobility Lags Behind G7

0%

5%

10%

15%

20%

25%

30%

JAPAN Italy Germany USA France Canada UK*

en

try/e

xit

as %

of

exis

tin

g f

irm

s

14

Exit Rate Still Low, Entry Rate Declining As of 2002

15

Competition Too Weak In Inefficient Side of Dual Economy

0%

2%

4%

6%

8%

10%

12%

14%

16%

78 79 80 81 82 83 84 85 86 87 88 89 90

Mar

ket

Sh

are:

Po

lyet

hyl

ene

film

Okura Kogyo Sekisui ChemWada Chem Ind Nakagaw a SeitaikakoTakigaw a kagaku

16

Within Mfg., Worst Sectors Show Least Improvement: 1997-2006

Food

Metals

OtherChemicals

Machinery

Textiles

R2 = 0.7264

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

40% 50% 60% 70% 80% 90% 100% 110%

Productivity (TFP) Relative to U.S., 1987

An

nu

al C

han

ge in

Pro

du

cti

vit

y, 97-0

6

17

Sectors with Worst Productivity Show Least Improvement: 1997-2005

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

Services Constr Distrib. Other Manuf.

Pro

du

ctiv

ity

Gro

wth

, 199

7-20

05

0%

25%

50%

75%

100%

125%

150%

175%

200%

Pro

du

ctiv

ity

% o

f M

fg.,

1997

Productivity growth (left)

Prod. % of Mfg. (right)

18

Japan Falls Behind Other G7in Output Per Worker

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

GD

P p

er w

ork

er %

of

US

, PP

P

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Canada Germany Italy

Japan UK France

19

II.

Demand Growth Is Unbalanced

Too Much Dependence on Business Investment and

Trade Surplus

Too Little Consumer Demand

20

Demand Ultra-Dependent On Investment and Trade Surplus

4.3%

55%

33%

16%

36%

41%

0%

10%

20%

30%

40%

50%

60%

Invest. Trade Surplus Household Consum.

Sh

are

of

GD

P G

row

th 0

2-I

to

07-I

V

Share of GDP

Share of GDP Growth

21

Wage Share of GDP Plunges

48%

49%

50%

51%

52%

53%

54%

55%

56%

57%

80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Co

mp

ensa

tio

n %

of

real

GD

P, 2

-qtr

MA

48%

49%

50%

51%

52%

53%

54%

55%

56%

57%1980-2001 average

22

Income is Deficit-Financed

58%

59%60%

61%62%

63%64%

65%66%

67%

68%69%

70%71%

72%73%

74%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Rea

l Dis

p. I

nco

me

as %

of

GD

P

58%

59%60%

61%62%

63%64%

65%66%

67%

68%69%

70%71%

72%73%

74%

Private income

Total net disposable income

Govt tax cuts and transfer payments

23

Household Savings Rate Drops

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Sav

ing

s ra

te (

% o

f d

isp

osa

ble

inco

me)

24

Firms Are Excess Savers

0%

2%

4%

6%

8%

10%

12%

14%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

% o

f G

DP

0%

2%

4%

6%

8%

10%

12%

14%

Household savings

Business saving

Total excess private savings

CY

25

Budget Deficits, Trade Surplus Offset Excess Savings

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

% o

f G

DP

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Govt budget Trade surplus Private demand gap

CY

Black line in this slide equals total excess savings in previous slide

26

Trade Surplus Record % of GDP

-0.5%

0.5%

1.5%

2.5%

3.5%

4.5%

5.5%

80 82 84 86 88 90 92 94 96 98 00 02 04 06

Tra

de

Su

rplu

s (%

of

GD

P)

27

Real Yen at 20-Year Low

50

60

70

80

90

100

110

120

130

140

150

1970 1975 1980 1985 1990 1995 2000 2005

Rea

l Exc

hang

e ra

te (1

970-

2008

= 1

00)

50

60

70

80

90

100

110

120

130

140

150

28

Falling % of Global Trade Surplus

0

100

200

300

400

500

600

700

800

900

1,000

1985 1990 1995 2000 2004

Tra

de

bal

ance

, go

od

s an

d s

ervi

ces

($ b

il.)

Japan surplus

Global sum of deficits of countries in deficit

29

III.

Japanese Medium-Term Growth Dependent on American Prospects,

Especially US Imports

30

Nikkei 225 Echoes S&P 500

12,000

13,000

14,000

15,000

16,000

17,000

18,000

19,000

May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08

Nik

kei 2

25

1,300

1,325

1,350

1,375

1,400

1,425

1,450

1,475

1,500

1,525

1,550

1,575

1,600

S&

P 5

00

Nikkei 225 S&P 500

31

Last Seven Years: 70% Correlation Between US and Japanese GDP

-1%

0%

1%

2%

3%

4%

5%

6%

2000 2001 2002 2003 2004 2005 2006 2007

US

Yr-

on

-Yr

GD

P g

row

th

-2%

-1%

0%

1%

2%

3%

4%

5%

Jap

an Y

r-o

n-Y

r G

DP

gro

wth

US (left scale) Japan (right scale)

Japanese exports tumble

32

Japanese Global Exports Mirror US Global Imports

-15%

-10%

-5%

0%

5%

10%

15%

20%

2000 2002 2004 2006

Yr-

on

-yr

% g

row

th

US imports

Japanese exports

33

Japanese Exports to China Mirror Chinese Exports to US

-20%

-10%

0%

10%

20%

30%

40%

50%

97 98 99 00 01 02 03 04 05 06 07

Yr-

on

-Yr

gro

wth

Japan exports to ChinaChina exports to US

Anti-Japan boycott in

China

34

Japanese Exports to Asia Mirror Asian Exports to US

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

99 00 01 02 03 04 05 06 07

Yr-

on

-Yr

gro

wth

Japan exports to Asia

Asia exports to US

35

Capex Mirrors Exports Two Quarters Earlier

-15%

-10%

-5%

0%

5%

10%

15%

20%

00 01 02 03 04 05 06 07

Yr-

on

-Yr

gro

wth

, E

xp

ort

s

-15%

-10%

-5%

0%

5%

10%

15%

Yr-

on

-Yr

gro

wth

, C

ap

ex

Exports Capex

36

US Imports Decelerating

-9%

-6%

-3%

0%

3%

6%

9%

12%

15%

2000 2001 2002 2003 2004 2005 2006 2007

Rea

l Im

po

rts,

Yr-

on

-Yr

chan

ge

recession

37

US trade deficit down 18% from peak

200

250

300

350

400

450

500

550

600

650

2000 2001 2002 2003 2004 2005 2006 2007

Go

od

s an

d s

ervi

ces

trad

e d

efic

it (

$ b

il.)

38

IV.

Japan’s Declining

Weight in the World

39

Japan’s Declining Weightin World GDP (PPP)

0%

2%

4%

6%

8%

10%

12%

14%

16%

1980 1984 1988 1992 1996 2000 2004

% o

f W

orl

d G

DP

, PP

P

0%

2%

4%

6%

8%

10%

12%

14%

16%

Japan

China

40

Japan’s Declining Weightin Asian GDP (PPP)

0%

10%

20%

30%

40%

50%

60%

1980 1984 1988 1992 1996 2000 2004

% o

f A

sian

GD

P, P

PP

0%

10%

20%

30%

40%

50%

60%

Japan

China

41

Japan Falls Behind China in Global Imports

0%

1%

2%

3%

4%

5%

6%

7%

8%

1980 1984 1988 1992 1996 2000 2004

% o

f W

orl

d Im

po

rts (

co

nsta

nt

2000 $

)

0%

1%

2%

3%

4%

5%

6%

7%

8%

Japan

China

42

Japan Not Asia’s Main Customer

0% 5% 10% 15% 20% 25% 30%

Hong Kong

Singapore

Taiwan

Korea

Malaysia

Thailand

Philippines

Indonesia

China

% of each country's GDP, 2003

Exports to Japan

Exports to China

Exports to EU

Exports to US

61%