Oct. 9 (Bloomberg) -- The consumer spending spree that Prime Minister Shinzo Abe and central banker Toshihiko Fukui are counting on to drive Japan's economic growth may fizzle.

Japanese wages still haven't reversed their decade-long slide even with the nation's economic expansion now in its 56th month. While businesses plan to increase their capital expenditures at the fastest pace in 16 years, higher raw- materials and fuel costs are making them reluctant to raise pay.

Japan's economy may be in trouble without consumer spending to compensate for weakening export markets. The world's second- largest economy has suffered three recessions since 1991, two coming as export sales flagged. Slackening demand from abroad now threatens to ``spoil'' Japan's longest expansion since World War II, according to the Asian Development Bank.

``If both export markets and the consumer don't show up to the ballgame, there is no ballgame,'' says Kirby Daley, a strategist at Societe Generale Securities' Fimat unit in Hong Kong. ``Somebody has to be there to buy the things companies are producing.''

A slowdown would be bad news for Abe, 52, who last month succeeded Junichiro Koizumi as prime minister and is counting on sustained growth to help him win parliamentary elections in July.

Economists have also been counting on expansion in Japan, along with China and Europe, to help sustain global growth as the U.S. economy cools.

A Problem for the World

``The whole idea of decoupling from a U.S. slowdown is dependent on domestic demand in these countries,'' says Nouriel Roubini, a former U.S. Treasury economist who runs his own investment consulting firm in New York. ``If Japanese consumers don't step to the plate, it's a problem for the world economy.''

Fukui, the Bank of Japan governor who in July led the bank to raise interest rates from near zero for the first time in six years, said May 31 that the driver of Japan's economic growth will gradually shift to consumer spending from corporate investment.

Evidence since then suggests that isn't happening. Capital spending increased at seven times the pace of private consumption in the quarter ended June 30. Household spending dropped 4.3 percent in August and has fallen every month this year, according to the statistics bureau.

``The Bank of Japan had thought the growth of corporate earnings would increase wages, boosting consumer spending,'' says Toru Umemoto, chief currency analyst with Barclays Plc in Tokyo. ``But this transition is not working out well.''

Wages fell 0.5 percent during August, even with the unemployment rate near an eight-year low, according to a Labor Ministry report Oct. 2.

Negative for the Yen

``Companies are still taking a very conservative approach on employment,'' Umemoto says. That will hold down consumer prices, making it more difficult for the Bank of Japan to raise interest rates, he says. ``This is certainly yen-negative; it will promote yen-selling.''

Umemoto expects the yen to fluctuate between 113 and 118 to the dollar this year. The yen traded Oct. 6 at about 119 to the dollar.

Until wages start rising, ``household consumption cannot be expected to become the prime driver of growth, and that makes Japan more exposed to a global slowdown,'' says Hiroshi Shiraishi, an economist at Lehman Brothers Holdings Inc. in Tokyo.

Already, some of Japan's most important export markets show signs of weakening. Growth in the U.S. economy slowed to 2.6 percent in the quarter ended June 30, from 5.6 percent in the previous three months.

South Korea and Germany

Spending by South Korean consumers is slowing because of rising interest rates and higher fuel costs. Germans may also spend less next year after their government raises the value- added tax, a form of national sales tax.

In Japan, wages fell almost 10 percent between 1997 and 2005, an average cut of more than 400,000 yen ($3,400), Labor Ministry reports show. Japan's households kept afloat during those years by spending money they would otherwise have put away for the future; the country's vaunted savings rate declined from to 2.4 percent from 10.4 percent.

Pay increases in the first half of 2006 did little to reverse that trend. Wages rose only 8,700 yen during the six- month period -- about the cost of filling a Toyota Corolla's gasoline tank.

Even if salaries rise more quickly, there's a risk households may choose to rebuild savings rather than spend, says Julian Jessop, chief international economist at Capital Economics Ltd. in London. ``We're in an environment where consumers are going to be a lot more nervous.''

A Tax Increase?

Japan has a shrinking population, the world's fastest-aging society and a public debt projected to exceed 150 percent of gross domestic product next year. Abe's government may not be able to fund its pension system without raising the consumption tax, a move that would leave Japan's households with less to spend.

While Abe says he ``won't run from the debate on taxes,'' he advocates cutting expenditures before seeking to increase the sales tax from 5 percent. A debate on taxes can wait until the latter half of 2007, after the upper house elections, he says.

Private-sector members of the government's economic policy council estimate a consumption tax of about 10 percent is needed to fund the country's pension and health-care systems, according to Kaoru Yosano, head of the Liberal Democratic Party tax panel.

Japan's sales tax was last increased in 1997, after which the country plunged into recession, consumer spending slumped and Prime Minister Ryutaro Hashimoto was forced from office.

Households aren't optimistic about the prospect of higher pay, the most recent Cabinet Office survey of consumer sentiment shows.

Bonuses Slow

Growth in summer bonuses at Japan's largest companies slowed to 2.86 percent from 3.63 percent the previous year, even as corporate profits climbed 35 percent to a record 20.6 trillion yen in the year ended March 31. Companies are forecasting profit growth to decline to 6.5 percent this year.

Falling margins will pressure companies to cut labor costs, says Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. ``We expect wages to go down later this year,'' he says. ``If that happens, you can't expect significant growth in personal consumption.''

Isetan Co. Ltd., Japan's most profitable department-store operator, isn't betting on the domestic economy. Tokyo-based Isetan ``has no plans to open any new stores in Japan,'' says spokesman Tadashi Okumura. ``We just don't expect the market to grow that much.''

To contact the reporter on this story: Jason Clenfield in Tokyo at jclenfield@bloomberg.net

Last Updated: October 8, 2006 13:29 EDT