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Japan: Too Much Faith in Exports?

Japanese business executives have a warning for policymakers: A recovery dependent on exports is risky business, especially when your currency is rising.

The Tankan survey for the second quarter showed a significant split in confidence between big manufacturers that export and businesses that rely on domestic demand for sales. The manufacturing index jumped from -38 in the first quarter to -18 in the second, but the reading for nonmanufacturers rose by only 4 points, to -16. Moreover, the negative readings for both sectors show Japan's industry is struggling (chart).

Other data also illustrate the split in Japan's economy. Real gross domestic product surged at an annual rate of 5.7% in the first quarter, with half the gain resulting from exports, which make up only 10% of real GDP. May industrial production jumped 3.9% from April, thanks to increased exports of cars and electronics. But domestic car sales in June were down for the 10th month in a row, and overall household spending fell 2.3% in May.

Weak labor markets are a big reason for the softness in domestic demand. Despite the gain in factory output, manufacturing jobs fell by 390,000 in May, and the jobless rate stood at a high 5.4%. The Tankan survey found a record gap between nonmanufacturers that felt they had too many workers and those service companies that thought they had too few.

Businesses are not hiring because they fear the export-led recovery will unravel, especially now that the yen is strengthening. The currency is up 10% against the dollar since the start of 2002, despite intervention by central banks to weaken it. A stronger yen will raise the prices of Japanese exports at the same time slower growth in the U.S. will curb demand for Japanese-made goods.

That's why increased domestic spending is needed to keep the economy expanding. But Japanese consumers seem more inclined to save than spend. And that attitude means Japan's economy may lack forward momentum. By James C. Cooper & Kathleen Madigan

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