Japan: The Upturn Is Losing Momentum

This spring, despite its burdensome structural problems, Japan's economy appeared on the verge of a moderate cyclical upturn, led by exports and factory output, as the global recovery gathered steam. Now, as prospects abroad begin to look dimmer, so do Japan's.

So far, nothing suggests a renewed round of outright recession, but forward momentum appears to be slowing. First, exports in July are falling, for the second month in a row. Second, while a rise in second-quarter machinery orders suggests that business outlays for equipment have bottomed out, third-quarter projections look weak. And third, deflation continues to ravage household spending, as it has led to record declines in both wages and employment.

Forecasters are already shaving their growth projections. Despite a solid first-quarter advance, growth in 2002 is expected to be so weak that the yearly level of gross domestic product will remain below its 2001 level, with barely any headway expected in 2003.

The poorer outlook appears to be influencing the government's 2003 budget in favor of less stringency. Recently adopted budget guidelines have sliced the planned cutback in public investment next year from 10% to only 3%, and they lift the cap on government bond issuance. Plus, policymakers are rethinking their plan to eliminate deposit insurance in April, 2003, out of concern over possible systemic risks to the financial system.

Nevertheless, even as deflationary pressures grip the economy, the Bank of Japan is still making only moderate efforts to counter the trend. Since the spring, the growth of the monetary base has slowed. Wages in June, down 1.7% from a year ago, fell faster than prices, and June employment fell a record 0.6% from a year ago. Despite pockets of rising labor demand, many companies want only part-time workers or certain skills that the unemployed do not have.

With a cloudier global outlook, a shaky financial system, and little progress on long-term reform, Japan appears to be stuck in the mire for at least another year.

By James C. Cooper & Kathleen Madigan

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