Japan: Another Return to Recession?

Japan's economy has suffered three official recessions in the past decade. Now it is flirting with No.4, as the modest recovery that was evident in the first three quarters of 2002 stalled at yearend.

Recent surprisingly weak data on industrial production, unemployment, and household spending suggest that fourth-quarter real gross domestic product, to be reported on Feb. 14, declined, and prospects for the first half of 2003 look dim. Continued deflation and the depressing effects of banking and industrial reform are smothering demand by consumers and businesses, while the threat of war in Iraq is hitting exports.

Exports, which had fueled solid growth in industrial production earlier last year, are slowing. Industrial output fell sharply at yearend, pushing last year's production down to a 15-year low. A U.S.-led rebound in exports will be crucial to Japan's first-half performance, but Iraq is clouding the U.S. outlook as well.

Meanwhile, domestic demand will be going nowhere. Many companies are restructuring at the expense of new investment, and they are slashing costs by eliminating jobs, cutting capacity, and moving operations to China and elsewhere in Asia.

All this is hard on households. In December, consumer confidence and spending plunged, amid a record 5.5% unemployment rate and a 0.3% drop in wages, including a big decline in bonus payments. Given the economy's latest stall, joblessness could exceed 6% this year. Many workers are simply dropping out of the labor force, given the increasingly poor job prospects.

Policy decisions in coming months will be crucial in Japan's three-year battle against deflation. December consumer prices, excluding fresh foods, fell 0.7% from the year before. The Bank of Japan's actions to date have pushed the growth rate of the monetary base to 20% annually, but bank lending continues to shrink at a 4% clip. Much will depend on Prime Minister Junichiro Koizumi's choice for a new BOJ governor, expected soon.

By James C. Cooper & Kathleen Madigan

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