canadian embassy tokyo april 2006 can a changing japan meet the productivity challenge in the...

Canadian EmbassyTokyo

April 2006

Can a changing Japan meet theproductivity challenge in the long-run?

Japan’s Economy RecoveredJapan’s Economy Recovered

– Current Outlook and IssuesCurrent Outlook and Issues– Macroeconomic situation, regional

economies, business, banks and labour, monetary policy normalisation

– StrengthsStrengths– Size, wealth, technology,

manufacturing, Asian integration

– Productivity challengeProductivity challenge– Demographics, LT structural change,

efficiency, bureaucracy

– AssessmentAssessment– Is Japan’s economy recovering?– What does this mean for Canada and

the world?

OverviewOverview

– Current macro outlookCurrent macro outlook

– Regional economiesRegional economies

– Business resurgenceBusiness resurgence

– Financial sector revivalFinancial sector revival

– Labour market upturnLabour market upturn

– Hot topicHot topic: monetary : monetary policy normalisationpolicy normalisation

Current trendsCurrent trendsand issuesand issues

2.7% growth in ’05- After 2.3% in ‘04

Strong end to ‘05- 05Q4: 5.4% q/q annualized- 05Q4: 4% over 04Q4

’06 and ‘07 forecastquite robust - Consensus of Japanese

forecasters (for fiscal year ending in March):- FY05: 3.4%- FY06: 2.6%, - FY07: 2.4%

Note: in 2005, Canada’s economy grew2.9%, with much faster population growth.

Economic growth:Economic growth:Real GDP growth strong in 2005

Source: Cabinet Office, Japan

Real GDP y/y % (05 preliminary)

01 02 03 04 05

Calendar year

Contributions to y/y real GDP growth % (05preliminary)

-0.3-0.5 -0.5

95 96 97 98 99 00 01 02 03 04 05

Calendar year

Final domestic sales Public demand Net Exports

Private andDomesticGrowth stimulus– Domestic final

sales (private cons. & invest. net of inventory changes) now growth driver

– Unlike 90s, public demand is weak: sharp cuts in public works

Modest netexport growth:– Economy firing

on all cylinders

GDP Growth:GDP Growth:More sustainable now

““Tech bubble”Tech bubble”

Source: Cabinet Office, Japan

Real GDP

NAGOYA: booming manufacturing centre

Recovery by city and region:Recovery by city and region:Boom centered on industrial heartland, urban areas

OSAKA-KYOTO-KOBE: re-emerging second urban region of Japan

Recovering strongly: robust growth overall; very tightlabour market; industry, services, real estate increasingly buoyant

Recovering: firm growth; tightening labour market;industry and services solid

Recovering mildly: growth picking up; labour market,Industry and services recovering, although picture is uneven

Signs of a turnaround: growth remains slow.Labour market slack remains; modest pickup in some industries

HIROSHIMA: Dynamic regional centre

FUKUOKA:modern city with

growing ties to NE Asia

Source: Cabinet Office, Embassy estimations

SAPPORO: Northern centreat heart of agri-food & tourism region

TOKYO-YOKOHAMA: growing financialand economic metropolis; world’s biggest city

with economy larger than Canada’s

Stagnant/Recession: no regions in thiscategory at this time

FY00 FY01 FY02 FY03 CY04 CY05

Core CPI CGPI

CSPI GDP Deflator

CPI inflationnow mildly positive– Core CPI 0.5% y/y Jan 06– Corp. goods prices – GDP deflator

– import prices key factor

BoJ has calledend of deflation: – “Quantitative easing” over:

– BoJ now targetting 0% interest rate

– Interest rates will stay at or near zero this year

– BoJ wants CPI at 0-2%

Deflation:Deflation:Easing…ending?

Source: Bank of Japan

Change in prices (y/y%)

Business sector recoveryBusiness sector recovery

Jul.*S

Restructuring payingoff, debt bubble gone– Corporate debt/GDP ratio now

below 1980 level (HSBC)– debt repaid by non-financial

corp’s: 40% of GDP!– Liab. / bal.sheet ratio lowest in 50

yrs. (Morgan Stanley)

Non-financial firms maybe in best shape ever– Profitability at 50-year highs– Q405: 14th consecutive Qtr. of

y/y profit growth– Longest period since 1960s

– Confidence, return on equity at post-bubble high

Non-financial firm profitability(current profit/sales - 4Q moving average)

“Property bubble”

“IT Bubble”

Source: Ministry of Finance

Banking sector revivalBanking sector revival

Non-perfoming Loans (NPLs) at major banks

2.9%2.4%

EndFY00

FY01 FY02 FY03 FY04 FY05H1

Total NPLs -- trillions of yen -- left scaleNPLs as percentage of total

Source: Bank of Japan

NPL problem fixed “Takenaka plan” to halve

2001 NPLs by 2004 exceeded

Capital adequacy, quality improved

Banks repaying pub. funds

Profit recovery isless certain FY05H1 saw highest profits

on record, but spreads tight and loan growth slow

Key: fee-based financial services

Rising interest rates will help bank profits

Unemployment (% of labour force)

Labour market upturnLabour market upturnRecovery may finally be spreading to the labour market

Restructuring = job cuts– Aging-driven labour force decline– “excess” labour throughout 1990s

Full-time jobs up again– Growth had been in part-time

jobs, full-time jobs were falling. This trend has reversed.

– Latest unemployment rate: 4.1%– Offers/applicant ration 1:1!

– Firms now perceive labour shortage

Rising incomes key torecovery, deflation end– Nominal employee compensation

rose 2.6% in 05Q4 over 04Q4Source: Bank of Japan

Hot topic: monetary policyHot topic: monetary policyWhat will the impact be of normalisation, rising i-rates?

overall in Japan Household (HH) assets = 4X HH debts consumption boost offsets profit impact; banks benefit from better spreads BUT: gov’t has to pay higher interest; book value of bondholdings fall,

overseas assets may suffer, possibly gold

1: Source: Nomura securities

Interest

increase

2: Source: Goldman Sachs

Gov’tinterestexpense

rises over time as debt rolled over

(JGBs= 150%Of GDP,Held 95%In Japan)

but, gov’tspending rises…

Book valueof JGB

holdingsfalls

Overseas Assets

Suffer as“carry trade”

abates

and JGBs, overseas assets fall.

Households gainY7.8 trillion2

Cons. spendingRises 0.8%1

Modest rise inprofits2

Loan spreadsimprove

Households, firms,banks benefit…

What if ratesincrease?

– Size, wealthSize, wealth

– manufacturing productivitymanufacturing productivity

– technologytechnology

– Asia’s rise and economic integrationAsia’s rise and economic integration

Japan’s strengthsJapan’s strengths

KANSAI

Size and wealth:Size and wealth:2nd biggest economy; biggest net creditor

Japan’s GDP:─ larger than rest of Asia─ equal to the combined

economy of all US states west of the Mississippi

(Tokyo Metro Region)

(Osaka-Kobe-Kyoto Region)

(Nagoya-Shizuoka Region)

= GDP larger than China’s, twice Canada’s

= GDP larger than India’s or Brazil’s

= GDP larger than Mexico’s or Korea’s

Kanto+Tokai – GDP larger than Germany’s – but Tokyo-Nagoya distance is less

than Montreal-Toronto

Despite gov’t debt,net foreign position

was CAN$ 2.2 trillion(What Japan is owed)–(what Japan owes) =

(Canada’s annual GDP X 2)

Individual financial assets in Japan= $CAN 17 trillion (280% ofGDP)= 4 times household liabilities

Strengths:Strengths:Manufacturing productivity, leading industries

Leader in manufacturing productivity– Japanese manufacturing productivity is 20% higher than in US

– This partly explains Japan’s trade surplus with the world.

Growing lead in key industrial sectors– E.g: “PAX TOYOTA”: it can be argued that Japanese automotive

“empires” are dictating terms of global auto industry– Result is growing prosperity in the “imperial capitals”, the Japanese

design and manufacturing centres (eg: Nagoya)– Leadership brings obligation to maintain “peace”, avoid trade friction

Strong investment in key markets, notably NAFTASome “restraint” in pricing strategy to avoid crippling US co’s

– Strong leadership in others sectors: Japan HQs global finance and tech hubs, from chemicals to electronics

Strengths:Strengths:Technology and R&D

Japan is R&D leader

– Highest R&D/GDP ratio in G7 (over 3% in 2001)

– Canada 3rd lowest in 2001 (<2%)

Japanese R&D = Total investment in Canada

R&D as Ratio of National GDP in G7 Countries (2001)

3.5 JapanUSGermanyFranceCanadaUKItaly

Result is tech leadership– “Old” industries have gone high-tech (eg: chem., steel)– Final assembly no longer key to value-added:

– eg: digital appliances; according to METI:– “Made in Japan” (ie: final assembly in Japan) products: 27% of global market– BUT, Japan supplies 51% of global high-tech parts and semiconductors, 54%

of manufacturing devices, and 65% of high-tech materials

– Higher energy efficiency than competitors (eg: US, Korea, China)

* Source: OECD

* Note: For Italy, the graph is based on the latest available data for 2000

Japanese exports (1990=100)

1990 92 94 96 98

2000 02

total US + EU

east asia china*

Strengths: Strengths: Japan a player in Asia’s rise and integration

Japan key to Asia growth pole– On the surface, US+EU becoming less

important in Japan’s trade– Japanese aid and FDI historically top

source in many Asian countries

China, ASEAN processJapan’s exports to US, EU; also products for Japanese market– Asia buys Japan’s tech. and capital

Japan trade surplus with China, Korea– Japan’s firms drive processing trade– Dynamic means US growth still has

twice impact on Japan as China’s– Chinese export growth key to Japan

Will Japan’s firms reach thenew Asian consumer? Source: Ministry of Finance, Japan

– Population decline– Productivity acceleration?– Long-term structural change– Capital allocation improvements– Remaining policy challenges– Decline or opportunity?

Japan’sJapan’sproductivity productivity

challengechallenge

Photos: Nikkei Weekly

Population declinePopulation declineThe demographic imperative for faster productivity growth

Source: Ministry of Internal affairs and communications

Japan’s population is now falling:

– 2005 saw first slight overall pop. decline

By 2050:– Down to 100M– 30 million less

people of working age (15-64)

– 10M more people age 65 and over

Total Population (thousands)

100,593

83,200

2005 =127,757

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Productivity acceleration?Productivity acceleration?Is the increase structural or temporary after slowdown?

Source: Cabinet Office

GDP/hour y/y growth slowed after bubble

– GDP/hour y/y growth slower in 94-03 vs. 85-93 (OECD)

Has productivity growth picked up again?

– GDP/hour y/y growth was well above trend in 2005

Key question: is Japan different than during post-bubble period in a structural way?

GDP/hour worked y/y%

-1.00%

-0.50%

Embassy Calculation based on Cabinet Office and Ministry of Labour data

Long-term changeLong-term changeDespite “stagnation” -- major structural shifts occurred

1990 1994 1998 2002

TERTIARYSECONDARYPRIMARYSource: Cabinet Office

Like in all advancedeconomies, the tertiary (services)sector’s share isgrowing:– The share of services in

GDP increased 10% between 1990 and 2002

– The share of manufacturing has fallen by 9% of GDP

Increased openness to tradeIncreased openness to tradeJapanese markets are becoming more contestable

Share of trade in economy is growing:

– Asian integration: growing two-way trade with China and other Asian economies

Long term may see a trade deficit

– Recovery and aging: savings down, cons. up

– current acc’t will stay positive: foreign inv. income

14.76%

9.47%13.35%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

10.00%

12.00%

14.00%

16.00%

Trade balance/GDP Exports/GDP Imports/GDP

Capital allocation improvingCapital allocation improvingBig problem in 1990s was poor allocation of capital

Overall, Japan is investing less as a share of GDP:

– Less total investment– Significant decrease in

public investment

Trend suggests I/GDP ratio is edging up:

– Due entirely to strong growth in private investment

– Firms increasing their capital, productivity, to meet growing demand, face labour shortages

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Fixed capital formation/GDPPublic Investment/GDPPrivate capital formation/GDP

Areas for further improvement:Areas for further improvement:Capital market, services, agriculture

Capital marketefficiency is improving– Households: 50% in cash; but

interest in risk assets is rising– Corp. fin was too bank-led

– Now: Co’s borrowing less, issuing more stock, bonds

– Lending down from peak (-20%), but may be on rise again: syndicated loan boom

– Corp. control more market-driven, arm’s-length investors now lead

– M&A, private equity booming– Efficiency was postal reform

key motive

Services need further reform

– lag US productivity up to 40%– Competition weak, but reforms

progressing: prices falling (e.g: utilities)

– OECD: Japan ahead on privatization, limiting financial interventionism, lags in dereg

Agriculture too protected─ Protection among highest in OECD─ Gov’t too slow to reform ag.

─ BUT, ag trade opportunities may spur new openness (eg: apples)

Government:Government:Debt, deficit and bureaucratic inefficiency

Rising debt, large deficit– 95% of debt held in Japan– Deficit 5-6% of GDP

– balance not likely until 2010s– Taxes among lowest in OECD

Aggressive cuts are risky– At odds with anti-deflation driveGov’t small, but inefficient– Red tape barrier to growth:

– privatization accomplished, but deregulation a work in progress

– Reform: better gov’t, not smaller – public works cuts, gov’t FI reform

– Rising social security costs: gov’t will get bigger (G/GDP)Source: IMF

Net public debt (% of GDP)

1999 2000 2001 2002 2003 2004 2005f 2006f

Canada Japan

Aging and population decline:Aging and population decline:Demographic challenge or opportunity?Demographic challenge or opportunity?

Aging or “greying” a milestone of social progress– Older people living longer healthier lives

– Japan asking what is place/role of elders beyond “dependency”?

Low birthrate (1.29) challenge, but also opportunity – Challenge: women not participating fully in paid economy

– Men: participation rate highest in OECD; women: among the lowest

– Can demog. decline mitigate social costs that plague Japan?– crowding, env. pressure, resource dependence

– Key policy priority: reform to boost output, taxes per worker– social security costs will double in the next 20 years– Capital reallocation + tech can increase productivity (labour,TFP)

Demog. decline does not mean lower living standard per capita GDP growth > GDP growth (eg: GDP 2%; pop –0.5%)

– Are Japan’s economic woes over?– What is the long-term future of Japan’s economy?– What does this mean for Canada and the world?

AssessmentAssessment

Are Japan’s economic woes over?Are Japan’s economic woes over?What is Japan’s long-term economic future?

Japan recovered, resilient, but LT challenges remainJapan recovered, resilient, but LT challenges remain– Shift from export-led growth to domestic demand well underway– Last short-term challenge is to normalize monetary policy– Falling population and fiscal constraint means Japan needs to boost its

productivity growth again: the reform imperative remains

Sudden change not Japanese way, but Japan is evolvingSudden change not Japanese way, but Japan is evolvingat an accelerating paceat an accelerating pace– China factor, Asian integration: Asia is Japan’s new strategic focus– Demographic change and new generation with different values– Stronger private sector, a government forced to change by finances,

households taking risks once again

TThe future will not be like the pasthe future will not be like the past– If handled right, the Japan that evolves will be fundamentally stronger

than the bubble economy that was so feared in the 80s; Japanese firms may already be in the best financial shape ever

Short-term outlook: main risks

DownsideDownside: Global economy, the US dollar and global: Global economy, the US dollar and globalimbalances, higher oil pricesimbalances, higher oil prices– Chinese economy stumbles hard and cuts off export growth– US looks good, but housing bubble bursting is a risk– US dollar fall would cause rapid yen rise and slow exports– Japan is energy efficient, so direct effect of high oil is

lessened, but may slow growth in key export markets

Upside:Upside: stronger than expected consumer revival, stronger than expected consumer revival,productivity growthproductivity growth– Labour market tighter; companies are increasing bonuses,

dividends and starting raise wages– Domestic demand may continue to surprise to the upside

– Improved capital allocation, labour shortages: more productive investment and rising productivity is possible

Japan is contributing to global growth againJapan is contributing to global growth again– The world’s second largest economy is integral part of Asian

growth pole, and imports are gaining as a share of GDP

Emerging Japan-US-China economic triangleEmerging Japan-US-China economic triangle

– “Imbalance” or a deepening of global integration? – Japan a big market, but is increasingly hub of investment and tech.– How does Canada “plug in to the network”?

Japanese government must change its relationship Japanese government must change its relationship with its people, but also with the world:with its people, but also with the world:– “less aid, more trade” applying both at home and abroad– Chequebook politics and diplomacy too expensive now: Japan will

seek influence through other means

AssessmentAssessmentWhat does this mean for the world?

– Opportunities for trade in traditional & emerging sectors

• Resources, housing, agriculture

• Innovation and science partner: IT, environmental technologies, nanotechnology, robotics, biotechnology, pharmaceuticals

• Investment partner

– Prospects for new partnerships in technology, services and investment, key areas of future growth

– Demographics mean significant change in consumption patterns, new opportunities particularly in services

– Canadian companies can take advantage of Japan’s central place in the booming Asian economy– We must see Japan as Asia’s financial and tech hub, very much

complementary to Asian high growth economies. – New International Policy Statement recognizes this.

AssessmentAssessmentWhat does this mean for Canada?What does this mean for Canada?

The Canadian Embassy in Tokyo, Japan7-3-38 Akasaka, Minato-ku, Tokyo 107-8503

Tel: (81) 3 5412-6200 Web: http://www.dfait-maeci.gc.ca/ni-kaContact:Laurence BlandfordFirst Secretary, Finance and EconomyEmail: laurence.blandford@international.gc.ca

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