OECD Economic Outlook, Volume 2018 Issue 1

Japan

Economic growth is projected to reach 1¼ per cent in 2018 and 2019, supported by exports, business investment and private consumption. In addition to buoyant international trade, firms facing labour shortages will increase business investment and employment. Wages are projected to edge up, although the gains to households will be partially offset by higher inflation, which is expected to rise to 1½ per cent in 2019. The current account surplus is projected to remain close to 4% of GDP through 2019.

Government debt relative to GDP is the highest ever recorded in the OECD area, which poses serious risks. Achieving fiscal sustainability requires a detailed consolidation programme that includes measures to control spending in the face of rapid ageing, and gradual hikes in the consumption tax rate, beginning with the planned increase in 2019. The Bank of Japan is expected to maintain its expansionary monetary policy until the 2% inflation target is achieved, which is appropriate. Continued structural reforms to boost productivity and sustain employment are also a priority to achieve fiscal sustainability and improve well‑being.

Growth has picked up and intensified labour shortages

The rebound in international trade since mid‑2016 has boosted exports and business investment. The upturn has also been driven by a surge in the number of international visitors, which nearly tripled from 10 million in 2013 to 29 million in 2017, and by preparations to host the 2019 Rugby World Cup and the 2020 Olympic and Paralympic Games. A series of supplementary budgets have also supported growth.

Japan

1. Seasonally-adjusted data (three-month moving average) based on establishments with 30 or more workers.

2. Deflated by the consumer price index, excluding rent.

3. Government projections in January 2018. It assumes that the hike in the consumption tax rate from 8% to 10% is implemented as planned in 2019. The primary balance is central and local governments, as a percentage of GDP on a fiscal year basis.

Source: Ministry of Health, Labour and Welfare; and Cabinet Office.

Statlink

With the working‑age population (15‑64) declining at an annual rate of 1.1% since 2013, labour shortages are becoming more severe. The unemployment rate has fallen to about 2½ per cent, while the ratio of job openings to applicants has risen to its highest level since 1974. A number of firms are cutting back services and operating hours to cope with labour shortages. Despite tight labour market conditions, wage growth remains sluggish and began falling in real terms in the second half of 2017 as headline inflation, led by rising food and energy prices, picked up. Nevertheless, private consumption has rebounded, reaching its highest level since 2013. The contraction in output in the first quarter of 2018 was a temporary correction, followed by a resumption of growth.

Japan. Demand, output and prices

Statlink

Structural reforms and fiscal consolidation are priorities

Japan's shrinking and ageing population makes it important to further remove obstacles to the labour force participation of women, whose employment rate is still 16 percentage points below that of men in Japan. There are also wide gender gaps in job quality. In Japan’s dual labour market, about two‑thirds of the relatively low‑paid non‑regular employees are women, contributing to the gender wage gap, which is the third highest in the OECD. Raising the female employment rate requires improving work‑life balance and encouraging a shift to flexible employment and wage systems based on ability rather than seniority. The New Economic Policy Package, launched at end‑2017, will help by further expanding childcare capacity and introducing free childcare for children between the ages of 3 and 5. It also aims to double labour productivity growth to 2% by 2020 through a range of measures, including corporate governance reforms, financial support for investment in ICT by SMEs and tax incentives for wage and investment increases. In addition, the package will increase flexibility in regulation to facilitate the creation of innovative start‑ups.

Japan

1. Excluding the effects of the April 2014 consumption tax hike, which added 2 percentage points to inflation in FY 2014 according to a government estimate. It also excludes the scheduled October 2019 consumption tax hike, which would add 1.1 percentage points to inflation in the fourth quarter of 2019, according to an OECD estimate.

2. OECD measure, which excludes food and energy.

Source: OECD Economic Outlook 103 database; and Ministry of Health, Labour and Welfare.

Statlink

Japan's gross government debt has risen to 224% of GDP. With a primary deficit (central and local governments) of more than 3% of GDP in 2017, the official target of a primary surplus by FY 2020 is out of reach. The failure to reach the target reflects lower‑than‑expected output growth, the postponement of the second consumption tax hike (from 8% to 10%), originally planned for 2015, to 2019, and the decision to use half of the revenue from the hike for additional spending. The government will announce a new fiscal strategy around mid‑2018 that includes a target date for a primary surplus. The new plan should go further by laying out a detailed and concrete consolidation plan to reduce the debt ratio and ensure confidence in Japan's fiscal sustainability. Measures to raise revenues should rely primarily on taxes that are less distortive, notably the consumption tax and environmentally‑related taxes. The 2019 consumption tax hike should be followed by gradual further increases to bring it towards the OECD average of 19%. On the spending side, the key is to contain social spending, which is driven by population ageing. The new fiscal plan should also include local governments.

The impact of high government debt has been mitigated by low interest rates resulting from large‑scale government bond purchases by the Bank of Japan, which now owns 43% of the outstanding stock of government bonds. The central bank is keeping the yield on 10‑year government bonds close to zero. The Bank of Japan's inflation‑overshooting commitment promises to continue expanding the monetary base until CPI inflation (excluding fresh food) exceeds the 2% target and stays above it in a stable manner. The projection assumes that the supportive monetary stance continues until the inflation target has been sustainably achieved, which is important to ensure a definitive removal of deflationary risks.

The expansion is projected to continue

Growth is projected to remain above 1% per year through 2019. Sustained growth above Japan's estimated potential rate is projected to underpin a gradual rise in inflation to nearly 1½ per cent (excluding the impact of the consumption tax hike). The New Economic Policy Package could lead to even faster growth, although its full benefits may take longer to be realised. Growth will also depend on wage developments. This year's wage agreements might not provide the real wage gains needed to sustain strong private consumption growth. Trade protectionism is another risk, although the recently signed Comprehensive and Progressive Agreement for Trans‑Pacific Partnership (TPP‑11) is a positive development. Japan’s unprecedentedly high level of public debt is a key risk. A loss of confidence in Japan's fiscal sustainability could destabilise the financial sector and the real economy, with large negative spillovers to the world economy.