Japan braces for economic headwinds

Australia & Japan in the Region

Volume 7, No 1, January 2019

The Japanese economy’s Goldilocks state continues, in which everything seems ‘just right’: modest but steady growth, a tight labour market, high corporate profits and elevated share prices. But there have also been notable developments on the ‘three bears’ that threaten to come home and disrupt the good fortune that Japan is still enjoying. An ageing population, the risk of a fiscal crisis and the need to open up the country for a supplementary source of labour all present significant risks.

Japan’s economic conditions continue to be neither too hot nor too cold. Growth momentum decelerated somewhat in 2018, but going forward there are reasons to believe that it might pick up again. Construction activities related to the 2020 Tokyo Summer Olympic Games are gearing up. The planned consumption tax hike will create a temporary pre-hike consumption upswing in the coming months. The labour market is still tight but wages are growing only moderately and inflation is still weak, justifying the Bank of Japan’s loose monetary policy despite the US Federal Reserve’s policy normalisation.

Turning to the bears, two important developments are unfolding.

First, the Abe administration seems to have made up its mind to implement the second leg of a two-stage consumption tax hike in September 2019, this time from 8 to 10 per cent. The second hike has already been postponed twice for fear of repeating the slump that occurred after the first step up in the tax in 2014.

Multiple tax rates not only impose a heavy administrative burden on shops that sell both food and non-food items, they also give rise to many anomalies

Second, the administration has at last come up with a plan to formalise the intake of foreign workers. An amendment to the country’s immigration law was recently approved by the Diet, against fierce resistance by opposition parties. Unlike the existing Technical Intern Training Program that has been used — and sometimes abused — to supplement the dwindling labour supply, the amended law officially recognises that Japan will accept medium- and low-skilled foreign workers. Along with the migration law amendment, the government has specified the scope and quantity of intake over the next five years starting from April 2019.

Both are a step in the right direction as they ease the demographic and fiscal pressures Japan is facing. But unfortunately ― perhaps as is always the case ― both are also being distorted by politics.

The most serious distortion related to the consumption tax hike is the decision to keep the tax rate on food items at 8 per cent. It has a seemingly innocent justification: to protect the poor, basic needs must be kept outside of the tax hike. But multiple tax rates not only impose a heavy administrative burden on shops that sell both food and non-food items, they also give rise to many anomalies — some of which are, in practice, ridiculous.

If shopping at a convenience store, for instance, a customer will be asked whether they intend to eat the sandwich that they are buying inside the shop (taxable at 10 per cent) or take it home (taxable at 8 per cent). The clerk needs to charge the right amount of tax based on the answer. This is poor administration.

A new bear is threatening not just Japan’s future but that of the entire world

The government is also planning to introduce a host of subsidy schemes to attenuate the after-tax consumption slump. While their need and effectiveness are questionable, they will certainly eat into the revenue increase from the tax hike.

The main concern about the amended immigration law is the way the government waited until the issue’s breaking point was nearing, then quickly proposed an amendment and pushed it through the Diet. Implementation will occur just as fast, within a few months. Opposition parties rightly expressed concern about the amendment’s ramifications, including for Japan’s social security system and lack of preparedness on the part of receiving firms, regulators and society in general. Still, somewhat hasty action is better than no action at all, and there will be plenty of time for Japan to learn to welcome foreign workers as indispensable colleagues and neighbours.

A new bear is threatening not just Japan’s future but that of the entire world: the trade tensions between the United States and China. Although the estimated negative impact on Japan is smaller than that on the two warring nations, it is sizeable compared with Japan’s potential growth of less than 1 per cent.

What is perhaps more unfortunate than any output loss is that the United States is resorting to unilateral bully diplomacy to settle its conflict with China and many other international disputes. The United States’ dwindling legitimacy as the world’s leading power is a source of unease in Tokyo, which must readjust to a world in which trade liberalisation is no longer a priority shared with its closest ally.

This article is part of an EAF special feature series on 2018 in review and the year ahead.

About the author

Masahiko Takeda is a professor in the School of International and Public Policy, Hitotsubashi University.

He received his PhD from the Massachusetts Institute of Technology. He has since held various roles at Hitotsubashi University, and his research interests are Analysis of Economic Policy and Development with a focus on Asia.

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