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Japan’s Economy

The Japanese Economy experienced a ‘miracle’ growth phase after the end of the Second World War and up until the 1980s to become the second largest economy in the world. However, in the 1990s it experienced a ‘Lost Decade’, and some of its structural problems continue to hold it back.
Thanks to low tax rates, plenty of economic freedom, and a system dominated by the private sector, Japan’s economy is the second largest economy in the world and the largest in Asia, based on real GDP, market exchange rates, and nominal GDP.
Japan uses planned development of science and technology, and has a strong work culture, which benefits the country as a whole. It also emphasizes good relationships between the industrial sector and national government.
According to the CIA World Factbook, the estimated GDP-Purchasing power parity of Japan in 2007 was $4.29 trillion, and the GDP (PPP) per capita was $33,600. Japanese GDP grew at 2.8% in 2007.
The economy is highly advanced and dominated by the services sector, accounting for 73.1% of the economy. The industrial sector, once the engine of Japan’s growth, contributed 25.3% of the GDP. The agricultural sector accounts for only 1.6% of the economy.
Japan has some peculiarities that have marked its rapid rise from the ashes of the Second World War, to preeminence in the 1980s. In particular, manufacturers, their suppliers and distributors work closely together in informal but tight structures called keiretsu, with intimate support from financial institutions and the government. For most of the last fifty years, large Japanese corporations have also provided guaranteed employment for life to ‘salarymen’, typically male employees who work the longest hours on the planet in return for that commitment.
Both of these classical Japanese structures are now breaking down under the weight of globalization and the negative impact of the ‘Lost Decade’, a period during the 1990s when the Japanese economy was stagnant. Some of the structural problems that Japan faced then still need addressing.
For sustained growth rates and stability in the Japanese economy, the government has recently been considering a number of stimulus ideas to manage inflation, increase service sector productivity, look at fiscal consolidation, and reform the tax system and labor market.
Years of Deflation Come to an End in 2008 – Inflation Makes a Comeback in Japan
Japan has been experiencing deflation – meaning an annual drop in prices - since 1999. In 2008, however, the whole world has been buffeted by rising oil, food and commodity prices. Japan’s inflation rate – excluding volatile fresh fruit, fish and vegetable prices – rose 1.5% in May 2008, its highest rate since 1998.
For a decade now, Japanese consumers have grown accustomed to dropping prices. With prices suddenly going up, consumer spending is expected to drop, spelling further trouble for the economy. Indeed, in the second quarterly report of 2008 issued by the Bank of Japan, 58.7% of those surveyed said they expect to cut their spending this year. This is the highest figure on record since the survey started in 1997.
The Bank of Japan will be hard-pressed to rein in inflation which has become a global phenomenon.
Achieving Progress on Fiscal Consolidation by Controlling Government Expenditures
With gross debt of 180% of GDP, further measures to reduce the large budget deficit are becoming increasingly urgent. An improvement in the budget balance of between 4% and 5% of GDP (on a primary budget basis) is needed just to stabilize the government debt-to-GDP ratio, a first step towards the government’s goal of lowering the ratio in the 2010s.
The first priority is to further cut government spending, which has fallen by 2½ percentage points as a share of GDP during the past five years, mainly through trimming public investment and the government wage bill. Expenditure reductions should be accompanied by reforms to improve efficiency in the public sector.
In addition, policies to limit increases in social spending, in the context of rapid population ageing, are essential for fiscal consolidation. However, expenditure cuts alone are insufficient to achieve Japan’s fiscal objectives, making it necessary to raise additional revenue.
Reforming the Tax System to Promote Fiscal Sustainability and Economic Growth
Tax reform is an urgent priority. As mentioned, Japan needs as much as 5% - 6% of GDP in additional government revenue just to stabilize public debt, which has risen to 180% of GDP.
In addition to raising revenue, tax reform should promote economic growth, address the deterioration in income distribution and improve the local tax system. Additional revenue should be obtained primarily by increasing the consumption tax rate, currently the lowest in the OECD area, while broadening the personal and corporate income tax bases.
The corporate tax rate, now the highest in the OECD, should be cut to promote growth, while eliminating aspects of the tax system which discourage labor supply and distort the allocation of capital.
Japan should also consider introducing an earned income tax credit to promote equity. The local tax system should be simplified, increasing reliance on existing taxes on property, income and consumption.
Enhancing the Productivity of the Service Sector in Japan
Labor productivity growth in the service sector, which accounts for over 70% of Japan’s economic output and employment, has slowed markedly in recent years in contrast to manufacturing.
The disappointing performance is associated with weak competition in the service sector resulting from strict product market regulation and the low level of import penetration and inflows of foreign direct investment (FDI). Reversing the deceleration in productivity growth in the service sector is essential to raise Japan’s growth potential. The key is to eliminate entry barriers, accelerate regulatory reform, upgrade competition policy and reduce barriers to trade and inflows of FDI.
Special attention should be given to factors limiting productivity growth in services characterized by either low productivity or high growth potential, such as retail, transport, energy and business services. Finally, it is essential to increase competition in public services, such as health and education, where market forces have been weak.
Reforming the Labour Market to Cope with Increasing Dualism and Population Ageing
The proportion of non-regular workers has risen to one-third of total employment. While non-regular employment provides flexibility cost reductions for firms, it also creates equity and efficiency concerns. A comprehensive approach that includes relaxing the high degree of employment protection for regular workers and expanding the coverage of non-regular workers by the social security system would help to reverse dualism.
Given that non-regular workers receive less firm-based training, it is also necessary to expand training outside of firms to support Japan’s growth potential, while enhancing the employment prospects of non-regular workers.
Reversing the upward trend in non-regular employment may also encourage greater female labor force participation, which is essential given the rapid population ageing that is already reducing Japan’s working-age population by almost 1% each year. Expanding childcare facilities and paying more attention to work-life balance would also boost female employment, while also raising Japan’s exceptionally low birth rate.