The Japanese Economy after the Consumption Tax Hike
Nippon Steel & Sumikin Research Institute Corporation
The Japanese economy slumped temporarily following the April consumption tax hike, but will pick up again as of fall due to the steady expansion of personal income and an upturn in capital investment and exports. However, the October 2015 hike will be postponed.
As expected, the April consumption tax hike pushed the Japanese economy into a temporary slump from which it is taking a while to recover. The Abe administration's excessive trumpeting of the success of its policies could also be viewed as having the opposite effect. At the same time, with personal income sustaining steady expansion and capital investment and exports both showing signs of picking up, there's no doubt that a recovery will occur sooner or later. The Japanese economy has also already experienced two brief slumps-caused respectively by the Great East Japan Earthquake in March 2011, and then the drop in exports to China and Europe in 2012-in the course of the current expansionary phase continuing since April 2009, and these short recessionary interludes have kept the recovery moving ahead without overheating.
The April consumption tax hike drove down the growth rate for the second quarter of 2014 by a hefty 7.1 percent per annum quarter-on-quarter. The 19.0 percent per annum drop in consumer spending in particular cast a shadow over economic prospects. However, statistical distortion undervalues consumer spending for that quarter, and while the higher consumption tax has undoubtedly exerted a negative impact, the actual state of consumer spending is not that bad. Consumer spending of Japan's GDP is estimated using the Family Income and Expenditure Survey and other questionnaire surveys. However, a sampling bias in recent questionnaire results has underestimated both income and spending.
For example, where questionnaire results on spending on car purchases have maintained virtually the same trajectory as actual car registrations, a significant deviation occurred around the time of the consumption tax hike, producing very weak questionnaire survey results. Given that the number of registered cars is a survey of total car numbers, making it a highly reliable statistic, a distortion is presumably arising in the questionnaire survey used for GDP estimates. The same distortion appears to be occurring in relation to consumer electronics consumption.
In addition, looking at statistics such as car registrations, flat-panel TV shipments, department store sales and chain store sales, the reaction to the pre-tax hike demand rush may have caused quite a slump around July, but the economy has been gradually heading toward recovery since August. Car registrations in particular above were driven up from 4.44 million for FY2012 to 4.84 million for FY2013 by pre-hike demand, but have sustained the relatively high level of around 4.5 million for the past several months, with the higher consumption tax in fact impacting only very lightly. The same trend is apparent in other statistics such as flat-panel TV shipments.
The consumption tax hike has also impacted very little on service-related consumption. For example, major travel agents' domestic travel proceeds remained up on the previous year even after the tax hike, while the operating rates for city hotels remain around 80 percent, the same level as during Japan's economic bubble at the end of the 1980s.
The personal income underpinning consumer spending has also displayed robust growth. High corporate profits and a tightening labor market, as well as pressure placed on companies by the Japanese government, have pushed the wage rise rate above two percent. Meanwhile, the unemployment rate dropped to 3.5 percent in August 2014, the lowest level since December 1997. With the labor force continuing to shrink, the number of workers continues to grow at less than one percent, which means that the unemployment rate can only continue to fall. Alongside the decline in the unemployment rate, the wage rise rate is expected to lift to above three percent. While the higher consumption tax rate is obviously depressing consumer spending to some extent, with personal income growth outstripping the consumption tax burden, consumer spending should remain robust in 2015.
In addition to consumer spending, signs are emerging of a substantial expansion in capital investment and exports, both areas which have until now evinced a rather slow recovery. The Development Bank of Japan's questionnaire survey on capital investment by corporate majors suggests that capital investment will jump by 15.1 percent year-on-year in FY2014, the greatest increase since the 17.5 percent rise recorded in FY1989. Strong corporate profits are expected to drive investment in maintenance and repairs which the manufacturing industry has been delaying, and with consumer spending-related firms doing well, their investment too should grow. While this new confidence has yet to reflect in machinery orders, construction orders are demonstrating steady growth. Demand for sophisticated warehouses has been particularly strong due to burgeoning e-commerce and an increase in same-day deliveries, while the graying of society is boosting the construction of hospitals and nursing care facilities. If the export recovery discussed below emerges as a clear trend, the machinery-related capital investment which the manufacturing industry has been postponing too should find an upward trajectory.
Despite the yen trending down since mid-2012, exports have barely grown at all. Factors behind this include: (a) a slower pace of expansion in China and the other emerging economies; (b) Japanese companies' proactive expansion of their overseas production activities; and (c) transfer pricing taxation, which makes it difficult to change contract prices, and has consequently kept export contract prices up despite yen depreciation. However, export-related orders have recently evinced steady growth, and, for the three following reasons, it is now almost certain that Japanese exports will start to rise as of fall.
First, while the economic situation in the emerging economics remains opaque, labor shortages and the growing need to upgrade production equipment have been boosting demand for Japanese machine tools and robots, etc. Second, as Japanese companies reach the end of their current round of offshore production expansion, the shift from exports to local production will also start to slow. Particularly in the case of cars, companies have finished building new plants in North America and Asia for the meantime, and this is likely to start braking the fall in exports. Third, yen depreciation is finally beginning to have a real effect. This trend is epitomized by ship-building. Ship-building demand collapsed due to the deteriorating supply and demand situation for ships following the Lehman shock, preventing Japanese ship-builders from enjoying the merits of the weaker yen. However, continuing high fuel costs have made it common practice to drop ship speed by around 30 percent to improve fuel efficiency, and ship demand has returned to normal levels. As a result, replacement demand has shot up, boosting orders to Japanese ship-builders particularly for ships with good fuel efficiency.
While the world economy is expected to maintain only a moderate pace of expansion, the above factors will place exports on an upward trajectory, with manufacturing industry investment also rising on the strength of more export-related production.
It is now certain that the next consumption tax hike planned for October 2015 will be postponed. With the Japanese economy gradually shaking off the negative impact of the April hike, this postponement will not be good for the economy. First, there is no guarantee that there will be only one postponement. Delaying the consumption tax hike at a time when companies are experiencing record profit levels and the unemployment rate is sitting around the three-percent mark suggests that a tax hike is only possible in extraordinarily good economic conditions. Second, the purpose of increasing the consumption tax rate is to prepare for increased social security spending in the future, and abandoning the effort to lock in medium- to long-term fiscal soundness for the sake of short-term economic conditions will impact negatively on the economy. Third, delaying the tax hike may also cause the currently extremely low long-term interest rate to skyrocket. The interest rate for 10-year JGBs is currently sitting at the extremely low rate of 0.5 percent, partly because of the Bank of Japan increasing its JGB holdings at a rate of 50 trillion yen per annum. However, the market view that a consumption tax hike will keep Japan's budget deficit steadily shrinking is one of the major reasons that the long-term interest remains so low.
Accordingly, postponing the hike without very good reason could see the long-term interest rate skyrocket. An interest rate rise of one percent would cause bond prices to plummet, generating a latent loss of 5.6 trillion yen for financial institutions. Small and medium-sized financial institutions would bear the brunt of the loss, feeding a negative impact through to the Japanese economy through various channels. Raising the consumption tax rate again in October 2015 would certainly have been desirable in terms of maintaining sound economic growth over the medium- to long-term, and it is regrettable that the government has chosen to prioritize political expedience and move toward postponing the hike.
(November 18, 2014)
(original article : Japanese)