Economic Survey of Japan 2006: Key challenges to sustaining Japan’s improved economic performance

The following OECD assessment and recommendations summarise Chapter 1 of the Economic Survey of Japan 2006 published on 20 July 2006.

Contents                                                                                                                           

The post-bubble obstacles to growth have been largely overcome…

Japan has finally emerged from an extended period of economic stagnation following the collapse of the asset price bubble in the early 1990s. Factors that had weighed on activity   such as falling asset prices and declining bank lending   have been slowed or reversed, while corporate restructuring to reduce employment, capacity and debt has largely run its course. This has allowed the initial export-led upturn in 2002 to develop since early 2005 into a full-fledged expansion driven by domestic demand. The strength and duration of this upturn pushed some measures of inflation into positive territory in the first quarter of 2006 and business and household confidence have now reached their highest levels since the early 1990s. The government’s reform measures have played an important role in laying the foundation for sustained and robust growth, in particular by strengthening the banking system. The positive trends in business investment and private consumption are expected to continue, making the current expansion the longest in Japan’s post-war history, with output growing between 2 and 3% in 2006 and 2007.

The end of the post-bubble period

1.  Diffusion index of firms responding ''excessive capacity'' minus those responding ''insufficient capacity'' for all industries.
2.  Interest-bearing debt as a per cent of cash flow for all industries.
3.  Diffusion index of firms responding ''excessive employment'' minus those responding ''insufficient employment''.
4.  Quarterly average of seasonally adjusted monthly data. Including part-timers.
5.  Tankan Survey for all industries.
Source: Bank of Japan, Ministry of Land, Infrastructure and Transport, Ministry of Health, Labour and Welfare, Ministry of Finance and Cabinet Office.

… but achieving robust growth over the medium term requires addressing some difficult challenges

However, sustaining the upturn over the medium term requires meeting a number of challenges:

• Achieving a definitive end to deflation and successfully implementing an effective monetary policy framework. A significant rise in market interest rates that is too early or too large would pose important risks to both economic activity and the fiscal situation.

• Ensuring fiscal sustainability in the context of exceptionally rapid population ageing. With gross public debt having risen to over 170% of GDP, measures to reduce the large government budget deficit are urgent.

• Addressing emerging concerns about income distribution and poverty while containing the growth of government spending. Rising income inequality and the increasing proportion of the population in relative poverty threaten to weaken the consensus for further economic reforms. 

• Upgrading the innovation system to help boost productivity growth. With population ageing slowing labour inputs, increasing the return on investment in innovation is essential to achieve the faster productivity gains needed to sustain the rise in living standards.

• Strengthening the integration of Japan in the world economy to benefit more fully from globalisation. Accelerating productivity growth also requires making fuller use of goods, services, capital, technology and human resources from abroad. 

In sum, Japan needs to implement monetary and fiscal policies appropriate to its unique macroeconomic situation while advancing on a wide range of economic reforms necessary to sustain growth.

Large budget deficits have pushed up government debt to over 170% of GDP
For general government, as per cent of GDP(1)

1. OECD estimates for 2005, 2006 and 2007.
Source: OECD Economic Outlook 79 database.

Setting appropriate macroeconomic policies

Policymakers face the challenge of managing a “double exit strategy”, with monetary policy exiting from zero interest rates, while fiscal policy exits from unsustainably high budget deficits. Finding the appropriate pace and policy mix for this exit strategy is a difficult task and macroeconomic conditions have to be taken into account. Deflationary pressures are not fully overcome, although the real economy has strengthened considerably. Furthermore, medium-term inflation expectations have to be anchored at the desired level in order to prevent an excessive rise in long-term nominal interest rates.

How to obtain this publication                                                                                     

The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.

The complete edition of the Economic Survey of Japan 2006 is available from:

• SourceOECD  for subscribing institutions and many libraries
• OECD Online Bookshop for non-subscribers
• OLISnet, under "Publication Locator", for government officials with accounts (suscribe)
• Accredited journalists (password required)

Additional information                                                                                                  

• Economic Surveys and Country Surveillance
• List of recent Japan surveys
• OECD Economics Department homepage
• OECD Japan website

For further information please contat the Japan Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Randall Jones, Tadashi Yokoyama and Taesik Yoon under the supervision of Willi Leibfritz.