What are the key challenges facing Japan?
The Japanese economy is in its best shape in a decade thanks to buoyant external demand, the progress in restructuring the corporate sector and economic reforms. Output has increased at an annual rate of more than 2 per cent since 2002 and 3¼ per cent excluding the negative contribution from the public sector. The pace of growth has been sufficient to boost employment during the past year and reduce the unemployment rate from its record high. Profit margins, as well as confidence in the business and household sectors, are at their highest levels since the early 1990s. These positive developments raise hopes that Japan is emerging from a decade of economic stagnation, although there are a number of risks to the current expansion.
Despite these favourable trends, Japan must successfully address a number of challenges in order to sustain a robust expansion and ensure rising living standards in the face of rapid population ageing:
Deflation remains entrenched, though at a low rate, and nation-wide land prices fell again in 2004, the 13th consecutive annual decline. In addition, bank lending continues to fall despite progress in rehabilitating the banking system.
Large government budget deficits have boosted gross public debt to more than 160 per cent of GDP - the highest in the OECD area - just as Japan enters a phase of rapid population ageing, reinforcing concern about fiscal sustainability.
A lack of fiscal discipline at the local government level is contributing to the run-up in debt. Moreover, problems in the relationship between different levels of government prevent Japan from reaping the benefits of decentralisation more fully.
A number of structural problems, including weak competition in some sectors, limit Japan's growth potential.
Increasing dualism in the labour market creates both efficiency and equity concerns, while population ageing is reducing the size of the workforce.
In sum, the positive developments during the current expansion do not reduce the urgency of a broad programme combining macroeconomic and structural policies.
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