There are increasing signs that the Japanese economy is rebounding from the impact of the April sales tax rise. Also, there has been positive news in Japan’s labor market.
There are increasing signs that the Japanese economy is rebounding from the impact of the sales tax rise that came into effect on April 1, 2014. Contrary to earlier expectations, total commercial sales saw a modest increase of 2 percent in the following two months. Consumer confidence improved 6.2 percent from April to May 2014 due to an improved employment outlook and higher willingness to buy durable goods.
The Markit purchasing managers’ index (PMI) for the Japanese manufacturing sector improved from 49.9 in May to 51.1 in June 2014.1 The index moved above 50 for the first time in three months, indicating an expansion in the sector. The PMI had fallen below 50 around the time the sales tax was increased in April. The Japanese industrial production index also increased 0.5 percent from April to May, after falling 2.8 percent in the prior month. Economic activity was hit after strong growth prior to the tax increase; both production of and demand for industrial goods fell in April post the national sales tax increase. However, the May data indicate that the industrial sector has stabilized and is now starting to rebound.
The Bank of Japan’s Tankan survey indicates that business conditions of large enterprises were stronger than expected in Q2 2014 and are expected to remain robust in the next quarter as well.2 The survey indicates that business confidence will likely bounce back in Q3 2014 after a brief fall in the previous quarter. The previous survey that was conducted three months ago had indicated that businesses intended to boost spending by only 0.1 percent in the current fiscal year relative to the previous year. However, the present survey indicates the intended business capital spending to be 7.4 percent in the current fiscal year. Thus business sentiment has improved in the past few months.
Strong labor market may boost consumption
There has been some positive news in Japan’s labor market. The unemployment rate fell to 3.5 percent in May, the lowest since 1997. It has remained fairly low over the last few years and has been trending down since 2013. A sustained low-unemployment situation implies that the economy is probably at or near full employment. This will likely result in labor supply shortages, which, in turn, may drive wage growth.
There has been some success in increasing the price levels in the economy through expansionary monetary and fiscal policies—the first two arrows of Abenomics.
One of the goals of Abenomics has been to raise prices in the economy, which has experienced a deflationary spiral for more than a decade. There has been some success in increasing the price levels in the economy through expansionary monetary and fiscal policies—the first two arrows of Abenomics. Latest data releases indicate that the consumer price index increased 3.7 percent year over year in May. This was the highest rate of consumer price inflation since 1991. However, so far the rise in prices has failed to motivate businesses to increase wages. Prime Minister Shinzo Abe too has failed to persuade companies to raise wages despite rising corporate profits due to a weaker yen, increasing prices, and recent policy initiatives.
Shortages in the labor market may compel businesses to raise wages. This will likely strengthen the labor market and help consumers weather the impact of the tax increase. So far consumer spending has remained weak; it fell by 4 percent and 7 percent year over year in April and May respectively, post the tax increase. A boost in wages will likely stimulate consumer spending and increase domestic demand in the economy. A rise in domestic demand may reduce the dependence of the economy on exports, which so far has been the biggest contributor to economic growth.
The third arrow of Abenomics: More reforms to come
The latest data bode well for a quick economic recovery from the tax-induced downturn. They also imply that the first big move of reforms has been relatively successful so far, and the economy may be fundamentally strong enough to pull itself together in the coming quarters.
Last month, Abe unveiled his long-awaited summary of deregulation proposals, which he intends to elaborate upon later. The focus of the deregulation strategy is to bolster private investment by bringing in corporate tax reforms, creating special economic zones, boosting foreign direct investment, improving corporate governance, and speeding the process to sign free-trade agreements (such as the Trans-Pacific Partnership), among others. The proposal also offers labor market reforms, which include encouraging women to join the labor force, increasing employment of young and old workers, and boosting immigration.3
These deregulation strategies have the potential to benefit the economy. However, according to many analysts, these reforms are not enough to sustain economic growth. Businesses are still hoarding cash and are not motivated to invest. Wages are stagnant, and aggressive monetary policies are not enough to push long-term growth. That said, the prime minister has at least shown the determination to implement reforms. It might be prudent for him to take small steps to ensure that the economy can adjust to structural changes before undertaking radical reforms. Adjustments along the reforms process will likely help the economy withstand shocks and uncertainties better.
EndnotesView all endnotes
- Markit Economics, “Markit/JMMA Japan Manufacturing PMI,” July 1, 2014, http://www.markiteconomics.com/Survey/PressRelease.mvc/e5b24eff8cfd489abf44c7f8cb545876.
- Bank of Japan, “Tankan: The comprehensive data set of the June 2014 survey,” July 2014.
- For more details, refer to Ira Kalish, “Japan: The third arrow of Abenomics,” Global Economic Outlook, Q3 2014, Deloitte University Press, July 2014.