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Is Japan’s Outlook Finally Getting Better?

Tokyo, Japan skyline at dusk.
Tokyo. Photo by Balint Földesi.

Japan surprised investors and economists by announcing strong growth for the first quarter of 2019. Given the country’s long-term struggles, it is worth considering whether this is a fluke or a sign that recovery is finally taking hold.

My colleague Eric Meermann and I posed the question “Japan: A Real Recovery?” back in 2004. In that case, the question was prompted in part by a jump in the Japanese Nikkei stock index. Japan had already faced more than a decade of economic bad news, including significant deflation and massive government debt. Our conclusion at the time was that a real recovery could not take hold until Japan addressed underlying structural problems. These included demographics and the government’s reluctance to let companies fail.

About a decade later, I revisited that piece, evaluating whether Japan had made much progress. At the time, I noted that while Japan’s gross domestic product had grown, deflation continued to plague the country. The country’s economy continued to tilt in favor of large, established companies rather than entrepreneurship. Government debt continued to grow. And, perhaps most dishearteningly, Japan had still failed to take real action to address its demographic crisis, resisting immigration even as its native workforce aged out.

That was 2013. A few weeks ago, Japan reported that its economy grew 2.1% in the first quarter of 2019, defying expectations. And recent data from the Ministry of Finance showed that capital expenditures increased by more than 6% in the same period, suggesting a possible upward revision when the next round of GDP figures arrive on June 10. So it is time to ask again: Has Japan course-corrected?

One of the most serious problems I identified in my first analysis, 15 years ago, was Japan’s demographic time bomb. Its citizens have long life expectancies, yet received pension benefits that started at age 60. Meanwhile, years of a birthrate far below that necessary to maintain population numbers meant the proportion of working adults to post-work pensioners was increasingly unbalanced. A decade later, Japan’s population had continued to age and shrink faster than that of nearly any other country.

Prime Minister Shinzo Abe took an important step toward recovery in 2016. After his “Abenomics” program initially stalled, he surprised observers by announcing that his administration would make it easier for foreign workers to secure permanent residency. The government also instituted policies to encourage foreign students to settle in Japan after graduation. For a culture long resistant to foreign settlers, these steps were unexpected. But three years on, they seem to be working.

Japan’s demographics will not change overnight. Yet observers can see progress. The Abe administration’s steps to increase immigration have begun to affect the labor force. While it is still very difficult for a foreigner to become a Japanese citizen, opportunities for skilled workers to become permanent residents are now more common. Two recently added visa categories allow blue-collar workers to work in Japan, too.

The Abe administration has also taken steps to expand the labor force by drawing on underused domestic populations, especially older adults. It gradually raised the national retirement age from 60 to 65, and required private companies to either raise or abolish set retirement ages. Companies could alternatively establish systems for re-employing retired workers. In some areas with especially tight labor markets, prefectural governments have created programs designed to encourage retirees to rejoin the workforce. As a result, many Japanese workers have continued to work, or resumed working, into their 70s.

Attitudes about women, especially mothers, in the workforce are also shifting with the support of policy. Government-backed programs have advised and supported businesses in redesigning jobs to make them more appealing to women with young children. Changes include offering shorter hours for workers who request them and emphasizing predictable hours, which make it easier to arrange child care.

The result: While Japan’s working-age population shrank by 4.7 million between 2012 and 2019, the number of people actually working grew by 4.4 million in that same period. In other words, more people who could work actually did.

Addressing its demographic challenges is a major step forward for Japan. The country has progressed elsewhere, too. The country has finally emerged from the shadow of deflation, though the central bank continues to struggle to achieve its target of 2% inflation. Government debt remains a major concern; the International Monetary Fund says Japan’s debt is about 240% of its GDP. But its ratio of debt to GDP has stopped rising, and the government has discussed concrete steps to rein in government debt.

So while it waited until the eleventh hour, Japan has taken real steps back from the economic abyss. For that, its policymakers deserve praise.

This is not to say that Japan faces no significant economic challenges. Japan’s Cabinet Office reported in May that both exports and imports fell in the first quarter of 2019, though imports fell faster. Private consumption also declined. Even as its domestic economy improves, Japan’s citizens seem reluctant to spend. And while the Abe administration has pledged to raise the country’s consumption tax this fall, for now Japan’s government remains deeply in debt.

Japan has also suffered from trade tensions between China and the United States. Japanese companies that sell unfinished manufacturing components to Chinese enterprises have especially struggled due to tariffs and the connected uncertainty. President Donald Trump has complained in the past about the trade deficit between the U.S. and Japan, and recently visited Tokyo for trade negotiations. The president suggested that the nations may announce a trade deal as soon as August, but the details remain an open question.

For an investor, Japan is still a little scary – but, frankly, the same can be said about a lot of countries these days. The global outlook is uncertain, but Japan’s progress means that international investors should not necessarily be warier of investing in Japan than any other major economy.

Assuming this is a real recovery, the next question about Japan becomes: Can they sustain it? There is only so much extra labor participation to tap in older workers and women. Some economists feel Japan is approaching that limit. If the birthrate doesn’t rise, Japan will still hit an economic ceiling. And if Abe’s successor reverses existing policies, Japan could quickly find itself facing economic Armageddon once again.

Japan’s challenge for the next five to 10 years will be to build on this initial success and resist complacency. If it manages to do so, I may finally be able to stop asking whether Japan is OK.

Vice President and Chief Investment Officer Paul Jacobs, of our Atlanta office, contributed several chapters to our firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55, including Chapter 12, “Retirement Plans;” Chapter 15, “Investment Approaches and Philosophy;” and Chapter 19, “A Second Act: Starting a New Venture.”

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