Japan Slips in Global GDP rankings

Ichiro Suzuki

At the turn of the 21st century, Japan was still comfortably the largest economy on earth, outside of the United States. At the height of its economic might in the late 1980s, the size of the Japanese economy rose to approximately 60% of the U.S,, with less than half the population. Then in 2008, China replaced Japan as the second largest economy, with torrid, double-digit growth rates that characterized the early years of the 21st century. This was inevitable, given the vastly larger size of the People Republic’s population. By the end of 2023, Japan fell a step further back, overtaken by Germany. This step back wasn’t inevitable.

As opposed to China back then, Germany isn’t doing any better than Japan. In fact, Germany is struggling immensely. Russian tanks’ invasion into Ukraine in February 2022 has revealed drawbacks of the systems that underpinned the German economy for decades. One was over-dependence on cheap Russian natural gas. Another was an absence of awareness of security risks that surround the country. Security arrangements under the NATO looked firm even after Putin grabbed Crimean Peninsula in 2014 for the first land grab in Europe after WWII. Then Russia’s Ukraine invasion had turned all the underlying assumptions upside down. Even worse, Chancellor Merz came to be aware of Germany’s over-dependence on exports to China during Angela Merkel’s sixteen years as Chancellor. 

On the other hand, Japan is doing fine essentially in its own right. True that the Japanese economy is no longer capable of delivering eye-popping growth rates. It is, however, leaving nightmarish decades of deflation behind. The United States has left the global economy behind after a deep recession caused by the coronavirus. Excluding the U.S., Japan has been essentially on par with the rest of the developed world. If anything, it is doing better than Germany. Both economies suffered a 4.1% setback in 2020. After the dismal year, Japan has notched the north of 1% growth on average the next four years as opposed to Germany’s less than 1%.  Germany registered two consecutive years of negative growth rates in 2023 and 2024 and has a chance of another one in 2025 for the aforementioned factors that are going wrong for the country. Japan’s economic performance could be regarded as commendable since it is achieved amid its population’s decline, which negatively affects household sector consumption. 

It was not economic performances that has made Japan fall behind Germany. The main culprit of the setback was the currency. While GDP statistics are compiled in local currency, international comparisons are based on U.S. dollar. As the Japanese economy got onto a path of relatively solid though slow recovery, its currency began to slide conspicuously. Before its historic descent, the Japanese yen was already undervalued as measured by real effective exchange rate but the market still sold the yen relentlessly. There has been simply too much money in the system. This is an economy that was mired in mild deflation for three decades. While ultra loose monetary policy has kept the Japanese economy from falling into a deeper hole, it has also made the economy addicted to too much money. Addiction has become so rampant that the economy can no longer live without very cheap money. Larger corporations exposed to the global economy were forced to fit themselves to the new reality through the waves of radical changes brought by globalization and the advent of the Internet. But it was less so for those that were insulated from such waves. More modest changes took place in agriculture and service sectors and small and medium enterprises in general. In contrast to large corporations that are today awash with cash and are pressed by the market to raise leverage for greater asset efficiency, less efficient segments of the economy have been carrying excessive debt and can’t live in a world of higher interest rates. In this two-tier economy, monetary policy is made to accommodate the weaker part. Amid inflation that’s running higher than in the U.S., policy interest rates are still set close to zero, for distinctly negative real interest rates. On top of it, private sector money relentlessly keeps flowing out of Japan seeking higher returns elsewhere, especially in the United States, in the form of portfolio investments as well as foreign direct investments. A combination of loose monetary policy and increased risk appetite for higher returns keeps the Japanese yen undervalued, regardless of what its value in theory might be. Should lifting the size of the economy in USD be the ultimate purpose of the Bank of Japan, the central bank might tighten money very aggressively. Such a move could drive the value of the yen up by 20% while causing a deep recession of negative 5% growth. This combination could still raise the Japanese economy’s size in USD by 14%, to solve the ‘problem’. No one wants such a move, however. 

About the author: Mr. Suzuki is a retired investment banker based in Tokyo, Japan.