Slowly Progressing Structural Change in Japan

Ichiro Suzuki

Inflation in Japan is persisting while it is subsiding in many parts of the world. Russia’s Ukrainian invasion caused supply side shocks and drove inflation up, but it is calming after three years. Donald Trump’s tariffs are widely expected to add up to prices of a variety of goods that go through U.S. customs. Such price hikes, however, are going to be one-off if tariff rates are held steady in the future. 

In contrast, inflation in Japan stands out. Adverse effects directly associated with the war appear largely gone for Japan as well as for everyone else. Crude oil prices are down sharply in recent months, contributing to lower inflation around the world. Japan is a big beneficiary of lower oil prices since they are the single largest import item, and a primary cause of the country’s trade deficits in recent. The yen’s relentless fall has been halted and the Japanese currency is 10% higher than it did once against the U.S. dollar. 

Despite all these factors that should be bringing the inflation down, prices are still going to the opposite direction in Japan. April CPI for Japan rose 3.6% over a year ago, while prices in the U.S, rose a relatively modest 2.3%. Food prices are making a big push to consumer prices over all. Rice prices in particular have doubled in a year. Don’t talk about core CPI that excludes volatile food and energy prices. Food prices have been rising steadily over the last few years after three decades of very little changes. Food or else, producers and stores have been wanting to raise prices for years but they stayed away from doing so for fear of losing costumers. They had to hold back a temptation to raise prices or their market shares would be eaten by someone else. 

The recent supply chain disruptions crushed long-held equilibrium that kept prices under pressure for a generation. The Japanese yen got onto a trend of marked depreciation in 2022, to andd extra upward pressure on prices. With prices rising on all front from raw materials, intermediate goods to electricity, producers and sellers were no longer able to absorb rising costs, and were left with no choice but passing costs to consumers. So they tried it, and consumers stayed with them, albeit very grudgingly. Pandora’s box is now wide open. In the meantime, consumers have been squeezed as their income growth is running behind higher prices. 

Ahead of the upcoming House of Councillors (Upper House) election in July, a number of politicians are clamoring for a cut in consumption tax, which is 8% on food and 10% on non-food items. They are trying to respond to consumers’ pleas, by easing their pains to a certain extent. A consumption tax cut, however, has a fundamental flaw. It’s a greater gift to well-off and well-to-do people than average men and women on the street simply because the former pay a larger amount of tax. Politicians nonetheless do things to woo votes, not to maximize economic effects. On top of it, few of them seriously care how to fund the tax cut, leaving it to printing more government bonds. 

Worse, a consumption tax cut might ease consumers’ pain only for a moment while doing nothing to solve the problem of rising prices. As it has become abundantly clear, it is supply constraints that are pushing prices up, not demand shortage. One of the reasons that put the Japanese economy to persisting mild deflation for such a long time has been excess capacity, which is weighing on the Chinese economy today. After a few decades, such redundant capacity appears to have been largely worked out at last, despite great many zombie companies are still kept alive on ultra low interest rates. Electricity has been in tight supply since the Fukushima nuclear disaster in 2011, which halted nuclear power generation. For decades, Corporate Japan was obsessed with keeping abundant cash on their balance sheets, for fear of rainy days when banks don’t lend them at a time of great need. When the Financial Supervisory Agency started pressing Japanese corporations to enhance shareholder value, returning cash to them became their next obsession. Capital investments has been put on sidelines for a very long time. The result not surprisingly turned out to be production capacity not meeting the needs of the 2020s. 

Most notably, declining population has begun to show its effect in rampant labor shortage. In the developed world, corona virus-induced tightness in the labor market has receded after a few years, but not in Japan. It remains tight to this day though the economy isn’t red hot. Qualified young people in particular have become scarce commodities and Corporate Japan is frantically raising salaries to new recruits and young and capable employees. 

Supply side pressure is at last forcing the Japanese economy to learn to operate more efficiently. An absence of productivity growth has been a major, major reason behind Japan’s stagnation for three decades. Ultra low interest rates under mild deflation gave much comfort to those who were not aspired to do better, to the detriment of productivity. The economy finally has come to a point that something needs to be done about it amid rising prices. A quarter century after the birth of the Internet revolution, Corporate Japan appears to have learned how to embrace modern technology. Real wage growth can’t be delivered without enhanced productivity. There will not be a productivity revolution, but some pick up in productivity is going to be experienced. This is a big deal for the Japanese economy, having been left behind the world for such a long time. Japan’s relentless fall in the global rankings of per capita income could be halted, at long last. 

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