Another Lost Decade?

Data on the macro and micro levels show that the Japanese economy has gone into free fall. In the October– December quarter of 2008, annual growth of real gross domestic product dropped all the way to a negative 12.1% rate. That was twice the size of the hit taken by the American economy, which registered negative growth of 6.2% in the fourth quarter. Only one major economy took a sharper plunge, that of South Korea, which experienced a 20.8% contraction. The pattern to be seen was one of steeper declines in countries with larger manufacturing sectors. Manufacturing in Japan has a 21.6% share of the economy (2007), above the level of the United States and Britain.

More bad news came in on April 1 with the unveiling of the results of the latest tankan, the Bank of Japan’s quarterly survey of business confidence. In a diffusion index subtracting the percentage of companies with an unfavorable view of business conditions from the percentage with a favorable view, the index for large manufacturing firms was –58, the worst result on record. The previous low was –57, which turned up in the tankan of May 1975, after the first oil crisis. Because of their heavy reliance on exports, automakers were especially pessimistic and had a –92 index level, but the industrial and electrical machinery industries also showed less confidence than ever before.

The respondents to the survey were slightly less pessimistic about the outlook for the future, partly because they have worked hard to reduce inventory levels in response to the sharp decline in production. Even so, the prospects for profitability are grim. Among large manufacturers in the processing category (which excludes basic materials industries), the level of profits in fiscal 2008 and 2009 (April to March fiscal years) is expected to be only one-fifth of the fiscal 2007 level. The tankan results also point to one of the effects of a profit slump: a steep decline in investment in plant and equipment. Large manufacturers say they plan to scale this back by 13.2% in fiscal 2009, and smaller manufacturers are projecting a much bigger cutback of 42.2%.

The poor picture for profits is also bad news for wages and employment, both of which will be under downward pressure, and it will probably cause consumer spending to taper off. Any downturn in domestic demand can only aggravate the sudden contraction in external demand, ushering in an even more severe business climate. In this way, it is not just the export-dependent manufacturers that are suffering; the business deterioration is also causing grief in the nonmanufacturing sector. The tankan results provide evidence of this. For nonmanufacturing as a whole, the –38 diffusion index for current business conditions worsens to –46 when firms are asked what they expect in three months’ time.

Witnessing this almost unbelievably sudden stagnation of the Japanese economy, including the sharply curtailed industrial production, Britain’s Economist worried in an April 4 article that "Japan is in danger of suffering not one but two lost decades." As Mizuno Kazuo argues in his article in this section, we may be wise to view the turmoil in the world economy not as a once-in-a-century event but as the biggest upheaval since the dawn of modern capitalism. Mizuno asserts that in order for Japanese firms to ride out the crisis, both large manufacturers and smaller nonmanufacturing firms must reorient themselves to meeting the demand of final consumers in other parts of Asia still on an expansionary track. This will require a reformulation of business strategies, which have been premised on a world economy centered on the United States.

FORK IN THE ROAD FOR AUTOS

The automobile industry provides clear signs of the vast changes now beginning in the structure of global demand. The world’s auto markets have entered what is basically their first recession over the entire period since World War II. The tremors rocking the industry are traveling outward from the United States. More than 830,000 new cars were sold on the US market in October 2008, but the number plummeted to the 660,000 level in January 2009.

Stagnant sales are by no means the only cause of the crisis that General Motors is reeling under. The roots of its problems go back to the days of Japan-US trade friction two or three decades ago, when American automakers blamed their problems on the structure of Japan’s exports, making this a controversial political issue. Failing to come up with good strategies for recovering competitive power, they did not put sufficient effort into developing fuel-efficient compact cars and hybrids, despite their popularity. Part of the problem for GM executives was that GMAC Financial Serv-ices, their financial arm, proved to be quite good at promoting sales of new cars with the use of attractive car loans. This success obscured the true nature of what needed to be done. The years of overblown consumption kept rolling along, and GM responded by producing high-priced, high-profit sport utility vehicles in increasing numbers, falling behind in the work of developing fuel-efficient models.

Japan’s automakers are facing different problems from those of the Big Three, but their situation is also dire, as revealed by estimates of their year-end results. Yoshida Tatsuo of UBS Securities Japan reported in the special April 13 edition of the weekly Ekonomisuto that the seven major Japanese automakers registered total sales of ¥43.5 trillion and operating profits of ¥3.3 trillion in the year ending in March 2005 and did even better in the year ending in March 2008, with sales at ¥59.4 trillion and operating profits at ¥4.4 trillion. In the year ending in March 2009, however, sales fell back to ¥48.2 trillion while operating profits reversed to a ¥387.0 billion loss.

Toyota Motor Corp. is in conspicuously poor shape. All of the automakers are scrambling to respond flexibly not just to poor sales on the American market but also to a strengthening yen and shifting world demand. In Toyota’s case, its best efforts were unable to save it from falling into the red, and it is expected to report a current loss of ¥450.0 billion for the year ending in March. Honda Motor Co., by contrast, appears to have ended the year in the black, although its current profits have greatly diminished. The article below by Inoue Hisao looks into Toyota’s situation. Observers are now waiting to see if the selection of Toyoda Akio, a grandson of the firm’s founder, as the next president will help to get Toyota back on its feet.

Polarization is in progress in the world market for automobiles. The advanced countries are moving in the direction of fuel-efficient hybrids, and the makers of these vehicles are gearing up for a shift from nickel-metal hydride batteries to lithium-ion batteries. In the emerging economies, meanwhile, demand will surge for simple, low-priced cars like the Tata Nano, now going on sale from India’s Tata Motors for only ¥210,000. The market for such low-priced vehicles is not one Japan’s automakers can enter.

Japan’s automakers need to radically restructure their competitive power and lay plans for the age of electric vehicles. Until now one of their key strengths has been their ability at so-called integral architecture, which involves not just assembling a lot of parts and components but skillfully harmonizing the operation of motors and other modules. This ability was sufficient to keep these firms competitive up to the stage of the hybrid, but for the electric car they will need to become adept at what is called modular architecture.

In this way, major changes are in store for global auto demand, and Japan’s firms will have to tackle a number of new tasks. To be sure, the day of widespread use of electric cars still lies in the future. As it approaches, though, the automakers of the advanced countries are likely to intensify their competition. The question is whether Japan’s firms can further fine-tune their existing strengths.

BEYOND FISCAL STIMULUS World leaders gathered in London on April 2 for a meeting of the Group of 20. After considerable pushing and pulling in the background, agreement was reached on a stimulus package through the end of 2010 valued at $5 trillion. The details of the package and its expected effect on the real economy were left vague, however, and other questions also went unanswered, such as how the United States and other countries with growing fiscal deficits will finance their spending. Another concern is the deteriorating balance sheets of central banks, which are buying the commercial paper of private businesses in huge quantities.

There are limits to the recovery-producing power of policies focused on government spending and other demand- side stimulus. In the current downturn, the industrial countries have ceased to be the world economy’s leading forces. Policymakers must also promote a supply-side response to demand in the emerging economies. This demand is undergoing change, and its features need to be carefully studied.

In this context, it becomes clear why it will not do for Japan to focus exclusively on the restructuring needs in the manufacturing sector. The first article in the next section below, by Homma Masayoshi, throws light on Japanese agriculture, which needs to be revived from its moribund state and transformed into a growth industry offering attractive employment opportunities. Japan has been pursuing a policy of cutting rice production and propping up rice prices, but this has sapped the competitiveness of farming and invited a decline in food self-sufficiency. As Homma argues, Japan should aim for a combination of efficiently operated large-scale farms and smaller operations run by part-time farmers. Policymakers need to look on agriculture as a sustainable industry with considerable potential, one that can be encouraged to flower by means of a multifaceted strategy. In order to climb out of the recession, accordingly, Japan needs not merely to stimulate demand but also to rebuild the industrial structure, including the structure of agriculture. (Nariai Osamu, Professor, Reitaku University)

© 2009 Japan Echo Inc.