Understanding the Paradox of Japan's Economy – The Diplomat

Two conflicting headlines about the Japanese economy recently caught people's attention. First, in 2023 Japan's GDP will surpass Germany's GDP. This dropped Japan to become the world's fourth-largest economy, overtaking China, which held second place in 2010, after 13 years. Yet the Japanese stock market continues to roar, with the Nikkei index hitting historic highs. Once it climbed above 40,000. It was well above its peak in 1989, just before the bubble burst.

It can be puzzling that these two headlines are happening at the same time. Is the Japanese economy in good or bad shape? How should people make sense of these paradoxical phenomena?

To be fair, it should be noted that nominal GDP is affected by the exchange rate. As the Japanese yen has depreciated nearly 30 percent against the U.S. dollar over the past decade, its GDP calculation will surely shrink.

That doesn't mean Japan's economy is secretly doing better than Germany's. Data from the IMF shows that Japan's average real growth rate is only 0.7 percent annually from 2000 to 2022, while Germany's growth is 1.2 percent. As a result, over the past two decades, Japanese GDP rose by only about 10 percent, while German GDP nearly doubled.

Meanwhile, Japan's labor productivity – measured by the value of goods or services a worker can produce per hour – ranked 30th out of 38 OECD countries as of 2022, and the lowest among advanced G-7 countries. Japan's labor productivity is only 60 percent of Germany's, second only to the United States. This is why Germany's GDP is able to catch up with Japan's GDP, even though it has two-thirds of Japan's population.

There are more worrying indicators for the Japanese economy. Japan's nominal GDP per capita in 2022 was $34,064, ranking 21st among the 38 members of the OECD – the lowest for Japan. Also, Japan's GDP will account for only 4.2 percent of the global economy as of 2022, the lowest percentage recorded since the 1980s. In the last quarter of 2023, private consumption and business investment declined by 0.4 percent and 0.1 percent, respectively, compared to the previous quarter.

Why is the stock market rising in such dire economic conditions?

The main reason is that many large Japanese companies are doing well because of the weak yen. Companies like Toyota benefit significantly from the yen's decline; These companies set records for profitability and market value.

Another major reason for the growth of the stock market is the investment from abroad. Investors like Warren Buffett keep pouring money into the Japanese stock market because the returns are good. Domestically the Japanese government is also encouraging people to invest with the new NISA policy.

Does the stock rise suggest a prosperous economy in today's Japan? The answer is no.

A weak yen is a double-edged sword. This brings huge profits to export-oriented companies and also affects import-oriented companies that rely heavily on foreign energy, food and commodities. Big companies can win the game, but most small and medium enterprises (SMEs) don't.

The biggest dilemma facing Japan's economy at the moment is the decline in consumption. This is mainly due to the fact that the wages of casual workers have remained almost at the same level for the past three decades. This is unusual for an advanced economy. Although big companies have increased the wages of their employees in response to the government's demand, most of the SMEs are reluctant to do so.

Due to the Bank of Japan's continued financial deregulation, the Japanese economy has gradually reversed from deflation to inflation in recent years. Commodity prices are rising sharply. However, the rise in salaries of the common man has not kept pace.

Inflation is expected to be around 3 percent this year, while newly released data showed real wages fell 0.6 percent year-on-year in January 2024. This trend not only restrains individual consumption but also leads to loss of human resources. There are reports that many skilled Japanese workers are moving to the US and Europe because they can earn higher salaries doing similar jobs.

Abenomics has gradually pushed the stock market to new heights over the past decade. Prime Minister Kishita Fumio's economic policy has been based on Abenomics. Although the Kishida administration has laid out its „new capitalism” agenda to focus on both the growth and redistribution of wealth, there are few signs that the underlying problems will be resolved anytime soon.