Japan: Brexit and its impact Global Economic Outlook, Q2 2017

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Prime Minster Shinzo Abe’s reforms seem to have put Japan’s economy on the track to recovery, with exports, employment, and inflation figures looking rosier. However, Japanese manufacturing and financial services companies operating in the United Kingdom could face some discomfort due to Brexit.

Brexit fallout

British Prime Minister Theresa May recently said, in reference to Brexit, that “no deal is better than a bad deal.”1 Yet it turns out that some Japanese business executives are uncomfortable with this sentiment. Indeed Japan’s Keidanren, which is a powerful business lobbying group, issued a statement asking that Britain give “deeper consideration” to the impact of Brexit.2 Japanese companies employ roughly 140,000 people in the United Kingdom, many in the manufacturing and financial services sectors. They have long seen Britain as a gateway to the rest of Europe. There is now fear that, depending on the terms of Brexit, they could lose their competitive advantages—especially as German companies are also expressing concerns about remaining in the United Kingdom. Nissan, the Japanese auto maker, was able to get a commitment from the British government that it would not face onerous consequences from Brexit. The details of that commitment are not known. Nor is it known whether Britain can afford to provide a similar commitment to every foreign company operating in the United Kingdom. Moreover, if that commitment entails subsidies aimed at offsetting any new tariffs, this would be seen as a violation of World Trade Organization rules and could lead to legal action by the European Union.

Japanese economic performance

Is Abenomics working? Recall that Abenomics is the name given to the three-pronged economic policy of Japan’s prime minister, Shinzo Abe. The three prongs, or arrows, were monetary stimulus, fiscal stimulus, and structural reform. Only the monetary stimulus has been implemented in a significant way. It has involved massive asset purchases by the central bank, combined with historically low, even negative, policy interest rates. The result has been a weak Japanese yen, low borrowing costs, rising asset prices, and a modest boost to inflation. So, again, is it working?

The answer may very well be yes. The Japanese government reports that, in the fourth quarter of 2016, real GDP grew at an annual rate of 1.0 percent and that, for all of 2016, real GDP was up 1.0 percent over 2015. In most countries, those numbers would seem quite disappointing. But remember that Japan has a declining population and, especially, a declining working-age population due to the aging of the population. Thus, real GDP per working-age population is rising at about 2.0 percent per year—a reasonably good number. Partly, this reflects rising productivity, but it also reflects a rising level of participation of working-age people in the labor force. That signifies a recovering economy. The growth in the fourth quarter was driven largely by a rebound in exports, itself likely due, in part, to the weak yen that Abenomics has created.

Lately, however, the weak yen was the counterpart to the strong US dollar, inspired by expectations about US economic policy. Also on the positive side, there was a pickup in business investment, a component of GDP that has until recently been disappointing. There was also good growth of government spending, likely due to the implementation of a new fiscal stimulus program. Interestingly, a decline in inventory accumulation cut 0.5 percentage points from growth in the fourth quarter. This is potentially good news in that it bodes well for expanded production in the coming months.

The growth in the fourth quarter was driven largely by a rebound in exports, itself likely due, in part, to the weak yen that Abenomics has created.

On the negative side, consumer spending growth was very modest, as wages failed to accelerate despite a relatively tight labor market. This is important as consumer spending is the largest component of GDP. If it fails to recover, it will be difficult to sustain strong growth on the basis of exports and investment. It has long been Abe’s intention to boost the growth of domestic demand. Moreover, although Japan benefitted from expanded exports, there is concern in Japan’s business community about the possibility of protectionist policies on the part of the new US administration. Abe’s recent visit to US President Donald Trump’s home in Florida, including a few rounds of golf, was seen as critically important in maintaining good economic relations between the two countries.

Although Japan benefitted from expanded exports, there is concern in Japan’s business community about the possibility of protectionist policies on the part of the new US administration.

Meanwhile, here are the most recent data on Japan’s performance at the start of 2017:

  • Japanese exports were up sharply in February, rising 11.3 percent from a year earlier, the biggest increase in two years. Exports to China were up 28.2 percent, while exports to the United States were up only 0.4 percent. Yet Japan’s trade surplus with the United States increased, raising fears that this will lead to the US government seeking trade restrictions. Meanwhile, Japan’s government is eager to negotiate a bilateral free-trade agreement with the United States in order to retain some of the benefits lost with the end of the Trans-Pacific Partnership. Negotiating such a deal, however, will be difficult if the US administration is concerned about Japan’s trade surplus with the United States.
  • For the first time since 2015, core inflation has returned to Japan. Consumer prices, excluding volatile food prices, increased 0.1 percent from December to January. If food and energy prices are excluded, prices were up 0.2 percent in January versus a year earlier. Headline inflation was 0.4 percent, driven largely by rising energy prices. Yet, aside from the impact of energy prices, economic conditions may be fueling inflation as well. The unemployment rate in Japan fell from 3.1 percent in December to 3.0 percent in January—nearly a 20-year low. In addition, the ratio of job openings to applicants remained close to a 30-year high. This suggests an extremely tight labor market that ought to generate wage acceleration. On the other hand, household spending declined in January versus a year earlier, while industrial output declined in January as well. This suggests that demand may not be sufficient to fuel further inflation. 
  • Although inflation is starting to rebound in Japan, wage increases have been disappointing. The government had hoped wages would start to accelerate given tight labor market conditions, but, in fact, wage increases this year have been slower than in the past year. The problem is that although the labor market is tightening, big companies have large numbers of lifetime employees who are unlikely to depart even if wage increases are modest. Thus, employers don’t have a strong incentive to accelerate wage gains. The government wants employers to boost wages in order to increase consumer purchasing power, something that’s needed to shift the economy away from a dependence on exports.
  • Meanwhile, Japanese retail sales grew at a feeble pace in February. Sales rose 0.2 percent from the previous month, and only 0.1 percent from a year earlier. In addition, sales at supermarkets and department stores, Japan’s main general merchandise retailers, fell 2.7 percent from a year earlier. At the same time, spending at petrol stations increased sharply due to the rebound in oil prices in the past year. In addition, spending on automobiles increased.