Article
7 minute read 21 September 2021

Japan

The pandemic adds yet another delay to Japan’s economic recovery

7 minute read 21 September 2021
Michael Wolf

Michael Wolf

United States

Despite pandemic-related challenges, Japan is positioned for stronger growth later this year and into 2022.

Japan’s struggles with the COVID-19 pandemic have delayed its economic recovery. Extended states of emergency have zapped demand for in-person services, which indicates consumer spending may have remained weak in Q3 2021. Nonetheless, higher vaccination rates should help put an end to the state of emergency, allowing spending to pick up before the end of the year. Manufacturing—helped by strong domestic and foreign demand—has been a notable bright spot for the Japanese economy. Unfortunately, high input costs, shortage of raw materials, and shipping delays are restraining the growth of goods producers. It is true that some inflationary pressures are building, but they will likely prove insufficient to warrant a change in policy from the central bank. Furthermore, the future course of fiscal policy has entered uncertain waters as the prime minister unexpectedly announced his decision to not run for reelection.

After a brief respite in late spring, infection rates began to rise significantly over the summer. As a result, at present, 21 of the country’s 47 prefectures are under a state of emergency that is expected to last into late September.1 Tokyo has been under a state of emergency since July 2021. As per law, these lockdown restrictions cannot be made mandatory. Although the National Diet, Japan’s legislature, passed a law that allowed the government to fine businesses that were not complying with restrictions, its lenient enforcement allowed people to flout the rules.2 It is this low compliance with restrictions, combined with new, more contagious variants of the virus, that has contributed to the recent surge in infection rates. The number of confirmed cases had reached new highs by August and hospital beds were rapidly filling up in the most affected areas.3

Consequently, the most recent outbreak has lowered expectations for GDP growth in 2021. The International Monetary Fund4 and the Bank of Japan5 both lowered their forecasts between April and July. Additional downward revisions could be on the horizon. Moreover, the outbreak has worsened since July, and recently Japan reported its first case of the new Mu variant. Although not much is known about this variant yet, officials are concerned that it could be vaccine-resistant and more contagious than earlier variants.6 If these concerns turn out to be true, renormalizing the economy will prove to be a challenging task.  

Although the vaccine approval process in Japan had been fairly slow, vaccine dissemination has been notably faster. As of September 1, 46.9% of the population was already fully vaccinated—just 5 percentage points lower than in the United States7 (figure 1). In some countries, vaccine hesitancy has slowed the pace of vaccination. However, the pace of vaccine dissemination remains strong in Japan, which is still giving out doses to about 1% of the population each day, a staggeringly fast pace compared to many other rich countries.8

The growing number of cases and the extended states of emergency have understandably weakened demand for in-person services such as restaurants. The au Jibun Bank’s Purchasing Managers’ Index (PMI) for services dropped to 42.9 in August, the lowest reading since May 2020.9 A reading below 50 indicates the sector is contracting. Retail sales had perked up in June and July, when most of the country was no longer under a state of emergency—posting an increase of 3.1% and 1.1%, respectively.10 This, however, was not enough to make up for the losses seen in April and May. Consumer spending likely slowed in August and September. Mobility near retail and recreation establishments deteriorated throughout August and was 17% below the prepandemic levels as of September 14.11 Consumer confidence also ticked lower in August.12 The extension of the state of emergency does not bode well for spending in September either. However, early signs that the current wave of infections is waning provides optimism that spending can pick up thereafter. 

Reversal of deflation on the horizon

Low inflation and at times outright deflation have given consumers additional purchasing power. Indeed, the Consumer Price Index (CPI) was down 0.3% from a year ago in July (figure 2).13 Telecommunication prices, which were down 25.7% year over year,14 held down the headline number. Policymakers recently pressured telecom companies to lower their prices, forcing the downward adjustment in the CPI. Other categories, meanwhile, are seeing stronger growth. On a year-ago basis, utility prices were up 2.2%, furniture and household utensils were up 2.4%, and reading and recreation were up 1.9%.15 Housing and clothing prices were also higher compared to last year, albeit only modestly. Furthermore, policies to lower the cost of early childhood education had previously held down the price of education services, but these prices too witnessed a year-over-year rise (1.1%).16

Even after excluding telecoms, inflation is still running well below the Bank of Japan’s 2% target, allowing for a continuation of its easy monetary policy. With the US central bank signaling that it will begin to taper its bond purchases,17 the yen may depreciate further against the dollar. Yen depreciation will raise the cost of imports, particularly commodities, such as oil, that are priced in dollars. Commodity prices have already surged across the globe. The higher cost of inputs, such as steel and lumber, contributed to a 5.6% year-ago gain in producer prices in July.18 Although the cost of lumber has somewhat eased since, most other commodity prices remain elevated, creating some inflationary pressure in the pipeline.

For inflation to persist, it would likely require stronger wage growth. For decades, low wage growth and low inflation have gone hand in hand in Japan, which seems likely to continue. Wage growth has been fairly stagnant recently—total cash earnings in June were virtually no higher than they were a year earlier despite weakness last year.19 Contractual cash earnings, which exclude certain types of compensation, such as bonuses, have been a bit stronger, but they remain firmly below prepandemic levels.20

The manufacturing sector outperforms but risks loom

Japan’s manufacturing sector has held up far better than the services sector (figure 3). Manufacturing production was up 11.7% in July compared to a year ago.21 As spending on in-person services plummeted during the pandemic, goods purchases ramped up, a trend evident in many countries around the world. Foreign demand has also supported growth in the manufacturing sector. In July, goods exports were 37.1% higher year on year.22 Furthermore, Japan is an important player in the semiconductor industry, providing critical components needed in the chipmaking process. As demand for goods has surged around the globe, so too has demand for the semiconductors used in many of those goods. Japan’s production of electronic parts and devices, which includes integrated circuits, surged 26.1% year over year in July.23 However, more recently, manufacturing growth has slowed. The au Jibun Bank manufacturing PMI dipped to 52.7 in August, which indicates that the sector is still expanding, although at a slower rate than what was seen earlier this year. The PMI’s exports order subindex slipped into contraction territory, highlighting some of the challenges exporters face, including a lack of raw materials and the longest lead times since the 2011 earthquake and tsunami.24

As some of the pandemic-related supply constraints ease, Japanese exporters could see better conditions. Input prices, the cost of shipping, and lead times should all improve. Demand for Japanese exports could also pick up. Furthermore, Japan, along with China, Singapore, and Thailand, ratified the Regional Comprehensive Economic Partnership (RCEP), a trade agreement that covers about 30% of the world’s population and output.25 The pandemic has delayed other countries’ ratification, which is a requirement for the multilateral agreement to become effective. Some analysts expect that to occur sometime next year.26 Once it goes into effect, the RCEP could add US$500 billion to global trade by 2030.27 The partnership is particularly important for Japan as it lowers tariffs for Japanese exports to China and South Korea, two of its three largest trading partners.

Suga’s resignation opens the door for new policy

Allowing the Olympics to go as planned proved widely unpopular in Japan, especially as it coincided with rising infection rates and extended lockdowns in some of the most populous areas of the country. As a result, the popularity of the prime minister, Yoshihide Suga, plummeted.28 Furthermore, Japan is scheduled to hold a general election before November 30 this year. Although it was expected that Suga would be reelected despite his drop in popularity, he announced that he would resign to focus on battling the pandemic rather than spending time in an election campaign.29 This has opened the door for other candidates. One of the early front-runners, Fumio Kishida, has advocated for additional economic stimulus, which could amount to “several tens of trillion yen.”30 Regardless of who wins the general election, the new prime minister may find it difficult to pass their legislative agenda. Based on the current electoral mood, the ruling Liberal Democratic Party is expected to win the general election, but it risks losing its two-thirds supermajority in the lower house,31 which could restrain planned spending.

After a series of pandemic-related challenges, Japan is positioned for stronger growth later this year and into 2022. Once the state of emergency ends, spending on services should rebound. At the same time, demand for goods should stay relatively strong. Easy monetary policy and the possibility of additional fiscal stimulus could add a bit more inflation and help lift stagnant wages. Of course, this is not the first time during the pandemic that Japan was poised for stronger growth. The presence of new variants could extend lockdowns and create more challenges in manufacturers’ supply chains. Hopefully, rising vaccine rates will be enough to allow for more in-person activity and usher in the long-awaited rebound in economic growth.

  1. Japan Times , “Japan considers two-week extension of COVID-19 emergency as cases remain high ,” September 1, 2021.View in Article
  2. The Economist Intelligence Unit.View in Article
  3. Mari Yamaguchi, “Tokyo opens makeshift oxygen station for Covid patients as hospitals buckle ,” Bloomberg, August 23, 2021.  View in Article
  4. Miya Tanaka, “IMF cuts Japan's growth forecast to 2.8% in 2021 as COVID-19 spreads again ,” Japan Times , July 28, 2021.   View in Article
  5. Bank of Japan, “Outlook for economic activity and prices ,” accessed September 17, 2021.View in Article
  6. NHK News , “COVID-19 variant Mu found in Japan ,” September 1, 2021. View in Article
  7. Our World in Data, “Share of the population fully vaccinated against COVID-19 ,” accessed September 17, 2021.  View in Article
  8. Our World in Data, “Daily COVID-19 vaccine doses administered per 100 people ,” accessed September 17, 2021.  View in Article
  9. au Jibun Bank, “au Jibun Bank Japan Services PMI ,” news release, Markit Economics, September 3, 2021. View in Article
  10. Trading Economics, “Japan retail sales ,” accessed September 17, 2021.View in Article
  11. Our World in Data, “COVID-19: Google mobility trends ,” accessed September 17, 2021.  View in Article
  12. Trading Economics, “Japan consumer confidence ,” accessed September 17, 2021.View in Article
  13. Trading Economics, “Japan Consumer Price Index (CPI) ,” accessed September 17, 2021.  View in Article
  14. e-Stat, “List of datasets ,” accessed September 17, 2021.  View in Article
  15. Ibid.View in Article
  16. Ibid.View in Article
  17. Lisa Pauline Mattackal, “Fed likely to announce taper in November, former Fed official says ,” Reuters , September 3, 2021.  View in Article
  18. Trading Economics, “Japan producer prices change ,” accessed September 17, 2021. View in Article
  19. Trading Economics, “Japan total cash earnings growth ,” accessed September 17, 2021.   View in Article
  20. Japan Institute for Labour Policy and Training, “Average monthly cash earnings of regular employees ,” accessed September 17, 2021. View in Article
  21. METI, “Indices of industrial production ,” accessed September 17, 2021. View in Article
  22. CEIC Data, “Japan total exports growth ,” accessed September 17, 2021. View in Article
  23. METI, “Indices of industrial production .”View in Article
  24. au Jibun Bank, “au Jibun Bank Japan Manufacturing PMI ,” news release, Markit Economics, September 1, 2021.  View in Article
  25. Economist Intelligence Unit, “RCEP unlikely to become effective until 2022 ,” August 4, 2021.View in Article
  26. Ibid.View in Article
  27. Peter A. Petri and Michael Plummer, “RCEP: A new trade agreement that will shape global economics and politics ,” Brookings, November 16, 2020. View in Article
  28. Isabel Reynolds, “Japan’s Suga quits as premier, throwing open succession race ,” Bloomberg, September 3, 2021.View in Article
  29. Ibid. View in Article
  30. Kana Inagaki, Robin Harding, and Leo Lewis, “Japan’s PM Yoshihide Suga to resign after failing to control Covid outbreak ,” Financial Times , September 3, 2021.View in Article
  31. Economist Intelligence Unit, “LDP’s dominance in Japan to be diluted ,” September 14, 2021. View in Article

Cover image by: Jaime Austin

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The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.

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Ira Kalish

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