Friday, February 17, 2006

Japanese Growth Strong As Expected

Just as was widely expected, GDP growth in Japan came in very strong for the fourth quarter of 2005, with GDP volume increasing 5.5% at an annual rate from the third quarter, and 4.2% from the year before. This means that GDP growth in Japan is not just stronger than in Western Europe, but also stronger than in America, although it is still of course lower than in China.

Going through the specifics of the report there seem to be no real negative aspects of the report.

-Growth was not based on inflationary monetary policy as money supply growth was weak. As a result of continued weak money supply growth and increased supply of goods, the rate of price deflation actually accelarated. Because of the high price deflation, real interest rates is actually higher than in America and Europe, further underlining that this boom is not based on unsustainable inflationary monetary policies. The high real interest rates have made the Japanese private sector reduce their debts and strengthen their balance sheets.

-Growth was not based on increased government spending, as government purchases actually declined from the previous quarter and rose far less than total GDP from the year before. This is in sharp contrast to America, where government purchases have increased slightly relative to GDP. It also means that the increase in the burden of government we saw in the third quarter seems to have been an abberation.

-Instead, growth reflected a broadbased increase in private demand, with private consumption, residential investments, business investments and the current account surplus all increasing strongly. Somewhat surprisingly, inventories gave no positive contribution to GDP, something which bodes well for the first quarter.

The only thing that could be construed as "negative" is that the deterioration in terms of trade accelerated somewhat, mostly due to higher prices on imported oil. But this is not really a negative, it just means that the headline volume number exaggerates real growth somewhat (why volume numbers that don't take terms of trade into account can be misleading see here).

Adjusted for terms of trade, real GDP growth was an annualized 4.3% compared to the quarter before and 3.2% compared to a year before. This is still higher than both the U.S. and Western Europe. The U.S. for example, had annualized growth of only 0.7% compared to the quarter before and 2.8% compared to the year before.

Moreover, if one considers that Japan have a shrinking population, compared to less than 0.5% population growth in the Euro-zone and 1% population growth in the U.S., Japan have a even bigger lead in GDP per capita growth than in GDP growth. In addition, Japan have a rapidly rising investment income surplus from abroad, meaning that real national income is growing even faster than GDP. By contrast, net investment income in both the U.S. and Europe is deteriorating meaning that their income growth is slower than GDP.

This is not to say that there aren't problems in the Japanese economy. The rapidly declining working age population means that growth is likely to be held back significantly in the future, although the effect of this could be mitigated if the Japanese is able to increase the average retirement age. Moreover, while private sector balance sheets are healthy, the government budget deficit is far too high, particularly when considering the aforementioned aging population. Indeed, the budget deficit is even higher relative to GDP than in America-or in Germany and France.

But still, while the aging population and the high budget deficit poses long-term dangers to the Japanese economy, the short-term outlook seems strong. Japan will likely outperform both America and Western Europe during 2006 in terms of GDP growth.


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