Japan's recovery ... am I seing ghosts?

Japan.jpg Leaving the dark matter of the US trade deficit I turn to one of the other economic conundrums of the week; Japan's recovery and the definite end of deflation. Only a few days ago I posted about Japan and the land of the rising indicators as the mighty opinion leaders of The Economist and Financial times hailed the recovery of Japan. I was rather critical of the notion of Japan's recovery but as this week's Economist once again hits me with Japan's recovery (and here) I would perhaps be wise to think again?

First off lets look at this argument that deflation is a thing of the past. The Economist presents us with two measures of the inflation one, the core consumer price index, which reports a meager 0.1% inflation and one, by "Japan's national accountants" measuring a deflation rate of 1.6%. Both are deemed wrong and unfit to describe the nature of the Japanese economy; the former because it includes the weighty and notoriously inflationary energy prices and the other ... well it is not actually refuted.

However according to The Economist we only need to look at nominal GDP ...

"This is why the only sensible measure of Japan's economic performance is nominal GDP, ie, total national output measured in money not volume terms. When inflation is high, only changes in real output offer any sensible guidance to how the economy is performing. But in a period of deflation, nominal changes matter much more: growing real GDP means little if the economy is contracting in money terms. Between 1997 and 2004 Japan's nominal GDP shrank by 5%, while America's spurted by 42%. The good news is that in the year to the fourth quarter of 2005 Japan's nominal GDP grew by 2.6%, its fastest annual growth for almost nine years. (Even so, nominal GDP still remains below its level in 1997.)"

I can accept the fact that nominal GDP is more valuable when we see deflation since real GDP obviously will be adjusted upwards if we adjust for deflation in stead of inflation. But are we not biting our own tail then? I.e. if we assume that nominal GDP is the most correct measure of growth in Japan we also accept the fact that deflation still persists ... or perhaps the cafeine shock is kicking in!? What do seem to be obvious though is the fact that Japan's economy is growing quite fast and steady be it nominally or real. However, the question in my opinion still remains; deflation or not?

Another interesting thing about the Economist's analysis is that the tightening of the labour market is mentioned as one of the dark spots of Japan's apparent recovery. The reason given however is a bit odd in my opinion ...

"(...) that the labour market has tightened over the past year, employment growth, at an annualised 0.5%, is still too sluggish. This, says Mr Jerram, could point to a skills mismatch in the economy, where people are insufficiently suited for the kind of jobs being offered; if he is right, then the situation is not likely to improve anytime soon."

Labour market bottlenecks and mismatchs ?! Well, I guess you could call it that but you could also call it an ageing population on whose back, I argue, we are unlikely to see any surge in demand to carry through a sustainable recovery especially not if we need statistical roundabouts to talk Japan out of deflation. Incidentally this is also confirmed by the other dark spot mentioned by The Economist; 

"[a] fairly soft import growth for such a purportedly robust recovery. This in part reflects the extent to which the recovery is taking place not chiefly in the manufacturing sector, but rather in services, where import demand is relatively low."

But then again The Economist also pulls out an increase in fixed capital investment of 7.2% in the last quarter of 2005 which is rather impressive; however, again we must ask ... is this investment driven by a foreign or domestic demand ?

Ending my post I should say that I am not trying to fend off what do seem to be obvious; i.e. Japan is beginning to show some promising signs but optimism could/should be held down for a couple of reasons in my opinion ...

1. Supply side issues; i.e. a tightening labour market.

2. Recovery driven by domestic demand ? In a near deflationary climate coupled with the world's oldest population?

See also this Bloomberg.com article by William Pesek Jr.  talking about the debt burden of the Japanese economy.

"Unless Japan moves to reduce its fiscal deficit sharply -- in the fat years of this business cycle -- its public sector debt-to-GDP ratio will rise without limit,'' said Carl Weinberg, chief economist at Valhalla, New York-based High Frequency Economics.

How efficiently Japan uses this window of opportunity to kick its debt addiction will say much about its outlook. Demographic trends are but one concern. Because of a low birthrate of 1.26 children per woman, Japan's population actually shrank in 2005.

``If the current birthrate, which is the lowest in the major developed countries, continues, there will be no Japanese,'' Jim Rogers, who co-founded the Quantum fund with George Soros in 1970, said in Tokyo last month. ``Who will pay the enormous debt?''"