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Japan's economy: Some gains, more pain

By Geoff Hiscock
CNN Asia Business Editor


Junichiro Koizumi

(CNN) -- "No gain without pain" could have been Japanese Prime Minister Junichiro Koizumi's motto when he came to power in April 2001.

Japan was stuck in the economic doldrums, continuing a pattern of poor performance that had blighted virtually the entire previous decade for the world's second largest economy.

The financial system was a shambles, with the big banks hamstrung by their own inept handling of bad loans to thousands of "zombie" companies that had been kept alive long after Japan's economic bubble of the late 1980s had burst.

While Japan was bumping along at the bottom of the scale in the early 2000s, China was surging ahead, turning in spectacular annual growth rates of 8 and 9 percent.

Koizumi promised economic recovery, built on an overhaul of the banks and wide-ranging administrative reform. But there would be painful times ahead, he warned.

He even vowed, if necessary, to destroy his own Liberal Democratic Party (LDP) to get his reform agenda through. In the lead-up to the September 11 election, it has almost come to that.

A key part of Koizumi's agenda was reforming Japan's postal service, splitting it into four operating units and moving to full privatization of Japan Post's huge savings and insurances businesses -- which control assets of 227 trillion yen (about $2.1 billion) -- between 2007-16. It was the defeat of this legislation last month, at the hands of LDP rebels, that is behind the September election.

For Koizumi's fans -- and they remain the majority -- economic recovery has been a long, slow process, with several hiccups along the way. A recession that began in January 2001 saw gross domestic product contract by almost 1 percent during Koizumi's first year in office.

Unemployment was at 5.4 percent by December 2001, incomes were shrinking and business confidence was well down. The specter of international terrorism after the September 11 attacks in the United States weighed on investors.

Domestically, the world's No. 2 economy was beset with a multitude of problems: consumers afraid to spend because of deflation, a mountain of bad debts among the big banks, a high jobless rate and a lack of progress on structural reform.

Japan's slowdown was also being exacerbated by the steady shift of manufacturing jobs offshore - particularly to China, where labor was cheap and red-hot economic growth meant consumer markets were expanding rapidly.

By January 2003, unemployment was still at a record 5.5 percent, but the first signs of recovery were being discerned. Industrial production began to pick up, and as the year went on, domestic demand rose and the economy finally began to add jobs.

Global factors, including the start of the Iraq war in March 2003, would come into play, pushing the stock market down.

When Koizumi was sworn in as Prime Minister on April 26, 2001, the key market indicator, the Nikkei 225, was trading just below 14,000. Almost exactly two years later, on April 28, 2003, it was at a 20-year low of 7,603.76 -- a far cry from the 38,915.87 that was the Nikkei's peak on December 29, 1989, at the height of the "bubble".

In June 2003, Tokyo-based economist Richard Jerram, then with ING Financial Markets, told CNN the economy was improving, albeit slowly. He was critical of what he said was a lack of economic policy action by Koizumi's government, declaring it had no interest in the economic agenda and was prepared "to look the other way" for as long as it possibly could.

But within a year, the picture was a lot brighter. A cheaper yen and a boost to exports courtesy of strong demand from the United States, China and Europe meant that by June 2004, Japan was able to upgrade the pace of its economic recovery, revising annualized growth to a rate of 6.1 percent.

That put it ahead of the 4.4 percent logged by the United States at the same time, and gave the country's consumers and investors a whiff of confidence.

The solid growth of 1.7 percent in 2003 was almost doubled to reach 3.2 percent last year. The likely outcome for 2005 is growth of 1.6 percent, accelerating next year past 2 percent.

From an average exchange rate of 125 yen to the U.S. dollar in 2002, the Japanese currency has strengthened to an average of 105 this year -- though experts are quick to say this is more a reflection of weakness in the dollar and a revaluation of China's yuan.

The share market has ticked up considerably since the 2003 low point, and is now close to a four-year high above 12,500.

Ahead of the election, recent economic data suggests that a relatively strong upturn is under way. There has been a steady rise in full-time employment -- the jobless rate hit a seven-year low of 4.2 percent in June -- and real incomes are up. And for the first time in 13 years, land values along major roads in residential areas of Tokyo are on the rise.

"The economy is coming out of its near-stagnant stage," Economy Minister Heizo Takenaka noted last month.

Bank of Japan Governor Toshihiko Fukui took a similar view, describing the economy as "having almost escaped its soft patch."

Richard Jerram, now with Macquarie Research in Tokyo, said on August 31 that all the economic data suggested a rate of improvement that was still relatively muted, "but the positive direction is increasingly apparent."

Other commentators, such as the Barclays Capital team in Tokyo, are confident Japan's expansion will remain intact, and note that the long-running reliance on exports for GDP growth may finally be replaced by domestic demand.

Koizumi has delivered some gains, despite the pain in the middle years of his tenure. But more reform lies ahead, particularly in the areas of tax and pensions; September's election outcome will point to how likely real progress on the reform front will be.

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