Economics 101: Japan slides into recession as tax hike takes toll

11/17/2014

Japan slides into recession in wake of tax hike, undermining global growth prospects

TOKYO –  Japan's economy unexpectedly slid into recession as housing and business investment declined following a tax hike, dragging the country into a recession and further clouding the outlook for the global economy.

In this Friday, Sept. 26, 2014 photo, trucks leave a container wharf in Tokyo. Japan reported Monday, Nov. 17 that its economy contracted at a real annual rate of 1.6 percent in July-September in the second straight quarterly decline. Most economists had forecast the world’s third-biggest economy expanded at about a 2 percent pace. The negative growth figure was much lower than expected and makes it very likely Prime Minister Shinzo Abe will delay implementation of a sales tax hike planned for October, 2015. (AP Photo/Koji Sasahara) (THE ASSOCIATED PRESS)

The world's third-largest economy contracted at a 1.6 percent pace in the July-September quarter, the government said Monday, contrary to predictions it would grow after a big drop the previous quarter. A country is officially in recession when two consecutive quarters fail to show any growth.

This is not just bad news for Japan as it deepens uncertainty about China were growth is slowing and for the 18-country eurozone that grew only 0.2 percent in the same quarter. The slowdown could drag on growth in Asia if Japanese companies hold back on foreign investment and manufacturers and consumers buy fewer imports such as mechanical parts, raw materials and food.

The gross domestic product figures showed across-the-board weakness in demand among consumers, manufacturers and builders. Many individuals and companies had spent money before the sales tax was hiked in April from 5 percent to 8 percent, and spending has languished since then.

"The impact of the sales tax was much more severe than expected," said Junko Nishioka, an economist at RBS Japan Securities.

Housing investment plunged 24 percent from the same quarter a year ago, while corporate capital investment sank 0.9 percent. Consumer spending, which accounts for about two-thirds of the economy, edged up just 0.4 percent.

Given the contraction, Prime Minister Shinzo Abe is expected to put off another sales tax hike planned for next October, slowing progress on efforts to rein in Japan's government debt, the largest among industrialized nations.

He also will likely make the dismal GDP reading the basis for calling a general election in mid-December to underpin the public mandate for his "Abenomics" policies of lax monetary policy, fiscal spending and structural economic reforms.

Japan emerged from its last recession just as Abe took office in December 2012, vowing to restore the nations' economic vigor after two decades of stagnation.

But the country is struggling to regain momentum as its population declines and ages. Apart from its automakers, many of its manufacturers have lost their leading edge in innovation while shifting production to cheaper locations offshore.

Household incomes, meanwhile, peaked more than a decade ago, and a growing share of workers are having difficulty making ends meet with part-time, contract work. Wage increases — mostly limited to a small share of workers in big-name companies — have lagged behind inflation.

Most economists had forecast that Japan would expand at about a 2 percent pace after a sharp 7.1 percent annual pace drop in April-June immediately following the tax hike. A recession commonly is regarded as two straight quarters of economic contraction. Compared to the previous quarter, GDP declined 0.4 percent.

While delaying the next tax hike could undermine confidence in Japan's ability to repair its battered finances, Abe and his advisers appear to view the threat to Japan's recovery as the more urgent risk.

In early 2013, Abe and Bank of Japan Gov. Haruhiko Kuroda united in seeking to end the long spell of deflation that they say is discouraging companies and consumers from spending money.

So far, price increases have fallen short of their inflation target of 2 percent, with most of the increases coming from the sales tax hike and from higher costs for imports due to extreme monetary that has helped drive the value of the Japanese yen to seven-year lows against the U.S. dollar.

On Oct. 31, Kuroda announced the central bank would step up its asset purchases, accelerating Japan's "quantitative easing" just as the U.S. was ending its own asset purchases. Despite that surprise move, Kuroda has insisted that the economy is still in the midst of a "moderate recovery."

The BOJ's move, along with a government decision to shift a large share of the public pension fund investments out of government bonds and into higher yielding but riskier shares, pushed Japan's share benchmark to seven-year highs this month.

But in morning trading, the Nikkei 225 stock index tumbled 2.6 percent to 17,037.65.

Monday's data is preliminary, with a revision due Dec. 8. Since some of the decline was due to reductions in inventory, things may not be as bad as the GDP reading suggests, economists said.

Pierre Ellis, senior economist at Decision Economics in New York, said increased business orders in the past three months for machinery, industrial equipment and other big ticket items should boost output in the coming months.

Abe already was expected to announce additional economic stimulus this week. The dismal Monday morning data will probably lead him to announce a package worth about 3 trillion yen to 4 trillion yen ($26 billion to $35 billion), Nishioka said.

That could include subsidies to low-income families and help for small and medium-sized companies that rely on imported components and energy that have suffered as the Japanese yen has weakened from about 80 to the dollar to its current level of about 116 to the dollar — a move that has helped exporters.

Critics say Abe has failed to deliver on promises for drastic reforms of labor regulations, the tax system and the health industry, among other areas. Meanwhile, companies have largely refrained from passing windfall gains from share price gains and surging profits on to their workers in the form of higher wages.

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AP Economics Writer Christopher S. Rugaber in Washington contributed to this report.

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