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Just when you thought it was safe ...

JUST as investors started thinking Japan had turned the corner, the March quarter negative GDP growth came out and put paid to that thought.

Initial thoughts that this was a relatively short-lived cyclical downturn were reassessed. It appears the downturn could be a lot more severe than most forecasters had anticipated.

A number of leading indicators are now giving a clear indication that some slowdown in industrial production, possibly acute, is on the way.

It seems the sudden decline in tech-nology spending has spread through to the Japanese economy.

In the first four months of this year there was a slump in demand for electrical machinery, leading to a drop in shipments of industrial products of around 8 per cent. Real exports in the March quarter fell 3.6 per cent.

The real danger, which has been anticipated for some time, is the sustainability of consumer spending. The danger is that the flat March figures could continue, or even deteriorate.

Most of the factors that were seen last year as being positive for consumer spending are turning negative. Consumption could have been expected to have held up reasonably well except for the manufacturing downturn, which has been far from mild. New job offers seem to be in decline and overtime work is already falling. Wages growth is only just positive. All of this is only going to dent consumer confidence.

Customarily, analysts would not be unduly worried when a cyclical down-turn occurs in Japan. The problem, as we are all aware, is that there are serious structural issues that have beset Japan for the past decade.

In that time, Japan’s growth rate has averaged barely 1 per cent per annum.

Poor policy decisions such as excessively tight monetary policy and an economic structure badly needing restructure have hampered Japan following the bubble years of corporate excess. Interestingly, Dr Shane Oliver of AMP Hendersons makes the point that globally competitive exporters such as Sony and Toyota represent only 10 per cent of total economic activity.

“However, Japan’s domestic manufacturing, construction and services industries, which account for the remaining 90 per cent of activity, have productivity levels running around 40 per cent below comparable industries in the US.

So how does Dr Oliver see a turnaround happening in Japan?

He suggests these uncompetitive industries be opened up to competition, along with cleaning up the banking system.

In the past decade Japan has seen a political process that has been dominated by lobby groups, factions and interest groups, which have combined to block reform.

Dr Oliver’s hope is that Prime Minister Koizumi will work with a reform agenda being supported by much of the population.

But even if Mr Koizumi does undertake the reform, Japan’s economy could actually get worse before getting better.

One of the estimates Dr Oliver refers to is that, if all the loans to bankrupt (or effectively bankrupt) customers and loans that are more than three months in arrears were written off, half of the employees in the companies concerned would lose their jobs. This would lead to job losses of around 1.25 million and lost “income” equivalent of 1.25 per cent of GDP.

If you then factored in the multiplier effect of this GDP loss, you could get a figure of closer to 2 per cent of GDP being lost.

Likewise, he points out that overseas experience suggests reform of structure and deregu-lation tends to result in declines in GDP before rises.

So, all of this leads Dr Oliver to the view that AMP’s assessment of Japan in 2001 is for a nation that will deliver zero economic growth at best. While this is obviously bad news for Japan, he then looks at the impact of this on other nations.

Dr Oliver says: “Over the last 10 years, the correlation between real economic growth in Japan and that in Australia has been -0.45, likewise with the US it is -0.49. In other words, weak growth in Japan is usually associated with strong growth in Australia and the US.

“By contrast the correlation in the US and Australia is +0.83, highlighting the close relationship between Australia and the US. On this basis, perhaps we should be celebrating the recent downturn in Japan as a sign that Australia and the US will soon be experiencing strong growth.”

There are, however, three risks that do exist for the rest of the world. These are:

p unlike the Japanese recessions of the 1990s, it is occurring at a time when the US economy arguably has structural problems of its own (over-investment following the tech boom and various financial imbalances). It thus risks accentuating the downturn already evident globally;

p a deep Japanese recession combined with aggressive monetary easing could result in a collapse in the yen. The loss of competitiveness for Asian economies, which compete quite closely with Japan, would be negative for their economies and their currencies. A sharply lower yen could also result in the US current account deficit blowing out even more; and

p slower growth in Japan could directly affect Australia’s commodity exports, particularly for the bulk items like coal and iron ore, where recently agreed price increases with Japanese customers could prove unsustainable.

What is the bottom line in all of this for us here in Australia? It would seem that we aren’t out of the woods just yet.

There is still a possibility that our Reserve Bank will need to watch the evidence coming out of Japan and be prepared to cut interest rates here simply to keep things on an even keel. This is the reason why most of us have not ruled out, categorically, the possibility of another cut in rates in this cycle.

This is something that we do need to keep uppermost in our minds, simply to ensure that the fallout from Japan is not too severe on us. Admittedly, the Japanese economy is far from being the influence it was in the 1980s, when Japan accounted for around 50 per cent of the world economies. Now Japan accounts for around 15 per cent of world economies. This is hardly a position of influence. It is simply the confluence of the Japanese recession with the likelihood of an American recession that is keeping us wary of the events.

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