Development Bank of Japan
Research Report
No. 36

Recent Trends in the Japanese Economy:
A Medium-term Scenario for
the Sustainability of the Japanese Economy

February 2003

Economic and Industrial Research Department
Development Bank of Japan

Contents

Summary ........................................................................................................................ iii
I

Global Economy Showing Signs of Slowdown ..................................................... 1 (Figures)
1. U.S. (1): Personal Consumption Propped Up by Automobiles but
Decline Continuing in Plant and Equipment Investment.................................. 1 (35)
2. U.S. (2): Recovery in Production at a Standstill as Difficult
Employment Situation Continues ..................................................................... 1 (36)
3. Economies of Major European Countries (Germany, France, U.K.):
Uncertainties about Recovery Prospects........................................................... 2 (37)4. Major Asian Economies: Recovery Continuing but
Concerns about a Slowdown............................................................................. 3 (38)
5. China: Strong Growth and Increased Risks ...................................................... 3 (39)

II

Japanese Economy: Slower Improvement ........................................................... 5
1. Overview: Production Rising, but Concerns about Leveling Off ..................... 5 (40)
2. Inventory Cycle Entering a Buildup Phase ....................................................... 7 (41)
3. Weak Recovery in Job Offers as Employment Conditions Remain Difficult... 7 (42)
4. Earnings Decreasing, Resulting in Worsening Consumer Confidence............. 8 (43 - 44)
5. Plant and Equipment Investment: Bottoming Out but Recovery
Expected to be Weak ...................................................................................... 10 (45)
6. Residential Investment Decreasing Slowly......................................................11 (46)
7. Public Investment Falling due to Difficult Financial Situation ...................... 12 (47)
8. Exports Slowing from Substantial Increase as Imports Rise .......................... 13 (48)
9. Wholesale and Consumer Prices Continuing to Decline ................................ 13 (49)
10. Credit Risk Aversion through Low Interest Rates .......................................... 14 (50)

III A Medium-term Scenario for the Sustainability of the Japanese Economy.... 16
1. Deflation and Structural Problems in the Japanese Economy ........................ 16 (51)
2. Supply-Demand Balance in the Japanese Economy after Structural Reform. 16 (52)
3. Recovery in Demand: the Key to Breaking the Grip of Deflation.................. 19 (53)
4. Number of Workers to Rise Gradually through Diversified Employment ..... 22 (54)
5. Consumption to Remain Flat, Followed by Mild Recovery ........................... 24 (55)
6. Plant and Equipment Investment to Recover Gradually through
Adjustments to Improve Capital Efficiency.................................................... 26 (56)
7. Net Exports to Increase with Higher Value-added Export Goods andStrong Economies Overseas ........................................................................... 28 (57)
8. Primary Balance of Public Finance to Improve Slowly.................................. 29 (58)(Appendix 1)(Appendix 2)(Appendix 3)(Appendix 4)Assumption of Longer Adjustment Period............................ 30 (59)
Economic Outlook and R&D Policies in Asia ...................... 30 (60)
Recovery from Economic Crisis in Korea: Structural
Reform and Increased Exports .............................................. 31 (61)Prompt Response to Bursting of Bubble in Sweden ............. 32 (62)Development Bank of Japan Research Report/ No. 36iAnalysts and Writers:
Hajime Wada
Junichi Nakamura
Akimitsu Fujii*
Wataru Miyanaga
Tadateru Hayashi
Naoki Shinada
Yoshiaki Hachiya
Michinori Takahashi***Overall supervision and Section III-1
Sections II-1, II-2, II-5, III-2, III-3 and III-6 and Appendix 1
Section III-8 and Appendix 4
Sections II-3, II-4, III-4 and III-5
Sections I-4 and I-5 and Appendices 2 and 3
Sections I-1, I-2, II-8 and III-7
Sections I-3, II-7 and II-10
Sections II-6 and II-9**

Currently with the Project Finance Department.
Currently with the Shikoku Branch.

ii

Development Bank of Japan Research Report/ No. 36

Recent Trends in the Japanese Economy:
A Medium-term Scenario for the Sustainability of the Japanese Economy
Summary
I. In recent years, economic changes in Japan
have tended to lag behind those of the U.S. andAsia, and the major economies of the world are
now showing signs of slowing down.
With the success of monetary easing, theU.S. economy started to recover from late 2001,
led by car purchases and housing investment.
However, consumer confidence has been weakening due to stagnant share prices and deteriorating employment conditions. Production facilities are operating at low rates, deterring plant andequipment investment.
In the major European economies, production has been recovering largely due to continuing inventory adjustment. However, the future
looks increasingly uncertain as employment conditions are deteriorating, particularly in Germany.
The major Asian economies continue to improve, led by personal consumption in Korea andexports to China in Taiwan. Concerns about apotential slowdown have been increasing, however, in countries that are heavily dependent onexports to the U.S.
The Chinese economy continues to growstrongly due to public investment, real estate investment and inflows of direct investment fromoverseas. Nevertheless, potential risks include
deflation and the housing bubble.
II. The Japanese economy has been painfully
slow to improve, as sluggish exports can nolonger drive the recovery. Uncertainty about the
future is increasing, largely due to the impact offalling share prices on corporate performanceand the financial system, as well as to concerns
about the sustainability of the recovery in the
U.S. economy.
On the supply side, the inventory cycle hasentered an intentional buildup phase. Althoughproduction is still rising, the pace has slowed
down and may be leveling off. Tertiary industry

activity remains weak, with no driving force.
Construction activity also remains sluggish. And
although employment has been improving interms of overtime hours, the numbers ofself-employed and employees in large-sized
firms both declined, with unemployment remaining high in the mid-5% range. In particular,
unemployment among young people has risen
significantly.
On the demand side, private consumption isholding steady despite the deteriorating income
and employment conditions, but may weaken
due to worsening consumer sentiment. Curbs onplant and equipment investment continue particularly in the non-manufacturing sector, such as
in deregulated industries, while return on investment is showing signs of recovery in the
manufacturing sector. Housing investment is falling gradually, mainly for owner-occupied
houses. Public investment is likely to continue todecline due to the financial difficulties faced bygovernments, particularly in local areas. Exports
have been slowing recently from the substantial
growth recorded since late 2001. Imports continue to grow, led by machinery and equipmentfrom Asia.
The major players in the financial markets
continue to avoid credit risk, as the Bank of Japan maintains its quantitative easing policy. The
limited supply of risk money means that the policy will be slow to take effect. Meanwhile, consumer prices continue to decline. The easy
money policy will therefore remain for sometime to address the protracted deflation.
III. Under the influence of globalization, thedeflation in Japan is characterized by debt deflation, resulting from balance sheet problems. In
January 2001, the government adopted in a
Cabinet Meeting “Structural Reform and Medium-term Economic and Fiscal Perspectives”
designed to control deflation and revitalize theeconomy and society. In line with the Medium-term Outlook, Chapter III presents a me-

Development Bank of Japan Research Report/ No. 36iiidium-term scenario for the supply and demandbalance and major demand items, based on thecurrent economic situation. The analysis focuseson building a nation based on the creativity ofscience and technology. The results of the analysis can be summarized as follows.
On the demand side, exports relying ontechnological advantage should prop up the
economy during the intensive adjustment period.
Thereafter, economic growth will depend on the
success of reforms, which should eliminate theconcerns about the future and lead to steady
growth of consumption, as well as on a gradualincrease in plant and equipment investment, led
by the growth of exports and consumption.
On the supply side, capital stock adjustments will make headway from fiscal 2003 to2005 through intensive adjustments in industrial
structure and intra-industry supply structures.
Labor input will structurally continue to make anegative contribution due to the reduction inhours worked per capita. Improvement in totalfactor productivity (TFP) will play a substantial
part in leading potential GDP after adjustment.
To arrest the current deflation, it is essentialthat the adjustment of excess capacity and thesearch for new demand lead to the expansion ofprivate demand and improvement in profitability.

In order to facilitate the movement of labor
between industries during the intensive adjustment period, job creation should be accompaniedby the diversification of employment. Consumer
fears must be allayed by ensuring job opportunities.
If these conditions are satisfied and theJapanese economy starts to grow sustainably,
then the primary balance of public finance will
gradually improve. However, there are noprecedents in promoting structural reform under
deflationary pressure. Furthermore, the medium-term scenario might be adversely affectedby delays in the recovery of consumer confidence and investor sentiment. Close attention
should therefore be paid to reconcile fiscal andmonetary policies designed to avoid the deflationary spiral with the management of government debt.
This report refers to the cases of Korea andSweden as examples of recovery from economiccrisis.
(As of December 9, 2002)[by Economic Research Group (e-mail: report@dbj.go.jp)]

iv

Development Bank of Japan Research Report/ No. 36

I Global Economy Showing Signs
of Slowdown
In recent years, economic changes in Japan havetended to lag behind those of the U.S. and Asia,1and those major economies of the world are now
showing signs of slowing down.
1. U.S. (1): Personal Consumption Propped
Up by Automobiles but Decline Continuing in
Plant and Equipment Investment(see p. 35 for Figures)
Real GDP growth in the U.S. (Figure 1-1) rose
substantially in October-December 2001 andJanuary-March 2002, followed by a slowdown in
April-June 2002, up only 1.3% on the previous
year, only to recover in July-September (up 4.0%
according to a provisional estimate), boosted bypersonal consumption.
Personal consumption has been leading real
GDP growth in recent periods. Following tax
reductions by the government, car sales continued to boom thanks to major campaigns using
incentives such as no-interest loans, which weremade possible by low interest rates in the market.
In addition, housing-related consumption (building materials, etc.) has stayed relatively strong
largely due to strong housing investment, thus
contributing to the continuing growth in consumption (Figure 1-2). The increase in consumption has also been helped by income growth.
However, it is generally considered that the
U.S. economic recovery will be weaker than the
V-shaped recovery expected at the beginning of
the year, due to low corporate profits and plantand equipment investment (to be discussed later),as well as to the severe employment situation,
which show no signs of improving. Uncertainty
about future business conditions has become
stronger, as share prices have tended to fall andautomobile sales, which have led overall consumption, are beginning to slacken. Consumer
confidence is therefore weakening, and personal
consumption in the months ahead must be moni1

See Development Bank of Japan, “Recent Trends in theJapanese Economy: Globalization and the Japanese Economy,” DBJ Research Report No. 30, August 2002, Section
I-1.

tored closely.
After consecutive drops on the previous
year from January-March 2001 to April-June
2002, plant and equipment investment started torise in July-September 2002, suggesting that thebottom had been reached (Figure 1-3). However,capacity utilization is still running at low rates.
Although information technology-related investment in hardware and software turned up in
IT-related industries, other kinds of capitalspending in general continue to decline, causing
overall plant and equipment investment to continue to fall. With the slow pace of recovery incorporate profits, it will take time for plant andequipment investment to recover fully.
2. U.S. (2): Recovery in Production at aStandstill as Difficult Employment Situation
Continues (see p. 36 for Figures)
Industrial production recovered rapidly in January-March 2002, the first increase in six quarters(Figure 1-4). Thanks mainly to the increased
production of consumer goods and milder decline in equipment production, the recovery continued to July-September. However, subsequentmonthly data indicate a pause in the recovery,
mainly for durable goods, as car production
turned from strong growth to decline. The capacity utilization in the manufacturing sector remained low at below 75% in July-September
2002, restraining plant and equipment investment.
As regards employment, the reduction in thenumber of employees has slowed, but unemployment still remains high, pointing to difficult
conditions overall (Figure 1-5). 2 In JulySetember 2002, the number of employees increased from the previous period for the firsttime in six quarters, largely due to the increase in
the service sector for two consecutive periods,
although the number in the manufacturing sector
continues to decline.
In the financial sector (Figures I-6 and I-7),
stock prices continued to fall until early Octoberdue to heightened concerns about future corporate performance and business conditions, in addition to the downward pressure resulting from2

Unemployment stands at 6.0% as of November 2002.

Development Bank of Japan Research Report/ No. 36

1the loss of faith in corporate accounting. Prices
then rose on the back of announcements of good
profits by some companies, although the economic outlook remains uncertain. The Federal
Fund target rate was lowered 0.5% to 1.25% on
November 6.
3.

Economies of Major European Countries(Germany, France, U.K.):
Uncertainties about Recovery Prospects(see p. 37 for Figures)This section examines the economic conditions
for three major European countries: Germany
and France, which are among the 12 countries
that in 1999 adopted the euro as their common
currency, and the United Kingdom, which is oneof the 15 members of the European Union (EU)but which has not embraced the euro.
The German economy has enjoyed accelerating exports since the beginning of 2002 due tothe recovery of business sentiment in the U.S.
and the falling of the euro against the dollar. As aresult, the growth of the German economy (seasonally adjusted real GDP, quarterly annualizedrate) was up 1.1% in January-March, turning
positive for the first time in four quarters (Figure
1-8(1)). Exports continued to increase but domestic demand remained stagnant, as fixed capital formation hardly moved. Thus, the growth
was limited to 0.6% in April-June and 1.1% in
July-September.
The French economy in 2002 saw an upturnin exports, improvement in business sentiment in
expectation of a recovery in production and inventory adjustment. Thus, GDP growth turned
positive for the first time in two quarters, up
2.4% in January-March (Figure 1-8(2)). Subsequently, however, the growth slowed gradually
due to smaller gains in exports and fixed capitalformation, up only 1.7% in April-June and 0.9%
in July-September.
Following a minimal growth of 0.5% inJanuary-March, the U.K. economy picked up
again in April-June, recording the largest growthamong the three European countries (up 2.5%).
During this period, the continued weakness in
fixed capital formation was more than offset byfavorable employment conditions and the asset
effect from rising house prices, resulting in

2

Development Bank of Japan Research Report/ No. 36

strong consumption. Despite a downturn in exports, the U.K. economy grew even more powerfully in July-September – up 3.3% – backed byincreased consumption and inventories.
Looking at the recent trends in production,
the industrial production index (seasonally adjusted, quarterly annualized) hit the bottom in all
three countries in October-December 2001, thenrose in January-March 2002 due to inventory
adjustment and stronger orders from overseas(Figure 1-9). The most recent data indicate thefirst decline in three quarters for France due toreduced orders from overseas, but little change in
the index for Germany and the U.K.
Figure 1-10 shows the employment situationin these countries in terms of unemployment rate
(ILO standards, seasonally adjusted). In Germany, the unemployment rate declined from thelatter half of 1998 thanks to an increase in service-sector jobs. In 2001, however, lower production in the manufacturing sector and increasing corporate failures accelerated employment
adjustment, causing unemployment to rise
gradually to 8.3% in September 2002. In response to the deteriorating employment situation,
the Schröder administration, after winning theelection for the Bundestag in September, introduced an Employment Reform Act in November.
The Act provides for measures to reduce unemployment, such as the organizational reform of
employment agencies and the creation of a special facility for SMEs that hire unemployed persons. The effects of such measures are expected
to appear in the coming periods.
Economic expansion and increased employment in the public sector reduced unemployment in France to 8.5% in the first half of2001, more than 3% lower than the peak. However, it rose gradually from the latter half of 2001
as corporate performance deteriorated, reaching
8.8% in September 2002.
The U.K. government has worked hard toincrease the flexibility of the labor market by
restraining unemployment benefit and promoting
deregulation, leading to an increase in the number of part-time workers. Thus, the unemployment rate has been constantly declining since
1993, and stood at 5.0% in July 2002, the lowest
level in 25 years.
In 2002, prices in the euro area were af-

fected by rising fresh food prices at the beginning of the year due to adverse weather conditions, as well as by the introduction of tobacco
taxes in some member countries. Thus, consumer
price inflation has been slightly higher than thereference value (up 2% from the previous year)of the European Central Bank (Figure 1-11). Although fresh food prices had returned to theirnormal level by midyear, upward pressure on
prices caused by labor cost is still strong.
The slower pace of recovery is adversely
affecting national budget balances. In Germany,
the budgetary deficit may exceed 3% of GDP
due to factors such as weaker economic conditions and the cost of repairs after the flood in
August, which inflicted much damage in theeastern part of the country. In France, a series of
economic stimulus measures were implemented
following the Presidential election in the spring,
including income and employment tax cuts andincreased government spending. As a result, thebudget deficit for 2002 is expected to reach 2.6%
of GDP, exceeding the initial target (1.9%).
Meanwhile, the budget deficit in Italy is expected
to exceed 2% of GDP for a second consecutive
year, and in Portugal it was confirmed that thebudget deficit had far exceeded the 3% target,
rising to as high as 4.1% of GDP. The Stability
and Growth Pact requires the euro bloc countries
to limit their annual budget deficit to 3% of GDP
or less, and so the European Commission of the
EU initiated procedures for the correction ofbudget deficit for Portugal in July, and for Germany in November. It also issued an early warning to France and continues to closely monitor
developments in Italy. Although it is not a euro
bloc country, the U.K. will experience a budget
deficit of 1.0% of GDP due to the slower increase in tax revenues.
In light of economic trends, the ECB lowered the official interest rate, which had remained unchanged since November 2001, by
0.5% to 2.75%, as inflationary pressure has eased
due to the economic slowdown and the stabilization of the euro.

4.

Major Asian Economies: Recovery Continuing but Concerns about a Slowdown(see p. 38 for Figures)

Figure 1-12 shows the trends of real GDP in major Asian economies. In general, they slowed inparallel with the U.S. economy from 2000, andTaiwan and Singapore experienced negative
growth in 2001, while the Korean economy,
however, continued to grow even during theslowdown.
As the U.S. economy recovered, positive growth
returned for Taiwan in January-March 2002 andfor Singapore in April-June. In this recovery
process, exports and imports both turned up(Figure 1-13), with net exports contributing to
GDP growth. Inventory investment also contributed to the growth, as production increased inview of the recovery in exports.
Prices (Figure 1-14) have been risingslightly in Korea, but declining in Taiwan andSingapore. Likewise, unemployment (Figure1-15) has continued to fall in Korea since the endof the Asian crisis, but has remained high in
Taiwan and Singapore, implying that the export-led recovery has not spilled over.
Recently, Asian economies have stalled dueto the slowdown in the U.S. economy: the Singaporean economy remained at the same growthrate from the previous period in July-September,and slowdowns might be expected.
5.

China: Strong Growth and Increased
Risks (see p. 39 for Figures)

The Chinese economy continues to grow powerfully (Figure 1-16). Although the growth slowedin 2001 almost in parallel with the U.S. recession,
the extent of the slowdown was insignificant
compared with other major Asian economies.
Growth accelerated again to 8.1% year-on-year
in July-September. For the year 2002 as a whole,
the Chinese economy is expected to grow byaround 8%3, surpassing the official target of 7%.
However, this rapid expansion of the Chinese
economy is accompanied by increased risks.
Chinese growth has been led by fixed asset
3

According to the Chairman of the National Development
Committee (Yomiuri Shimbun, November 11, 2002).

Development Bank of Japan Research Report/ No. 36

3formation, which has been growing by more than
20% since the beginning of 2002 (Figures I-17
and I-18). The growth of investment completed
is not necessary autonomous, because it owes
much to the increase in capital construction development including infrastructure development,
which is largely financed by the government.
There has also been a substantial growth in realestate development, which accounts for over
20% of investment in fixed assets. The growthreflects housing construction booms in Shanghai
and other coastal cities. Real estate prices continue to rise despite increased inventories, 4
which raises concerns about a real estate bubble.5
Direct investment has been increasing rapidly
largely due to the accession of China to the WTO
in December 2001, contributing to the growth of
fixed asset formation.
Consumption (Figure 1-19), another pillarof domestic demand, has been increasing by
about 10%. However, savings6 has been rising
faster than consumption, indicating that more of
the income growth has gone to savings rather
than to consumption. This may be partly ex-

plained by the increase in unemployment due tothe reform of state-owned
enterprises. The official unemployment rate inurban areas increased from 3.1% at the end of
2000 to 3.6% at the end of 2001, and has reached4-5% so far this year.7 If the number of laid offfrom state-owned enterprises is added, theunemployment rate as of September 2002 willreach 7%. 8 Job insecurity is one of the main
reasons of the weak consumption.
Exports and imports (Figure 1-20) experienced slower growth following the collapse of
the IT bubble in the U.S., but have been increasing since the beginning of 2002, backed by therecovery of the U.S. economy. Although China
continues to enjoy a trade surplus, its contribution to GDP growth is not significant as exports
and imports are both increasing.
Prices have been falling (Figure 1-21). Although the post-Asian crisis deflation has been
overcome, the consumer price index has turned
negative again as prices for raw materials andex-factory industrial products have been declining due to oversupply.

4

The inventory index rose from 91 in March 2001 to 98 inAugust 2002. At the same time, real estate prices continue
to rise by an average annual rate of 9% in Shanghai andover 2% nationwide.
5
For example, Prime Minister Zhu Rongji, on a visit toShenzhen on China’s National Day, directed bank executives to adopt more strict criteria in examining loan applications from real estate investment firms, calling attention tothe overheating of investment in the real estate market (Nihon Keizai Shimbun, October 19, 2002).
6
On a stock basis, the year-on-year growth of savings
amounted to 15.2% in January-March 2002, 17.4% in
April-June and 18.1% in July-September. This translates
into 23.1% in January-March, 136.1% in April-June and53.1% in July-September on a flow basis.
4

Development Bank of Japan Research Report/ No. 36

7

According to the Deputy Chief of the National Bureau of
Statistics (Jiji Press, October 16, 2002).
8
According to the Director of the Department of Labor andSocial Security (Nihon Keizai Shimbun, November 12,2002).

II Japanese Economy: Slower
Improvement
1.

Overview: Production Rising, but Concerns about Leveling Off(see p. 40 for Figures)

The recovery of the Japanese economy has recently stopped, due to slower growth in exports,
the major contributor. Looking ahead, there iseven greater uncertainty due to overseas factors
such as concerns about the sustainability of the
U.S. economic recovery. Falling share prices arealso a threat as they affect corporate performanceand the financial system.
Led by the recovery of exports, real GDP
turned from a decrease of 3.3% on the previous
year in January-March 2002 to an increase of
1.5% in July-September, the first increase in fivequarters (Figure 2-1). On a seasonally adjusted
basis, however, the GDP growth on the previous
year excluding the change in inventories9 slowedfrom 0.6% in April-June to 0.3% in
July-September. Although private consumption
unexpectedly propped up the economic growth in
the July-September period, the growth from October-December onward may be difficult to sustain, partly because of the potential impact offalling share prices. The decline in the GDP deflator slowed to 0.6% on the previous year in
January-March 2002, then rebounded to 1.6% in
July-September, pointing to the resilience of deflationary pressure.
Looking at the trend of each GDP (GDE)
component, consumption has stayed almost unchanged under persistently severe income andemployment conditions. The year-on-year
growth of real private consumption increased
from 0.9% in April-June to 2.5% in
July-September, the first increase in five quarters,
due to buoyant small car sales, as well as totemporary factors such as the extremely low
consumption in the previous year and unusually9

In August 2002, the Cabinet Office thoroughly revised themethod for calculating quarterly GDP estimates, and the
new method entails larger fluctuations in private inventories
than the traditional method. Since April-June 2002, inventories have made a substantially positive contribution due toinventory buildup following the bottoming-out of theeconomy.

hot weather. The upturn in business sentiment
seems to have contributed to the relatively steadyrise in consumption since the beginning of theyear. However, consumer confidence has been
showing signs of weakness since the summer
following downward revisions to corporate profits and falling share prices.
Plant and equipment investment, thoughbottoming out, has not proved robust. The
year-on-year decline in real private plant andequipment investment was reduced from 12.1%
in October-December 2001 to 4.7% in
July-September 2002. The investment is alsobottoming out in terms of seasonally adjusted
change from the previous quarter. However, therecovery in production, the main contributor to
the bottoming-out, has stalled recently, leadingsome observers to suggest that the economic recovery since the beginning of the year will be
short-lived. Thus, corporate investment sentiment may now be even worse than in the firsthalf of the year. The recovery of leading indicators such as machinery orders is also losing
steam.
Housing investment has been poor, with real
private housing investment falling from the previous year for six consecutive quarters toJuly-September 2002. The seasonally adjusted
change from the previous quarter also indicates amild downtrend. Besides investment inowner-occupied houses remains low, inventories
are increasing for condominiums in the Tokyo
metropolitan area, which have led housing investment on the back of falling land prices and a
growing desire to return to the urban area. Increased investment in houses for rent, observed
until April-June, is not considered sustainable.
Reflecting the financial difficulties faced bycentral and local governments, public investment
has been declining on the previous year in realterms since October-December 1999 (except for
January-March 2001 when it was flat). In
July-September 2002, it accounted for 6.2% of
GDP (in nominal terms), down more than 2points from the most recent peak of 8.2% recorded in January-March 1999. This downward
trend is expected to continue as the central government carries out fiscal restructuring and due
to financial constraints faced by local governments.

Development Bank of Japan Research Report/ No. 36

5The substantial growth of exports seen since
the beginning of the year has been slowing recently. Real exports turned up in early 2002,
mainly automobiles to the U.S. and machinery toAsia. The recovery of production was led by thesubstantial growth of exports, up 4.8% in January-March and 5.9% in April-June, in terms of
the seasonally adjusted change from the previous
quarter. However, exports grew only 0.6% in
July-September as the recovery of IT-related
demand faltered. Imports are on the rise. After
bottoming out in January-March on a seasonallyadjusted quarterly basis, real imports have been
increasing since April-June, led by machineryfrom Asia. The contribution of net exports has
been positive for three straight quarters since
January-March 2002 on a year-on-year basis. In
terms of seasonally adjusted change from theprevious quarter, however, it turned negative,
albeit slightly, in July-September for the firsttime in four quarters, as export growth slowed.
Real GDP for fiscal 2002 is set to increase
for the first time in two years, exceeding both theforecast in the government’s Economic Outlook
in January 2002 (0.0% in real terms),10 and the
Cabinet Office Estimates in September (up 0.2%
in real terms)11, as the relatively strong performance in the first half of the fiscal year will morethan offset any slowdown in the coming
months.12 Looking ahead, however, pessimism
is growing that the Japanese economy may contract as early as in the first half of fiscal 2003,
depending on trends in the U.S. economy andshare prices. Thus, the growth for fiscal 2003,
although considered to be slightly positive on
average, is likely to be smaller than for fiscal
2002.13
10
According to Cabinet Office, “Fiscal 2002 Economic
Outlook and Basic Stance toward Economic and Fiscal
Policy” (Cabinet Decision on January 25, 2002).
11
According to “Fiscal 2002 Economic Trend Estimates(Cabinet Office Estimates)” in Cabinet Office, “On Future
Economic Trends” (September 20, 2002).
12
The average of real economic growth forecasts for fiscal
2002 by 16 private forecast institutions based on the quarterly GDP estimate (preliminary data) for July-September
2002 = up 1.0% (Nihon Keizai Shimbun, November 21,2002).
13
The average of real economic growth forecasts for fiscal
2003 by 16 private forecast institutions based on the quarterly GDP estimate (preliminary data) for July-September
2002 = up 0.3% (Nihon Keizai Shimbun, November 21,

6

Development Bank of Japan Research Report/ No. 36

To confirm this GDP trend from the supply
side, Figure 2-2 shows the trends of key components for the index of all-industry activity: theindustrial production index (22.4% weighting),
the tertiary industry activity index (59.5%) andthe construction activity index (8.1%), all seasonally adjusted.
With the progress of inventory adjustment
in electronic devices and other IT-related products, the industrial production index turned up in
January-March 2002, followed by a relatively
rapid recovery, up 3.8% in April-June and 2.2%
in July-September on the previous quarter.
However, production in electric machinery,
which initially led the recovery, has been flat
since June, while transport equipment, which
supported industrial output in July-September,faces uncertainties over the sustainability of car
exports to the U.S. According to an estimatebased on actual data for October and the Manufacture Production Forecast Survey for November and December, the index is projected to rise
only 0.2% on the previous year in October-December, which would be a substantial deceleration. Although industrial output is still rising, it is slowing down and may level off.
The tertiary industry activity index rose forthe first time in four quarters in January-March
2002, edging up 0.1% on the previous period,
only to decline 0.4% in April-June, especially incommunications and corporate services. Although it bounced back in July-September, up
0.4% due to contributions from amusement andother personal services, the growth may not besustainable. As consumption stays flat, previous
leading industries such as mobile communicationand information services are suffering faltering
growth. Thus, tertiary industry activity remains
weak overall.
The construction activity index temporarily
recovered in January-March 2002 due to progress in public works and private civil engineering projects, followed by a further slump andweakness in both the public and private sectors.

2002).

2.

Inventory Cycle Entering a Buildup Phase(see p. 41 for Figures)

On a graph with the year-on-year growth of inventories plotted on the horizontal axis and thatof shipments on the vertical axis, the inventory
levels are empirically known to move in clockwise circles, confirming the existence of the inventory cycle. In other words, although producers try to adjust production to match shipment
volume, the time lag between noticing a change
in shipment growth in line with the economic
cycle and the subsequent adjustment of production volume causes swings in the inventory level.
For example, when shipments grow as the
economy expands, producers intentionally build
up inventories by increasing production so as not
to miss opportunities for profit (intentionalbuildup phase). However, the economy will
eventually pass its peak and the growth in inventories will exceed the growth in shipments(crossing the 45°line in the first quadrant fromupper left to lower right). This means that inventories, despite the efforts of producers, continue
to increase above a reasonable level (unintended
accumulation phase). Further recession, causing
decreases in shipments, forces producers to cut
back production faster than the decline in shipments until inventories fall to a reasonable level(inventory adjustment phase). The economy
subsequently bottoms out and shipments start torecover. However, inventories will then be decreasing faster than shipments (crossing the 45°
line in the third quadrant from lower right to upper left). This means that the producer unintentionally reduces inventories (recovery phase).
Once the producer realizes that inventories havefallen below the suitable level, production willagain start to be increased. This creates the inventory cycle consisting of the above fourphases.
According to this concept, the inventory
cycle for the mining and manufacturing sectors
combined entered an intentional buildup phase in
July-September 2002, as shipments recoveredsmoothly, led by producer goods, for which inventory adjustment was completed most quickly(Figure 2-3). The previous cycle spent threequarters in the recovery phase, whereas it only
took one quarter for the current cycle to complete

the recovery phase, which mostly consisted ofadjustments in IT-related products. The pace ofrecovery after bottoming out was faster because
the adjustment was more drastic. However, only
producer goods have experienced a clear inventory adjustment and entered the buildup phase;the decrease on the year-on-year basis in inventory is still accelerating for capital goods andconstruction materials.14
By type of goods, capital goods, for which
adjustment was slowest, entered the recovery
phase in July-September, as the decline in shipments slowed substantially. In particular, theshipments of capital goods for manufacturing
equipment exceeded the level of a year earlier for
the first time in six quarters thanks to the bottoming-out of plant and equipment investment(Figure 2-4). The fall in shipments of construction materials, although still severe, has been
decelerating gradually (Figure 2-5). The shipments of consumer goods slightly exceeded thelevel of the previous year in July-September,largely due to healthy car exports (Figure 2-6).
Inventory adjustment for producer goods wascompleted in January-March, earlier than for final demand goods. Although shipments grew
rapidly mainly for electronic devices, the growth
has slowed somewhat since last summer (Figure
2-7).
3. Weak Recovery in Job Offers as Employment Conditions Remain Difficult(see p. 42 for Figures)
The ratio of active job openings to applicants has
been rising since the bottom of 0.51 in January-March 2002, but the recovery is slow (Figure2-8). This is because the denominator of the ratio(i.e. the number of job seekers) has stayed highdespite the rising numerator (i.e. the number of
job offers). The unemployment rate has remained
high for more than a year, and was 5.4% in
July-September (Figure 2-8). On a monthly basis,
it reached a record-high of 5.5% in October. By
age group, unemployment has increased significantly for the young generations to the mid-30s
14

In the previous cycle, producer goods also led final demand goods in the process of economic recovery, but the
decline in the inventories of final demand goods had alreadyslowed at the comparable stage.
Development Bank of Japan Research Report/ No. 36

7

(Figure 2-9). The unemployment rate for the
15-24 age bracket has risen rapidly since around1998, and is now a high 10%. In the last 12
months, the biggest increase in unemployment
was recorded in the 25-34 age bracket, indicatingthat the deteriorating employment situation has
begun to affect slightly older generations.15 As
firms continue to curb new hiring, the rise in
unemployment is attributable to the reduction in
job opportunities for younger people as well as tothe expansion of less-stable forms of employment.16
Although the number of employees continues to decline from the previous year, the decrement shrank somewhat in July-September 2002
(Figure 2-10(1)). By industry, the number continues to plummet in the manufacturing sector. It
also fell by 300,000-400,000 in wholesaling/retailing due to successive corporate failures.
Those declines are partially offset by the increaseof employees in services. Looking at the different employee classifications, the downtrend continues for the self-employed and family employees, and the decline in the number of regular employees has been protracted (Figure 2-10(2)).
Meanwhile, the number of temporary and daily
employees has been rising. The decline in thenumber of employees is thus being stemmed by ashift to employment for a fixed period, which ismore flexible and helps suppress wages andwelfare expenses such as social insurance premiums.17 By size of corporation, the number of
employees in small- and medium-size corporations has remained much the same as a year earlier, but that in large corporations that employ
500 or more workers continues to fall sharply
15
By relationship to the head of household, unemployment
has risen for “family members other than the head andspouse” and in single-member households, whereas theaverage unemployment rate remained flat for the past 12
months.
16
When the employment situation upon graduation is severe, the mismatch between available jobs and the qualifications of applicants not only raises the subsequent severance rate and also increases the possibility of unemployment by preventing the development of job skills. See Ministry of Health, Labour and Welfare, “Analysis of Labour
Economy (White Paper on Labour Economy) FY 2002,”
Section 2-2, for example.
17
Temporary and daily employees refer to those hired for aperiod of one year or less, and regular employees refer to
executives and those hired for a period of over one year orfor an undetermined period.

8

Development Bank of Japan Research Report/ No. 36(Figure 2-10(3)).
The amount of overtime hours has been increasing since the turn of the year on a quarterly
basis (Figure 2-11). On a monthly basis, however,it recorded in September the first decline on theprevious month since December 2001 for the
manufacturing sector as the recovery of production stalled, and the decline accelerated in October. Although the decline in the number of employees is expected to slow, the leading indicators of production and hours worked show thatthe recovery is weakening. Furthermore, the recovery in employment is limited to peripheral or
marginal areas, specifically to part-time employees. In light of the wage situation which will be
discussed later, firms are now increasingly committed to reducing labor costs. If the current recovery phase turns out to be short-lived, theeconomy is likely to re-enter an adjustment
phase without any perceived improvement in
employment.
4.

Earnings Decreasing, Resulting in Worsening Consumer Confidence(see pp. 43-44 for Figures)

The consumption situation continues to worsen
in line with the deteriorating income and employment situation. The year-on-year change intotal cash earnings per person based on theMonthly Labor Survey indicates that bonuses
and special earnings as well as scheduled earnings have continued to shrink since April-June
2001 (Figure 2-12). According to the survey, thepart-time worker ratio (the ratio of part-timeworkers to the total of full-time and part-timeworkers) moved up 1 point from the previous
year to 22.0% in July-September 2002, supposedly reducing the average wage by a little lessthan 1%. 18 However, the wages of full-timeworkers, traditionally resistant to downward
pressure, started to show signs of decline in 2002.
Thus, the decline in total wages can be explained
not only by the increasing share of part-timeworkers, but also by the reduction in wages ofindividual workers whose statuses do not

18
In terms of total earnings, part-time workers receive justover 2% of the wages earned by full-time workers, in partdue to the difference in hours worked.

change.19
The downtrend is particularly significant forbonuses, which have traditionally been used toadjust wages. The summer bonus for 2002 witnessed a record drop of 5.9% from the previous
year, even higher than all forecasts. Changes inincome usually lag behind those of corporate
performance by about six months. However, astructural reduction in labor cost is now underway to lower labor’s share, which has remained
high since the mid-1990s. 20 The 2002 winterbonus is expected to record a similar drop to thatof the summer bonus. As the outlook for the
economy remains uncertain, the income situationis unlikely to improve for the time being. Although deflation supports real purchasing power,
the downtrend of real wages on the previous year
has accelerated since the latter half of 2001,
down 3.4% in July-September 2002.
Despite this difficult situation, the change
from the previous quarter in real private andhousehold consumption according to the GDP
estimate rose briskly for four straight quarters toJuly-September 2002 (Figure 2-14). This is particularly impressive under the newly adopted
estimation method which enhanced the smoothness of the estimated series.21 Consumption has
an inherent upward trend due to such factors as
the increase in population and in the number ofhouseholds (see Section III-5). In light of the
subdued recovery in plant and equipment investment and the slowdown in exports, however,the sustainability of the steady growth in consumption will be tested in the months ahead.
According to the Family Income and Expenditure Survey, the level of real household
consumption declined gradually from 1998, but
19
The Labor Force Survey points to a rise in the averageage of all employees, particularly among full-time workers
due to curbs on new hiring. Despite the resulting upward
pressure on wages, the regular wages and earnings offull-time workers have been falling on the previous year so
far in 2002, and declined 0.3% in July-September.
20
See Wataru Miyanaga, “Labor’s Share and the Adjustment of Wages and Employment,” DBJ Research Report,
No. 27, June 2002.
21
The change in the method of calculating the GDP estimate in August 2002 corrected its traditional heavy dependence on the Family Income and Expenditure Survey,
which reflects the demand side, by adopting a weighted
average incorporating the supply side (demand: supply =0.5271: 0.4729).

has stayed almost unchanged since 2000 (Figure2-15). In July-September 2002, consumption exceeded the level of a year earlier, which seems tohave contributed to the brisk movement of consumption in the GDP statistics. It should be
noted however that this movement includes someelements that are inconsistent with the trend ofother indicators.22
On the supply side, the retail sales index(Figure 2-16) is still falling for such products as
clothing and food, due to the significant impact
of deflation. As regards home appliances, theindex has declined rapidly in reaction to thesurge in demand just before the promulgation of
the new home appliance recycling law in April
2001 and to the decline in personal computersales.
Against this backdrop, the number of passenger cars sold has been recovering sincearound 2000 and exceeded the annualized number of 3.4 million in the recent two quarters(Figure 2-17). The share of small cars in the total
number of cars sold including standard-sized andmini vehicles exceeded 90% until the 1980s, butthen dropped to 52% in fiscal 1999 following theelimination of the commodity tax in 1989 andchanges in mini car specifications in 1990 and
1998. However, this long-term trend has been
reversed since fiscal 2000, with the share ofsmall cars accounting for 55.1% of the cumulative total from January to October 2002.
In the short term, this may be explained by
the marketing of new “compact” models in thesmall class as consumers prefer lower-priced vehicles, as well as the effects of vigorous sales
campaigns. However, the sustained buoyancy of
car sales for more than two years despite theoverall consumption slump can only be explained by the structural increase in demand for
replacement. The number of small cars owned
22

Although consumption increased on the previous year in
July-September 2002, a closer look reveals that the propensity to consume has “raised” the consumption level. Thisprecludes any interpretation of this movement as the ratchet
effect, which could only “maintain” the consumption level.
The decline in consumption recorded in July-September
2001, which is partly responsible for this increase, wascaused by the decrease in spending on essentially stable
items such as education and rent, thus implying the effect of
re-sampling. See also Cabinet Office, “Annual Report on
Economy and Finance, FY 2002,” Columns 1-3.
Development Bank of Japan Research Report/ No. 36

9exceeds that of standard-sized cars by more than
100%, and the average age of small cars has been
rising despite the recent buoyant sales. The stockof standard-sized cars has also been increasing
despite the decline in the number sold sincearound 1996, but the average age of standard-sized cars is rising more rapidly, approximately 10 years after the sales boom in the early
1990s. This implies that increased demand for
replacement is now expected, including a shift tosmall cars. Strong sales of passenger cars willthus continue for some time, but such sales do
not constitute a change in attitude toward consumption as a whole. Passenger car sales are leveling off in terms of value, due to the rising
shares of small and mini vehicles, and the salesof home electric appliances, another typical durable goods, are still stagnant. These facts imply
that consumer confidence remains weak.
Looking at tourism sales (Figure 2-18),
overseas travel rose in September 2002, one year
after the terrorist attacks in the U.S., which led toa protracted decline. As compared with September 2000, however, the sales are still down 5.7%
overall and down 7.3% for overseas travel, indicating that a total recovery has yet to come. In
particular, the unit price per customer for domestic tours has been declining. According to thestatistics on brand sales by travel agencies, theunit price has been falling by some 10%, morethan offsetting the 5% increase in the number ofcustomers.
Finally, consumer sentiment, which improved in the spring of 2002 largely in anticipation of an economic recovery, has recently
shown signs of deterioration again (Figure 2-19).
Although the Consumer Confidence Index forthe coming six months continued to improve in
the September survey, this is because the expectation of falling prices was counted as a positive
factor. The employment and income prospects
both hit record lows since the survey of December 2001. Other consumer confidence indicators(Figure 2-19(2)) also deteriorated in surveys
conducted in July-September, indicating reduced
expectations for economic recovery as income
and employment conditions continue to worsen.
It is becoming increasingly difficult to expect
consumption to maintain its current level amidst
this deteriorating environment.

10

Development Bank of Japan Research Report/ No. 36

5. Plant and Equipment Investment: Bottoming Out but Recovery Expected to be
Weak (see p. 45 for Figures)
Plant and equipment investment is bottoming out
but the pace of improvement is painfully slow
with poor prospects of recovery.
Historical data based on the Statistical Survey of Incorporated Enterprises shows that therate of year-on-year growth in plant andequipment investment 23 is strongly correlatedwith return on investment defined as operating
asset profit rate minus the average contracted
interest rates on new loans (Figure 2-20).
Empirically, the threshold return on investment
vis-à-vis the change in plant and equipment
investment is 5% for manufacturing and 3% for
non-manufacturing.24
Looking at the trend in the manufacturingsector, return on investment rose in January-March 2002 as the economy bottomed out,
and surpassed the 5% threshold in April-June forthe first time in four quarters, followed by a further improvement in July-September to 7.0%. In
response, the year-on-year decrease in plant andequipment investment has slowed sinceApril-June, but the improvement is weaker thanin the previous recovery (late 1999), when returnon investment stood at a similar level. Indeed,
the pace of recovery slowed in July-September.
Plant and equipment investment in the
non-manufacturing sector has slumped almost
constantly since 1998, as controls on spending
have been in place in industries exposed tostrong pressure to reduce costs largely due toderegulation. Looking at the recent trend, investment declined 8.8% from the previous year
in July-September 2002, which indicates that the23

According to the Statistical Survey of Incorporated Enterprises, “Plant and Equipment Investment Including Software” was taken as the official amount for plant and equipment investment since July-September 2001, but time series
data before this period could not be obtained. Therefore, inthis research report analyses are made using the “Plant andEquipment Investment Excluding Software” figures.
24
In the non-manufacturing sector, the relationship between the change in plant and equipment investment andreturn on investment is not as stable as in the manufacturingsector. Formerly, the threshold return on investment wasconsidered to be 2.5% for non-manufacturing, but this report adopts the level of 3% in light of recent trends. In any
case, the value should not be taken for granted.

decline has been slowing. Nonetheless, the current situation of non-manufacturing sector plantand equipment investment is particularly severe
compared not only with the situation in 1996-97,
when the correlation between return on investment and plant and equipment investment wasstrong, but also with the situation in late 1999,
when the two indicators had already started todiverge. (Return on investment was at similarlevels in the three cases.)
Looking ahead, return on investment willcontinue to recover at least until the end of fiscal
2002. Trends in the Bank of Japan’s Tankan andthe mid-term account settlements announced in
September indicate that corporate performancefor fiscal 2002 is still following a V-shaped recovery, even though some initial plans were revised downward. However, the profit environment for the next fiscal year onward is highly
uncertain, as prospects for the U.S. economy andthe recovery of domestic demand look doubtful.
Thus, it is difficult to predict whether the recovery in corporate performance will directly translate into higher plant and equipment investment.
Machinery orders (domestic private demand
excluding ships and electric power), which is agood leading indicator of plant and equipment
investment, have shown a smaller decline on theprevious year in both the manufacturing andnon-manufacturing sector (Figure 2-21). Nonetheless, the recovery in the months ahead may
prove to be weak, as the ratio of achievement toprojection declined in the latest period.
The decline in orders from the manufacturing sector bottomed out in October-December
2001, down 36.4% on the previous year (thelargest decline so far under the present standard).
Since then, the decline has been slowing progressively, in particular for electric machinery, as
inventory adjustment has made headway in electronic devices (down 8.5% from the previous
year in July-September 2002). According to the
Cabinet Office projection (simple aggregate ofprojections by corporations x average ratio ofachievement over the recent three quarters), machinery orders will increase in October-December 2002 for the first time in sevenquarters. On a seasonally adjusted quarterly basis,
however, machinery orders declined in
July-September, albeit by only 0.6%, for the firsttime in three quarters. This will be followed byanother small decline in October-December(Cabinet Office projection), pointing to a slowdown in the recovery. The ratio of achievement
to projection also declined in July-September for
the first time in three quarters. This implies a
subtle change in investor sentiment following theslowdown in production.
Orders from the non-manufacturing sector(excluding ships and electric power) continue toslump. In communications, controls on investment are expanding from fixed phones25 to mobile phones, while investment in information
technology related to reorganization and new
entries has halted in finance & insurance. On a
year-on-year basis, orders plummeted 16.8% inJanuary-March 2002, followed by a smaller decline of 8.7% in July-September. According to
the Cabinet Office projection, however, the October-December period will witness a steeper
drop of 15.3% from the previous year. The ratioof achievement to projection also declined
slightly in July-September, although the drop
was not as significant as in the manufacturingsector.
Looking ahead, investor sentiment is wavering in the manufacturing sector, which was
expected to lead the recovery, and orders fromthe non-manufacturing sector continue to slump.
If industrial production, a key factor for machinery orders, does level off, the current recovery
might prove to be even shorter than the previous
recovery.
6.

Residential Investment Decreasing Slowly(see p. 46 for Figures)

Housing starts (seasonally adjusted annual rate)
remained around 1.2 million units after 1999, buthave tended to be below 1.2 million since 2001
(Figure 2-22). The year-on-year change by component (Figure 2-23) indicates that the construction of owner-occupied houses has declined since
January-March 2001 in reaction to the surge indemand before the revision of the housing loan
tax reduction scheme,26 and due to the severe
25

Broadband-related investment in fixed phones has stayed
firm, but its share in total investment is insignificant.
26
The surge in demand occurred seemingly because the
Housing Loan Tax Reduction (applicable to those who
Development Bank of Japan Research Report/ No. 36

11employment and income conditions. Total housing starts increased on the previous year in
April-June 2002, as the reactionary drop inowner-occupied houses subsided and the construction of housing for rent remained strong. In
July-September, however, they declined 6.2% on
the previous year, largely due to a substantial
drop in housing for sale, particularly condominiums.
Floor area for new housing (Figure 2-24)
has not increased on the previous year since
January-March 2001, attesting to the weaknessof housing starts as a whole.
As can be seen in the movement of housing
starts, its leading indicator, real private residential investment (seasonally adjusted annual rate)
has fallen gradually since April-June 2001, when
it recorded a substantial drop (Figure 2-25).
In the condominium27 market (Figures 2-26
and 2-27), there has been growth in stock recently in both the Tokyo metropolitan area andKinki area.28 In both areas, the term-end stock
has posted double-digit growth on the previous
year since the beginning of 2002, raising concern
about possible loosening of the condominium
market.
7.

Public Investment Falling due toDifficult Financial Situation(see p. 47 for Figures)

Public investment (public capital formation,seasonally adjusted, annualized nominal values)
has been declining almost constantly since the
moved into their newly purchased home by June 2001) offered much greater advantages in terms of the deduction
period and amount as compared with the so-called “New
Housing Loan Tax Reduction” (applicable to those who
moved into their newly purchased home between July 2001
and December 2003).
27
For the purpose of this report, the term “condominium”
refers to a subdivided housing lot made of reinforced steel
frames, ferro-concrete or steel frames.
28
The statistics of Building Construction Started include
condominiums in housing for sale. Condominiums accounted for 65% of housing for sale in fiscal 2001 (based on
the number of new housing starts). In the latest period,
condominium housing starts in the Tokyo metropolitan andKinki area accounted for about three-quarters of the national total. Therefore, condominium contract rates andinventory trends in these two areas are important leading
indicators for the construction of condominiums and housing for sale as a whole.
12Development Bank of Japan Research Report/ No. 36

latter half of 1999, due to the fading effects oflarge-scale economic stimulus measures and cutsin expenditures induced by financial difficulties(Figure 2-28). Consequently, public investment
accounted for only 6.2% of GDP (seasonally adjusted nominal values) in the most recent period,
down 3 percentage points from the peak period.
Contracted public works orders, a leading
indicator, fell 7.8% in fiscal 2001, the third
straight year of decline (Figure 2-29). Although
the delayed implementation of the second supplementary budget for fiscal 2001 provided support in April-June 2002, the indicator continues
to drop due to sustained cuts in expenditure.
Cutbacks in spending are particularly significant
in funds allocated to local regions, which accountfor 70% of public investment, in the face of theextremely difficult financial situation.
The government plans to present a supplementary budget bill for fiscal 2002 to the ordinary Diet session in January 2003, but the additional expenditure for public investment will belimited to some ¥1.5 trillion. The supplementarybudget will not stop the decline in public investment, as the initial budget for fiscal 2002 proposed substantial reductions from the previous
year of 10.7% in central government expenditures on public works projects and 9.5% in investment expenses under local finance plans.
In line with the decline in public investment,
budget revenue is slumping due to the sluggish
economy and income and other tax reductions,
resulting in high budget deficits in both central
and local governments. Since the deficits havebeen largely financed by government bond issues
and by borrowings in the special account for local allocation tax, outstanding government debts
have been ballooning. Indeed, the outstanding
long-term debts of central and local governments
will total ¥693 trillion at the end of fiscal 2002,
accounting for some 140% of GDP (Figure2-30).
At present, Japan has huge general government debts as compared with other developed
countries, as well as a substantial deficit in the
primary balance, i.e. the budgetary balance excluding bond issues, interest payments and bondredemption (Figure 2-31). This fiscal position isin stark contrast to the fiscal restructuring carriedout by the EU and the U.S. since the late 1990s.

So far, the Koizumi Cabinet has adhered to its
commitment to cap new central government
bond issues at ¥30 trillion. However, tax revenues for fiscal 2002 will fall short of the planned
amount by more than ¥2 trillion, and economic
stimulus measures including tax cuts are becoming more likely. Thus, a supplementary budget
for fiscal 2002 will probably result in the ¥30
trillion cap being exceeded, raising concerns
about further deterioration of the government’s
finances.
8.

Exports Slowing from Substantial Increase as Imports Rise(see p. 48 for Figures)

Figure 2-32 shows the trend of real effective exchange rates for major currencies. The Japanese
yen tended to depreciate to January-March 2002,
then both the yen and euro strengthened against
the dollar from April-June 2002 as the U.S.
economy started to slow, resulting in depreciation of the dollar.
Figure 2-33 compares the long-term trend of
the yen/dollar exchange rate with purchasing
power parity. The yen/dollar rate in 2001 saw theyen weaken after strengthening for almost two
years. The movement better approximates thelevel of purchasing power parity, which is still
lower than the exchange rate but has a trend toward yen appreciation.
Against these trends in the foreign exchange
markets, Japanese exports and imports both increased in the first half of 2002. Looking at theseasonally adjusted monthly indicators for export
and import volumes (Figure 2-34), the volume ofexports bottomed out and switched to a substantial increase in 2001 as the U.S. economy recovered and exports to Asia started to grow again.
Recently, however, export growth has come to ahalt, as the prospects of the U.S. economy become increasingly uncertain and the recovery of
the real economy slows down. Imports are increasing after staying almost flat until early
2002.
Looking at a breakdown of export volumes
by country (Figure 2-25), exports to Asia increased on the previous year in January-March
2002 due to inventory adjustment in IT-related
products. Exports to Asia have been increasing

substantially since then, leading the overall
growth of exports. Exports to the U.S. also roseon the previous year, backed by the recovery in
the U.S. economy and strong car exports.
Figure 2-36 shows the trend of exports foreach type of goods based on the “Analysis of All
Industrial Activities” published by the Ministryof Economy, Trade and Industry. The data indicate that the substantial increase in exports since
early 2002 has been led by producer goods, duelargely to the recovery in demand for semiconductors.
Figure 2-37 shows the import trends foreach type of goods. As inventory is adjusted in
the country, imports have been increasing on theprevious year, led by producer and capital goods,
particularly IT-related imports from Asia.
9.

Wholesale and Consumer Prices Continuing to Decline(see p. 49 for Figures)

International commodity prices (excluding crudeoil) turned down in October-December 2000 andcontinued to decline on the previous year
through 2001 due to the slowdown in the global
economy (Figure 2-38). In the latest period,
however, they rose for the first time in eightquarters as prices for agricultural products andbeverages increased on the previous year.
The wholesale prices of domestic demand
goods (weighted average of domestic and importprices) have been falling by about 1% since October-December 2001. Although the decline in
the prices of intermediate goods has been slowing since April-June 2002, prices are now falling
faster for final goods.
The Consumer Price Index 29 (excluding
fresh food) declined by 1% from the previous
year since October-December 2000 (Figure 2-39).
Analyzing the year-on-year change by component (goods and services), the decline is led bygoods mainly due to technological progress andthe spread of low-priced imports in the domestic
29

The Consumer Price Index from the August 2001 announcement has been using 2000 as the base year withitems such as personal computers and overseas package
tours being added in the calculation of the index. As a resultof the revision, the index now reflects more accurately thecomposition of actual household consumption.
Development Bank of Japan Research Report/ No. 36

13market. In services, public services30 have been
contributing to the decline since April-June 2002,
largely because major electric power companies
lowered their utility charges.
The Corporate Service Price Index continued to decline by more than 1%, mainly in leasing and rental and communications and broadcasting.
10.

Credit Risk Aversion throughLow Interest Rates(see p. 50 for Figures)

In the financial markets, the overnight unsecured
call rate has remained near 0% since March 2001,
when the Bank of Japan introduced the quantitative monetary easing policy by adopting the current account balance as the direct target of its
financial guidance policy (Figure 2-40). Yields
on three-month CDs (bid), which represent
short-term interest rates, had been relatively stable in a 0.1-0.15% range since the start of quantitative easing. In October 2002, however, they
began to rise as expectations heightened for accelerated write-offs of non-performing loans following the announcement of the Integrated
Measures against Deflation (“Integrated Measures for the Acceleration of Reforms”), whichwere drawn up by the government and the rulingcoalition. Also, financial institutions tilted toward more conservative fund management due tothe slump in bank and other share prices.
Meanwhile, yields on 10-year government
bonds, a good indicator of long-term interest
rates, remained low since February 2001 as economic prospects worsened due to slumping shareprices both in Japan and overseas. In September
2001, however, yields rose sharply to almost
1.3% largely due to the surprise announcementby the Bank of Japan that it would purchaseshares held by banks, only to drop again as financial institutions adopted a more conservative
investment attitude, taking account of the slump
in bank and other share prices. In the most recent
period, the yields were extremely low, falling
below 1.0% for the first time in four years.
As regards monetary policy, quantitative
30
Electricity, city gas & water charges are included in public services, while publications are included in general services.

14

Development Bank of Japan Research Report/ No. 36

easing measures are still in place. From December 2001, the target for the Bank of Japan’s current account balance was set at ¥10-15 trillion.
As an additional easing measure, the target balance was raised to ¥10-20 trillion in late October
2002. The measure seeks to generate some effectby announcing that the government and the central bank will work together to fight deflation. It
is also designed to prepare for any disruption in
the financial markets that might be caused by thewrite-offs of non-performing loans. As a result,the current account balance (monthly average)
surged from the traditional ¥15 trillion range toover ¥18 trillion.
As a means of monetary control, themonthly amount of long-term government bondbuys was raised from ¥1 trillion in February
2002 to ¥1.2 trillion in October. The maturity forbills purchased was extended from six months to
one year in October.
The monetary base, i.e. the total of the Bankof Japan’s current account balance and cash incirculation, has accelerated since 2001. It recorded a substantial growth of 31.2% on the previous year in April-June 2002, the third consecutive quarter of increase by 20% or more from ayear earlier (Figure 2-41). Since the end of April,however, the monetary base has stayed almost
unchanged from the previous month. The growthof money stock has stayed around 3% since thelatter half of 2001 in terms of M2+CD, whichlargely consists of bank deposits. The credit multiplier, i.e. money stock divided by the monetarybase, reached a high of 13 in the first half of1992. It has been falling since then, however,
due to the relatively rapid growth of the monetary base, which means that it will take significant time before the current monetary policies
take effect. In the latest period, the credit multiplier fell below 8, its lowest level ever, due to the
sharp expansion of the monetary base.
The year-on-year change in M 2 +CD bycomponent indicates that since 2001, ordinary
deposits have increased sharply in stark contrast
to the accelerated decline in time and savings
deposits (Figure 2-42). Investors are averting
credit risk by (1) shifting time deposits into different accounts as the government lifted its fullguarantee for time deposits exceeding ¥10 million as of April 2002, and (2) moving money

from some investment funds back into ordinary
deposits after MMF and open-ended bond investment funds successively fell below par value.
In terms of credit, the main reason for theincrease in M2+CD is the buying of government
bonds, as lending to the private sector, industrial

debentures and stocks continue to decrease (Figure 2-43). This trend implies that private banks
are continuing to avoid the credit risk inherent in
new loans by diverting funds to risk-free assets
including government bonds.

Development Bank of Japan Research Report/ No. 36

15

III A Medium-term Scenario for
the Sustainability of the Japanese
Economy1.

Deflation and Structural Problems in theJapanese Economy(see p. 51 for Figures)

Under the influence of globalization, including
the transition to market economies of China andother former socialist states, the deflation facing
the Japanese economy (sustained decline inprices) has been accompanied by a debt deflation,arising from balance sheet problems in the
post-bubble era.
As shown in the conceptual diagram on
page 51, real GDP (horizontal axis) and pricelevel (vertical axis) are determined by the intersection between the downward-sloping aggregate
demand curve and the upward-sloping aggregate
supply curve. In this context, a decline in prices
is caused by a rightward shift of the aggregate
supply curve (1), a leftward shift of the aggregate
demand curve (2), or both (3). The Japanese
economy has been suffering deflation sincearound fiscal 1997 due to both demand and supply factors. The demand factor essentially arosefrom balance sheet problems in all sectors(household, corporate, financial and government).
It is considered that the resultant deflation, byincreasing debts in real terms, has further restrained demand in such forms as curbs on consumption in the household sector due to uncertainties and reduced income, controlled investment and employment in the corporate and financial sectors under pressure for restructuring,as well as reduced expenditure in the government
sector.31
In an effort to fight this deflation and revitalize the economy, the government adopted in a
Cabinet meeting in January 2002, “Structural
Reform and Medium-term Economic and Fiscal
Perspectives”. This envisages a “steady growthof at least 1.5% in real terms or 2.5% in nominal
terms led by private demand” in the medium
31

See Development Bank of Japan, “Recent Trends in theJapanese Economy: The Japanese Economy under Deflation,” DBJ Research Report, No. 19, August 2001, Chapter
II for details on the interpretation of the diagram.
16

Development Bank of Japan Research Report/ No. 36

term by overcoming the deflation through a “period of intensive adjustment for structural reform.”
In light of this Medium-term Outlook, thischapter presents a medium-term scenario for the
supply-demand balance and major demand items,
taking account of the current economic situationand focusing on building a nation based on thecreativity of science and technology, which isone of the “models of economic society to berealized” according to the Medium-term Outlook.32
In addition to the examination of a medium-term scenario for Japan, this chapter also
outlines the economic outlook for, and R&D
policies in, Asia including China. The cases of
Korea and Sweden are also discussed as examples of recovery from an economic crisis.
2.

Supply-Demand Balance in the Japanese
Economy after Structural Reform(see p. 52 for Figures)

Assuming that the reform is designed to build anation based on the creativity of science andtechnology, this chapter considers the possible
relevant adjustment process if necessary conditions are met, as well as the supply-demand balance in the Japanese economy after the adjustment. The discussion covers the period to fiscal
2010. This section explains the concept of theestimation and outlines the results.
The medium-term vision of the Japanese
economy envisaged in the Medium-term Outlook
and economic fluctuations during the transition
period were spelled out in a background paper
prepared by the Cabinet Office and presented to
the Council of Economic and Fiscal Policy on
January 18, 2002. Based on the estimates in themulti-sector
medium-term
macroeconomic
model (the first version of the Economic andFiscal Model) published by the Cabinet Officeon November 2, 2001, the background paper
projects the trends to fiscal 2006 and the values
32

Measures have already been taken under the Basic Law
on Science and Technology of 1995 and the Basic Programfor Science and Technology, and their impact will be felt inthe years ahead. As a preliminary measure for fiscal 2003,
the tax relief scheme for corporate R&D will become permanent after a thorough review. These efforts are expected
to ensure renewed growth.

for fiscal 2010 concerning macroeconomic factors such as real and nominal growth rate, priceinflation (GDP deflator) and the saving-investment balance in each sector, as well as
the financial state of the government such as theprimary balance. The data, however, do not contain information about the underlying economic
structure, such as the trend for each demand item
such as private consumption and plant andequipment investment or the overall supply-demand balance.
The estimation in this chapter has two major
objectives. First, it gives an “example” of theconceivable supply and demand structure basedon the trend of medium-term growth provided
necessary conditions are met. The estimation inthis chapter is not a forecast in that it assumes
that certain conditions are met, such as proper
economic and fiscal policies by the government
and a favorable environment in the external
economy so that the Medium-term Outlook may
produce the expected results. This chapter, byshowing the estimation in this manner, thus analyzes how the economic structure would change
if the Medium-term Outlook materializes, thus
enabling discussion of the conditions necessary
for restoring growth in the deflationary economy.
The second objective is to update the background
paper, which is based on information as of late2001. Since then, the Japanese economy haschanged greatly, and the general perception of
the sustainability of the economy and time required to eliminate deflation has worsened. By
incorporating the downtrend of the real economy,
this chapter presents a more realistic transition
process that would eventually lead to the growthenvisaged in the Medium-term Outlook.33
The estimation is premised on the following
scenario. As regards the business cycle, the current expansion phase following the trough ofJanuary-March 2002 is assumed to enter a recession in mid fiscal 2003. 34 It is difficult toachieve the goal identified in the Medium-term
Outlook to complete intensive structural adjustment in two years (fiscal 2002 and 2003), as the
deflationary pressure of structural adjustment
accompanying the reform will amplify the impact of cyclical adjustment. Therefore, the gradual approach will be necessary to cover the period to fiscal 2005, when the next economic expansion is expected. Thus, economic growth will
stay near zero during the full-scale adjustment
from fiscal 2003 to 2005, even if proper macroeconomic management is ensured mainly
through monetary policies to avoid a deflationary
spiral. from fiscal 2006, it is assumed that theJapanese economy will slowly break out of deflation thanks to cyclical recovery and the reforms, and that the growth of over 1.5% assumed
in the background paper will be achieved, about
two years behind schedule. As regards the budget
blocs, the estimation does not consider the introduction of policies discussed in the government after the publication of the Medium-term
Outlook or any original assumptions. On the expenditure side, the estimation in this chapter
closely follows the assumptions of the background paper (the government shouldering
one-third of the basic pension payments), exceptthat estimated values of nominal GDP are considered in tax revenues. Government debts are
assumed to maintain their creditworthiness in themarket.
The estimation process adopts a variant version of the “successive approximation method.”35
On the demand side, the trend of real/nominal
GDP and its deflator shown in the background
paper is adopted as a benchmark (the government shouldering one-third of the basic pension
payments), then the method assumes a (probable)
series of revised values in line with theabove-mentioned scenario. On this premise, tentative estimates of the real value, the nominal
value and the deflator are calculated for eachdemand component to compile revised values of33

In this respect, the Medium-term Outlook itself will be
reviewed annually to reflect any change in the economic
situation. However, relevant information has not been disclosed so far, such as the timing of such review and theform of its publication.
34
No official statement has been made about the most recent economic trough, so we must wait for a determinationby the Working Group of Indexes of Business Conditions of
the Cabinet Office. As for the view that the economy will

peak in the middle of fiscal 2003, see the “Summary Conclusion of the Working Group on the Analysis and Examination of Economic Trends,” presented to the Council of
Economic and Fiscal Policy on September 20, 2002.
35
For the description of the successive approximation
method, see Takao Komine, Nippon Keizai Keiki Yosoku
Nyumon (Introduction to the Forecast of the Japanese
Economy), Toyo Keizai, 1992, pp. 41-47, etc.
Development Bank of Japan Research Report/ No. 36

17

GDP and its deflator. This process is repeateduntil a consistent estimate is obtained. However,
the estimation process is different from the ordinary successive approximation method in that it
considers as given the real GDP growth rates
from fiscal 2006 on, as the projections shown inthe background paper for fiscal 2004 and after
are assumed to materialize with a time lag of two
years. Thus, any divergence between the given
real GDP growth rates for fiscal 2006 onward
and the result of compiling the preliminary estimate for each demand component on this premise will not lead to revision of the growth rates,
but will be reflected on the exogenous shift parameters in each component.36 Thus, the estimation in this chapter is not a forecast, but examines
the conditions required to restore growth in the
deflationary economy. For instance, it is assumed
that eliminating concerns about the future willraise the propensity to consume. Exports are assumed to grow more rapidly, backed by Japan’s
technical capabilities. However, these assumptions do not predict that things will be so, but
merely present the conditions required for the
resumption of economic growth. Nevertheless,the assumptions do not mean number crunching,
and analyses are conducted as to whether the
scenario could take place as given under the
relevant conditions.
The principle of estimation is similar on the
supply side and the balance of supply and demand, but is simpler than on the demand side.
Namely, it is assumed that the GDP gap ratio
will be zero (potential GDP will be realized)
from fiscal 2006 onward. To be consistent withthis premise, a series of tentative values is estimated for the potential GDP and the contributionof each production factor to the potential growthrate (which is deemed probable in light of actual
data and the reform scenario). Then proper assumptions are made on exogenous variables including population, labor force participation rateand capital stock retirement rate, and the consistency of the assumptions is checked against otherfactors such as the trend of plant and equipment
investment estimated on the demand side. Anyremaining divergence will not lead to revision of36

The trend in the adjustment period to fiscal 2005 will berevised at the same time.

18

Development Bank of Japan Research Report/ No. 36

the potential growth rate but will be reflected on
total factor productivity (TFP) as a “condition”
for sustaining the growth track.
The definition of and estimation of actual
values of potential GDP and capital/labor inputs
are based on OECD’s “Economic Outlook 71(June 2002). 37 The concept of potential GDP
according to OECD38 is the “level of real GDP
that is sustainable in the medium term under stabilized inflation.” This level is determined byassigning the trends39 of potential labor input on
a NAWRU (non-accelerating wage rate of unemployment) basis, capital stock (actual value)
and TFP (total factor productivity) to the production function 40 formulated and estimated foreach country. The contribution of each production factor to potential growth is based on ourown calculation assuming a Cobb-Douglas production function41, with an equilibrium capital
distribution rate of 0.3342.
Based on the ideas described above, Figures
3-1 to 3-3 show the result of estimating the37

The calendar year data published by OECD are converted into fiscal year values by a simple linear interpolation.
38
OECD revised the method for estimating potential GDP
in 1995. It adopted a production function approach after
considering an approach based on the estimation ofsmoothed GDP using the Hodrick Prescott filter, in addition
to the traditional split time-trend method. For details, see
Giorno, C., P. Richardson, D. Rosevaere and P. van den
Noord, “Estimating Potential Output, Output Gaps andStructural Budget Balances,” OECD Economics Department Working Papers, No. 152, 1995.
39
Smoothed by the Hodrick-Prescott filter.
40
Here, the production function refers to that of the business sector, and government consumption is consideredseparately.
41
In estimating potential GDP, OECD also uses a
Cobb-Douglas production function in principle to publish
the composition of potential growth by production factor.
As regards Japan, however, OECD uses a CES (constantelasticity of substitution) production function, which puts
the elasticity of capital-labor substitution at 0.4, and does
not publish any breakdown of the growth rate on the
grounds of incomparability. Although the method used inthis chapter enables the contribution by production factor to
be calculated easily, it lacks precision as it relies on OECDestimates for potential GDP and capital/labor inputs, while
making separate ad-hoc assumptions regarding the production function, so special attention is required when interpreting or using the results.
42
According to the assumption in Notes 2-4 in Cabinet
Office, “Annual Report on Economy and Finance,
FY2001.”

trends of supply-demand structure and balancethat are conceivable if growth of over 1.5% is tobe achieved from fiscal 2006.43 On the demandside, private consumption and plant and equipment investment will both continue to slump in
the adjustment period to fiscal 2005, as severe
income and employment conditions will prevail
due to cutbacks on labor cost by corporations,which will coincide with an intensive stock adjustment to improve capital efficiency. As theforeign exchange rate will remain stable, 44
however, negative growth will be recorded onlyin fiscal 2004, with contributions from exports
backed by technical capacities in such fields as
the environment, information technology andmaterials. From fiscal 2006, when the structuraladjustment will have been completed, households’ concerns about the future will be eliminated as the reforms proceed, and so the propensity to consume will rise in parallel with the aging of the population and changes in the supply
structure, eliciting new demand. Consequently,
private consumption will recover its strength inline with economic growth. Plant and equipment
investment is expected to be controlled in orderto improve capital efficiency, but will eventually
increase as the expected growth rate and shareprices rise. The growth of exports will be milder
than in the adjustment period, but will remain
brisk. Meanwhile, the government sector in general will stay almost neutral to GDP growth, as
the reduction in public investment will be offset
by the rise in government consumption including
health care expenses for the elderly.
On the supply side (potential growth rate),
intensive adjustments in industrial structure andintra-industry supply structure will make headway during the adjustment period, with corporate
self-help efforts boosted by reform measures including deregulation. Capital input will makenegative contributions from fiscal 2003 to 2005,
as the capital stock retirement rate will rise substantially in addition to curbs on plant andequipment investment. As labor mobility between industries will increase as employment
43
The estimation in this chapter is based on primary QE
data for July-September 2002 (FY2000 annual estimationbasis), published in November 2001.
44
The foreign exchange rate is assumed to be almost constant at around ¥120/$.

status becomes more diverse, labor input will
structurally continue to make negative contributions at around the current level, mainly due tothe reduction in hours worked per person. Although potential GDP will decline in fiscal 2003
and 2004, when the growth of TFP will be temporarily halted, the reduction in the GDP gap
through the adjustment of overcapacity will
eventually eliminate the expectation of deflationin the household and corporate sectors, and soreal demand will return to normal. Following thecompletion of the adjustment, capital input will
resume its positive contribution due to a respite
in structural adjustment, but to a lesser extent ascorporate plant and equipment investment will
still be focused on capital efficiency. At thisstage, the GDP gap will have been eliminated,which means that any slowdown in potential
GDP growth will immediately restrain actual
GDP growth. Therefore, technological advancesand efficiency improvements will need to deliver
TFP growth comparable to that in the 1980s, if asustained growth rate of over 1.5% is to beachieved.
3.

Recovery in Demand: the Key to Breaking the Grip of Deflation(see p. 53 for Figures)

In considering the mechanism of the deflation
facing Japan and necessary conditions for its
elimination, the simultaneous output/price determination model in the framework of the aggregate demand and supply functions (hereafterreferred to as the “AD-AS model”) is a useful
tool for intuitive understanding, although themodel depends on various strong assumptions(see the conceptual diagram on page 51).45 With45

The AD-AS model can be summarized as follows. The
aggregate demand function, which is based on the so-called
IS-LM model in textbooks, represents the combinations of
aggregate demand (GDP) and general price (GDP deflator)that bring about the equilibrium in the goods market and themonetary market under a given money supply and exogenous demand. The AD function is shown as a downward-sloping curve in a diagram. In general, prices are assumed to be linked to aggregate demand via the real money
supply (and interest rates, plant and equipment investment,etc.). In a textbook case, the aggregate supply function
represents the combination of aggregate supply and generalprice that bring about the equilibrium in the labor market
under a production function (technology) of diminishing
Development Bank of Japan Research Report/ No. 36

19

a simple empirical analysis, this section estimates the aggregate demand and supply curves atdifferent points in time, and investigates the
background of the current deflation by identifying demand factors and supply factors behind thechanges in output and general price levels, toenable the requirements implied by our estimation for overcoming deflation to be examinedtheoretically. The structural VAR model 46 iscommonly used in recent empirical analyses to
identify the impact of temporary shocks inducedby money supply and other monetary factors as
demand factors and that of permanent shocks dueto physical factors including technology andpopulation as supply factors.47 However, as therobustness of the result and its interpretation are
still controversial, this section estimates parameters of the aggregate demand and supply curves
in a static framework and decomposes them into
supply and demand factors based on the shifts ofthe two curves due to changes in exogenous
variables.
The method of estimation is shown in theNote of Figure 3-4.48 In the aggregate demand
curve formula (1), the third term on the right side
represents exogenous demand. The fourth andfifth terms represent the impact of the exchange
return, when premised on the nominal rigidity of wages andprices or a mistake in expectation concerning price level.
The AS function is shown as an upward-sloping curve in a
diagram. In general, prices are assumed to be linked withaggregate supply directly or through real wages. The equilibrium output level and general price level are determinedby the intersection of the aggregate demand and supply
functions. Accordingly, deflation (sustained decline inprices) is caused by a rightward shift of the aggregate supply curve ((1) in the pattern diagram at the beginning of thischapter), a leftward shift of the aggregate demand curve (2),or both (3).
46
VAR (Vector Autoregression) is a multivariable
time-series analysis technique not premised on any specificeconomic theory (priori assumption). The structural VAR
method is a technique to identify the relations among variables with minimum priori assumptions.
47
Recent analyses on the Japanese economy include Hitoshi Mio, “Infure Ritsu no Youin Bunkai: Kozo-gata VAR niyoru Juyo-Kyokyu Yoin no Shikibetu (Factor Dissolution of
Inflation Rate: Classification of Supply and Demand Factors
with Structural VAR),” Kinyu Kenkyu (Financial Research),
Vol. 20, No. 4, Financial Research Center, Bank of Japan,
2001. Examples of analysis are also provided in Economic
Planning Agency, “Annual Economic Report, FY 1998”(see Note 2-1-2).
48
The formulation draws on Economic Planning Agency,“Annual Economic Report, FY 1996, Table 1-10-2.
20Development Bank of Japan Research Report/ No. 36

rate and asset prices on plant and equipment investment, which is expected to be positive (withweaker yen and higher land prices leading to increased plant and equipment investment). As aresult, coefficient sign conditions are all positive,
including for the third term. In the aggregate
supply curve (2) formula, the third term on theright side represents nominal wage rate incorporating productivity. The fourth and fifth terms
represent cost factors not reflected on the GDP
deflator (import prices and asset prices). Coefficient sign conditions are all negative, including
for the third term. The exchange rate and asset
prices (land prices) have an impact on the two
curves: in the same direction as regards prices(weaker yen raising prices both on the demandside and the supply side, for example) and in
opposite directions as regards output (weaker yen
raising output on the demand side, while lowering it on the supply side, for example). The direction of impact on output at the equilibrium
point will depend on the relative magnitudes of
the coefficients.49

49
The impact on the equilibrium output will be positive
when the following condition is satisfied: α2γ1>α1γ2 for theyen/dollar rate, and α2δ1>α1δ2 for land prices.

Explained variable: real GDP, estimated with log-linear, two-stage least-squares method
Estimation period: Q2 1990 – Q1 2002
t values in parentheses ( ).
Real consumption + real
Constant term
GDP deflator
government expenditure +real exports
Aggregate demand
α1
β1
curve
2.28
-0.4480.920(2.53)(-3.37)(10.6)
Constant term
GDP deflator
Unit labor cost
α2β2Aggregate supply
curve
0.32
3.033
-1.541(0.12)(5.40)(-4.36)
Note: See text and Note of Figure 3-4 for details of the estimation method and data.

The result of the estimation is shown above.
Except for the exchange rate for the aggregate
supply curve, estimated coefficients significantly
satisfy the sign conditions in all explained variables. It is evident that the absolute value of thecoefficient on GDP deflator (the magnitude of
the coefficient representing elasticity as the estimation formula is log-linear) is greater for theaggregate supply curve, which means that output
is easily influenced by the shift of the aggregate
demand curve while prices are easily influenced
by the shift of the aggregate supply curve. Judging simply from the relative magnitudes of theestimated coefficients, a weaker yen and higher
land prices will both have a positive influence on
the equilibrium output. Here, the term “influence” merely indicates that, based on the economic structure in the estimation period, “greater
equilibrium output” corresponds to “lower exchange rate for the yen” or “higher asset (land)
prices”; the word does not signify any causal
links.
Using the parameters of the aggregate supply and demand curves thus estimated, the shifts
in the two curves and their intersection (theoretical equilibrium values of real GDP and GDP
deflator derived from the model) can be observedfor each of the fiscal years (based on the averageof quarterly estimates) in the experience period(fiscal 1990-2001) by interpolating the actual
values of the explaining variables (left diagramin Figure 3-4). As regards the forecast period(fiscal 2002-2010), the shifts in the two curves
can be observed as a condition for realizing the¥/$ rate

Land prices

γ1
0.061
(5.78)¥/$ rate
γ2
0.002(0.08)

δ1
0.150(3.37)
Land prices
δ2-0.466(-11.3)

estimates of GDP and GDP deflator, which areconsidered as given, assuming that the coefficient on GDP deflator will remain unchanged
from the experience period for both curves (right
diagram in Figure 3-4). Based on the movementsof the two curves thus specified, Figures 3-5 and3-6 decompose the changes in output and prices
into demand factor and supply factor. In thisanalysis, demand factor refers to the changes in
GDP and GDP deflator caused by the shift of theaggregate demand curve when the aggregate
supply curve remains unchanged from the previous year. Likewise, supply factor refers to thechanges in GDP and GDP deflator caused by theshift of the aggregate supply curve when the aggregate demand curve remains unchanged fromthe previous year.
As a whole, the left diagram in Figure 3-4
and Figures 3-5 and 3-6 indicate that the economic slowdown and price decline since the1990s have taken place in three stages: fiscal
1990-1993, when output and prices were stillrising (the period when the bubble burst); fiscal
1994-1996, when prices started to decline, albeit
very slowly (the disinflation period); and since
fiscal 1997, when prices have declined at a fasterpace while output growth has fallen to almost
zero (the deflation period). The shifts in the aggregate demand and supply curves indicate thatchanges on the supply side played a major role in
the transition from the period when the bubble
burst to the disinflation period. That is, the aggregate demand curve, on average, continued tomove toward the upper right, as in the period
Development Bank of Japan Research Report/ No. 36

21when the bubble burst, but the aggregate supply
curve started to shift toward the lower right as
economic globalization progressed50 and drove
down prices. On the other hand, changes on the
demand side played an important part in thetransition from the disinflation period to the deflation period. Although the aggregate supply
curve, on average, continued to move toward thelower right, as in the disinflation period,51 theaggregate demand curve stopped moving toward
the upper right, as concerns mounted about thefinancial system and future income. Thus, output
recorded only a marginal growth, assisted
slightly from the supply side, and the decline inprices accelerated.
In this context, the shifts of the aggregate
demand and supply curves required to realize theestimates for the forecast period, as well as thecomposition of the changes in output and prices,
have the following characteristics. First, asshown in Figure 3-4, the slope of the aggregate
supply curve has been fairly mild, at least within
the realized values of output in the past. Therefore, the aggregate demand curve must shift toward the upper left if the vision of the Medium-term Outlook of solid economic growthand mild price inflation (a shift of the equilibrium point toward the upper right on the output/price plane) are to be achieved. Althoughreforms on the supply side will also undoubtedly
be required to eliminate households’ concerns
about the future and to materialize potential
consumer needs, the key is the extent to which
demand will actually increase, including the effect of such reforms, and so the various factorsthat affect or are closely related to demand 52
must be monitored carefully. Second, the aggregate supply curve will eventually stop shifting to
the lower right and will then reverse slightly.
This movement represents a reduction in overcapacity and expectation for the elimination of
deflation, and therefore is not inconsistent withthe rise in TFP, which was identified as a neces50

It was also during this period that the so-called “pricedestruction businesses” emerged.
51
The curve temporarily shifted toward the upper left in
fiscal 1997 as the consumption tax rate was raised, but theshift toward the lower right accelerated in fiscal 1998 and1999.
52Such factors include, but are not limited to, money supply, the exchange rate and asset prices.
22

Development Bank of Japan Research Report/ No. 36

sary condition on the supply side. The demandside and the supply side are not totally independent of each other. Any expansion of aggregate demand backed by the improvement in
consumer confidence in households and in corporate profit cannot be realized without changing
the supply structure and halting the downward
slide of the aggregate supply curve. Conversely,
technology and know-how will materialize as
TFP only if they are accompanied by the expansion of aggregate demand.
4.

Number of Workers to Rise Gradually
through Diversified Employment(see p. 54 for Figures)

The population of productive age (15-64) has
already started to fall from the peak of 87.25
million in 1995 and is expected to drop to 81.67
million in 2010 (Population Projection for Japanby the National Institute of Population and Social
Security Research, medium variant for January2002). Our estimates for future employment are
as follows. During the adjustment period, thenumber of employees will stay flat at just over
53 million, and the working population will decline slightly due to the decline in the number ofself-employed and family laborers. In the growth
process from fiscal 2006, the number ofself-employed and family laborers will continue
to decline but the number of employees will start
to rise, thus slightly increasing the total working
population. Although the total working population will still be smaller in fiscal 2010 than therecord level in fiscal 1997, the number of employees will rise to some 5.5 million (Figure 3-7,left).
The number of displaced workers will inevitably rise, as the number of employees will be
restrained largely due to the disposal of
non-performing loans and business reorganization. The unemployment rate will peak at 5.9%
in fiscal 2004-2005, with the jobless population
increasing by 0.5 million from the average of
3.48 million in fiscal 2001 (Figure 3-7, right).53
53
Here, no estimation is made concerning how many
workers will lose their jobs due to the disposal of
non-performing loans, as it is difficult to make any assumptions on the amount of loans to be written off. According to
the estimate of the Cabinet Office in the summer of 2001,

This scenario is only possible conditional on thefollowing assumption: the typical “pain” of unemployment is shared through the expansion ofdiverse job opportunities, as mentioned below,
and work sharing to reduce the average hours
worked. Such changes in employment systems
will greatly support production at the same time,through its favorable impact on consumption, as
discussed in the following section.
Diversified employment patterns mean that
more people, both men and women, work for ashorter time. Our estimation expects that the
number of employees will increase while the average hours worked will decline by more than
1% per year even in the growth process. The decline in labor input in the outlook of potential
GDP corresponds to this idea. The number ofhours worked has already fallen as the five-day
week has become commonplace. With the expected increase in short-time workers, the number of hours worked will fall further, by about
6% on average by fiscal 2010.
As a means of reducing labor cost, employment systems have already become morediverse since around 1997, with the increase incontingent workers.54 This trend is expected tocontinue during the adjustment period. Furthermore, employment is expanding in industries
such as wholesale/retail and services, where
non-career workers account for much of theworkforce. This expansion of the service industry will encourage greater employment diversity.
On the labor side, there is a growing needfor expanding the choice of employment systems
to fit workers’ personalities and abilities. For
women, diversified employment allows work to
be reconciled with childcare and housework. For
men, there is a need for increased involvement in
the family and local communities. Regarding
regular workers, mostly men, demands forthe disposal of ¥1 trillion would increase the number of
unemployed by 10,000 to 15,000. However, the accumulated effect for multiple years may be smaller than the simple aggregate due to reemployment or exits from the labormarket.
54
Here, “contingent workers” comprise those who work fora few hours a day such as part-time workers (close to thedefinition of part-time workers in the Monthly Labor Statistics), workers employed (under contract) for a determined
period of time (including temporary and daily workers in
the Labor Force Survey), and in some cases dispatchedworkers, contract employees and temporary employees.

shorter working hours are increasing, as changes
to the lifelong employment system based onseniority are eroding workers’ traditional preference for long service; more of the education andtraining for employees is now conducted outside
the company as part of self-development.
We assume that women’s labor participation
rate needs to rise in order to achieve the medium-term scenario. The labor participation
rate55 in Japan is similar to that in Europe andthe U.S., but is one of the highest for men among
the developed countries, at 85%. For women, on
the other hand, the rate is 59.6%, which is higher
than in Spain and Korea, but substantially lower
than in the Netherlands, Germany and France(over 60%), as well as in the U.K. and the U.S.
(approximately 70%). Women’s labor participation rate in Japan is known to follow an
M-shaped curve as the rate declines in the lower
30s due to marriage and the concomitant housework, childcare, etc. In order to ensure consistency with the increase in the number of employees assumed in the present estimation, it isnecessary to eliminate the dip in the middle ofthe M curve and to raise women’s labor participation rate to 66% on average by fiscal 2010, if
men’s labor participation rate is to remain at thecurrent level.
The gap between the future vision and thestatus quo is not small. The number of part-timeworkers is increasing, while the number of hours
worked per person has been declining, implying
work-sharing among part-time workers become
more common. However, the treatment ofpart-time workers has not improved even since theenactment of the Part-time Labor Law56. In contrast, the number of hours worked by full-timeworkers has remained almost constant since theeconomy went into recession in October 2000.
Against this backdrop, the government, theJapan Federation of Employers' Associations(“Rengo”) and the Japanese Trade Union Confederation concluded an industrial partner
agreement on work sharingin March 2002. Ulti55
The labor force (work force + unemployed) aged 15-64
divided by the total population, according to OECD, Employment Outlook 2001.
56
The Part-time Labor Law (“Law for Improving the Employment Management of Short-time Workers”), designed
to improve the labor conditions, education/training andwelfare of part-time workers, took effect in December 1993.

Development Bank of Japan Research Report/ No. 36

23mately subject to an independent decision bylabor and employees, the Agreement calls for theelimination of employment insecurity and treatment suited for individual working patterns. In“Employment Policy Agenda and Current Development” (July 2002), the Employment Policy
Study Group of the Ministry of Health, Laborand Welfare provided guidelines for a “society
with diverse choices” in view of labor shifts andchanging employment structure in the future.
These guidelines state that in order to encourage
diversified employment, the current disparity
between full-time and part-time workers in termsof job contents and treatment must be eliminatedto ensure fairness, so that short-term employment
may be selected as a positive form of employment. Non-career forms of employment such as
freelance part-time workers, or “freeter” havealready become popular among the younger generations. In short-time labor, incentives for job
continuation and skill upgrading need to be provided to encourage the development of skilledlabor and improve productivity.
In the adjustment period, the shift of laborto the service sector will accelerate. The change
in employment structure over the past 30 years(Figure 3-8) shows that the work force in theservice sector has been increasing constantly. In
contrast, the work force shrank in the 1990s for
manufacturing. In wholesale/retail, the growth in
the number of workers slowed down after increasing almost in parallel with that of the service sector, followed by contraction in late 2001
mainly due to corporate failures.
The service sector may be characterized as
an aggregate of “miscellaneous” business activities, and has typically expanded by incorporating
various new industries. The job creation plan
presented by the Council of Economic and Fiscal
Policy in May 2001 advocated the creation of 5.3
million jobs in the coming five years, i.e. over 1
million new jobs per year (Figure 3-10). If thisfigure means a net increase, the past growthtrend (see Figure 3-8) will need to be accelerated
significantly. Nonetheless, it seems achievable tocreate jobs for 0.6–0.7 million persons per year
to fiscal 2010. The plan specifically lists personaland family services that will be required in thediverse employment society, including childcare,elderly care and adult education. Thus, jobs need24

Development Bank of Japan Research Report/ No. 36

to be created by commercializing areas that traditionally belong to housework and by creating
new services through deregulation.
Finally, the mobility of labor between industries should be examined. Figure 3-9 shows
the movement of labor in the 12 months to 1997.
Hiring and turnover are both significant in services, wholesale/retail and manufacturing, reflecting the scale of employment in these industries. A majority of those who changed jobs werere-employed in the same industries, but 45% ofthem shifted to other industries: the magnitude of
new hiring and severance in a year suggests thatthe employment structure is changing rathersmoothly. Of course, measures should be taken
to address the destabilization of employment,
because many job leavers will experience hardship in those sectors that are cutting back on employment and the labor shift should boost productivity. Such measures should include theutilization of placement services, dispatched labor and term contracts, as well as the provisionof efficient vocational training opportunities. In
the growth process after the adjustment, it is assumed that the manufacturing sector will improve productivity while reducing the number ofworkers, whereas the non-manufacturing sector
will expand without losing efficiency. However,for this to happen, the conditions mentioned
above must be met.
5.

Consumption to Remain Flat,
Followed by Mild Recovery(see p. 55 for Figures)

As regards consumption, there are two main
points: the extent to which it will prop up the
economy in the adjustment period, and its role in
the renewed growth process. Before examining
the relationship between such economic environment and the present scenario, the following
basic trends in consumption should be noted: (1)Consumption fluctuates very little. (2)Macro-consumption fluctuates due to the influence from the number of consumer units, such as
population and households. The first trend can be
explained by people’s tendency to maintain theirpresent level of consumption. A good example is
the ratchet effect, which smoothes the amount ofconsumption against short-term fluctuations ofincome when there is no change in long-term
income prospects. So far, consumption has increased in line with GDP. The only exception
after the high-growth period happened in fiscal
1997, when consumption recorded a definite decline as the impact of recession was amplified
following the surge in demand just before theconsumption tax hike in the previous year.
The second trend, i.e. the number of consumer units, is shown in Figure 3-11. The National Institute of Population and Social Security
Research (hereafter referred to as IPSS) estimates that the population will reach a peak in
2006, supporting consumption in the adjustment
period. Households are considered to be more
realistic consumer units, and so we forecast statistics at the household level. Here, the numberof households is estimated based on the future
number of households estimated by IPSS
(1998).57 In order to compare the estimated trendof the number of households with that of population, Figure 3-11 calculates a population index
based on the number of households in 1990
(simply multiplied). The data shows that while
the population is increasing very slightly, thenumber of households has increased in recent
years at an annual rate of about 1% and is stillassumed to increase by some 0.3% in 2010. By
type of household, the “others” including
three-generation households will continue to decline and the increase in the number of
two-generation households will slow, whereas
the number of single-member households is expected to continue to grow strongly. Although
the change in structure will lead to a decrease in
the average number of household members, theexistence of the basic, fixed part of consumption
including housing, utility expenses means thatthe increase in the number of households will
57

The household estimate of IPSS is based on the previous
population estimate in 1997. The estimate based on the new
population estimate in 2002 will be published later. The
new population estimate is different from the old one in theassumption of birth rate (with the peak of the medium variant being moved up one year to 2006). Since the number of
those who were born after 1997 and will become household
heads by 2010 is negligible, the main impact on the revision
to the household estimate will be due to the change in theactual part of the transition probability for each type ofhousehold. The present estimation uses the average numberof household members in the 1998 household estimate andthe population estimate at 2002.

contribute to the growth of macro- consumption.58
Despite those long-term factors, the income
and employment situation is expected to worsen
in the adjustment period, as cutbacks on labor
cost will continue. Since the growth of GDP, andtherefore income, will stay near zero, and labor
share will be reduced due to the diversification of
employment, employee remunerations are estimated to decline until fiscal 2006, one year after
the starting point of GDP recovery. As observed
currently, this adjustment will primarily involve
pay cuts. Although the pace of pay reductions
will gradually slow, wages and employment
conditions will not improve until fiscal 2007
(Figure 3-12). Under these difficult conditions,consumption will stagnate but manage to maintain its current level, due to the following factors
in addition to the structural increase in population and the number of households.
The first factor that will support consumption is the rising ratio of elderly retired people.
The public pension scheme, although susceptible
to fluctuations of economic condition due to its
assessment system, now guarantees stable benefits to a wide range of pensioners, as comparedwith the pre-high-growth period. Furthermore,elderly people now hold some 40% of the financial assets of the total population, worth ¥1,400
trillion. With the exception of interest receipts,
the elderly population has almost finished earning money for purchasing. Their consumption is
expected to remain strong, unaffected by theslumping economy and production, particularly
because the real value of the principal rises as
deflation proceeds.
As regards the working generation, wages
per person will decline on average. However,greater employment diversity will heighten job
security, i.e. the possibility for motivated persons
to find some sort of work, which will help main58
The Family Income and Expenditure Survey indicatesthat if consumer spending in the two- to five-member
households in 2000 is regressed to the number of household
members, fixed expenses (segment) account for 59.1% of
the monthly consumption expenditure of a four-member
household. A simple application of this result means that the
split of a four-member household into 2 two-member
households will result in a 60% increase in total consumer
spending. Of course, such simple calculation will not materialize, because consumption is closely related to income.

Development Bank of Japan Research Report/ No. 36

25

tain the current purchasing power. In the future,
this will alleviate the fear of losing one’s income
due to unemployment, i.e. the uncertainty of lifetime income, thus reducing the need to make additional contingency savings. It is therefore important to reduce concerns about the future, particularly regarding the social redistribution system. Uncertainties about the future have alreadylowered the level of consumption, particularly inworker’s households. In the adjustment period,
any revisions to the systems that are disadvantageous to the younger generations under slowed
growth, such as pension, taxation and medical
insurance, will improve the prospects for lifetime
income and thus increase the consumption of theworking generations.
Moreover, if the adjustment is widely recognized as preparation for future growth, people
will have greater confidence in the viability ofthe social security system and receiving net
benefits, in addition to the improved prospects
for income. This will boost consumption further.
Assuming those outcomes, consumption is
expected to show a stronger trend than income,but its growth will only be about 0.2% for fiscal
2003-2005. Partly due to the rising ratio of elderly people, the propensity to consume is expected to rise as a whole, which will support
consumption. A comparison of this increase in
consumption with GDP growth (Figure 3-13)
confirms that the fluctuation of consumption will
be smaller than that of GDP, as noted earlier inthis section.
Following the transition to the growth process, consumption is assumed to grow slightly
faster than GDP, thus leading the whole economy. As the income situation improves, the risein the propensity to consume in worker’s households in the adjustment period will become almost flat, but the propensity as a whole will continue to rise due to the increasing ratio of elderly
people. Nonetheless, financial assets will continue to increase in the household sector, as thesavings-investment balance in the sector will stay
positive, albeit to a lesser degree.
As regards the content of consumption, increases are expected for family services including housework, childcare and elderly care as theservice sector expands. The reduction in the average number of hours worked and the resultant

26

Development Bank of Japan Research Report/ No. 36

increase in leisure time will also stimulate consumption.
The
expected
increaseintime-consuming activities such as movies andtours will be accompanied by the consumption ofclothing and bags. The willingness and opportunities to pay for a wider range of goods and services are also expected to rise as people seek tolearn more about products.
Finally, Figure 3-14 compares real consumption with real housing investment perhousehold. After recording parallel increases in
the high-growth period, housing investment
started cyclical fluctuations with the formation ofa certain level of stock. Since consumption
started to slump in the 1990s, household expenditure has been declining in both terms. Althoughpotential demand for high-quality spacious
housing will hold up, stock is expected to be
mobilized by expansion of the second-handmarket. The present estimation assumes that
housing investment will rise slightly on averagein the long term and that consumer spending,
after a slight drop in the adjustment period, will
eventually pick up as economic growth resumes.
All in all, they are both expected to remain relatively flat.
6. Plant and Equipment Investment to Recover Gradually through Adjustments to Improve Capital Efficiency(see p. 56 for Figures)
The future increase in plant and equipment investment and capital stock depends on the improvement of the slumping return on capital.
The average return on capital stock59 (Figure 3-16) has been declining since the 1980s,
particularly in the early 1990s following the col59

Capital stock is represented by the OECD estimate basedon Cabinet Office, “Gross Capital Stock of Private Enterprises,” etc., and includes public corporations. For convenience, the average return on capital is calculated indirectlyfrom the capital share/capital coefficient (definition: capitalshare = 1 – compensation of employees/national income
represented by factor costs, capital coefficient =GDP/capital stock). As a matter of concept, the average
return on capital represents the ratio of corporate operating
surplus including interest and rent to capital stock, and it
must be noted that the calculation here is far from precise
due to the fact that no adjustments are made for proprietorship income and the imputed rent of owner-occupied houses,etc.

lapse of the bubble economy. Since then, corporations have been switching to investment focused on capital efficiency, and the return on
capital has been barely showing signs of bottoming out since fiscal 1999, at almost half thelevel of fiscal 1980. When we decompose thefluctuation of the return on capital into two factors, capital share (1 – labor share) and capitalcoefficient (inverse of average capital productivity), it is clear that the rapid drop in the return on
capital in the early 1990s was largely due to thechange in capital share. Meanwhile, the capitalcoefficient continued to rise even in the late
1990s when plant and equipment investment
started to be scaled back, thus providing structural downward pressure on the return on capital.
Of course, it is not true that a higher returnon capital is always better, both from a macroeconomic viewpoint and in terms of corporate
management. Essentially, macroe- conomics aim
to maximize economic welfare at any point in
time, whereas corporations seek to maximize
their market value. The return on capital is
automatically determined by the optimal courseof capital accumulation chosen for that purpose.
However, it is evident that the return on capitalin Japan in recent years is not simply the consequence of dynamic optimization. Rather, it isnatural to suppose that the capital coefficient
continued to rise as a result of the unexpected
slump in GDP growth and TFP, and not a resultof any change in technical conditions or factor
prices.
Recently, Japanese companies have been
adopting very strict criteria not only in selecting
new investment projects but also in revising theefficiency of existing stock, such as closing establishments and reorganizing their business.
Such adjustments are inevitable in order to improve the return on capital to a normal level andeliminate the expectation of deflation by giving
the impression that overcapacity is being corrected. It is not easy to determine the normal orappropriate level of the return on capital forachieving the Medium-term Outlook. Our esti-

mation expects that the capital share will be adjusted upward by fiscal 2006 to around 0.3360,
which is assumed to be the equilibrium capitalshare in Section 2. The capital coefficient islikely to peak at 2.5 in fiscal 2002, falling subsequently to just under 2.4, which corresponds tothe level of fiscal 1999. As a result, the return on
capital will regain about half the loss sufferedsince the relatively stable period in the
mid-1980s and reach the level of fiscal 1992-93.
Although this improvement does not seem solarge, it will require substantial adjustments andtemporary negative growth of capital stock fromfiscal 2003 to 2005. This means that the retirement rate for existing capital will peak at 8.5%,
which is twice as high as the current level, andthat plant and equipment investment will bottom
out at just over 13% of GDP (nominal basis),which is 2 points lower than the present level(Figures 3-15 and 3-17).
The improvement in the return on capital,
accompanied by secondary effects including rising stock prices, is expected to lead to anautonomous recovery of plant and equipment
investment. However, firms will continue to focus on capital efficiency, as the absolute return isstill lower than in the mid-1980s and the capitalcoefficient will not increase even after the
economy starts to grow again. Consequently,
assuming a retirement rate of about 5%, which isslightly higher than the current level, plant andequipment investment in fiscal 2010 will only
account for a little less than 15% of GDP (nominal basis), which is still lower than the current
level. However, the fact that the share stands at
about 13% (as of 2000) in the U.S., Germany,
France and the U.K., although the difference inindustrial structure should be taken into consideration, suggests the above-mentioned level is
not considered from a macroeconomic viewpoint
to represent an underinvestment that will impair
the technical capabilities of Japan. Further improvement in the quality of investment is indispensable if Japan is to build a nation based on thecreativity of science and technology.
60
The level of 0.33 corresponds approximately to the average level of the 1980s in Japan. Incidentally, capital shareis considered to be about one third in most countries (seeRomer, D., Advanced Macroeconomics, McGraw-Hill, 1996,
p. 21).

Development Bank of Japan Research Report/ No. 36

27

7.

Net Exports to Increase with Higher
Value-added Export Goods andStrong Economies Overseas(see p. 57 for Figures)This section presents assumptions on Japanese
net exports in light of the trends in the domestic
demand projected thus far. Figure 3-19 shows thetrends in the balance of payments based on thepresent scenario. Exports rose in January-March
2002 as the U.S. economy bottomed out and theeconomic cycle was completed in Asia. Thus, thetrade account surplus is expected to resume its
expansion in fiscal 2002. In July-September
2002, however, the substantial increase in exports in the preceding months stopped as the U.S.
economic recovery faltered, which points to only
a mild growth of exports for the whole of fiscal
2002.
Nonetheless, net exports are expected to
grow strongly in the medium term, particularly to
the U.S. and Asia. The U.S. economy is likely tomaintain just over 3.0% annual growth in realterms (Figure 3-20). A medium-term forecast by
the Congressional Budget Office in August 2002
indicates that the potential growth rate will reach
3.0% for 2002-2012. Although the growth oflabor input in the non-agricultural sector will besmaller than in the 1990s, capital input and TFP
are expected to record increases comparable tothe average level of the 1990s. Thus, the U.S.
economy will maintain 3% growth if the rapid
rise in labor productivity in the latter half of the
1990s can be sustained.
Backed by strong final demand in the U.S.,
Asian economies are also expected to perform
well. Figure 3-21 shows the actual figures andestimates of world imports according to the IMF.
The data indicate faster growth for the developed
countries including Asian NIEs to 2007. Substantial growth is also expected for the developing countries including China and ASEAN
members in 2004-2007.61
The prospect of such strong economic
growth in the U.S. and Asia allays concern about
the demand for Japanese exports, which are ex61

The growth rate for all developing countries is expected
to be 5.8% on average in 2004-2007. Asian countries (excluding NIEs) will experience average annual increases of
6.7% in real GDP, 9.7% in exports and 10.7% in imports.
28

Development Bank of Japan Research Report/ No. 36

pected to increase in 2004-2005 when the U.S.
economy resumes its stable growth of over 3%.
As domestic demand is expected to remain flat inthis period, Japanese economic growth will be
led by net exports, and so the trade surplus is
expected to increase gradually to 2010.
The expansion in the trade surplus, however,assumes that Japanese export goods remaincompetitive. Defining technology-intensive
goods as the goods (industries) for which theratio of R&D to sales is highest, Figure 3-22
shows the trend of imports for each category of
goods classified by this criterion. The data indicate that throughout the 1990s, more technology-intensive goods experienced higher export
growth, implying that high-value added products
such as electronic/communication machinery andscientific/optical instruments led the improvement in export competitiveness. However, suchexport competitiveness is inherently relative, andany transfer of production facilities overseas toimprove manufacturing processes would lead toa decline in the exports of the goods concerned.
A system that allows the creation of more productive goods will be necessary to maintain domestic production of the goods that could leadexports in the medium term.
On the other hand, the balance of income ismostly attributed to the balance related to thereturn on security investment. In addition to thesustained increase in net external assets, continued yen depreciation since 2001 has helped inflate the surplus, resulting in a larger income
balance surplus. Although this trend is expected
to continue, the income balance surplus will notnecessarily grow faster than the trade balance
surplus in the medium term, as the size of theincome balance surplus is susceptible to fluctuations in the foreign exchange rate. The increasein net external assets will be accompanied by acontinued growth of income balance surplus if
there is no major fluctuation in the foreign exchange rate until 2010. In the meantime, Japanese exports, backed by stable economic growthin the U.S. and Asia, will remain strong in themedium term, led by high-value added goods.
Therefore, the current account surplus, particularly the trade account surplus, will continue.

8.

Primary Balance of Public Finance to
Improve Slowly(see p. 58 for Figures)

As described in Section 1-7, public demand, in
terms of public investment (public capital formation) has been falling since peaking in the
mid-1990s. Meanwhile, government consumption (government final consumption expenditure)
has been rising, largely due to increases in social
benefits in kind such as medical expenses as wellas in the consumption of fixed capital (Figure3-23).62
For the period covered by the scenario, thesame assumptions as the premises in the Background Paper are used in principle to avoid any
substantial deterioration of budgetary discipline.
Namely, it is assumed that government expenditure
will be curbed through measures such as the annual reduction of 3% in investment expenses, of¥300 billion in medical expenses through healthinsurance reform, of 0.5% in the number of government employees and of 1% in the cost of supplies. As a result of such curbs on expenditure,public investment will continue to decline. Thus,
government- sector demand will remain neutral
as a whole, despite the growth in government
consumption largely due to the expected increases in expenditure in the education sector aswell as in medical expenses induced by aging.
In light of the current budgetary situation,
public investment will be forced to be curtailed
as planned, as the local governments, which account for 70% of public investment, have steadily cut back on investment expenses by around
10% per annum since fiscal 1999 (Figure 3-24).
Incidentally, public investment will account forless than 4% of GDP by 2010, if the budget cuts
are to be realized as planned.
As regards the budgetary situation, tax reve-62

In the National Accounts, the consideration of medical
services covered by social security funds, net of payments
by individuals, is included in government final consumption
expenditure as benefits in kind.

nues have not been able to cover the general expenditure since fiscal 1998 on a national accountbasis. The budget deficit has been expanding withthe distribution of some ¥20 trillion in central government subsidies to local governments (Figure3-25). The structure of the budget deficit reveals
that local governments receive large subsidies fromthe central government, causing the budget balanceof the central government to deteriorate while suffering from falling tax revenues and the aging-induced increase in social security cost. In particular, tax revenues have been adversely affectedby the decline in nominal terms due to the economic slump and deflation, as well as by the special tax reduction in fiscal 1998 and the permanent
reduction in income and corporate taxes since fiscal
1999.
We will have to wait until economic growthstabilizes in nominal terms, to achieve the budgetbalance by the above-mentioned cuts in government expenditure. Until then, the primary balance will stay at its current level, and so outstanding government debts will continue to increase. However, further deterioration in the
primary balance will be avoided through sustained efforts to reduce government expenditure.
Also, monetary policy will continue to be supported by the market by maintaining the relatively loose market condition to avoid any substantial rise in interest rates. New central government bond issues will peak at some ¥40 trillion, with outstanding government debts accounting for more than 160% of GDP. Thereafter,
the primary balance will slowly improve thanks
to the economic recovery expected from fiscal
2007. In fiscal 2010, the deficit will stand atsome 1.7% of GDP, with moves toward a balanced budget expected from the first half of the2010s.63

63

It is assumed that a tax reduction of about ¥500 billion
per annum on a tax revenue basis will be introduced mainly
for R&D, starting in fiscal 2003. See the Note of Figure
3-25 for other assumptions regarding tax revenues.

Development Bank of Japan Research Report/ No. 36

29

(Appendix 1)
Assumption of Longer Adjustment Period(see p. 59 for Figures)
Structural reform in a deflationary economy, theobjective of the Medium-term Outlook, is a difficult challenge without precedent in Japan or
any other country. As shown in the scenario described above, one of the major conditions forturning around the economy is creating confidence about the future in the household and corporate sectors. However, this is extremely difficult to achieve in practice. Policy-makers should
therefore take precautions against a deflationary
spiral through both fiscal and monetary policies
and the management of government debts, bearing in mind that even if sustained growth of over
1.5% is ultimately achieved, its timing and necessary adjustment process may vary considerably(i.e. downward risk).
Figures 3-26 to 3-28 show the estimation fora case with an adjustment period that is two
years longer than in the above-mentioned basescenario, taking account of possible delays in therecovery of consumer and investor sentimentseven with appropriate macroeconomic management. In this case, the GDP gap ratio is expected
to peak at a higher level than under the economic
slump induced by the yen depreciation, as negative growth will continue for three years fromfiscal 2003 to 2005, thus slowing down the adjustments in industrial structure and intra-industry supply structure designed to ease thedeflationary pressure. Consequently, it may takean extra four years to eliminate the GDP gap andbreak away from deflation.
(Appendix 2)
Economic Outlook and R&D Policies in Asia
(see p. 60 for Figures)kets for Japan.
Assuming that GDP growth from 2005 onward will be 5.0% for Hong Kong, Taiwan andSingapore, 65 7.1% for China 66 and 6.2% forother countries,67 the share of China in the total
GDP will increase gradually due to its higher
growth rate, up from some 40% in 1995 to about
50% in 2005 (Figure 3-29).
A forcast, based on per capita GDP growth68
of 4.2% for Taiwan and Singapore, 7.0% for
China and 5.4% for other countries, indicatesthat China, despite its overwhelming share in the
total GDP, will still have a small per capita GDP
in 2005, comparable to the levels of Indonesia
and the Philippines (Figure 3-30).
The source of such economic growth is innovation of technology. The following part outlines R&D efforts in Asian countries (Table 3-1).
In China, the total amount of R&D is notlarge, as private companies are not yet actively
involved in R&D; R&D accounted for only 1.0%
of GDP in 2000. The 10th Five-Year Plan aims at
raising this ratio to 1.5% by 2005. Relevant R&D
policies include the establishment of Science
Parks such as Zhongguancun in Beijing, active
support for venture businesses, better management of intellectual property rights, the encouragement of foreign affiliates to set up R&D institutions, and the invitation of excellent humanresources from overseas.
In Korea, a Basic Law on Science andTechnology was enacted in line with thelong-term vision on R&D policy adopted in 1999.
The Law provides for technological development
led by the private sector, rather than the traditional government-led efforts, as well as the designation of focus areas including information
technology and biotechnology.

65

Asian economies are expected to show relatively
high growth rates from 2005, thanks largely to
improvements in education, secure law enforcement, high savings rate, sound fiscal policy andopen investment and trade, although someweaknesses may emerge until 2004 mainly due
to economic fluctuations.64 Thus, these economies are expected to become major export mar64

30

World Bank, Global Economic Prospects, p. 190.
Development Bank of Japan Research Report/ No. 36

Calculated as the sum of the expected per capita GDP
growth of 4.2% for the Non-OECD High Income Countries
and the average expected population growth of 0.8% forEast Asia and the Pacific.
66
Although the growth rate will be 6-7% according to theWorld Bank, Global Economic Prospects, this report adopts
the figure of 7.1%, taking account of the objective stipulated
in China’s 10th Five-Year Plan.
67
Average for East Asia and the Pacific excluding the
Non-OECD High Income Countries.
68
World Bank, Global Economic Prospects, p. 190. The
growth rate for China takes account of the target of 0.9% for
population growth stipulated in the 10th Five-Year Plan.

In Taiwan, as the transfer of production facilities to China has become a major issue,“Challenge 2008” program was adopted in May
2002 to address the problem. The program incorporates a plan to develop Taiwan as an international hub for R&D, with the objective of
raising the share of R&D in GDP to 3%. 69
Plicies measures include extension of
low-interest loans for R&D amounting to NT$50
billion, the establishment of R&D centers and theinvitation of international human resources for
R&D. IC systems, biotechnology andnano-technology have been identified as key focus areas.
In Singapore, the “Industry 21 Plan”
adopted in 1999 intended to turn the country intoa hub of knowledge-intensive industries. The
plan identified eight focus areas including electronics, communications/media and biomedical.70
The five-year Science and Technology Program
prepared in 2002 sets out policies such as concentration on niche areas, the encouragement of
R&D in the private sector, the establishment ofan effective system for technology transfer, andthe management of intellectual property rights,
as well as the overseas recruitment and domestic
development of talented human resources.
As described above, electronics and biotechnology are common focus areas for R&D
policies in China and other major Asian economies. The introduction of foreign capital andhuman resources from overseas are also common
policy measures.
(Appendix 3)
Recovery from Economic Crisis in Korea:
Structural Reform and Increased Exports(see p. 61 for Figures)This and the following section take the cases of
Korea and Sweden as examples of recovery froman economic crisis.
Korea was hit by an economic crisis in 1997,
which resulted in negative economic growth in1998 (Figure 3-31). The economic crisis in
Thailand raised concerns about the high debt ra-

tios of Korean companies depending on
short-term foreign funds, thus triggering theflight of overseas capital.71 The sound conditionof government finance in Korea at that time wasin stark contrast to the situation in Latin America,
where government debt crises have led to economic crises (Figure 3-32).
The Korean economy recovered rapidly in
1999, with GDP growth exceeding 10%. Internal
factors behind this recovery include the conglomerate (chaebol) and financial reforms carried out under IMF programs.
In the framework of the conglomerate reform, the Korean government required major
chaebol to reduce their debt ratios, which caused
the economic crisis, to at least 200%. It also required companies in financial difficulty to submita reconstruction plan, which were then forced outof business when reconstruction was deemed
impossible. As a result, many firms were obliged
to break up or sell themselves. Thus, the Daewoo
conglomerate was forced into bankruptcy, while
separate companies were spun off from theHyundai conglomerate. Foreign capital was also
introduced in the process of the chaebol reform:
Samsung Motors and Daewoo Motors were soldto Renault and GM respectively. Following thisintroduction of foreign capital, the inflow of foreign direct investment has been exceeding theoutflow in the balance of payments since 1998
(Figure 3-33).
As regards financial reform, 150 trillion
won (¥15 trillion), which amounts to 25% ofGDP, was injected from government funds toconsolidate financial institutions. As a result, thenon-performing loan ratio dropped rapidly after
reaching 8.3% in 1999 to 2.5% in March 2002
(Figure 3-34).
In addition to those internal factors, external
factors also played an important role. As a resultof the economic crisis, the Korean won depreciated substantially from 900 won/$ to 1,700
won/$. The effective exchange rate also fell by
about 40%, helping improve the export competitiveness of Korean products (Figure 3-35). Korean exports, generally led by electric machineryand electronics, also expanded due to factors on

69

The share stood at 2.1% in 1999.
Pharmaceuticals led the increase in production in thesummer of 2002, which was pointed out an early result of
encouraging the biomedical industry.

70

71

The movement of short-term funds appears in “otherinvestment” in the balance of payments (Figure 3-33).
Development Bank of Japan Research Report/ No. 36

31the demand side including the IT boom in the
U.S. and other economies. A breakdown of GDP
into components (Figure 3-31) indicates that exports continued to make a positive contribution
even in 1998, when Korea experienced a negative growth, offsetting the declines in components such as private consumption and fixed
capital formation, also helped by the decrease inimports.72 Such support from net exports eased
the shock of the economic crisis and the subsequent structural reform, and facilitated a smoothtransition to economic growth led by domestic
demand.
As a result of the structural reform in thisperiod, private demand remained strong despite
the collapse of the IT bubble in the U.S. startingin the second half of 2000,73 which helped tomaintain the positive growth of the Korean
economy.
(Appendix 4) Prompt Response to Bursting of
Bubble in Sweden (see p. 62 for Figures)
The Swedish economy has been recoveringsmoothly since the early 1990s, when it experienced a serious economic slump and financial
crisis following the bursting of the bubble
economy. This segment describes the background of this economic recovery, which provides insights into the current Japanese economy.74
In the latter half of the 1980s, the Swedish
economy experienced an asset price bubble,
namely share prices rising rapidly along with realestate prices, mainly for commercial properties(Figure 3-36). Share prices and real estate prices
peaked in 1989 and 1990 respectively, followed72
Due to such trends in exports and imports, the “tradebalance” in the balance of payments turned to a substantial
surplus in 1998 (Figure 3-33).
73
As regards the recent trend of consumption in Korea,
however, there have recently been concerns about signs ofoverheating, such as the increase in outstanding credit carddebts and the rapid rise in real estate prices.
74
The description about Sweden is based on OECD, Economic Surveys: Sweden. Sweden has a GDP of aroundSKr2.1 trillion (Skr1=$0.1) and a population of about 8.9
million. According to Adema, W. (2001), Net Social Expenditure (2nd Edition), net government expenditure forsocial security accounted for 31% of GDP based on theOECD standard, which is substantially higher than the levelof Japan and the U.S. (about 15%).

32

Development Bank of Japan Research Report/ No. 36

by sharp declines of 40% and 60%. As asset
prices skyrocketed, the banking sector’s credit to
the private sector as a percentage of GDP rosefrom 40% in 1985 to 56% in 1990, but it plummeted after the bubble burst to 35% in 1995
(Figure 3-37). Meanwhile, the financial crisis
continued until two of the four major banks were
nationalized. Measures for stabilizing the financial system were led by the government, with theinjection of public funds amounting to over 4%of GDP.75
The financial crisis in Sweden was triggeredin the autumn of 1990 by the failure of Nuckeln,a major non bank credit company. In response,
efforts were made to clean up the aftermath of
the bubble, with the government in 1991 increasing the capitalization of Nord Bank, thesecond largest in the country. In the spring of
1992, policy scope still stayed within the framework of traditional economic stimulus packages,
including supplementary budgets incorporating
increased public investment.
In mid-1992, however, the financial crisis
suddenly reached a critical stage, as a full-scale
bailout of Nord Bank became necessary. The
government committed itself to full protection ofdeposits and settlement accounts in September
by announcing measures to grant government
guarantees to banks. As a specific measure, thegovernment purchased all Nord Bank shares held
privately, then injected capital. Some of the
non-performing loans of the Bank were transferred to a newly established special debt recovery bank. Government guarantees were also provided for the financing of the debt recovery bank.
In December of the same year, the fourth-ranked
Gotha Bank was also nationalized, followed by asimilar transfer of non-performing loans a year
later. The other major banks that were not subjected to nationalization adopted the same approach, setting up special recovery banks andtransferring non-performing loans. Each recovery bank proceeded with corporate renewal using
active measures including M&A.76
75
The four major banks accounted for almost 80% of total
assets in Sweden.
76
Nord Bank acquired Gotha Bank in 1993. The disposalof shares held by the government in 1995 amounted to
Skr67 billion, which nearly equaled the amount of government funds injected into the two banks at that time. The
measures to deal with the financial crisis were entirely liftedA monetary crisis erupted in September
1992, leading to the floating of the Swedishkrona in November. Subsequently, the real effective exchange rate fell 24% on average between
1992 and 1993, which led to a rapid recovery ofexports (Figure 3-38). The recovery was particularly significant in the materials industries supported by price competitiveness, such as
wood/wood products, paper/pulp and iron/steel.
The expansion of domestic demand through increased plant and equipment investment in thoseindustries was accompanied by increases in exports led by automobiles and electronic/opticalequipment as the world economy started to recover. This recovery in the manufacturing sector
pulled the whole economy out of the crisis, fueling domestic demand including private consumption in the late 1990s (Figure 3-39). In thesame period, investment in R&D (research anddevelopment) became active particularly in electronic equipment and pharmaceuticals. Thus,
Sweden has remained top among OECD members in terms of R&D investment.77
During the economic crisis, private consumption fell from the previous year both in1992 and 1993, while the savings ratio in thehousehold sector rose substantially from nearzero in 1990 to over 10% in 1993 and 1994
(Figure 3-40). Since 1995, however, private
consumption has recovered significantly despite
the persistently high unemployment rate, resulting in a constant decline in the household savings
ratio. Although the deteriorating budget situation
had a non-negligible impact on the financial
market at one time as institutional investors rebelled against the absorption of government
bonds, the financial reconstruction measures announced in 1994 as a necessary condition foraccession to the EU have started to bear fruit(Figure 3-41). By 1998, the primary balance improved by as much as over 12% of GDP on a
cumulative basis.78 Price inflation was also stable during the financial reconstruction, thus contributing to the recovery of consumption in thehousehold sector from the financial as well asmonetary aspects.79
In a relatively small economy like Sweden,
the business cycle tends to be more dominant
than in Japan. However, the process of overcoming an economic crisis may be characterized
by a recovery in exports thanks to a falling exchange rate, as well as by a recovery in consumption following financial consolidation andflexible fiscal policies.

78

in July 1996, and the government guarantees were terminated after almost four years.
77
Sweden tops the OECD members in R&D as a percentage of GDP.

A multi-faceted systematic reform package was introduced for financial reconstruction, including the increase ofworker’s share in medical insurance premiums, the reduction of old-age pension benefits, temporary reduction ofincome tax and cutbacks on investment in the constructionof roads and railways.
79
The Central Bank of Sweden introduced an inflation
target of 2±1% for consumer prices in 1993 to enable
flexible fiscal policies through the short-term financial
market. Perotti (1999), “Fiscal Policy in Good Times andBad,” Quarterly Journal of Economics, 114, pp. 1399-1436
uses data for 19 OECD member countries to demonstratethat the reduction in budgetary expenditure under a financial
crisis supports private consumption when liquidity constraints are not significant.
Development Bank of Japan Research Report/ No. 36

33

34

Development Bank of Japan Research Report/ No. 36

I. Global Economy Showing Signs of Slowdown
U.S. (1): Personal Consumption Propped Up by Automobiles but Decline Continuing in
Plant and Equipment Investment
Figure 1-1. Trends in Real GDP(annualized change on previous year, %)12

Personal consumption
Residential investment
Government consumption
GDP growth rate (annualized change on previous year)

8

Residential investment
Net exports
Non residential investment

4
0
-4
-8
91

92

93

94

95

96

97

98

99

00

01
02
(CY quarterly basis)

Source : U.S. Department of Commerce, “National Income and Product Account.”

Figure 1-2. Personal Consumption Trends(1985=100)(annualized change on previous year, %)
5

160

4

140

3

120

2

100

1

80

0

60

-1

40
Consumption propensity factor
Personal consumption (annualized change on previous year)

-2
-3
91

92

93

94

95

96

Disposable income factor
Consumer confidence index (right scale)

97

98

99

00

Sources : U.S. Department of Commerce, “Personal Income and Outlays;” The Conference Board data.

20
0

01

02

(CY quarterly basis)

Figure 1-3. Trends in Real Plant and Equipment Investment and Corporate Profits
6(annualized change on previous year, %)(annualized change on previous year, %)Corporate profits (right scale)

25
20

4

15
10

2

5
0

0

-5

-2

-10
IT-related (hardware)
Buildings
Overall plant and equipment investment

-4
-6
91

92

93

94

95

96

IT related (software)
Others

-15
-20
-25

97

98

99

Corporate profits, with inventry valuation and capital consumption adjustments,
represent nominal seasonally adjusted annualized change from the previous quarter.
Source : U.S. Department of Commerce, “National Income and Product Account.”
Note :− 35 −00

01

02(CY quarterly basis)

U.S. (2): Recovery in Production at a Standstill as Difficult Employment Situation Continues

Figure 1-4. Industrial Production Growth (seasonally adjusted)(%)
100(change from previous quarter, %)

4

95

2

90

0

85
-2

80

-4

75

-6

70
91

92

93

94

95

96

97

98

99

00

01
02
(CY quarterly basis)

Manufacturing capacity utilization (right scale)
Final goods
Consumer goods
Equipment

Source :FRB, “Industrial Production and Capacity Utilization.”

Figure 1-5. Quarterly Changes in Number of Employees and Unemployment Rate(seasonally adjusted, 10,000 persons)

150

(%)

8

Changes in the number of employees

100

7

50

6

0
5

-50
-100

Manufacturing

Services, etc.

Mining/construction

Government

4
Unemployment rate (right scale)
3

-150
91

92

93

94

95

96

97

98

99

00

01

(CY quarterly basis)

Note : The number of employees represents monthly average for the non-agricultural sector.
Source :U.S. Department of Labor, “Employment Situation.”

Figure 1-6. Stock Market Indexes

Figure 1-7. Long- and Short-term Interest Rates(points)

($)

6000

7

5000

6

10000

4000

5

9000

3000

4

12000
Dow Jones Industrial

11000

8000
7000

Nasdaq Composite Index (right scale)

6000

02

2000

3

1000

2

0

1

00/1 00/5 00/9 01/1 01/5 01/9 02/1 02/5 02/9

(%)

00/1

Sources : Dow Jones; DRI.

FF target
rate

00/5

10-yeargovernment bonds

00/9

01/1

01/5

01/9

Sources : FRB data; Wall Street Journal.

− 36 −

02/1

02/5

02/9

Economies of Major European Countries (Germany, France, U.K.):
Uncertainties about Recovery Prospects
Figure 1-8. Real GDP of Major European Countries(annualized change from previous quarter by component)(%)(1) Germany

10
▲1.2

5

1.1 0.6 1.1

0-5(CY quarterly basis)

-10
96

97

(%)

98

99

00

01

02

(2) France

10▲2.0 2.4 1.7

5

0.9

0
-5

(CY quarterly basis)

-10
96

(%)
10

97

98

99

00

01

02

(3) U.K.

2.5

0.9 0.5

5

3.3

0
-5
-10

Private consumption
Fixed capital formation
GDP

Government consumption
Exports

Inventories
Imports (reverse sign)(CY quarterly basis)

Sources : Statistisches Budesamt (StBA), Direction Générale de l’Institut National de la Statistique et des Etudes Economiques (INSEE) andU.K. Central Statistical Office data.

Figure 1-9. Industrial Production Index in Major
European Countries(annualized change from previous quarter)

(%)
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12
96

Figure 1-10. Trend of Unemployment Rate
12
10
8
6
4

(%)

96

97

98

99

Germany

98

01
02(monthly basis)

FranceU.K.

Figure 1-11. Consumer Prices and Financial
Policy in Euro Area

Germany
FranceU.K.
9700(CY quarterly basis)
99

00

01

02

(change on previous year, %)6
4

2
1. Based on seasonally adjusted values.
2. Based on the ILO standard values for international comparisons 0of unemployment.
-2
3. The German consumer price index excludes fuels.
96
Sources: StBA, INSEE, U.K. Central Statistical Office, Eurostat andEuropean Central Bank data.
Notes :

− 37 −(monthly basis)

97

98

99

00

01

ECB intervention rate
Consumer price index (euro area)
Consumer price index (euro area, core)Consumer price index (Germany)02

Major Asian Economies: Recovery Continuing but Concerns about a Slowdown
Figure 1-12. Real GDP Growth Rate
20
15
10
5
0
-5
-10
-15
-20
-25

Korea

(%)

12
10
8
6
4
2
0
-2
-4
-6
-8

6.3

(CY quarterly basis)

98

99

00

01

Taiwan(%)

Singapore

(%)

10
4.1

3.7

5
0
-5
-10
-15

(CY quarterly basis)

98

02

15

99

(CY quarterly basis)

-20

00

01

98

02

韓国

Fixed capital formation
Net exports

Private consumption
Change in inventories

99

00

01

02

Government consumption
GDP

Figure 1-13. Exports and Imports
Korea

Taiwan($100 million)(%)

Singapore(%)($100 million)($100 million)

(%)

60

30

40

40

20

40

20

20

20

10

20

0

0

0

0

0

0

-40

-20

-20

-20

-10

-20

-40

-40

-40

-20

60

60

80

40

40

120

-80
(CY quarterly basis)

-60

-120
98

99

00

01

(CY quarterly basis)

-60

02

98

Trade balance

99

00

01

Export growth (right scale)Figure 1-14. Price Inflation
10

-60

-40
(CY quarterly basis)

-30
98

02

60

99

00

01

-60

02

Import growth (right scale)Figure 1-15. Unemployment Rate
(%)

(%)

9
Korea

8

TaiwanSingapore

6

8

Korea

7

Singapore

Taiwan

6
5

4

4

2

3

0

2
1

-2
98

99

00

01

02
(CY quarterly basis)

Notes :

98

1. Exports for Singapore in Figure 1-13 represent net exports.
2. Growth rates represent year-on-year.
Sources : National statistics.

− 38 −

99

00

01

02
(CY quarterly basis)

China: Strong Growth and Increased Risks
Figure 1-16. Real GDP Growth12

Figure 1-17. Investment Completed,Direct Investment Inflows(trillion yuan)

(%)

(%)

4

10

8.1

8
6
4
2
0
-2

Fixed capital formation
Government consumption
Net exports

-4
-6

3

30

2

20

1

10

0

0

-1

Household consumption
Changes in inventories
Growth rate

-10
Investment completed
Foreign capital actually used
Growth of investment completed (right scale)
Growth of foreign capital (right scale)

-2

-8

-3

Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ
02
01
01
02

95 96 97 98 99 00 01

95 96 97 98 99 00 01

(%)

40
30

2.0

20

1.5

10

1.0

0

0.5

-10

0.0

-20
-30

-0.5
99

00 01

Capital construction
Real estate development
Growth of capital construction (right scale)
Growth of innovation (right scale)

Ⅱ

Ⅲ Ⅳ

Ⅰ Ⅱ
02

450
400
350
300
250
200
150
100
50
0
-50
95 96 97 98 99 00 01
Trade balance
Import growth (right scale)

(%)

4

40

3

30

2

20

1

10

0

0

Ⅲ

95 96 97 98 99 00 01

Innovation
Other investment
Growth of innovation (right scale)

AmountFigure 1-20. Exports and Imports(trillion yuan)-30

Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ
01
02(trillion yuan)

2.5

Ⅰ
01

-20

Figure 1-19. Retail Sales of Consumer Goods

Figure 1-18. Composition of Investment
Completed(trillion yuan)
3.040

Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ
01
02Change on previous year (right scale)Figure 1-21. Price Indexes
(%)

45
40
35
30
25
20
15
10
5
0
-5

12
10
8
6
4
2
0
-2
-4
-6

Ⅰ Ⅱ Ⅲ Ⅳ Ⅰ Ⅱ Ⅲ
01
02

(%)

95 96 97 98 99 00 01

Export growth (right scale)Notes :

Ⅱ Ⅲ
Ⅲ Ⅳ
Ⅳ Ⅰ
Ⅰ 02
ⅡⅢ
Ⅲ
Ⅱ
Ⅱ
Ⅰ 01
01

02

Retail price index

Raw Materials price index

Ex-factory prices index of industrial
products

Consumer price index

1. Data on the value added of industrial production covers state-owned enterprises and non-state owned enterprises of acertain scale. The growth rate is in real terms. The amount of value added is not available for 1995-1998.
2. Savings represent the Saving Deposit in the International Financial Statistics.
3. The growth rate represents change on the previous year.
Sources : IMF, "International Financial Statistics", China Statistical Yearbook, China Monthly Economic Indicators and People’s
Bank of China data.

− 39 −

II. Japanese Economy: Slower Improvement

Overview: Production Rising, but Concerns about Leveling Off
Figure 2-1. Trends in Real GDP (Year-on-year change by component)
(%)
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
90

91/2

97/5

93/10

00/10

99/1

Year-on-year change in GDP

Exports
Government consumption
Inventory investment
Private consumption
Plant and equipment
Public investment
Imports (reverse sign)

Housing investment(CY quarterly basis)

91

92

93

94

95

96

97

98

99

00

01

02

Note : 1995 as base year. Government consumption includes the contribution of public inventories.
Source : Cabinet Office, “National Accounts.”

Figure 2-2. Trends in Production Indicators (Seasonally adjusted)
120

97/5

93/10

91/2

115

99/1

00/10

Industrial production index(1995=100, weight: 22.4%)

110
105
100
95
90
85

Tertiary industry activity index(1995=100, weight: 59.5%)80Construction activity index(1995=100, weight: 8.1%)

75
90

91

92

93

94

95

96

97

98

99

00

01

02

(CY quarterly basis)
1. Weights represent shares in all-industry activity index (GDP from the supply side) and add up to 100 in sum with the agriculture,
forestry and fishery production index (weight: 1.8%) and public service activity index (8.2%).
2. The industrial production figures for October-December 2002 are a combination of actual results for October and forecasts for
November and December based on the Survey of Manufacturing Production Forecast.
Source : Ministry of Economy, Trade and Industry.
Notes :

− 40 −

Inventory Cycle Entering a Buildup Phase10
02/7-9(△10.1,4.1)

500/10-120-5Concept

97/4-6

Change in shipments on
previous year (%)

Change in shipments on previous year (%)

Figure 2-3. Inventory Cycle (total of mining andmanufacturing sector)

01/1-3

99/1-3

02/4-6

01/4-6-10

01/7-902/1-345-degree

Buildup

Unintended
accumulation
Recovery

Adjustment

01/10-12

-15
-15

-10

-5

0

5

10

Change in inventories on previous year (%)

Change in inventories on previous year (%)

15

Figure 2-5. Inventory Cycle ofConstruction Goods

00/10-12

10

97/4-6

5

01/1-3
01/4-6

0

02/7-9(△14.6,△3.6)-5-10

99/1-3-15

01/7-902/4-6-20

01/10-12

02/1-3

-25
-20

-15

-10

-5

0

5

Change in shipments on previous year (%)

Change in shipments on previous year (%)

Figure 2-4. Inventory Cycle of Capital Goods(excluding transport equipment)

5

10

00/10-12

0

02/7-9(△11.6,△2.9)
01/4-601/10-12-5
02/4-6
99/1-3

-10

15

-15

-10

97/4-6
99/1-300/10-12
01/1-3
01/4-6
01/7-902/1-3

Change in shipments on previous year (%)

Change in shipments on previous year (%)

02/7-9(△8.3,0.3)

02/4-615-501/10-12

0

5

10
5
0

00/10-12

97/4-6

02/4-6
99/1-3

01/1-3-5

01/4-6
02/1-3-15

5

10

02/7-9(△10.3,10.1)

01/10-12

-20

-10

0

-10

-10
-15

-5

Figure 2-7. Inventory Cycle ofProducer Goods

10-501/7-9Change in inventories on previous year (%)

Figure 2-6. Inventory Cycle ofConsumer Goods

002/1-3-15

Change in inventories on previous year (%)

5

01/1-3
97/4-6

10

Change in inventories on previous year (%)
Source : Ministry of Economy, Trade and Industry, “Industrial Index.”− 41 −-15-10

01/7-9

-5
0
5
10
15
Change in inventories on previous year (%)

Weak Recovery in Job Offers as Employment Conditions Remain Difficult
Figure 2-8. Trends in Ratio of Job Offers to
Applicants and Unemployment Rate
0.9

(times)Figure 2-9. Unemployment Rate by Age Group(%)
Ratio of job offers to applicants
Unemployment rate (right scale)

0.8

(%)

5.5
5.0

25-34

0.7

4.5

8

0.6

4.0

6

0.5

3.5

0.4

3.0
(CY quarterly basis)

0.3

2.5

96

97

98

99

00

01

02

15-24

10

55-64
35-44

4

45-54
65-

2
(CY quarterly basis)0

Note :
Seasonally adjusted.
Sources : Ministry of Public Management, Home Affairs, Posts
and Telecommunications, “Labour Force Survey;”
Ministry of Health, Labour and Welfare, “Statistics on
Placement Activities.”

95

96

97

98

99

00

01

02

Note :
Seasonally adjusted.
Source : Ministry of Public Management, Home Affairs, Posts
and Telecommunications, “Labour Force Survey.

Figure 2-10. Trend of Year-on-Year Change in Number of Workers and Employees by Component(1) By industry
150(2) By status(10,000 persons)

150

100

100

50

50

0

0

-50

-50

-100

-100

(CY quarterly basis)

-150
96

97

98

99

00

Construction
Wholesale/retail and restaurants
Services
Total

01(10,000 persons)(CY quarterly basis)

-150

02

96

Manufacturing
Transport/communications
Others

97

00

01

02

Employees (regular)

Employees (temporary and daily)

Total number of workers

Figure 2-11. Overtime Hours(seasonally adjusted)(10,000 persons)110

500 employees or over
30-499 employees
1-29 employees
Total

50

99

Self-employed and family workers(3) By size of corporation (excluding
agriculture, forestry, fisheries and government)

100

98

(index, 2000=100)
All industries
Manufacturing

105
100
95

0

90

-50

85
(CY quarterly basis)(CY quarterly basis)

-100
96

97

98

99

00

00

80
95

02

96

97

98

99

00

01

02

Source : Ministry of Health, Labour and Welfare, “Monthly
Labour Survey.”

Source : Ministry of Public Management, Home Affairs, Posts
and Telecommunications, “Labour Force Survey.”− 42 −

Earnings Decreasing, Resulting in Worsening Consumer Confidence
Figure 2-12. Year-on-Year Change in Wages andSalaries per Person
4(%)

Figure 2-13. Spring Wage Increases and Change
in Bonuses on Previous Year
(%)

4

2.83

3

3

2.86

2.90

2.66

2.21

2

2.06

2.01

1.66

1

2

0
-1

1

-2
-3

0

-4

-1

Summer bonus
Year-end bonus
Spring wage increases

-5
-6

-2
-3
-4
95

96

97

98

95
Notes :(CY quarterly basis)
99

00

01

02

Figure 2-14. Consumption on GDP Basis(%)(￥trillion)

96

97

98

99

00

01

02

1.

Summer bonus and year-end bonus include wages and salaries paid assuch in June-August and November-January respectively in businessestablishments with five or more employees.
2. Spring wage increases cover listed companies with trade unions
employing 1,000 or more workers and capitalized at ￥2 billion orover.
Source : Ministry of Health, Labour and Welfare, “Monthly Labour Statistics” and“Spring Wage Increase Requests and Settlement Conditions for Major
Private Corporations.”

Note : Business establishments with five or more employees.
Source : Ministry of Health, Labour and Welfare, “Monthly Labour
Force Survey.”

Figure 2-15. Real Household Consumption
Expenditure
330

108

2

320

106

0

310

-2

300

-4

290

-6

280

4

(FY)

-7

Bonus and special earnings
Overtime pay
Regular wages and salaries
Total wages and salaries(2000=100)

All households
Worker’s households

104
102
100

Real private final consumption
expenditure
Change on previous year

-8

270
260

-10
96

97

98

99

00

01

96
96

02

(CY quarterly basis)
1. Seasonally adjusted annual rate.
2. Data since January-March 2000 are calculated with the newquick estimate method. Growth rates for the periods prior
to the change in calculation method are on a confirmed
information basis. The levels of consumption are calculated
retrogressively from the growth rates.
Source : Cabinet Office, “National Accounts,” second QE for JulySeptember 2002.
Notes :

98

97

98

99

00

01

02

(CY quarterly basis)
Notes :

1. Moving average of the consumption level index with two
preceding periods.
2. The consumption level index is obtained from the monthly
consumption expenditure per household, which is converted
into the amount of consumption for a four-member householdin 30.4 days (365 days/12 months). This amount is thentranslated into an index based on the average for 2000, andfinally divided by the consumer price index for conversion into
real terms. Seasonal adjustment is based on the Census Bureau
method II (X-11).
Source : Ministry of Public Management, Home Affairs, Posts and Telecommunications, “Family Income and Expenditure Survey.”− 43 −

Car Sales Flat as Consumer Confidence Deteriorates Further

Figure 2-16. Retail Sales Index(seasonally adjusted)

Figure 2-17. New Car Registrations(seasonally adjusted)
400

130(96/1Q=100)

125

97/1Q

380

02/3Q

360

Householdmachines/appliances

120(annual rate, 10,000 vehicles)

340

00/2Q

320

115

300

110

280

105

260
96

100

Retailindustry95

99/4Q(CY quarterly basis)

98/1Q
97

98

99

00

01

02

Note : Passenger cars including mini automobiles.
Source : Japan Automobile Dealers Association data.

Automobiles

90

Figure 2-18. Tourism Sales(change on previous year, %)

85
20
10
0
75
-10
(CY quarterly basis)
70
-20
-30
96
97
98
99
00
01
02
Note : Retail sales index except for total represents the average -40-50
of published seasonally adjusted figures weighted-60
by the salesof each industry.
80

Textiles, clothing, personal
items, foods and beverages

Source : Ministry of Economy, Trade and Industry, “Report of
the Current Survey of Commerce.”

Overseas tours
Internal tours(CY quarterly basis)

96

97

98

99

00

01

02

Source : Ministry of Land, Infrastructure and Transport,“Tourism Sales of 50 Major Tourist Agencies.”

Figure 2-19. Consumer Confidence Indicators(1) Quarterly change in consumer confidence index(seasonally adjusted)(2) Other Confidence Indexes

(%)
5

160

Overall livelihood

Income growth

Price inflation

Willingness to buy durable goods

Employment

Consumer confidence index

3

Living Insecurity
Index

140
120

Nikkei Consumption
Forecast Index

100

1

80
60

-1

96
-3

97

98

99

00

01

02

(CY quarterly basis)(CY quarterly basis)

-5

97

98

99

00

01

02

− 44 −

Note :

Consumer confidence index is based on surveys for the
coming six months. Figures for individual components
were redistributed from seasonally adjusted data.
Sources : Cabinet Office, “Consumer Confidence Survey;” Japan
Research Institute, “Consumer Sentiment Index;” Nikkei
Industrial Consumption Research Institute data.

Plant and Equipment Investment: Bottoming Out
but Recovery Expected to be Weak
Figure 2-20. Year-on-Year Change in Plant and Equipment Investment and Return on
Investment (corporations of all sizes)
Non-manufacturing

Manufacturing
(%)

97/5

99/1

(%)

(%)

00/10

30

15

97/5

30

20

99/1

00/10

(%)
6

20

5

10

4

0

3

-10

2

-20

1

10
10

0

5

-10
0
-20

-5

-30
95

96

97

98

99

00

-30

01
02
(CY quarterly basis)

095

Sources :

97

98

99

00

01

02

(CY quarterly basis)

Year-on-year change in plant and
設備投資前年同期比equipment investment

Notes :

96

Return on investment (right scale)
投資採算(右目盛)

1. Plant and equipment investment excludes software.
2. Return on investment = operating asset-profit rate – average contracted interest rates of banks(new loans, total), where operating asset-profit rate = operating profit/(tangible fixed assets + inventories).
3. No adjustments are made for changes in the accounting rule on business tax (ministerial order revisedin December 1998).
Ministry of Finance, “Quarterly Report of Statistical Survey of Incorporated Enterprises,” etc.

Figure 2-21. Orders Received for Machinery(trend of year-on-year change by industry)(%)

Manufacturing

40

40

30

30

20

20

10

10

0

0

-10

-10
OthersIron/steel
Chemicals
Automobiles
General machinery
Electric machinery
Manufacturing

-20

-30

Non-manufacturing(excluding ships and electric power)

(%)

-20

OthersReal estate
Construction
Wholesale/retail
Finance/insurance
Telecommunications
Non-manufacturing (excluding ships and electric power)

-30
-40

-40
95

96

97

98

99

00

01

95

02

(CY quarterly basis)

Cabinet Office estimate for October-December 2002.
Note :
Source : Cabinet Office, “Orders Received for Machinery.”− 45 −

96

97

98

99

00

01
02
(CY quarterly basis)

Residential Investment Decreasing Slowly
Figure 2-22. Trend of Housing Starts(seasonally adjusted annual rate)(10,000 units)

(%)
30

180
150

Owner-occupied houses

Housing for rent

Company’s houses

Housing for sale

10

90

0

60

-10

30

(CY quarterly basis)

0
97

98

99

00

01

-30

02

95

Source :Ministry of Land, Infrastructure and Transport,“Building Construction Started.”

96

97

98

99

00

01

02

Source : Ministry of Land, Infrastructure and Transport,“Building Construction Started.”

Figure 2-24. Floor Area of Housing Starts(trend of year-on-year change by component)
30

Housing for rent
Housing for sale-20

(CY quarterly basis)
96

Owner-occupied houses
Company’s houses
Total

20

120

95

Figure 2-23. Housing Starts(trend of year-on-year change bycomponent)

Figure 2-25. Real Residnetial Investment(seasonally adjusted annual rate)( trillion yen)

(%)

30

20

Owner-occupied houses

Housing for rent

Company’s houses

Housing for sale

Total

25

10
0

20

-10
15
-20
(CY quarterly basis)-30(CY quarterly basis)

10
95

96

97

98

99

00

01

02

95

Source : Ministry of Land, Infrastructure and Transport,“Building Construction Started.”

98

99

00

01

02

Figure 2-27. Contract Rate and Stock of
Condominiums (Kinki area)(%)
100

Term-end stock
Contract rate (right scale)

100

97

Source : Cabinet Office, “National Accounts.”

Figure 2-26. Contract Rate and Stock of
Condominiums (Tokyo metropolitan area)(100 units)
120

96

90

(100 units)
80

Term-end stock
Contract rate (right scale)

70

(%)
100
90

60
80

80

60

70

40

60

80

50
40

70

30

60

20
50

20
(CY quarterly basis)

40

0
96

97

98

99

00

01

02

50

10

(CY quarterly basis)

0

40
96

Note :

97

98

99

00

01

02

Contract rate refers to the quarterly average of the percentage of housing sales contracts that were actually closed from among
the total number of contracts started for any given month. Stock refers to the figure at the end of the quarter.
Source : Real Estate Economic Institute Co., Ltd.

− 46 −

Public Investment Falling due to Difficult Financial Situation
Figure 2-28. Trend of Public Investment

Figure 2-29. Trend of Contract Value for
Public Works(change on previous year, %)(%)(trillion yen)

30

45

9
20

40

Central

Local

Others

Total

8
10

35

7
0

30

6

Public fixed capital formation-10

As % of GDP (right scale)(CY quarterly basis)

25
91

92

93

94

95

96

97

98

99

00

01

91

02

Note : Data represent seasonally adjusted annual rate.
Source : Cabinet Office, “National Accounts.”

93

97

99

01

4-6
01

1012

4-6
02

In the legend, “Local” represents the total of prefecturesand municipalities. “Others” represent the total ofcentral and local public business entities.
Source : Surety Association for Construction Companies, “Public
Works Prepayment Surety Statistics.”

Figure 2-31. International Comparison of
Financial Situations(trillion yen)
Debts of local governments
Debts of central government
Duplication
Total

600

95

Note :

Figure 2-30. Long-term Outstanding Debts ofCentral and Local Governments

700(quarterly basis)

(FY)

-20

5

Japan

(%)

150

U.S.

EU15

(1) General government debts/Nominal GDP

130
110

500

90

400

70
300

50

200

91
(%)

100

6

93

94

95

96

97

98

99

00

01

02

(2) Primary balance/Nominal GDP

3

0

0
-3

-100
91

Note :

92

92

93

94

95

96

97

98

99

00

01

02

-6

(FY)

-9

Figures for fiscal 2001 represent estimates after
supplementary budget and those for fiscal 2002 areestimates based on the initial budget.
Source : Ministry of Finance, “Budgetary Data (March 2002).”(Calendar year)

Notes :

1. Values for 2002 are estimates.
2. Figures for some European countries in 2000 include
income from the selling of cellular phone licenses (around
1% of the primary balance).
Source : OECD, “Economic Outlook 71.”

− 47 −

Exports Slowing from Substantial Increase as Imports Rise
Figure 2-32. Trends of Real Effective Exchange
Rate (1990=100)

Figure 2-33. Japan’s Purchasing Power Parity
and Yen/Dollar Rate
(yen)

140

300
Currency appreciation

130
U.S.
120
110

Japan

100
Euro

Purchasing power parity
Yen/dollar rate

250
200
150

90

100

80

(Calendar year)(CY quarterly basis)

70
97

98

99

00

01

50
80

02

Exchange rate is converted into real terms with the pricelevels of the country and its 44 trading partners and thenweighted for trade in industrial products in 1990.
Source : J.P. Morgan, “World Financial Market.”Figure 2-34. Export and Import Volume Indices(1995=100)

86

88

90

92

94

96

98

00

Figure 2-35. Export Volume Index by Destination(change on previous year)

130

15
Exports

84

Source : OECD, “Purchasing Power Parities and Real
Expenditure.”

Note :

125

82

Imports

(%)

10

120

World

5

115

0

110

-5

105

-10

100
(monthly basis)

95
97

98

99

00

01

U.S.
Asia

-15

02

97

EU
Others

98

99

00

01

02

Three-month moving average of seasonally adjusted values based on
X-11.
Source : Ministry of Finance, “Trade Statistics.”

Source : Ministry of Finance, “Trade Statistics.” (CY quarterly basis)

Figure 2-36. Export Shipment Index of Industrial
Goods (seasonally adjusted change from previous
quarter)

Figure 2-37. Import Supply Index for Industrial
Goods (seasonally adjusted change fromprevious quarter)

15

15

Note :(%)

Capital goods
Construction materials
Consumer durable goods
Consumer non-durable goods
Producer goods
Total

12
9
6

(%)

Capital goods
Construction materials
Consumer durable goods
Consumer non-durable goods
Producer goods
Total

12
9
6

3

3

0

0

-3

-3

-6

-6
97

98

99

00

01

02

(CY quarterly basis)
Source : Ministry of Economy, Trade and Industry, “Analysis of Industrial
Production Activities.”− 48 −

97

98

99

00

01

02

(CY quarterly basis)
Source : Ministry of Economy, Trade and Industry, “Analysis ofIndustrial Production Activities.”Wholesale and Consumer Prices Continuing to Decline
Figure 2-38. Trends in Commodity Prices and Wholesale Prices (domestic demand goods)(change on previous year, %)(change on previous year, %)525
Final goods
Intermediate goods

420

Raw materials
Wholesale prices (domestic demand goods)

3International commodities (excluding crude oil)(right scale)

15

2

10

1

5

0

0

-1

-5

-2

-10

-3

-15
(CY quarterly basis)

-4

-20
96

Notes :
Sources :

97

98

99

00

01

02

1. Wholesale prices represent the average of domestic and import prices for domestic demand goods.
2. International commodities for the third quarter of 2002 represent the year-on-year change of July-August average.
Bank of Japan, “Monthly Report on the Wholesale Price Indexes;” IMF, “International Financial Statistics.”

Figure 2-39. Trends in Consumer Prices (excluding fresh foods) andCorporate Service Prices(change on previous year, %)4Agricultural & aquatic products and industrial products
General services, etc.

3

Public services, etc.
Consumer price index (excluding fresh foods)
2

Corporate service price index

1

0

-1
(CY quarterly basis)-296Notes :

Sources:

97

98

99

00

01

1. “General services, etc.” include publications. “Public services, etc.” include electricity, gas and water charges.
2. Corporate service price index excludes ocean freight transportation, international airfreight transportation andinternational air passenger transportation.
Bank of Japan, “Monthly Report on the Wholesale Price Indexes;” Ministry of Public Management, Home Affairs,
Posts and Telecommunications, “Monthly Report on Consumer Price Index.”− 49 −

02

Credit Risk Aversion through Low Interest Rates
Figure 2-41. Trends in Monetary Base andMoney Stock Rates

Figure 2-40. Trends in Selected Market
Interest Rates(change on previous year, %)

(%)
2.5

Yield on long-term government bonds
Three-month CDs
Inter-bank overnight lending rate (unsecured)

2.0(times)32
Monetary base
Money stock (M2+CD)
Credit multiplier (right scale)

28

13

24
20

1.5

16

11

12

1.0

Guidance of BOJ current account balance started (Mar. 19)

8

Fiscal year-end measure(Feb. 28)

0.5

9

4
0

0.0

7

-4
99/1

7

00/1

7

01/1

7

02/1

Guidance rate raised (Aug. 11)
Guidance rate reduced (Mar. 1)

7(daily basis)

BOJ current account balance guided upward,
etc. (Aug. 14, Sep. 18, Dec. 19, Oct. 30)

1. Yield on long-term government bonds represents that on
10-year bonds.
2. Three-month CDs are represented by the quotation (bid)rate on new issues.
Source : Nihon Keizai Shimbun.
Notes :

90 91 92 93 94 95 96 97 98 99 00 01 02(CY quarterly basis)
1. Change on previous year in average balance.
2. Credit multiplier = money stock (M2+CD)/monetary base.
Seasonally adjusted.
Source : Research and Statistics Bureau, Bank of Japan, “Financial andEconomic Statistics Monthly.”Notes :

Figure 2-42. Money Stock (M2+CD) by
Category Rates

Figure 2-43. Money Stock (M2+CD) by
Credit Component(change on previous year, %)(change on previous year, %)

14

8

12
6

10
8

4

6
4

2

2
0

0
-2

-2

-4

Currency in circulation
Quasi-money
Total

-6
-8

Deposit money
CD-4(CY quarterly basis)

-6

-10
97

98

99

00

01
02
(CY quarterly basis)

Note :
Average balance for the period.
Sources : Research and Statistics Bureau, Bank of Japan, “Financial andEconomic Statistics Monthly” and “Money Stock (quick
estimate).”M1

M2

Currency in circuration:
Bank notes not held by a bank……………………………… ○○Deposit money:
Demand deposits (current deposits, ordinary deposits, etc.)… ○○Quasi-money:
Time and savings deposits (term deposits, etc.)…………………… ○− 50 −

97

98

99

Foreign assets
Lending to private sector
Others00

01

02

Government bonds
Corporate bonds & shares
Total

Note :
Term-end balance.
Source : Research and Statistics Bureau, Bank of Japan, “Financial andEconomic Statistics Monthly.”III. A Medium-term Scenario for the Sustainability of the Japanese Economy
Deflation and Structural Problems in the Japanese Economy
Economic globalization (transition of ex-socialist countries to market economies,
innovation of IT and financial technologies)●Mega-competition (between companies, regions and institutions)●Emergence of vast and global capital markets (pressure on markets for higher efficiency)●Standardization of competition rules (IAS, BIS, ISO)

Aggregate supply
Price level P

AS

AS’

Aggregate demand
AD
AD’

Increase in real purchasing power

Technological advances, improved
productivity(possibly accompanied by rightward
shift of AD)

P0
Control on plant andequipment
investment
Wage reduction andpressure for cutbacks
on employment
Increase inbankruptcies

Increase in supply

Reform of budget
structure

Reduction in demandControl on consumption, preference for low prices①②③

Deregulation, increased new entries(possibly accompanied by rightward
shift of AD)
Increase in imports(accompanied by leftward shift ofAD)
Price war businesses

Sustained decline in prices = deflation

Continuation of high real interest rates
Continuation of high real wages

Y0

YF’

YF

Real GDP Y

Aging with decreasing birthrate, decline in expected nominal growthConcerns of households about
futureDecline in permanent income

Continuous pressure for restructuring on
corporate, financial and government sectors

Balance sheet problems (asset deflation, liability deflation)●Household sector: unrealized losses on financial assets (including pensions) and real estate, debt burden●Corporate sector: unrealized loss on financial assets and real estate, debt burden●Financial sector: non-performing debts, pay off, negative spreads in life insurance●Government sector: budget deficits, pension and social welfare problems
Impact of purchasing power transfer → distortion on real economy
Impact of net losses → ultimately born by population regardless of where problems emerge

Aftershock of bubble economy
Source : Development Bank of Japan, “Recent Trends in the Japanese Economy: The Japanese Economy under Deflation,”
Research Report, No. 19, August 2001, p. 22.

− 51 −

Supply-Demand Balance in the Japanese Economy after Structural Reform

Figure 3-1. Trend of Real GDP Growth by Demand Component
(%)
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4

Plant and equipment investment
Residential investment
Public investment
Exports
GDP

Private consumption
Private inventories
Government consumption
Imports

Forecast(FY)
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

DBJ estimates for fiscal 2002 and after.
Note :
Source : Cabinet Office, “National Accounts.”

Figure 3-2. Trend of Potential GDP Growth by Component Based on Growth Accounting(%)
5

Contribution of TFPContribution of capital input
Contribution of labor input
Potential growth43

Forecast

2
1
0
-1

(FY)

-2

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Notes : 1.
2.

The trends in potential GDP and capital/labor inputs are identified by converting the calendar year values in OECD, “Economic
Outlook 71” into fiscal year values. DBJ estimate for fiscal 2002 and after.
The breakdown of potential growth rate is based on growth accounting and premised on a Cobb-Douglas production function,with an equilibrium capital share of 0.33 (see Annual Report on Economy and Finance, FY2001, Note 2-4).

Figure 3-3. Trend of GDP Gap Ratio
(%)
4
3
2
1
0
-1
-2
-3
-4

Forecast(FY)
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Notes :

1. DBJ estimate for fiscal 2002 and after.
2. GDP gap ratio = actual GDP/potential GDP – 1 (%).
Sources : Cabinet Office, “National Accounts;” OECD, “Economic Outlook 71.”

− 52 −

Recovery in Demand: the key to Breaking the Grip of Deflation
Figure 3-4. Estimation and Forecast of AD and AS Curves(horizontal axis: real GDP (trillion yen), vertical axis: GDP deflator)
Experience period (fiscal 1990-2001)

102

Forecast period (fiscal 2002-2010)
95

101
93

100

10

94

96

99

02

93

98

03

99

97

92

00

96

04

90

95

01

91

93
460

480

500

520

06

05

94
90
520

540

540

560

580

Notes :

1. The AD and AS curves are estimated from the following simultaneous equations based on the two-stage least-squares method(all variables converted into logarithmic values).
(1) Real GDP = const. + α1GDP deflator + β1(real consumption + real government expenditure + real exports) +γ1 yen/dollar rate + δ1land prices + ε1
(2) Real GDP = const. +α2GDP deflator + β2unit labor cost + γ2 yen/dollar rate + δ2land prices + ε2
The estimation period is from the second quarter of 1990 to the first quarter of 2002. Real GDP, GDP deflator and unit
labor cost (=nominal employee remunerations/real GDP) are based on the seasonally adjusted time series before the change
in the QE estimation method. Land prices are represented by the index of urban land prices (nation-wide, average of alluses).
2. In the experience period, the AD/AS curves for each fiscal year are obtained from the average of quarterly estimates of thesecurves. The loci of real GDP and GDP deflator both represent theoretical values derived from the intersections of the two
curves, and are therefore different from actual values.
Sources : Cabinet Office, “National Accounts;” Japan Real Estate Institute, “Index of Urban Land Prices,” etc.

Figure 3-5. Trend of Economic Growth by Component Based on Estimation of AD and AS Curves
(%)
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5

Demand factor
Composite factor

Supply factor
Real GDP growth

Forecast

(FY)
91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Figure 3-6. Trend of Price Fluctuation by Component Based on Estimation of AD and AS Curves
(%)
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5

Demand factor
Composite factor

Supply factor
Change in GDP deflator

Forecast

(FY)
91

92

93

94

95

96

97

98

99

00

01

Notes :

02

03

04

05

06

07

08

09

10

1. Real GDP growth and change in GDP deflator are theoretical values and therefore different from actual values.
2. Demand factor indicates any change in GDP and deflator caused by a shift of the AD curve when the AS curve remains unchanged
from the previous year. Supply factor means any change in GDP and deflator caused by a shift of the AS curve when the AD curve
remains unchanged from the previous year.
Sources : Cabinet Office, “National Accounts;” Japan Real Estate Institute, “Index of Urban Land Prices,” etc.

− 53 −

Number of Workers to Rise Gradually through Diversified Employment
Figure 3-7. Labor Force Prospects(10,000 persons)(10,000 persons)

(%)

90

8500

80

Productive-age population(population aged 15-64)

9Labor participation

70

7500

↑ as % of population aged 15-64↓ as % of population aged 15+

60

Number of workers

6500

Number of employees

40

5Peak at 5.9%
(FY 2004-2005)

30
4500

4

20

3
(FY)

(FY)
10

3500
90

92

94

96

98

00

02

04

06

08

8
7
(%)
6

Unemployment rate(right scale)

50

5500

10

→ Forecast→ Forecast

10

2
90

92

94

96

98

00

02

04

06

08

10

Note :

Labor participation refers to the shareof the total number of workers and theunemployed in the potential work
Figure 3-8. Change in Employment Structure byforce.
Industry (annual rate)
Sources : Ministry of Public Management,
Others(10,000 persons)Home Affairs, Posts and120
Telecommunications, “Labour Force
Finance/insurance/
100
Survey” and “Population Census;”
real estate80
Social Security and Population
Agriculture/forestry/
fisheries
60
Research Institute, “Estimation of
Manufacturing
Future Population of Japan (January402002),” etc.
20
Construction

0
-20
-40
-60

Wholesale/retailServices
Total

70→75 75→80 80→85 85→90 90→95 95→00

Figure 3-10. Government’s
Job Creation Plan

Source : Ministry of Public Management, Home Affairs, Posts andTelecommunications, “Labour Force Survey.”

Job creation in service industry(coming five years)

From other industries

Personal and family services
Adult education
Corporate services
Secondhand housing-related
services
Childcare
Elderly care
Medical care
Legal services
Environment
Total

Retirees

Source :Figure 3-9. Current Situation of Labor Shift between
Industries (annual data)
200(10,000 persons)

School graduates

150

New workers (excluding
school graduates)

100
50
0
-50

To other industries-100

Net increase-150

Shift within industries

es
on
tail
ring
tions
rance
tructi
Servic olesale/re
factu
unica
e/insu
Cons
Manu
Wh
comm
inanc
F
t/
r
o
p
Trans

Source : Ministry of Public Management, Home Affairs, Posts andTelecommunications, “Basic Survey on Employment Structure (1997).”− 54 −

195 (10,000 persons)
20
90
55
35
50
55
20
10
530

Expert Group on the Reactivation of
the Economy Based on the Strategy
of Job Increase in the Service Sector,
Committee of Economic and Fiscal
Policy, “Immediate Report” (May11, 2001).

Consumption to Remain Flat, Followed by Mild Recovery
Figure 3-11. Prospects of Number ofHouseholds

100

5500

→ Forecast

4500

4000

40
20

6

5000

Population index

60(annual
rate)

3500

1990-95
90

92

94

96

98

00

02

04

06

08

3
2
1
0
-1

(FY)

-4

3000

91
91 9293 9495 96 97 98 99 00 0102 0304 0506 07
08

10

1. Population is represented by an index adjusted forthe number of households, with 1990 as base year.
2. DBJ estimates for fiscal 2002 and after.
Sources : Ministry of Public Management, Home Affairs, Posts andTelecommunications, “Population Census,” “Current
Population Estimates” and “Basic Resident Register
Population Directory;” Social Security and Population
Research Institute, “Estimation of Future Population ofJapan (January 2002)” and “Estimation of Future Numberof Households in Japan (October 1998).”
Notes :

0910

Notes :

1. Wages refer to employee remunerations per perso
2. DBJ estimates for fiscal 2002 and after.
Sources : Cabinet Office, “National Accounts;” Ministry of
Public Management, Home Affairs, Posts andTelecommunications, “Labor Force Survey.”

Figure 3-13. Growth of Private Consumption
Expenditure

Figure 3-14. Consumption Expenditure andHousing Investment per Household(real terms)

(%)

6

4

-3

(FY)

1995-2000

5→ Forecast

-2

0
-20

Wages
Number of employees
Employee remunerations

7

Number ofhouseholds(right scale)

80

(%)

8

(total, 10,000 households)(increment, 10,000 households)

120

Others
Two-generation households
Single-member households

Figure 3-12. Prospects of Income and
Employment Situation

70→ Forecast

5

60

3

Housing investment (10,000 yen)

Private final consumption
expenditure
Total GDP

4

2
1
0
-1
-2

50
40
30
20

Fiscal 1955-1980

10

Fiscal 2002-2010 (forecast)Fiscal 1980-2001

(FY)

-3

0
90

92

94

96

98

00

02

04

06

08

10

Note : DBJ estimates for fiscal 2002 and after.
Source : Cabinet Office, “National Accounts.”

0Notes :

100
200
300
400
500
600
700
Household consumption expenditure (10,000 yen)800

1. Figures for fiscal 1955-1980 are based on theold standard, but are expanded for 1980 toequal the new standard value for adjustment to1995 prices.
2. DBJ estimates for fiscal 2002 and after.
Source : Cabinet Office, “National Accounts.”− 55 −

Plant and Equipment Investment to Recover Gradually through
Adjustments to Improve Capital Efficiency

Figure 3-16. Capital Coefficient, Capital Shareand Average Return on Capital

Figure 3-15. Trend of Capital Stock Growth byComponent
(%)
15

3.0
Forecast

10(%)
Forecast

(%)
35

2.5

30

2.0
5

25
Capital coefficient
Capital share (right scale)
Average return on capital (right scale)

1.5
0

20

1.0
-5

15

0.5

Retirement rate
Plant and equipment investment/capital stock ratio
Capital stock growth

-10

(FY)

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Notes :

1. DBJ estimates for fiscal 2002 and after.
2. Capital stock represents OECD estimates including
public enterprises. Retirement rate refers to estimates
based on “Gross Capital Stock of Private Enterprises”
and adjusted for special factors. The plant andequipment investment/capital stock ratio represents thedifference between the two.
Sources : OECD, “Economic Outlook 71;” Cabinet Office, “Gross
Capital Stock of Private Enterprises.”

Figure 3-17. Plant and Equipment Investment
as % of GDP
(%)
22

(FY)

0.0

Nominal plant and equipment investment
Real plant and equipment investment

1. DBJ estimates for fiscal 2002 and after.
2. Capital stock represents OECD estimates including
public enterprises.
3. Average return on capital = capital share/capitalcoefficient.
Capital share = 1 – (compensation of employees/
national income expressed in factor costs).
Sources : OECD, “Economic Outlook 71;” Cabinet Office,“National Accounts.”
Notes :

Figure 3-18. Recovery Scenario for Plant andEquipment Investment
Con tinued curtailment(selection) of p lant andequipment inv estment

Progress in adjustm ent o f in dustrial structure
an d intra-in dust ry supply structure during
intensive adjustment period

20
Retiremen t rate↑

Forecast
18

Capital stock growth ↓16

Share prices↑

14

Capital sh are↑Return on capital↑

Modest recovery in p lant andequipment inv estment

(FY)

12

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Note :DBJ estimates for fiscal 2002 and after.
Source : Cabinet Office, “National Accounts.”− 56 −

10

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Net Exports to Increase with Higher Value-Added Export Goods andStrong Economies Overseas
Figure 3-20. U.S. Economic Growth,Actual and Forecast

Figure 3-19. Trends in Balance of Payments(trillion yen)

(%)

25

Forecast20

5.0(change on previous year, %)
12

4.5

10

4.0

15

Nominal growth8

Forecast

3.5
10

6
3.0

5
2.5
0
-5
-10

2.0

2

1.5

0

1.0

-2

85 87 89 91 93 95 97 99 01 03 05 07 09(FY)
Current transfers
Balance on income
Balance on services
Trade balance
Current account balance
Current account balance/nominal GDP ratio (right scale)Real growth

84 86 88 90

92 94 96

98 00 02

04 06 08 10(CY)

Note :DBJ estimates for fiscal 2002 and after.
Congressional Budget Office, “The Budget and Economi
Source : Outlook (August 2002).”

Note : DBJ estimates for fiscal 2002 and after.
Source : Bank of Japan, “Balance of International Payments
Statistics.”

Figure 3-22. Export Growth by Level ofTechnological Intensity (1988=100)
200
180

Figure 3-21. World Imports,
Actual and Forecast

160
140

(average annual growth, %)9120Developed countries
Developing countries

8

4

100

7

80

6

60
40

5

20

4

Technological intensity level 1
Technological intensity level 2
Technological intensity level 3
Technological intensity level 403

88 89 90 91 92 93 94 95 96 97 98 99 00 01(CY)

2

Note :

1
0
84-91

92-99

00-03

04-07

Notes : 1. IMF forecasts for 2002 and after.
2. Developed countries comprise 41 countries including
the U.S., the EU, Japan and the Asian NIEs.
Source : IMF, “Economic Outlook (September 2002).

Technological intensity levels are classified according to
the R&D/sales ratio calculated from Ministry of Public
Management, Home Affairs, Posts andTelecommunications, “Survey Report on TechnologicalResearch” (with level 1 being the highest).
Level 1: electronic/communication machinery andscientific/optical equipment
Level 2: chemicals, electric machinery, precision
machinery and rubber products
Level 3: general machinery, transport equipment, plastic
products
Level 4: textiles, ceramics/cement/glass, iron/steel andnon-ferrous metals

Source : Ministry of Finance, “Trade Statistics.”− 57 −

Primary Balance of Public Finance to Improve Slowly
Figure 3-23. Public Fixed Asset Formation and Government Final Consumption Expenditure(trillion yen)120

(Major premises for fiscal 2003 and after)
Public fixed capital formation

100● Investment expenses: –3%/year→Forecast● Social security cost:

Government final consumption expenditure

1/3 of basic pension payments covered by central government

80

Cutback of 300 billion yen/year through health insurance reform● Labor cost: personnel cutback of 0.5%/year

60● Others:

40

Cost of supplies reduced 1%/year
Other expenses to rise in line with price inflation

20
(FY)

0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Sources : Cabinet Office, “Annual Report on National Accounts,” etc.

Figure 3-25. Condition of Government Finance

Figure 3-24. Public Investment byLocal Governments(trend of ordinary construction works expenditure,included in investment expenses)
35

Note : Based on the same premises as in Cabinet Office,“Structural Reform and Medium-Term Economic
and Fisal Perspectives: Background Paper(January 2002).”(trillion yen)
10

1%→Forecast(trillion yen)
0%

0

-1%

-10

-2%

-20

-3%

-30

→Forecast
30

Other project expenses
Independent project expenses

25

Subsidized project expenses

20
15

-4%

(FY)

-40

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

10

Central government's subsidy to local governments + Net increase in debts on
special account for tax allocations (right scale)5

Tax revenues of central government – general expenditure (right scale)
Primary balance as % of nominal GDP (local and central governments)

0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10(FY)

Notes :

1. Primary balance is calculated on an ordinary account basis
for local governments and on a general account basis for
Notes : 1. Closing values until fiscal 2000 and forecasts ofthe central government (different from the general government
closing values for fiscal 2001 and after.
basis). Interest on postal savings is accounted for in the yearof payment, and does not include expenses such as contribu2. In addition to ordinary construction works, investment
tion to the Deposit Insurance Corporation.
expenses include disaster restoration and other projects,
2.
The calculation of tax revenues is based on Cabinet Office,which amount to several hundred billion yen per annum.
“Structural Reform and Medium-Term Economic andSources : Ministry of Public Management, Home Affairs,
Fisal Perspectives,” with an elasticity of 1.1 to nominal
Posts and Telecommunications, “Annual
economic growth. It is assumed however that the effect
Report on Statistics of Public Finance,” etc.
of tax reform on R&D will become permanent with apreliminary tax reduction of 1.5 trillion yen expected forfiscal 2003.
Sources : Cabinet Office, “Annual Report on National Accounts;”
Ministry of Finance, “Outline of Closing Account (various
fiscal years)” and “Budget Explanation (various fiscal
years);” Ministry of Public Management, Home Affairs,
Posts and Telecommunications, “Annual Report on
Statistics of Public Finance,” etc.

− 58 −

(Appendix 1) Assumption of Longer Adjustment Period
Figure 3-26. Trend of GDP Growth by Demand Component
(%)
8
7
6
5
4
3
2
1
0
-1

Private inventories
Residential investment
Public investment
Exports
GDP

Private consumption
Private consumption
Government consumption
Imports

Forecast

-2
-3
-4

(FY)
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Note : DBJ estimates for fiscal 2002 and after.
Source : Cabinet Office, “National Accounts.”

Figure 3-27. Trend of Potential Growth Rate by Component Based on Growth Accounting(%)
5
Contribution of TFPContribution of capital input
Contribution of labor input
Potential growth rate

43Forecast

2
1
0
-1

(FY)

-2

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Notes : 1. Trends in potential GDP and capital/labor inputs represent calendar year estimates of OECD, “Economic Outlook 71” convert
fiscal year values by DBJ. DBJ estimates for fiscal 2002 and after.
2. Breakdown into components based on growth accounting uses a Cobb-Douglas production function with an equilibrium capitof 0.33 (Annual Report on Economy and Finance, FY2001).

(%)

Figure 3-28. Trend of GDP Gap Ratio

4
3
2
1
0
-1
-2
-3
-4

Forecast(FY)
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Notes : 1. DBJ estimates for fiscal 2002 and after.
2. GDP gap ratio = actual GDP/potential GDP – 1 (%).
Sources : Cabinet Office, “National Accounts;” OECD, “Economic Outlook 71.”

− 59 −

(Appendix 2) Economic Outlook and R&D Policies in Asia
Figure 3-29. Real GDP
4.5($ trillion)

Figure 3-30. Per Capita Real GDP(%)

Forecast

4.0
3.5

($)
60

40,00050

35,000

Forecast
Hong Kong

30,000

3.0

40

2.5

30

2.0
1.5

20

25,000Singapore

20,000
Taiwan15,00010,000

1.0

10

0.5

0

0.0

Malaysia

0

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
(CY)
China
Korea
TaiwanHong Kong
Singapore
ASEAN4
Share of China (right scale)96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
(CY)
China
Hong Kong
Malaysia

ASEAN4 comprises Malaysia, Thailand, Indonesia
and the Philippines.
2. Forecast growth rates are 5.0% for Hong Kong,
Taiwan and Singapore, 7.1% for China, and 6.2%
for others.
3. The share of China refers to the share in the total of
China, NIEs and ASEAN4.
Sources : World Bank, “Global Economic Prospects,” etc.
Notes :

Korea

5,000

1.

Korea
Singapore
Indonesia

TaiwanThailandPhilippines

Note :

Forecast per capita growth rates are 4.2% for Hong Kong,
Taiwan and Singapore, 7.0% for China, and 5.4% for other
Sources : World Bank, “Global Economic Prospects,” etc.

Table 3-1. R&D Policies in China and NIEs
China
th
Laws/
10 5-Year Plan (2001-05),
programs comprising five sub-programs.

Korea
TaiwanMay 2002: Challenge 2008
1997: 5-Year Program.
1999: Basic Law on Science andTechnology enacted under theLong-term Vision for Science andTechnology to 2025.

Singapore
1999: Industry 21 Program, aimed atdeveloping the country into a hub forknowledge-intensive industries, withdesignated focus areas.
2000: Science and Technology Program, thethird 5-year program, with a budget allocationof S$7 billion.

Contents

5-Year Program is centered on targets
Promotion of privatization.
concerning R&D expenditures in government
Establishment of high-tech industry
sector.
development zones.
Encouragement for foreign capital to establish Basic Law on Science and Technology seekstransfer of leadership from government to
R&D centers.
Objective: R&D accounting for 1.5% of GDP. private sector, with designated focus areas.

Creation of international R&D bases.
Concentration on niche areas.
· Low-interest loans for R&D (50 billion yuan) Encouragement of private R&D.
· Establishment of R&D centers on advanced Technology transfer and management oftechnology
intellectual property rights.
· Invitation of international R&D human
Recruitment of human resources from theresources
world.
Objective: R&D accounting for 3% of GDP. Networking.

Focus
areas

Chip circuits and software
Information technology.
information security.
Biotechnology.
Biogenetics and biochips.
New drug development andmodernization of herbal
medicines.
On-line government and finance.
Electric motorcars.

IC systems.
Information technology.
Biotechnology.
Nano-technology.
Digital contents.

Electronics.
Communications & media.
Bio-medical.
Energy.
Chemicals.
Education.
Health care.
Logistics.

Invitation of R&D human resourcesfrom overseas.
Its status as an R&D center isthreatened as production facilities aretransferred to China.

Aims at the introduction of foreign
capital in the short term, and thedevelopment of domestic humanresources and research capacities in thelong term.

Character- Weak private R&D and small R&D
amount are issues to be addressed.
isticsEncouragement of foreign capital
introduction.

Sources : Various data.

− 60 −

(Appendix 3) Recovery from Economic Crisis in Korea:
Structural Reform and Increased Exports

Figure 3-32. Budgetary Balance and Budget
Deficit as % of GDP

Figure 3-31. Trend of GDP(%)

30(trillion won)

(%)

1600
20
10
0
-10
-20

20

1400

10

1200

0

1000

-10

800

-20

600

-30

400

-40

200

-50

0

-60

-200
(CY quarterly basis)

-30
97

98
99
Fixed capital formation
Government consumption
Imports
GDP

Note :
Source :

00

-70
(CY)

-400
90

01
02
Private consumption
Exports
Increase in inventories

Year-on-year growth.
Bank of Korea data.

91 92 93 94 95 96 97
Fiscal revenues
Fiscal expenditures
Budget deficit
Budget deficit/GDP (right scale)

98

99

00

-80

01

Source : Monthly Statistics of Korea.

Figure 3-33. Balance of Payments by Component($100 million)

Figure 3-34. Non-performing Loans30500(trillion won)

(%)

9
8
7
6
5
4
3
2
1
0

25

400

20
300

15

200
100

10

Outstanding non-performing loans5Non-performing loan ratio (right scale)

0
0

97

98

99

00

01

02.3

Source : Financial Supervisory Agency of Korea.

-100
-200

Figure 3-35. Foreign Exchange Rate

-300

(1995=100)

(CY)

-400
90

91

92

93

Trade balance
Direct investment
Other investment
Errors and omissions

94

95

96

97

98

99

00

01

Other current accountPortfolio investment
Other capital balance
Change in foreign exchange reserves

Source : IMF, “International Financial Statistics.”(won/$)

180

0

160

Effective exchange rate

200

140

Won/dollar rate (right scale)

400

120

600

100

800

80

1000

60

1200

40

↓Won depreciation

20
0
97

98

99

Source : OECD statistics.

− 61 −

00

1400(monthly basis)
01

02

1600
1800

(Appendix 4) Prompt Response to Bursting of Bubble in Sweden
Figure 3-36. Trend of Asset Prices(1994=100)
250

Figure 3-37. Balance of Banking Sector
Credit to Private Sector

Share price index
Commercial real estate prices
Housing prices

200(Kr trillion)

12

150
100

50

8

40

6

30

0
85

86 87

88

89 90

91

92

93 94

95

96 97

20

Banking sector credit to private sector
As % of GDP (right scale)

2

(CY)

60

10

4

50

(%)

10
0

0
98

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00(CY)

Note :
Real estate prices are all measured in Stockholm.
Source : IMF, “International Financial Statistics.”
Sources : IMF, “International Financial Statistics” (for share prices);
BIS, “Annual Report” (for commercial real estate prices);
Central Statistical Office of Sweden data (for housing prices).

Figure 3-38. Foreign Exchange Rate andNet Exports

Figure 3-39. Trend of Real Domestic Production(year-on-year change by component)
(%)
(%)
10 10
8
8
6
4
6
2
4
0
-2
2
-4
0 -6

130
120
110
100
90
80

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01(CY)
Private consumption
Government consumption
Inventories
Fixed capital formation
Exports
ImportsGDP

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01(CY)
Net exports (as % of GDP, right scale)Real effective exchange rate (1995=100)

Sources : Central Statistical Office of Sweden data(for net exports); IMF, “International Financial
Statistics” (for real effective exchange rate).

Source : Central Statistical Office of Sweden data.

Figure 3-40. Consumption and Unemployment
(%)

(%)

(%)

Figure 3-41. Fiscal Condition(as % of nominal GDP)

(%)
80

12

8

6

9

4

70

4

6

0

60

2

3

0

0

-4

50

8

-2
-4

(CY)

-3 -8

(CY/FY)-6 -1285 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

Fiscal balancePrimary balance
Effect of financial reconstruction in 1994-98
Government debts (right scale)Household savings ratio (right scale)
Unemployment rate (right scale)
Private consumption (change on previous year)

Notes : 1. Unemployment rate is based on the OECD standard.
2. Private consumption is on an SNA basis in real terms.
3. Household savings ratio is measured against disposable
income on a net basis (excluding fixed capitalconsumption by households and proprietorships).
Source : OECD, “Economic Outlook 71.”

− 62 −

Note : General government basis.
Source : OECD, “Economic Outlook 71.”

40
30

List of Back Numbers (Including JDB Research Report)
No. 36 Recent Trends in the Japanese Economy: A Medium-term Scenario for the Sustainability of the Japanese Economy (this issue)
No. 35 Concerns for the Future and Generational Consumption Behavior, February 2003
No. 34 Prospects and Challenges Surrounding Japan’s Electrical Equipment Industry: General Electrical
Equipment Manufacturers’ Restructuring of Operations and Future Prospects, November 2002
No. 33 Survey on Planned Capital Spending for Fiscal Years 2001, 2002 and 2003, November 2002
No. 32 Behavior Trends of Japanese Banks toward the Corporate Sector and Their Impact on the Economy,
October 2002
No. 31 Microstructure of Investment and Employment Dynamics: Stylized Facts of Factor Adjustment Basedon Listed Company Data, October 2002
No. 30 Recent Trends in the Japanese Economy: Globalization and the Japanese Economy, August 2002
No. 29 Corporate Financing Trends in Recent Years: Fund shortages and repayment burden, August 2002
No. 28 Urban Renewal and Resource Recycling: For the Creation of a Resource Recycling Society, July 2002
No. 27 Labor’s Share and the Adjustment of Wages and Employment, June 2002
No. 26 Survey on Planned Capital Spending for Fiscal Years 2001 and 2002, May 2002
No. 25 Environmental Information Policy and Utilization of Information Technology: Toward a Shift in Environmental Policy Paradigm, March 2002
No. 24 The Changing Structure of Trade in Japan and Its Impact: With the Focus on Trade in Information
Technology (IT) Goods, March 2002
No. 23 Microstructure of persistent ROA decline in the Japanese corporate sector: Inter-company disparties
and investment strategies, March 2002
No. 22 Recent Trends in the Japanese Economy: The Japanese Economy under Deflation and Prospects ofEvolution, February 2002
No. 21 Survey on Planned Capital Spending for Fiscal Years 2000, 2001 and 2002, December 2001
No. 20 Current Situation and Challenges for Cable Television in the Broadband Era, October 2001
No. 19 Recent Trends in the Japanese Economy: The Japanese Economy under Deflation, August 2001
No. 18 Introduction of a Home Appliance Recycling System: Effects & Prospects: Progress towards Utilisationof Recycling Infrastructure, June 2001
No. 17 Survey on Planned Capital Spending for Fiscal Years 2000 and 2001, June 2001
No. 16 Revitalization of Middle-aged and Elderly Workers in Japan’s Labor Markets: Requiring the Expansionof the Vocational Training Functions, March 2001
No. 15 Risk-Averting Portfolio Trends of Japanese Households, March 2001
No. 14 Consumption Demand Trends and the Structure of Supply: Focus on Retail Industry Supply Behavior,
March 2001
No. 13 Recent Trends in the Japanese Economy: Weakness of Current Economic Recovery and Its Background,
March 2001
No. 12 Empirical Reassessment of Japanese Corporate Investment Behavior: Features and Changes since the1980s, based on Micro-level Panel Data, March 2001
No. 11 Survey on Planned Capital Spending for Fiscal Years 1999, 2000 and 2001, October 2000
No. 10 Job Creation and Job Destruction in Japan, 1978-1998: An Empirical Analysis Based on EnterpriseData, September 2000
No. 9

Recent Trends in the Japanese Economy: Information Technology and the Economy, September 2000

No. 8

Trend of International Reorganization Affecting the Japanese Automobile and Auto Parts Industries,
June 2000

No. 7

Survey on Planned Capital Spending for Fiscal Years 1999 and 2000, June 2000

No. 6

Current Status and Future Perspective of the Japanese Remediation Industry: Technology and Market
for Underground Remediation, May 2000

No. 5

Recent Trends in the Japanese Economy: The 1990s in Retrospect, March 2000

No. 4

Destabilized Consumption and the Post-bubble Consumer Environment, February 2000

No. 3

The Slump in Plant and Equipment Investment in the 1990s: Focusing on Lowered Expectations, theDebt Burden and Other Structural Factors, January 2000

No. 2

Survey on Planned Capital Spending for Fiscal Years 1998, 1999 and 2000, November 1999

No. 1

Corporate Strategies in Japan’s Semiconductor Industry: Implications of Development in Other AsianCountries, November 1999_________________________________________________________________________________________JDB Research Report
No. 96 Recent Trends in the Japanese Economy: Focused on Fixed Investment and Capital Stock, August 1999
No. 95 Efforts to Protect the Natural Environment in the United States and Germany: Environmental Mitigation and Biotope Conservation, July 1999
No. 94 Survey on Planned Capital Spending for Fiscal Years 1998 and 1999, June 1999
No. 93 Towards the realization of ‘environmental partnership’: A survey of Japan’s environmental NPO sector
through comparison with Germany, June 1999
No. 92 The Impact of Demographic Changes on Consumption and Savings, March 1999
No. 91 Recent Research and Development Trends in Japanese Enterprises: Technology Fusion, March 1999
No. 90 Recent Trends in the Japanese Economy: Prolonged Balance Sheet Adjustment, January 1999
No. 89 Impact of Asset Price Fluctuations on Household and Corporate Behavior: A Comparison between Japan and the U.S., December 1998
No. 88 Survey on Planned Capital Spending for Fiscal Years 1997, 1998, and 1999, December 1998
No. 87 Foreign Exchange Rate Fluctuations and Changes in the Input-Output Structure, November 1998
No. 86 Structural Changes in Unemployment of Japan: An Approach from Labor Flow, November 1998
No. 85 Recent Trends in the Japanese Economy: Characteristics of the Current Recession, August 1998
No. 84 R&D Stock and Trade Structure in Japan, August 1998
No. 83 Survey on Planned Capital Spending for Fiscal Years 1997 and 1998, August 1998
No. 82 The Significance, Potential, and Problems of DNA Analysis Research: Establishing Public Acceptanceis Essential, May 1998
No. 81 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1996, 1997 and1998 Conducted in August 1997, March 1998
No. 80 Recent Trends in the Japanese Economy: Growth Base of the Japanese Economy, January 1998
No. 79 Information Appliances: The Strength of Japanese Companies and Tasks for the Future, January 1998

No. 78 Challenges and Outlook for the Japanese Machinery Industries: Impact of ISO14000 Series and Environmental Cost, January 1998
No. 77 Current Conditions and Issues of Computerization in the Health Care Industry: For the Construction of
a Health Care Information Network, January 1998
No. 76 Household Consumption and Saving in Japan, December 1997
No. 75 The Direction of Japanese Distribution System Reforms: Strengthening the Infrastructure to Support
Diverse Consumer Choices, November 1997
No. 74 Foreign Direct Investments by Japanese Manufacturing Industries and Their Effects on International
Trade, October 1997
No. 73 The Impact of the Changing Trade Structure on the Japanese Economy: With Special Focus on the Effects on Productivity and Employment, October 1997
No. 72 An Analysis of Foreign Direct Investment and Foreign Affiliates in Japan, August 1997
No. 71 Recent Trends in the Japanese Economy: Stock Replacement and New Demand as Aspects of Economic Recovery, August 1997
No. 70 Corporate Fundraising: An International Comparison, June 1997
No. 69 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1996 and 1997
Conducted in February 1997, May 1997
No. 68 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1996 and 1997
Conducted in August 1996, August 1997
No. 67 An International Comparison of Corporate Investment Behavior: Empirical Analysis Using Firm Data
from Japan, France and the US, April 1997
No. 66 Housing in the National Capital: Analysis of the Market for Housing using Micro Data, March 1997
No. 65 The Environment for Locating Business Operations in Major East Asian Cities, January 1997
No. 64 Direction of Reconstruction of Business Strategy in the Chemical Industry, January 1997
No. 63 Reflection on Discussions Concerning Regulation of the Electric Power Industry: Deregulation of theElectric Power Industry in Japan and Implication of Experiences in the United States, December 1996
No. 62 Current Status and Future Perspective of the Japanese Semiconductor Industry, November 1996
No. 61 A Breakthrough for the Japanese Software Industry?: Responsiveness to Users’ Needs is the key, October 1996
No. 60 Recent Trends in the Japanese Economy Focusing on the Characteristics and Sustainability of the Current Economic Recovery, September 1996
No. 59 Analysis of the Primary Causes and Economic Effects of Information: Related investment in the UnitedStates and Trends in Japan, August 1996
No. 58 Selected Summaries of Research Reports: Published in FY1995, June 1996
No. 57 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1995 and 1996
Conducted in February 1996, May 1996
No. 56 Recent Trends in the Japanese Economy, May 1996
No. 55 Issues Concerning the Competitiveness of the Japanese Steel Industry, February 1996
No. 54 Changes in the Financial Environment and the Real Economy, January 1996
No. 53 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1994, 1995 and1996 Conducted in August 1995, October 1995

No. 52 Current Economic Trends: Focusing on the Appreciation of the Yen and its Effects, October 1995
No. 51 Problems Concerning the International Competitiveness of the Petrochemical Industry, October 1995
No. 50 An Economic Approach to International Competitiveness, October 1995
No. 49 Selected Summaries of Research Reports Published in FY1994, July 1995
No. 48 Strategies for Improving the Efficiency of the Japanese Physical Distribution System: Part 2, July 1995
No. 47 Issues on International Competitive Strength of the Auto Industry, June 1995
No. 46 Problems Concerning the International Competitiveness of the Electronics and Electric Machinery Industry, June 1995
No. 45 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1994 and 1995
Conducted in March 1995, June 1995
No. 44 Strategies for Improving the Efficiency of the Japanese Physical Distribution System, March 1995
No. 43 Capital Spending Recovery Scenario Cycle and Structure, August 1994
No. 42 Progress of International Joint Development between Industrialized Countries on the Private Level,
May 1994
No. 41 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1993, 1994 and1995 Conducted in August 1994 , November 1994
No. 40 Selected Summaries of Research Reports Published in FY1993, June 1994
No. 39 Recent Trends in Japan’s Foreign Accounts, April 1994
No. 38 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1993 and 1994
Conducted in March 1994, April 1994
No. 37 Economic Zones and East Asia Prospect for Economic Activity Oriented Market Integration, December
1993
No. 36 Japanese Corporate Responses to Global Environmental Issues, December 1993
No. 35 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1992, 1993 and1994 Conducted in August 1993, September 1993
No. 34 Structure of Profit to Capital in the Manufacturing Industry, September 1993
No. 33 Comparison of the Japanese and The U.S. Labor Markets, October 1992
No. 32 The Relative Competitiveness of U.S., German, and Japanese Manufacturing, March 1993
No. 31 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1992 and 1993
Conducted in March 1993, April 1993
No. 30 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1991, 1992 and1993 Conducted in August 1992, December 1992
No. 29 Flow of Funds in the 80s and Future Corporate Finance in Japan, November 1992
No. 28 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1991 and 1992
Conducted in February 1992, April 1992
No. 27 An Analysis of Foreign Direct Investment in Japan, March 1992
No. 26 Projection of Japan's Trade Surplus in 1995: Analysis of Japan's Trade Structure in the 80s, February
1992
No. 25 Intra-Industry Trade and Dynamic Development of The World Economy, November 1991
No. 24 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1990, 1991 and1992 Conducted in August 1991, September 1991
No. 23 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1990 and 1991
Conducted in February 1991, March 1991
No. 22 Trends of the Petrochemical Industry and its Marketplace in East Asia, March 1991
No. 21 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1989, 1990 and1991 Conducted in August 1990, September 1990
No. 20 Deepening Economic Linkages in The Pacific Basin Region: Trade, Foreign Direct Investment andTechnology, September 1990
No. 19 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1989 and 1990
Conducted in February 1990, March 1990
No. 18 Petrochemicals In Japan, The US, and Korea an Assessment of Economic Efficiency, February 1990
No. 17 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1988, 1989 and1990 Conducted in August 1989, October 1989
No. 16 Impact of the EC Unification on Japan’s Automobile and Electronics Industries, August 1989
No. 15 Industrial and Trade Structures and the International Competitiveness of Asia’s Newly Industrializing
Economies, August 1989
No. 14 The Japan Development Bank Reports on Capital Investment Spending: Survey for Fiscal Years 1988
and 1989 Conducted in February 1989, March 1989
No. 13 The Japan Development Bank Reports on Capital Spending: Survey for Fiscal Years 1987, 1988 and1989 Conducted in August 1988, September 1988
No. 12 Growing Foreign Investors’ Activities and the Future of Internationalization, September 1988
No. 11 Futures Tasks and Prospects for the Japanese Machine-Tool Industry, July 1988
No. 10 International Division of Labor in the Machine Industries Among Japan, Asia’s NICs and ASEANCountries, June 1988
No. 9

Trends of the Petrochemical Industry and its Marketplace in East Asia around Japan, May 1988

No. 8

The International Competitiveness of Japan and U.S. in High Technology Industries, April 1988

No. 7

The Japan Development Bank Reports on Private Fixed Investment in Japan, March 1988

No. 6

Economic Projections of the Japan’s Economy to the Year 2000, February 1988

No. 5

The Japan Development Bank Reports on Private Fixed Investment in Japan, September 1987

No. 4

Current Trends in the Japanese Auto Parts Industry in Overseas Production, July 1987

No. 3

Current Moves for Foreign Direct Investment into Japan, May 1987

No. 2

Overseas Direct Investments by Japanese Corporations, May 1987

No. 1

Current U.S. Consumption Trends, May 1987