Masaaki Shirakawa: Japan's economy after the great earthquake -
rebuilding, revival, and further growth
Speech by Mr Masaaki Shirakawa, Governor of the Bank of Japan, at a meeting held by the
Naigai Josei Chousa Kai (Research Institute of Japan), Tokyo, 25 May 2011.
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Introduction
I am privileged to have the opportunity to speak before such a large audience today.
Two and a half months have passed since the Great East Japan Earthquake, but many
continue to face severe hardship, including those being forced to live at evacuation sites. I
would like to offer my heartfelt sympathy to those who are suffering. At the same time, moves
toward rebuilding life and infrastructure are under way in disaster areas, albeit gradually. At
the beginning of May, the Diet approved the supplementary budget aimed at early rebuilding
following the disaster. Discussions toward revival of the disaster areas are also under way.
Moreover, discussions toward formulating growth strategies for Japan's economy, which has
been the great challenge since even before the earthquake, have also been regaining
momentum. Those individual efforts and discussions are important and linked together.
Today, I will first explain the current situation and near-term outlook for Japan's economy. I
will then share with you some of my ideas on the challenge Japan's economy faces in each
of the coming phases of rebuilding, revival, and further growth.
I. The current situation and outlook for Japan's economy
Downward pressure on the economy by the earthquake disaster
Let me start with the current state of Japan's economy. From early 2011, Japan's economy
had emerged from the pause since autumn 2010. The earthquake disaster struck the
economy when it was about to regain recovery momentum. The earthquake, tsunami, and
accident at the nuclear power plant have changed the situation significantly, and Japan's
economy is currently facing strong downward pressure. Let me note that industrial production
for March decreased by 15 percent on a month-on-month basis, the largest one-month drop
on record. The recent sharp and substantial economic plunge is similar to that following the
failure of Lehman Brothers but different in terms of its mechanism: the recent downward
pressure is caused by a supply-side shock. The earthquake and tsunami caused
considerable damage to social capital stock, such as roads and ports, as well as private
capital stock, such as factories and commercial facilities, in a wide area from the Tohoku
region to the northern Kanto area. The destruction of factories led to disruptions in the supply
chains of parts and materials, which affected production not only in disaster-stricken areas
but also a wide range of non-affected areas. The damage to power-generating facilities
constrained electricity supply mainly in the Kanto and Tohoku regions. These factors have
resulted in a decline in the capacity for supplying goods and services in Japan's economy as
a whole. As a result, exports have decreased substantially and domestic demand has been
declining. It should be noted, however, that demand itself has not disappeared, but that it
could not be realized due to supply constraints. In this regard, the current situation is
significantly different in nature from that which followed the failure of Lehman Brothers, when
demand both at home and abroad "evaporated" due to the rapid contraction of financial
markets. There has been no significant change in the fundamental conditions that supported
Japan's economic recovery prior to the earthquake - namely, the expansion of markets for
Japan's exports on the back of robust growth in overseas economies. Therefore, the most
vital near-term challenge for Japan's economy is to resolve supply constraints as early as
possible, and this should be addressed with utmost efforts.
At the same time, however, the supply-side factor is not the sole cause of downward
pressure on the economy. Additional downward pressure from the demand side, which is
partly related to the supply-side shock, is also contributing. The accident at the nuclear
power plant and power shortages have exerted downward pressure on economic activity
through a deterioration in business and household sentiment, as well as a declining number
of tourists from abroad. Voluntary restraint by consumers spread nationwide immediately
after the earthquake, dampening spending particularly for services such as tourism and
eating out, as well as for luxury goods. Even if the initial shock is brought about by supply
constraints, if the sluggishness in production persists, there will be an increase in adverse
effects on corporate profits and on employment and wages, thereby putting the brakes on
business fixed investment and private consumption.
In sum, the current downward pressure differs from the "evaporation" of demand following
the failure of Lehman Brothers. Nevertheless, it is necessary to carefully examine whether or
not demand-side factors will exert downward pressure on the economy.
The baseline scenario for the outlook
Next, I will talk about the outlook for Japan's economic activity. The Bank of Japan judges
that Japan's economy for the time being is likely to continue facing strong downward
pressure, mainly on the production side. But from the beginning of autumn 2011, supply-side
constraints are likely to ease as the power shortage problem is mitigated amid the progress
with reconfiguration of supply chains. In fact, in the past two and a half months since the
earthquake, an increasing number of factories have made progress in restoration efforts and
resumed production. Against this background, some firms have brought forward their
originally targeted dates to resolve supply chain disruptions. As for consumer sentiment,
which deteriorated sharply immediately after the earthquake, voluntary restraint has recently
eased somewhat, and from April there have been signs of recovery in sales of electrical
appliances as well as sales at department stores. During the Golden Week holidays - the
period from late April to early May that includes four national holidays - more than just a few
tourist sites were crowded compared with the pessimistic forecast made ahead of this period.
These developments suggest that Japan's economy has started to move toward recovery
from the tumble immediately after the earthquake. Overseas economies have also continued
to grow rapidly. According to the forecast by the International Monetary Fund, the growth rate
of the global economy will be 4.4 percent in 2011 and 4.5 percent in 2012, surpassing the
average rate of 4.0 percent for the ten years preceding the financial crisis. In this situation,
Japan's exports are likely to start recovering as supply-side constraints ease. The
replenishment of inventories, which was significantly reduced due to the disaster, will act as
a factor to boost production, and demand for restoring capital stock will gradually increase.
Therefore, in the second half of fiscal 2011, the sense of recovery will be somewhat more
noticeable, although it will fall short of a V-shaped recovery. In fiscal 2012, Japan's economy
is projected to continue to realize relatively high growth because we will see a more effective
utilization of the transmission mechanism by which the strength in exports and production
feeds through into income and spending, and because rebuilding demand will continue
increasing. If expressed in numerical terms, the annual real GDP growth rate is projected to
expand to 2.9 percent in fiscal 2012, after staying at a low 0.6 percent in fiscal 2011 due to
the drop in the first half.
Uncertainty regarding the outlook
As I mentioned earlier, the Bank's baseline scenario is that, in the second half of fiscal 2011,
Japan's economy will recover from the tumble caused by the earthquake and return to a
moderate recovery path. However, the Bank fully recognizes that this outlook entails various
uncertainties.
First of all, there are uncertainties regarding developments in overseas economies and
international commodity prices. There continues to be the two-speed pattern of overseas
economies, with moderate recovery in advanced economies and very strong growth in
emerging economies. In the United States, balance-sheet adjustment pressure following the
bursting of the credit bubble - such as a decline in home prices and excess debt in the
household sector - has continued to weigh on the economy. In Europe, concern about fiscal
problems in some peripheral countries such as Greece has not been resolved. Meanwhile, in
many fast-growing emerging economies, continued monetary tightening has not sufficiently
calmed economic overheating and concern over inflation. This might cause another
longerterm risk of more volatile fluctuations in economic activity, which could undermine
sustainability in growth. Although our minds have been occupied with domestic events, we
also need to pay careful attention to these developments in overseas economies.
Having said that, the highest degree of uncertainty lies in the effects of the disaster on
Japan's economy. It is particularly important to consider when various supply constraints
associated with the disaster will be removed. In terms of electricity, the supply and demand
balance is expected to tighten in the summer, when demand peaks due to the use of air
conditioners. Various measures have been taken to weather this difficult period: a
strengthening of supply capacity by electric power companies; the use of in-house power
generation; and firms and households' efforts to conserve electricity and to level out demand.
As for supply chains, the situation has been improving. However, we should not forget the
difficulty in making precise projections at this point regarding the prospect of electricity supply
shortages and supply chain disruptions. The summer demand for electricity depends
significantly on the temperature. Concern over electric supply might be long-lived beyond
summer 2011 depending on the rate of operation in nuclear power plants across Japan,
which could be affected by the recent decision to shut down the Hamaoka nuclear power
plant located in central Japan. Moreover, the pace of reconfiguration of supply chains will
differ across industries and products. It might take time for consumer sentiment to fully
recover depending on the aftermath of the accident at the nuclear power plant and on the
employment and income situation.
To put it the other way around, if problems regarding supply constraints start to be resolved
at a faster pace than expected, the economy could deviate upward from the projection. While
there is a high degree of uncertainty about the prospect of supply constraints, in conducting
monetary policy, the Bank considers it appropriate to pay more attention to downside risks
for the time being. What is certain is that the most important challenge to eliminating
downside risks is to remove supply constraints as early as possible. On this point, many
firms have been making their utmost efforts to restore affected facilities, carry out production
at alternative sites, and secure alternative suppliers. Looking at worksites in the
manufacturing industry, various continued efforts and attempts have involved putting aside
the usual rivalries; for example, firms in the same industry temporarily covering the
production of disaster-stricken firms and several manufacturers of final products cooperating
in terms of sending staff to parts manufacturers to support their restoration efforts. The
Japanese industry has proved its competitiveness in overcoming and addressing challenges
in a flexible manner on many occasions. I hope that an early resolution of supply constraints
will be enhanced by utilizing such "competitiveness at worksites," or genbaryoku, in various
areas. Needless to say, it is important to prevent any deterioration in sentiment and
heightening of risk aversion with a view to avoiding any additional decline in demand until
supply constraints will be resolved. In this regard, the Bank has been swiftly implementing
various measures since immediately after the earthquake, which I will address later.
Price developments
Next, I will talk about price developments. I have just mentioned that the recent decline in
economic activity is basically caused by the supply shock. Thus, there is a view that the
decrease in supply capacity will cause a tightening of the supply and demand balance,
thereby potentially increasing inflationary pressure. However, as I said earlier, the disaster
has also resulted in a decline in demand. Therefore, the near-term prospect of the aggregate
supply and demand balance is not so obvious. Still, in the longer run, the year-on-year rate of
change in the consumer price index (CPI) is expected to remain slightly positive, as the
economy returns to a moderate recovery path from the second half of fiscal 2011.
For this projection to materialize, it is important that medium- to long-term expected rates of
inflation for businesses and households remain stable. On this point, as far as the results of
economists' surveys are concerned, no significant change has emerged in medium to
longterm expected rates of inflation. Another factor that affects prices is import costs. In this
regard, developments in international commodity prices, such as prices of crude oil, grains,
and nonferrous metals, are important. International commodity prices rose rapidly until spring
2011 and have experienced some adjustment since the end of April. It is difficult to forecast
the short-term fluctuations of market-determined international commodity prices. Thus, in
making its forecast, the Bank assumed that such prices are likely to continue a moderate
uptrend given strong growth in emerging economies. Expressing the outlook in numerical
terms, the year-on-year rate of change in the CPI is projected to be 0.7 percent both in fiscal
2011 and 2012.
If this projection materializes, the CPI for fiscal 2011 will become positive on a year-on-year
basis for the first time in three years, although this requires a supplemental explanation. In
August 2011, the Ministry of Internal Affairs and Communications, which compiles the CPI, is
scheduled to conduct the base-year change to the CPI, regularly conducted every five years.
It has been pointed out that there is usually a technical upward bias in the CPI compilation -
namely, a greater chance of having a somewhat higher inflation rate on a year-on-year basis
in the period immediately before the revision because substantial price declines in goods
such as personal computers and televisions are not sufficiently reflected. Thus, the rebasing
is likely to cause the year-on-year rate of change in the CPI to be revised downward.
Although there are some points that should be kept in mind, as described earlier, Japan's
economy is expected to return to a sustainable growth path with price stability in the longer
run. Having said that, the question we must ask ourselves is: to what kind of growth path
should Japan's economy return? I would also like to stress the significant importance of
serious efforts to raise Japan's economic growth rate in the medium to long term - beyond
the cyclical economic recovery.
II. Efforts to address medium- to long-term challenges
Even before the earthquake, the great challenge for Japan's economy was to raise its growth
potential amid a rapidly aging population that is unprecedented in other countries. Now, the
task of rebuilding and revival following the disaster is added to the list of challenges. In the
meantime, we cannot stop ongoing structural changes in the global economy, such as
economic and financial globalization as well as emerging economies catching up. What I
would like to emphasize today is that, even when doing our utmost to overcome the disaster,
we should not retreat from efforts to address the medium- to long-term challenges that have
been recognized for years. Rather, we need to change our way of thinking such that we
regard the post-quake responses and measures, including the revival of the disaster areas,
as a new starting point for the task of raising the growth potential of the economy.
A. Efforts toward raising the growth potential of the economy
The average growth rate of Japan's economy fell substantially to around 1.5 percent in the
1990s. In the 2000s, the average fell to barely 1 percent, partly due to the economic plunge
triggered by the failure of Lehman Brothers. This long-term downtrend in the growth rates
reflects the slowdown in the productivity growth rate from the 1990s and the accelerated
decline in the working-age population from the early 2000s. These problems need to be
addressed in order to sustainably raise Japan's economic growth rate.
First, given that the decline in the working-age population is the result of demographic
dynamics, it is not possible to immediately stop this long-term trend. Thus, in order to
revitalize the economy based on the current demographic trends, efforts to raise the share of
working people - namely, the labor force participation rate - are essential. In this regard, of
key importance is how to raise the labor force participation rate of the elderly and women,
especially women in their 30s, whose participation rate is low compared with abroad. With
regard to the participation rate of the elderly, large firms typically used to have a retirement
age of 55. Upon reaching that age, the remaining average life expectancy, which was
20 years for men and 24 years for women at the beginning of the 1970s - the last
highgrowth era - has risen to 27 years for men and 33 years for women, an increase of around
10 years over the past 40 years. Although their working patterns are not exactly the same as
those of younger generations, it is essential that the elderly join the workforce by making use
of their experience. In order to raise the labor force participation rate, it is necessary to
change the way of thinking within firms and society as a whole, such that workers are able to
have more flexible working patterns depending on their lifestyles and sense of values.
Second, it is also essential to raise the productivity growth rate. "Raising productivity" is often
perceived as pursuing more efficient management through a reduction in personnel and
equipment. It is true that, in the case of Japan, firms have a tendency to enhance productivity
through intensive cost reductions. However, such "streamlining" alone in many cases does
not lead to the enhancement of productivity for the economy; rather, it might end up in
contracted equilibrium. Raising productivity that would contribute to economic growth is
nothing more than raising individual persons' capacities for generating value-added, thereby
increasing the size of the economy as a whole. To this end, of importance are efforts to
discover new demand and create new markets both at home and abroad - namely,
embracing the role of innovation. In what follows, I will talk about these challenges in terms of
both global and domestic demand, and then the demand directly related to the earthquake
disaster.
Capturing global demand
In order to raise the productivity and growth potential of Japan's economy, even in this tough
situation after the earthquake, it is important to actively capture fast-growing demand in
overseas markets by adjusting to accelerating globalization. Since the earthquake, mainly
because of the effects of the accident at the nuclear power plant, Japan's reputation for
being "safe and secure" has been undermined; as a result, the number of visitors from
abroad have fallen substantially across the country and exports of food have been adversely
affected. This underscored the need to accurately and actively provide information on
Japan's situation, thereby dissuading from "passing on Japan," which might otherwise occur
on the basis of misunderstanding and rumors. At the same time, it is important to further
increase the added value of Japanese goods and services by responding to the needs of
foreign customers in a flexible manner.
Before the earthquake, the number of tourists from Asia increased by three times in
10 years, in what could almost be called a "Japan Boom." The disaster has ruined many
factories but not Japan's sophisticated technologies. The "soft power" that has supported
Japanese society is still there, as epitomized by good public safety, reliable business
operations, and personalized and courteous customer service. By making use of this
strength, if efforts continue to be made to polish the attractiveness of Japan's goods and
services, Japanese brands will see a revival and be viewed as more attractive with resolution
of the nuclear power plant problems and the passing of time since the earthquake.
It is a cause for concern that the disaster might affect Japanese firms' strategies for their
overseas production network and foreign firms' policies for procuring parts. Specifically, the
possibility has been pointed out that disruptions to supply chains and power shortages may
accelerate Japanese firms' shift to overseas production. Some foreign firms have started to
replace parts and materials obtained from Japan with products made abroad. There is a
possibility that this will not be a temporary emergency measure and thus result in a
permanent decline in the ratio of procurement from Japan. However, from a different point of
view, the disaster has reconfirmed that Japan's high-end parts and materials occupy
irreplaceable positions within worldwide manufacturing, especially in the areas of
automobiles and electronics. Japanese manufacturers have been increasing the ratio of
overseas production in the long run while creating new technologies and products in Japan
that other countries cannot easily imitate. This process is not the so-called hollowing-out of
Japan's manufacturing base, but rather product differentiation or a more advanced division of
labor across the national border. Since emerging economies are becoming more competitive
and sophisticated, the only way Japan can sustain itself in the global economy is by
continuing to strengthen efforts to generate products and services that are always one step
ahead. So long as Japanese firms maintain their fundamental strength, the global supply
chains will be reconfigured, with manufacturing within Japan as the central core. Moreover, in
order to provide a favorable environment in which Japanese firms and industries prosper
together with the global economy, it is important to steadily expand the framework for free
trade agreements and economic partnership agreements.
Exploring new domestic markets
Next, I would like to emphasize the need to explore new domestic markets. I mentioned the
decline in the working-age population as one of the factors behind the decrease in Japan's
economic growth rate. At the same time, however, Japan's economy has been faced with
chronic excess employment, and developments in wages and prices have been weak for a
protracted period. This fact suggests that simply blaming the decreasing workforce numbers
due to the aging of the population as the cause of the slowdown in Japan's growth rate
misses the point. The structural cause of slow growth in Japan is that firms and industries
have failed to recognize changes in the content of the potential demand driven by
demographic dynamics. The other side of the coin is that, once the existing markets for
goods and services mature and fall into excess supply, this situation tends to persist, and this
has become a factor responsible for generating excess employment and deflationary
pressure. The demographic dynamics of a declining working-age population itself is not a
direct cause of a decline in the economic growth rate; rather, it is more attributable to
economic and social systems that have failed to appropriately adapt to such demographic
changes.
The decline in the working-age population also represents the decline in the population that
accounts for the bulk of consumption. This will act as a factor to shrink the domestic market,
mainly the market targeting families, on the demand side. In this situation, without capturing
new demand arising from the aging of the population, the domestic market would shrink as a
whole. The desire to make life more comfortable is constant regardless of age. An
increasingly aging population should be creating new potential demand across a wide range
of areas such as health and nursing care, tourism, leisure, and cultural activity. The growth
areas are not limited to global demand. If potential demand is carefully examined, there are
also many seeds for growth in the domestic market. Of course, in order to explore new
demand, it is essential to have a strongly motivated management and financial infrastructure
that enables risk taking. In this regard, determination and efforts by the management of
individual firms to take up such challenges is the starting point for everything. At the same
time, it is important to have a business environment that supports such forward-looking
corporate activity, and to this end, collaborated efforts by all the concerned parties in the
country are needed. The aging population is not the only key area with regard to exploring
new markets. Given the problems in electricity power supply after the earthquake,
technological innovation in the energy area is promising as a way to increase the growth
potential of Japan's economy. Having nurtured sophisticated technologies for years, Japan is
well placed to explore business opportunities by pursuing the following three goals together:
"saving energy" to conserve energy through the wider use of LED lighting; "creating energy"
through the use of solar power; and "storing energy" through the efficient storage of energy
through improvements in battery storage. Constraints from natural resources and energy is
the big challenge that the global economy faces in the long run, and becoming a forerunner
in this area will be helpful in capturing global demand going forward.
Innovations to rebuilding and disaster prevention
In order to raise the growth potential of Japan's economy, the strength to develop new
markets by discovering potential demand is required. This also applies to the rebuilding
process in the disaster areas, which will make further progress going forward. The Tohoku
and northern Kanto areas are endowed with rich resources for agriculture and fishery as well
as tourism. These areas also have a solid foundation in academic research and
manufacturing, indicating considerable potential for responding to prospective demand.
Rebuilding of the disaster areas involves the process of reconfiguring places for industries
and employment in accordance with local peoples' needs, by making use of the areas'
advantages and competitiveness. Needless to say, the first priority is to return the people in
the affected areas to safe and comfortable lives as soon as possible. After completing such
rebuilding of lives, even if it takes some time, the disaster areas will definitely move forward
into the next phase, in which measures with new innovative ideas for regenerating the
regional economy will be implemented.
Moreover, the earthquake disaster has brought a renewed recognition that the Japanese
Islands always hold the inherent risk of earthquakes and tsunami. Not only the disaster areas
but also Japan as a whole need to make efforts to improve both physical and human
infrastructures, in order to make the country more resistant to natural disasters. There are
many kinds of potential demand, and in order to meet such demand, innovation again plays
an important role.
B. Efforts toward sustaining fiscal balance
I have stressed the importance of addressing the challenge of raising the medium- to
longterm growth potential of the economy, which is closely related to another challenge: efforts
toward sustaining fiscal balance. As the aging of the population will advance further, pension
payments and the costs of health and nursing care are projected to increase substantially. In
this situation, allowing the fiscal deficit to perpetuate itself would result in the uncontrollable
expansion of government debt outstanding, which is not sustainable. Once concern about
fiscal sustainability heightens, this could impair the smooth issuance of government bonds.
Moreover, if more people expect that a greater burden on the working-age population is
inevitable, the economy could fall into a vicious circle in which more cautious spending by
firms and households leads to a further economic downturn and a deterioration in fiscal
conditions.
As just described, the two challenges of raising the growth potential and fiscal consolidation
are not independent but inextricably linked. One challenge should not be given priority over
the other, but rather these must be addressed together. The large fiscal deficit has continued
since the 1990s on the back of successive fiscal stimulus measures and the rise in social
security costs, and addressing fiscal consolidation was an urgent task even before the
earthquake. Fiscal measures for the rebuilding and revival of the disaster areas will definitely
push up fiscal spending further even though it is still difficult to make an accurate estimate.
The expected fiscal deterioration in the short run makes it all the more important for the
government to present a more definite path toward medium- to long-term fiscal consolidation.
Fortunately, long-term interest rates in Japan remain stable at a low level on an international
comparison. With regard to the issuance market for government securities, these have been
issued quite smoothly since the earthquake. There are two reasons why the market for
government securities remains stable in this manner. The first is with regard to the aggregate
savings and investment balance. That is, in view of the continuing net saving position in the
household and corporate sectors, and given that financial institutions are maintaining a solid
capital base, there is a sufficient amount of domestic funds to purchase government
securities for the moment. The second reason concerns confidence in future policy
management. As for fiscal policies, despite the significant deterioration in fiscal balance,
market participants still expect that necessary steps will ultimately be taken to restore the
balance. Regarding monetary policies, there is confidence that monetary policies are
conducted with the objective to achieve sustainable economic growth with price stability.
Considering the severity of fiscal conditions, none other than the confidence I just described
is supporting the stability in the government securities market. People tend to believe without
doubt that what has continued over a long period will stay as it is, but we should be mindful
of the fact that confidence in the stability in the government securities market is only
maintained by people's will to adopt such a stance. Therefore, it is essential to take concrete
steps toward raising the growth potential and fiscal consideration when stability in the
government securities markets is maintained. Enhancement of market stability through these
efforts is also likely to contribute to promoting a supportive environment for the rebuilding and
revival following the disaster.
Given the already enormous fiscal deficit, underwriting of government securities by the Bank
of Japan is occasionally discussed as an option for funding new government spending.
However, it should be noted that there is no magic wand that creates something from
nothing. Whether government securities are underwritten by the central bank or purchased
by private financial institutions in the market, there is no change to the big picture in which
government securities are issued using firms and households' savings as a resource. Rather,
the central bank's underwriting of government securities often comes with a serious side
effect of weakening fiscal discipline. If the government depends on the central bank's
underwriting and ignores the market's risk assessment function, the government debt could
eventually expand to a level beyond the taxpayers' funding capacity. After the earthquake,
there has been increasing public interest in the historical episode of the Bank's underwriting
of government securities in the 1930s, when Mr. Takahashi was the Minister of Finance. This
started as "temporal" but it soon became impossible to put a brake on the increase in the
amount of underwriting and the associated expansion of currency issuance, which ultimately
resulted in serious inflation. We need to reflect on this hist