Japan experienced a sharp contraction in GDP in the fourth quarter of 2019 (Figures 1 and 2). GDP fell by -1.6% (quarter-on-quarter, non-annualised), its biggest contraction since the -1.9% fall in the second quarter of 2014. This poor performance was due to falling private domestic demand. Consumer spending was hit particularly hard. Over the year as a whole, the Japanese economy grew by 0.7%.
Collapse in private consumption, significant weakness in business investment
The Japanese economy suffered from two sizeable shocks in the final quarter of 2019.
A clear dip in GDP in Q4 2019First, having delayed its implementation, the authorities decided at last to increase VAT from 8% to 10% in October 2019. This was the 3rd increase since the tax was introduced (1997, 2014 and now 2019). The last time the rate was raised, Japanese consumers significantly reduced their spending. The fall in private consumption of around 3% (q/q) in the 4th quarter of 2019 is less than the 4.8% contraction in Q2 2014 when VAT was raised from 5% to 8%.
Private domestic demand suffered in Q4 2019The fourth quarter was also affected by a typhoon which did significant damage to domestic demand. Against this background, private non-residential investment fell by nearly 4% (q/q) in Q4 2019 relative to Q3. A quiet decent growth of public sector investment came nowhere near offsetting the drop in investment by private companies.
That being said, public sector investment is likely to remain strong over the next few quarters, given the ramping up of the investment programme (to around 2% of GDP) announced by the national authorities in December.
Although the contribution to growth from international trade, in the form of net exports, was significantly positive in the fourth quarter 2019, this was solely the result of a fall in imports in response to the deterioration of domestic demand. Exports were flat from one quarter to the next.
Japanese private consumption: a structural weakness
Private consumption is relatively low (% of GDPPrivate consumption accounts for a relatively small share of Japanese GDP compared with the average for other OECD countries, and particularly in comparison to the United States (Figure 3). Moreover, the share of consumption in the Japanese economy has significantly declined since 2014. Conversely, the total investment rate in Japan is relatively high compared to the OECD and the US. The latter have a level of economic openness (exports/GDP) that is also less than Japan’s.
Consumer spending is seeing a structural slowdown in Japan, with virtually no growth on average since the VAT hike in 2014 (Figure 4). This trend was notably related to the downward trend in nominal wages. Since late 2013, this has reversed, but growth in real wages remains lacklustre (Figure 5).
The uneven pattern of private consumptionLastly, consumers can, in certain circumstances, bring forward purchases before the increase in VAT. However, on previous occasions when the VAT rate has been increased, the following quarter has not brought the recovery in consumer spending that this might lead one to expect. Past examples therefore suggest little in the way of positive prospects for early 2020.
Conditions will remain challenging in the early part of 2020
Little support from real wagesThe economic weakness in late 2019 is already hitting the trends for 2020, with a negative carry-over growth effect. Given its close relations with China, the effect of the Coronavirus outbreak on Japan could be significant and will have two channels of transmission: trade (directly or through value chains) and tourism.
As far as trade is concerned, China receives 20% of total Japanese exports of goods. Given the scale of its manufacturing sector (20% of Japanese GDP), this could suffer from a slowdown in demand from China. In addition, the content of Japanese added value in Chinese domestic demand (and vice versa) is far from marginal.
As far as the tourism channel is concerned, Chinese visitors are an important factor, accounting for more than a quarter of all tourist visits to Japan last year.
All in all, there are significant threats to the macroeconomic scenario. It now looks possible that Japan’s economy will contract this year.
