Potential growth rate (Average of CAO and BoJ estimate)
Economy should rebound from COVID-19 slump, but longer-term outlook bleak
There are as yet no signs of an end to COVID-19 pandemic either in Japan or elsewhere, but the Japanese and global economies are rebounding from their Q2 bottom and we expect them to sustain a gradual recovery. However, several structural issues lead us to take a cautious longer-term view.
Three structural issues
The main structural issues for Japan’s economy and society are
- a falling birth rate and ageing population (demographics),
- the sustainability of government debt and the social insurance system (fiscal sustainability), and
- low productivity. The pandemic could further exacerbate all three.
Reasons for low labour productivity
The Japanese economy’s low productivity mainly reflects
- low ICT investment/adoption,
- minimal investment in intangible assets, and
- inappropriate resource reallocation.
Labour productivity’s link with stock market and ROE
ROE at Japanese firms has consistently remained below US and European peers. There is a positive correlation between major countries’ ROE and labour productivity, both of which are low in Japan. We think changes that prompt higher ROE at listed companies would benefit Japan as a whole.
Implications from COVID-19: DX, move away from Japanese labour practices
The pandemic has spurred moves to (1) shift to remote and online activities, (2) streamline administrative procedures, and (3) decentralise away from Tokyo. We think these three changes will accelerate the digital transformation (DX) of Japan’s economy and society. They may also shift Japan’s employment system from a membership (seniority) structure to a role-based (pay for performance) footing. Broad-based change on this front could increase labour market liquidity and facilitate corporate and industrial reorganization.
Not optimistic, but potential exists for bottom-up change
However, it is hard to be optimistic about a future rise in productivity and the changes it would require. This reflects
- reduced investment due to a sharp contraction in overall demand,
- excessive worker protections,
- the lack of political/government will, and
- social conservatism.
Despite this, we see the potential for corporate leaders, equity investors, and individuals (workers) to drive change. We will be following DX progress and changes in labour practices as a gauge of prospects for better productivity in Japan’s economy and companies.