Real GDP in July-September Quarter Looks to Have Contracted Slightly

The July-September 2023 Quarter Primary Report, set to be released by the Cabinet Office on November 17, is expected to show that real GDP contracted from the previous quarter. This would mark the first negative growth seen in one year since the July-September 2022 quarter.

However, this negative growth would very much seem to be a reactionary decline following the major uptick in the real GDP growth rate during the preceding April-June 2023 quarter, when it grew 4.8% on an annualized quarter-on-quarter basis (Secondary Report). For this reason, even with the negative real GDP growth rate for the July-September quarter, the economy is still on track for a recovery.

According to the ESP Forecast Survey (October survey) conducted by the Japan Center for Economic Research, the average predicted value for real GDP in the July-September quarter was -0.48% on an annualized quarter-on-quarter basis. Real imports—which fell substantially last quarter and thereby helped boost the growth rate—were instead up this time by 2.3% from the previous quarter, thus putting downward pressure on the growth rate. Meanwhile, real private consumption and real business fixed investment, each a pillar of domestic demand that contracted last quarter, are actually expected to have risen by 0.4% and 0.9% respectively from the previous quarter.

Real GDP growth in the October-December quarter is projected to show relatively stable quarter-on-quarter growth of 0.7%. Circumstances suggest at the very least that domestic economic conditions for the rest of the year will not be a major cause for concern.

Overseas economic risks shift from China to the U.S.

That said, heading into next year, the Japanese economy is expected to face headwinds coming both from abroad and domestically. The overseas factors include a slowdown in overseas economic conditions and slower export activity. The economy of China, which is Japan’s largest export market, continues to stagnate. With the economic measures taken by the government remaining limited in scale, given what’s happening with the ongoing real estate slump and the accompanying defaults on corporate bonds from real estate developers, as well as the defaults on real estate-related wealth management products and trust products for investment, any monetary turmoil could cause the Chinese economy to stall.

Conversely, the economy of the United States, which is Japan’s no. 2 export market, saw a real GDP growth rate of 4.9% in the July-September quarter over the previous quarter. However, according to the GDPNow forecast from the Atlanta Fed, the current forecast for the real GDP growth rate in the October-December quarter is 2.1% on an annualized quarter-on-quarter basis, meaning a return to cruising speed is expected. On the other hand, the October hiring statistics and housing-related indicators also show signs of weakness, and it’s even possible that the effects of the significant interest rate hikes and rise in long-term interest rates that began last year could lead next year’s growth rate to fall substantially.

If the U.S. economy were to follow China’s by showing clear signs of slowing down, Japan’s export environment would suddenly become tighter.

Real wages continue to decline

In terms of domestic factors, the adverse effects had by high prices on private consumption remain a strong headwind for the economy. The September real wage growth rate (nominal wage growth rate – inflation rate) was -2.4% year-on-year, making for 18 consecutive months of decline. With the wage growth rate unable to keep up with inflation, people are continuing to feel the squeeze in their daily lives.

On October 19, RENGO announced the “Basic Concept” of its approach for the 2024 spring labor-management wage negotiations. It raised its overall wage hike target from “around 5%” as stated in 2023 to “5% or more” for 2024, while also raising its base pay hike target from “around 3%” to “3% or more”.

With the further raising of these targets, there are also mounting expectations that next year’s wage growth rate will significantly surpass this year’s level. In fact, it’s expected that if economic conditions hold steady, and labor market conditions continue to be tight, during next year’s wage negotiations the wage growth rate could even reach its highest level in recent years.

However, whether next year’s wage growth rate will significantly exceed this year’s level remains to be seen. That’s because a downward trend in inflation would be unfavorable for wage growth.

Companies wary of base pay increases significantly higher than 2%?

In the January Consumer Price Index, which was used as a reference when this year’s wage negotiations were in full swing, the Core CPI (excluding perishables) growth rate was at +4.2% year-on-year. By contrast, the current Core CPI was 2.8% higher year-on-year in September, falling below 3% growth for the first time in 13 months. Furthermore, this figure is expected to fall to just over 2% growth next January. That would only be at around half the level seen last January.

Given the history involved here, in which price trends have played a major role in Japan’s wage decisions, it’s possible that under such price conditions the wage growth rate next year won’t necessarily outpace this year’s level by very much. What does have a major effect on prices by way of higher private consumption and corporate labor costs is a rise in base pay, but that can be expected at most to increase by around 2.5% next year. As a result, it’s expected that positive growth in real wages will not come next year but will rather be pushed off till 2025.

In the latest Tankan short-term economic survey from September released by the Bank of Japan, the average forecast for inflation five years down the road among companies surveyed (All Enterprises and Industries) was +2.1%. Since the medium-term inflation forecast was around +2.0%, companies are likely wary about raising their base pay by a level far surpassing that.

Given how difficult it would be in Japan to negatively adjust base wages and reduce people’s base salaries, companies will probably be cautious in deciding their base wage increases each year, mindful of the risk that future labor cost increases could put pressure on their earnings. 

Spring wage negotiations could even trigger a downtick in private consumption

Meanwhile, the medium- and long-term inflation forecast among individuals is perhaps much higher than that among companies. Further, there are also expectations of high wage growth over the medium- and long-term, meaning that even with real wages continuing to fall, private consumption has held fairly steady.

In addition, there are growing speculations in the financial market that next year’s spring wage negotiations might deliver a major wage hike, which could trigger the Bank of Japan to declare that its 2% price stability target has been achieved, and lead the BOJ to embark on a full-scale monetary policy revision including the elimination of its negative interest rate policy.

However, if the wage growth rate actually falls short of the financial market’s expectations and base pay goes up by around 2.5%, there’s a risk that this would deal a major disappointment to consumers, and lead private consumption to decline.

The government’s comprehensive economic package will have limited effects

The government officially decided on November 2 on a comprehensive economic stimulus package. What gained the most notice in that package were the income tax reductions and benefits. The total sum of the 40,000 yen in income tax reductions plus another 40,000 yen in benefits for dependents would come out to around 3.6 trillion yen, which is estimated to boost real GDP by 0.12% over one year.

The additional income tax reductions and benefit payments including those for low-income households would reach a total of around 5 trillion yen in scale, yet the boost to real GDP from those would be limited to 0.19%, which gives one the sense that the cost-effectiveness of these measures will generally be small.

When the comprehensive economic package is viewed in its entirety, it can be expected to boost GDP by 1.19%, which would be somewhat effective. But approximately half of that (the part that will presumably have relatively significant effects) lies in “5. Improving National Resilience, Disaster Prevention and Mitigation”, which at its core involves public-sector investment having major economic stimulus effects. However, this is budgeted every year under the government’s autumn economic measures as part of the supplementary budget, and is something normal, as it were. For that reason, this can’t be expected to produce very much in the way of economic stimulus effects compared to last year. Excluding the 0.59% increase achieved from “5. Improving National Resilience, Disaster Prevention and Mitigation”, the real GDP boost from the comprehensive economic stimulus package in overall terms would come out to only around +0.6%.

The Japanese economy to face troubles both at home and abroad next year

A larger proportion of these temporary (non-permanent) tax reductions and one-time benefits payments will no doubt go to savings, and this is why the economic effects of such measures will be limited. The government’s current round of economic measures, particularly the centerpiece income tax reductions and benefit payments, are not really aimed at stimulating the economy, but are rather being positioned as measures for dealing with inflation outpacing wages, and as medium- and long-term measures intended to steadily overcome deflation.

Yet as seen in the above estimates, any measures that won’t have much of an effect on individuals’ consumption behavior in the short term probably won’t be very effective at softening the psychological blow to consumers from high prices, or at boosting the economy in the medium and long term.

With the government’s economic measures thus not likely to have any significant effects, high prices and falling real wages could prove detrimental to private consumption next year as well, and disappointment in wage growth following the spring wage negotiations could bring a decline in private consumption. Furthermore, a deteriorating economic environment overseas could also impede economic conditions in Japan, leaving the Japanese economy next year exposed to troubles both at home and abroad.

• 

  Takahide Kiuchi

  Executive Economist