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Briefing Report

The Outlook for the Japanese Economy in 2006

General Manager and Chief Economist, Investment Research Department, Mitsubishi UFJ Research and Consulting Co., Ltd.
Mr. Yuji Shimanaka

[Economy] January 13 , 2006

Now I would like to introduce one striking feature of the Japanese economy that I discovered―
amely, the principle of the first half and second half of a decade. Dividing each decade into a first half of five years and a second half of five years and looking at the ratios of each half in periods of economic expansion, we see that the second half is always more expansionary than the first half. This is not something that I made up myself; it is quite true. Since the 1950s, without fail the Japanese economy has shown more expansion in the second half of the decade than in the first. For example, in the period from 1956 to 1960 the ratio of capital investment to GDP increased, and there was a strong expansionary period that was the beginning of the high growth of the Japanese economy through the Jinmu boom and the Iwato boom. From 1961 to 1965 the economy relatively weakened in order to adjust the swelled capital investment, but then from 1966 to 1970 there was another boom in capital investment and consumer durables, and the Izanagi boom, which I mentioned earlier, continued for 57 months. After that, although there was a difference in degree because of such events as the oil shocks, the Plaza Accord, the financial crisis, and so on, the basic current of the Japanese economy has remained unchanged. And this year, 2006, brings a year of upward movement. That is to say, from this year the Japanese economy has entered the second half of the decade and the upward phase in the Juglar cycle.

Next, I would also like to introduce a long-term cycle of 20 years discovered by the American economist Simon Smith Kuznets [1901–85]. This is called the Kuznets cycle. Although there is no reason to link the Kuznets cycle with construction activity for discussion, in Japan it does seem to be connected to construction activity and real estate trends. For example, the floor area of construction work starts in the mining and manufacturing industries and the job offers-to-applicants ratio, which shows labor supply and demand, coincide almost perfectly, repeating ups and downs in a cycle of about 20 years right up to the present. Also, trends in the number of cases of domestic plant location and trends in the construction starts floor area are almost identical. They both hit the bottom in 2002 and are now on the rise. This is especially so because domestic plant location has been increasing since 2003.

Japanese companies often used to set up plants overseas, but recently companies in high-added-value industries or manufacturing high-added-value products, such as the digital household electronic appliance industry and the auto industry, have shown a tendency to locate plants in the suburbs of large cities in Japan, where land prices have become cheaper. From past trends, it is said that once it has started to rise, the number of cases of domestic plant location continues to increase for about 10 years. However, this is nothing more than a kind of prediction, and there is no guarantee that plant location will continue to increase if there is no substance. I think that the key here lies in the rise of land prices.

Looking at the year-on-year growth rate, as a total average, of the urban land price index in six major cities and the year-on-year growth rate of the 225-issue Nikkei stock average, we see that these two also coincide. As a general trend, stock prices tend to move ahead of land prices by about a year and a half. As you know, the current increase in stock prices is extremely sharp indeed. Judging from past experience, the growth rate in land prices will probably also accelerate from now on. Actually, the year-on-year growth rate of the land price index in six major cities stood at –0.8 percent at the end of September 2005. But the figure six months earlier, at the end of March 2005, was –3.7 percent, and six months before that, at the end of September 2004, it was –5.8 percent, so I expect that it will be positive at the end of March 2006.

Of course, plant location is not the only reason for the rise in land prices. Other factors are, concerning residential land, the movement of the middle-aged and elderly baby-boom generation and the acquisition of housing by their children, as well as the grand urban renewal that is taking place at the moment in Tokyo and other large cities, which involves the construction of large office buildings and so on. On the other hand, a negative factor for land prices is the reduction of public works investment. This is clear if you look at the ratio of public works investment to GDP. In fact, public works investment was also heavily squeezed at the time of the administration of Prime Minister Yasuhiro Nakasone 20 years ago, before the bubble era. The Nakasone administration followed almost the same course as the current administration of Prime Minister Junichiro Koizumi, not only in reducing public works investment but also restraining fiscal expenditures and promoting privatization. There is a debate about whether this reduction of public works investment led as a result to the bubble economy or whether there were completely different factors at work. I think that it was probably the latter, in other words, deregulation and the super-easy monetary policy, but nevertheless, looking at this trend of public works investment, I cannot help thinking that it is extremely similar to the situation 20 years ago.

Whatever the case, since it has become difficult for regional land prices to rise because of the reduction of public works investment, with the exception of the three major metropolitan regions and ordinance-designated cities, in smaller regional cities, such as prefectural capitals, the urban land price index continues to show an extremely large negative figure compared with the previous year. This is creating an economic gap between the main cities and the provincial regions in Japan. Land prices continued to fall for 14 consecutive years from 1992, but I believe that from now on land prices as a whole are going to leave this downward trend and steer the Japanese economy toward a situation that, in the words of Minister of Internal Affairs and Communications Heizo Takenaka, “is no longer the post-bubble period.”

Finally, to sum up, there are four types of economic cycle. The first is the short-term inventory cycle. This is the Kitchin cycle, named after the American economist who discovered it, Joseph Armstrong Kitchin [1861–1932]. The Kitchin cycle repeats itself in cycles of about three and a half years. The second is the Juglar cycle, a capital-investment cycle repeating itself about every 10 years. The third is the 20-year Kuznets cycle, which I understand to be a cycle of construction investment. And the fourth is the Kondratieff cycle, named after the Soviet economist Nikolai Dmitrievich Kondratieff [1892–1938]. The Kondratieff cycle, which repeats itself in cycles of about 55 years, shows the deviation from the trend line of the domestic corporate goods price index and, as a financial statistic taken for a long time in the past, the deviation from the official discount rate trend line. There is a debate about why this occurs, but I understand it to be a cycle of infrastructure investment. Furthermore, the Kondratieff cycle also has a separate aspect. It can be taken to mean trends in technological innovation, nominal trends, and price trends.

When we look at these four cycles in the light of actual statistical data, we see that, in terms of the Kitchin cycle’s shipment-inventory balance, the Japanese economy has completed the phase of inventory adjustment and is entering the phase of reacceleration. In terms of the Juglar cycle, at present the ratio of capital investment to GDP is beginning to rise and is expected to continue increasing from now on. In terms of the Kuznets cycle, from construction starts floor area and the year-on-year land price index, I think it will continue to increase from now on. And in terms of Japan’s Kondratieff cycle, which is shown by domestic corporate goods prices and the official discount rate, it appears to have hit the bottom in 2002 and 2003 and at present to be moving upward. In other words, long-term moves away from deflation have come into view.

I think we can say that for the Japanese economy in 2006, all four cycles― he inventory cycle, the capital investment cycle, the construction investment cycle, and the price or infrastructure investment cycle―will show increases. I call this situation “the golden cycle.” Until now there have been extremely pessimistic views of the Japanese economy in various quarters, but I believe the time is coming for us to do away with this pessimistic-only thinking.