Serious Money:In his farewell speech on the White House lawn in 1974 Richard Nixon remarked that, "only when you've been in the deepest valley can you ever know how magnificent it is to be on the highest mountain".
The former president's sentiments are unlikely to be lost on long-suffering investors in the Japanese stock market who have earned zero capital gains over the past two decades and suffered a more than 50 per cent drop in prices from the market's record high set in 1989. However, Japan has emerged from years of economic stagnation and is currently enjoying the longest period of uninterrupted growth in the post-war era.
Not surprisingly, stock prices have advanced in each of the past four years, the longest winning streak since the 1980s. Is it time to reconsider Japan?
Japan's economic and financial malaise through the 1990s and beyond is unprecedented among developed economies in the post-war period but its performance in recent years suggests that the country has finally surfaced from the massive deflationary correction.
The current expansion recently surpassed the 57-month Izanagi boom of the 1960s as the country's longest post-war upturn. Corporate profits have increased in each of the past five years and business confidence is the highest in more than 15 years. Exports as a percentage of GDP have recently surpassed the record levels of two decades ago. Unemployment is hovering close to an eight-year low.
Importantly, the GDP deflator for domestic demand finally turned positive during last year's second quarter. Solid growth combined with the end of deflation encouraged the Bank of Japan to raise interest rates above zero last July for the first time in six years.
The country has also managed to make progress on structural issues in recent years. Corporate debt as a percentage of GDP has dropped to pre-bubble levels, industrial capacity has declined to the lowest level since 1987 and there has been considerable progress in reducing the non-performing loans of the major banks.
However, the country, despite the significant improvements in certain areas, faces a number of daunting challenges, which are likely to depress potential economic growth to little more than 1 per cent in the years ahead.
Japan's population is ageing rapidly and the labour force looks set to decline by 10 per cent within the next two decades. The drop in the labour force should begin this year as the baby boomers born in 1947-1949 are set to turn 60, the compulsory retirement age in more than 90 per cent of all companies. A steady drop in the hours worked per capita since the early-1990s compounds the problem and this trend is unlikely to be reversed as the population ages.
To tackle the impending demographic problem, Japan needs to increase the retirement age, raise the relatively low female labour participation rate and embrace large-scale immigration.
The retirement age has remained at 60 for years despite continuous increases in life expectancy, which is already the highest in the world. Potential economic growth could be raised by a quarter of a percentage point if retirement was delayed until 70 but such a sharp increase is unlikely.
Japan's female labour participation rate is one of the lowest in the developed world and, at 60 per cent, it is almost 10 percentage points lower than the US. Japanese women typically leave the labour force when they get married or give birth and return to work when their children have become independent. However, they usually return to work on a part-time basis as their own parents often require convalescent support by that stage.
The authorities need to tackle the problem through the introduction of tax efficiencies for married women to remain in the workforce and an expansion in the amount of childcare available. However, progress is slow.
Japan remains a largely closed economy and foreign workers account for a mere 1 per cent of the labour force. Additionally, only the highly skilled are welcome.
There is considerable potential to boost the number of immigrants, particularly from nearby countries with large young populations. However, given that there has been no change in migration policy in recent years, Japan is unlikely to embrace the potential.
Despite reforms in recent years, Japan's business sector still remains relatively closed to what Joseph Schumpeter described as the "perennial gale of creative destruction". The country's business closure and start-up rates are less than half the level seen in the US.
Under such circumstances, it is not surprising that there has been a steady decline in the productivity of capital over the past three decades. Additionally, the flexibility to hire and fire is relatively low, which contributes to the lowest level of labour productivity among the seven major industrialised economies. It is 30 per cent below US labour productivity and the gap continues to widen. Japan needs to embrace creative destruction if it wishes to keep pace with the rest of the developed world.
Japan has finally emerged from years of economic stagnation and the expansion is likely to persist through the current year.
However, headwinds that could depress long-term growth to just 1 per cent lie in store. Its stock market looks attractive on a short-term basis as global economic growth remains strong but whether it can be considered a home for long-term investment is far from clear.
Charlie Fell is an independent consultant and lectures in finance and investment at UCD and the Institute of Bankers in Ireland
