The Cabinet Office’s Annual Economic and Fiscal Report

The Japanese Cabinet Office has released its “Annual Economic and Fiscal Report — Fiscal Year 2024”, under the direction of the Minister of State for Economic and Fiscal Policy, with the theme “Towards a new economic stage brimming with energy”.

Introduction

Japan’s economy is at a pivotal moment, having emerged from the COVID-19 pandemic and facing a confluence of unique challenges and opportunities. This report provides a comprehensive analysis of Japan’s macroeconomic trends and outlines critical policy considerations to address these challenges and realize the full potential of the Japanese economy.

Chapter 1: Macroeconomic Trends and Challenges

1.1 Recent Economic Performance

• Moderate GDP Growth: While the Japanese economy is recovering gradually, the pace remains sluggish, particularly in private consumption. Several factors contribute to this, including wage growth lagging behind inflation, leading to weakened purchasing power among households.
• Robust Corporate Sector: Corporate profits have reached record highs, and capital investment, particularly in manufacturing, is robust. However, labor shortages continue to pose a constraint on further expansion.
• Sluggish Private Consumption: While service consumption is recovering, non-durable goods consumption remains weak due to inflationary pressures and consumers’ preference for saving over spending.
• External Trade Dynamics: Exports are facing headwinds due to global economic slowdown, especially in China. Imports, driven by digital services and other imports excluding inbound tourism, continue to increase.

1.2 Building a Sustainable, Non-Deflationary Economy

• Wage-Price Spiral: Japan is finally witnessing a positive wage-price spiral, with wage growth reaching its highest level in three decades. However, nominal wage growth still lags behind inflation, hindering a robust recovery in private consumption.
• Inflationary Pressure and Policy Implications: While overall inflationary pressure has moderated from its peak, core inflation remains above the 2% target. The report emphasizes the need for a continued focus on achieving sustained wage growth exceeding inflation, thereby fostering a virtuous cycle of increased consumption and investment.
• Price Pass-Through and Policy Response: The report highlights the evolving price pass-through mechanism in Japan, with corporations increasingly passing on rising input costs to downstream prices. This shift in corporate behavior necessitates a re-evaluation of various economic policies, including public service fees, to ensure they reflect the evolving economic reality.

Chapter 2: Addressing Growth Constraints Posed by Labor Shortages

2.1 Labor Market Dynamics

• Severe Labor Shortages: Japan is experiencing historically high labor shortages, particularly in sectors like construction, transportation, and healthcare. The report underscores the need for a multi-pronged approach to address this challenge, including:
   — Wage Increases: Encouraging companies to raise wages, especially for workers in high-demand sectors, to attract and retain talent.
   — Labor-Saving Investment: Promoting investment in labor-saving technologies, particularly in sectors facing severe labor shortages.
   — Facilitating Labor Mobility: Addressing the issue of labor market mismatch through initiatives such as reskilling programs and streamlining hiring processes.

2.2 Labor Mobility and Mismatch

• Mismatch in the Labor Market: While the unemployment rate is low, Japan’s labor market is characterized by high levels of mismatch, particularly in major metropolitan areas. Specifically, there is an oversupply of clerical and sales workers in urban areas, while other occupations, such as construction, nursing, and engineering, face widespread labor shortages.
• Improving Labor Mobility: The report emphasizes the importance of facilitating labor mobility between sectors to address the mismatch issue. Key recommendations include:
   — Reskilling Programs: Investing in reskilling programs to equip workers with the skills needed in high-demand sectors.
   — Promoting Job-Type Employment: Encouraging the adoption of job-type employment contracts to enhance transparency and facilitate labor mobility.
   — Addressing Regional Disparities: The report also highlights the need to address regional disparities in labor market conditions, with major metropolitan areas experiencing more severe labor shortages compared to other regions. Promoting regional revitalization and decentralization strategies could help alleviate some of these pressures.

2.3 Foreign Workers in Japan

• Growing Importance of Foreign Workers: The number of foreign workers in Japan has been steadily increasing, reaching a record high of over 2 million, accounting for 3.4% of total employment. This trend highlights the critical role foreign workers play in addressing labor shortages.
• Wage Gap between Japanese and Foreign Workers: The report acknowledges a wage gap between Japanese and foreign workers, although it finds that most of this gap can be explained by differences in individual attributes and workplace characteristics. However, a portion of the gap remains unexplained, suggesting the possibility of discriminatory practices.
• Promoting Integration and Retention: The report emphasizes the need to promote the integration and retention of foreign workers in Japan. Key recommendations include:
   — Addressing Wage Disparities: Addressing any remaining unexplained wage gaps between Japanese and foreign workers, ensuring fair treatment and equal opportunities.
   — Facilitating Skill Transfer: Easing restrictions on job mobility for foreign workers and promoting the recognition of their skills and qualifications.
   — Supporting Integration into Japanese Society: Providing support for foreign workers in terms of language learning, access to social services, and community integration.

Chapter 3: Leveraging Stock Assets for a More Prosperous Society

3.1 Current State and Challenges of Household Financial Assets Investment

• Abundant Financial Assets: Japanese households hold a vast amount of financial assets, exceeding 2,000 trillion yen. However, these assets are predominantly held in low-yielding cash and deposits, resulting in low returns and hindering effective utilization of these assets for the broader economy.
• Shifting Investment Behavior: Recent policy initiatives, such as the expansion of the NISA (Nippon Individual Savings Account) program, are contributing to a gradual shift in household investment behavior, particularly among younger generations who are increasingly allocating their assets to riskier assets such as stocks and mutual funds.
• Promoting “Savings to Investment”: The report emphasizes the need to further promote the flow of “savings to investment” to channel household financial assets into more productive investments that can contribute to economic growth. Key recommendations include:
   — Enhancing Financial Literacy: Enhancing financial literacy among households to empower them to make informed investment decisions.
   — Promoting Long-Term Investment: Creating a more favorable environment for long-term investment, including through tax incentives and financial education programs.

3.2 Outlook and Challenges of Housing Stock

• Shifting Demand Structure: Japan’s housing market is facing significant structural changes due to demographic shifts, including population decline and aging. The demand for new homes is declining, while the demand for existing homes is increasing, particularly among younger generations and those living in urban areas.
• Expanding the Existing Home Market: The report emphasizes the need to expand the existing home market to meet the evolving needs of Japanese households. Key recommendations include:
   — Promoting Renovation: Promoting renovation and refurbishment of existing homes to improve their quality and longevity.
   — Enhancing Transparency in Transactions: Improving transparency in existing home transactions, including through the wider use of home inspections and the development of standardized valuation methodologies.

3.3 Current State and Challenges of Older Worker Employment: Knowledge and Experience Stock Utilization

• High Employment Rate Among Seniors: Japan has a relatively high employment rate among seniors, exceeding that of other developed countries. This trend is attributed to the combination of a strong work ethic among older generations, government policies encouraging continued employment, and increasing labor demand in sectors facing labor shortages.
• Potential for Increased Labor Input from Seniors: Despite the high employment rate, there is still potential for further increases in labor input from seniors, particularly among women. The report emphasizes the need to address factors hindering female labor participation, such as childcare responsibilities and gender wage gaps.
• Promoting Senior Employment: The report highlights the importance of creating a more supportive environment for senior employment to leverage the knowledge, experience, and skills accumulated by older workers. Key recommendations include:
   — Easing Restrictions on Working Hours: Addressing regulations that discourage seniors from working longer hours, such as the “earnings test” for pension benefits.
   — Promoting Skill Transfer and Mentorship: Encouraging companies to create programs that facilitate skill transfer and mentorship between older and younger workers.

Conclusion

Japan’s economy faces significant challenges, including sluggish private consumption, labor shortages, and an aging population. However, by embracing the evolving economic reality and implementing policies that address these structural issues, Japan can build a more sustainable, dynamic, and prosperous economy for all.

This report serves as a vital blueprint for policymakers, businesses, and individuals to navigate Japan’s current economic landscape and chart a course towards a more prosperous and equitable future.

Please follow us to read more about Finance & FinTech in Japan, like hundreds of readers do every day. We invite you to also register for our short weekly digest, the “Japan FinTech Observer”, on Medium or on LinkedIn. Our global Finance & FinTech Podcast, “eXponential Finance” is also available through its own LinkedIn newsletter, or via our Podcast Page.

Should you live in Tokyo, or just pass through, please also join our meetup. In any case, our YouTube channel and LinkedIn page are there for you as well.