Japan's economy

Down but not out

Japan could yet outperform the other big rich economies over the next year

THE surprise resignation of Japan’s prime minister, Yasuo Fukuda, has once again left the world’s second-largest economy rudderless—just as it seems to be drifting dangerously towards the rocks. Although America is the centre of the world’s financial troubles, Japan’s economy appears to have been hit harder: its GDP fell sharply in the second quarter, whereas America’s continued to expand. Indeed, many economists expect Japan’s economy to shrink again in the three months to September, which on the rule of thumb of two consecutive quarters of decline, would imply a recession. You might conclude that without radical reform Japan will continue to underperform. However, a more thorough health check suggests that Japan’s economy is actually in better shape than it looks, and its downturn may be shorter and shallower than those in America and most European economies could be.

Three days before Mr Fukuda quit, fears that the economy was sinking into another deep recession panicked the government into announcing a modest stimulus package of tax cuts and financial assistance for transport and construction industries, and for smaller firms. Even if these measures are carried out, most economists do not think it would do much to revive the economy. Some politicians would like a big increase in public spending, but the government has promised to eliminate its primary budget deficit (ie, before interest payments) by 2011-12 in order to reduce public-sector debt of 170% of GDP—the largest among the big rich economies.

The government’s balance sheet may seem dire, but the private sector’s looks healthier than for many years, because Japan has avoided the economic and financial imbalances that threaten many economies in the West. Unlike America and parts of Europe, notably Britain, Japan is not experiencing a credit crunch and house prices are not collapsing. Consumer and corporate finances are also generally in better shape.

Japanese financial institutions’ losses on securities linked to American subprime mortgages so far amount to just $17 billion, out of worldwide losses of $500 billion. As a result, most banks can still lend, except to property developers, some of which rely heavily on funding from abroad and from small regional banks. Several of them have gone bust in the past few months. More generally, however, Japanese house prices are unlikely to crumble. After its housing bubble burst in the 1990s, the market has not inflated again.

The biggest contrast with America and Britain is that Japanese households have reduced their debt from 71% of GDP in 2000 to 63% this year, according to Goldman Sachs. This is much lower than debt ratios of around 100% in both America and Britain, where borrowing has exploded over the past decade (see chart). The only other G7 economy where consumer debt has declined is Germany, which has also avoided a housing bubble.

Japanese companies have trimmed their debts even more dramatically, to 78% of GDP from 130% in 1991. The level is now well below where it was before the 1980s bubble, though higher than corporate America’s debt of less than 50% of GDP. (American firms have traditionally relied more on equity financing.) On the other hand, corporate debt has expanded rapidly in the European Union.

Heavy debts, falling property prices and a shortage of new credit are a lethal cocktail, which could depress economic growth in America and parts of Europe for several years—as Japan itself found out in the 1990s. Today Japan’s economy is much less burdened by debt and so likely to recover more quickly.

Another reason why the downturn in Japan could be fairly mild is that almost half of Japan’s exports go to other buoyant Asian economies. Exports had been the main force behind Japan’s recovery before they slowed this year. Shipments to America and to Europe have fallen, but demand from the rest of Asia remains strong. In July, for the first time, Japan exported more to China than to America.

Japan’s long-term growth rate has undoubtedly been strangled by the lack of reform. Yet its economy is now in better shape than for many years. Japan’s GDP is likely to grow faster than both America’s and the euro area’s over the next year. If so, 2009 will be the fourth year running that Japan’s GDP per head shows the biggest increase of the three. And that is not only because its population is shrinking.

Russia and the West

A deal, for now

Europe shores up the Russian-Georgian ceasefire agreement

HUMILIATION avoided, but hardly a triumph: that is the upshot of President Nicolas Sarkozy’s talks in Moscow on Monday September 8th, where he tried to get the Kremlin to implement in full a French-brokered ceasefire that ended Russia’s war with Georgia.

After sometimes stormy talks, Mr Sarkozy, accompanied by the European Union’s nominal foreign-policy chief, Javier Solana, and the EU commission’s president, José Manuel Barroso, gained agreement on the withdrawal of Russian troops from a buffer zone established around the two breakaway regions of South Ossetia and Abkhazia. Russia (but so far almost nobody else) has recognised both places as independent states.

Russian forces will leave positions around the port of Poti within a week, and pull back from the rest of the buffer zone ten days after EU monitors are deployed, which must be by October 1st. Yet that is pretty much what Mr Sarkozy thought he had gained in the first ceasefire agreement, which envisaged (at least in Western eyes) troops from both sides moving back promptly to their pre-conflict positions.

Mr Sarkozy said that the deal, if honoured, would allow the resumption, presumably in October, of talks between the EU and Russia on a new partnership agreement. The decision of an emergency European summit was to suspend these talks amid unprecedented displeasure with Russia for its invasion of Georgia and recognition of the breakaway regions.

Yet the coming weeks offer plenty of scope for quibbling and foot-dragging. Russia has repeatedly accused Georgia of breaking the ceasefire agreement: that could be one pretext. Another could be any signs of American help to rebuild the shattered remnants of the Georgian army—which the Kremlin refers to hyperbolically as “Georgia’s military machine”. Russia also wants the Georgian leadership to sign a binding agreement renouncing the use of force to recover the lost territories. The EU says it will guarantee this. It also wants Mikheil Saakashvili, Georgia’s president, to stand trial for war crimes. It is unclear whether a 200-strong EU force will be able to patrol inside the breakaway regions.

Blame for the muddle rests partly with France, currently in charge of the EU. Mr Sarkozy allowed two different versions of the vaguely worded ceasefire agreement to circulate, with ambiguous translations on a key issue: whether Russia is allowed to provide security “in” the breakaway regions, or “for” them.

The latest agreement also allows Russia to maintain many more troops in South Ossetia and Abkhazia than before the conflict. Western diplomats say that insisting on a reduction to pre-war levels is unrealistic. None of that is much comfort for the Georgian leadership, which is coping with tens of thousands of refugees and a nose-diving economy. Russian pressure for his departure may have shored up Mr Saakashvili’s position for now, but behind the scenes Georgian politicians are manoeuvring to replace him.

The worst east-west row for more than two decades may have stopped hotting up, but it is not cooling off much. Russia is sending a flotilla headed by one of its largest warships, Peter the Great, a nuclear-powered cruiser, to the Caribbean for joint manoeuvres with Venezuela, America’s most pungent adversary in the region. That follows the deployment of a handful of American naval ships to deliver humanitarian aid to Georgia. America has suspended a deal with Russia that would have allowed companies from both countries to invest in each other’s nuclear industry.

Russia may be betting that Europe and America cannot stay focused on Georgia for long. Russian help is needed on a range of other global issues, from Afghanistan to Iran. The EU and NATO are both deeply divided on Russia, with countries such as Italy loudly opposing sanctions of any kind, and others such as Germany highly mindful of Russia’s role as an energy supplier. A more hawkish camp, including Britain, Sweden, Poland and the Baltic states, want a fundamental rethink of relations with Russia. But even proponents of that admit that the costs will be high, and the benefits distant.