Japanese GDP Extends the Status Quo

When is 6.0% annualized quarterly GDP growth bad news?^[i] Evidently, when it is Japan growing solely because exports and government spending masked a sizable drop in consumer spending. So it went in Q2, with most coverage of the report dwelling on the big disconnect between external and domestic demand. With China and Europe teetering, the story goes, exports risk petering out, leaving consumption-light Japan with no meaningful growth drivers. We agree it isn’t a great report—far from as good as a 6% annualized rate implies in isolation. But weak domestic demand isn’t new in Japan, and there are some signs it should turn up soon. Headline growth may slow as the post-COVID tourism boom reverts to more normal long-term trends, but Japan should continue contributing to global growth.

Japan’s gap between domestic demand and exports isn’t new—it predates COVID by many, many years and owes largely to entrenched structural issues. Prior governments have passed some reforms to boost competitiveness, but they are taking time to bear fruit, especially with ill-conceived monetary policy compounding headwinds. Capping long rates at ultra-low levels not only hampers bank lending by reducing loan profitability, but it also keeps tired and bloated companies on life support, making it hard for competition to break through. It all manifests in weak private investment and plodding consumption, which the government tries to cover with public spending and investment. Meanwhile, exporters are able to capitalize on stronger conditions outside Japan and reap tidy profits from currency translation when the yen is weak, making them the country’s primary economic engine. This helps Japanese multinationals do pretty well, but it doesn’t drive big investment at home.

Q2 GDP was an extreme example of this long trend. Exports surged 13.6% annualized, rebounding from a Q1 drop.^[ii] Public investment jumped 5.0% annualized.^[iii] But consumer spending fell -2.2% annualized, business investment barely eked out 0.1%, and imports—which represent domestic demand—dropped -16.2%.^[iv] Combine these numbers with another round of disappointing monthly data in China, and we can understand why the report didn’t generate many smiles.

But we think the gloom overlooks some things. For one, inbound tourism was a big driver of the export boom, with international visitors finally returning in droves after the pandemic and splashing out at shops, restaurants and hotels. This will probably wane somewhat as most post-pandemic boomlets have worldwide, but the reversion to more normal seasonal patterns is no bad thing. Two, for all the handwringing about what China means to Japanese exports from here, it isn’t like China was propping external demand until now. Monthly data show Japanese exports to China fell double digits year-over-year in volume terms (stripping out inflation and currency impact) for nine consecutive months through June. If exports have done ok even with China detracting, it seems weird to argue China would suddenly pose some big risk—especially since we think hard landing fears remain as off-base as ever. (A topic for another day.)

Three, Japanese consumers are finally starting to get some relief on the price front. Not only are energy costs down from last year’s highs, but real wages finally started growing in Q2, giving households more firepower. The weak yen complicates matters by raising import costs, but rising pay is a pretty underappreciated silver lining.

So no, we don’t think Japanese GDP will stay gangbusters. That seems unrealistic. But things don’t look quite as bad under the hood as most of today’s coverage implies, and people seem to be ignoring the potential for domestic conditions to improve looking forward. Even middling growth would probably suffice to beat dreary expectations, which should be fine for the global economy and stocks.