Japan has experienced a period of deflation and low economic growth since its economic bubble burst in the early 1990s. The second Abe administration, which took office in 2012, used the three pillars of "Abenomics" to try to revive the economy. The three pillars are aggressive monetary policy, a flexible fiscal policy, and a strategy for growth. Despite these efforts, Japan still faces economic challenges.

Three structural challenges that Japan currently faces have been exacerbated by the COVID-19 epidemic, which is causing the worst recession since the end of World War II. This article examines three of Japan's immediate economic concerns: the pandemic, sales tax, and dwindling exports.

Key Takeaways:

  • Japan has experienced a period of deflation and low economic growth since its economic bubble burst in the early 1990s.
  • The second Abe administration, which took office in 2012, has attempted to use aggressive monetary policy and a flexible fiscal policy as a strategy to revive economic growth.
  • Despite these efforts, Japan still faces economic challenges exacerbated by the COVID-19 epidemic.
  • The epidemic has affected Japanese manufacturing and has caused exports and tourism to dwindle.

The Coronavirus Pandemic

Japan was preparing to host the 2020 Olympics, which would have been an economic boost, but then the coronavirus hit, and the decision was made to postpone the Olympics to the summer of 2021. As the coronavirus spread, Japan’s economy was on the brink of a recession because of a slump in Chinese demand for Japanese exports and reduced consumer spending.

Though Japan has lifted the state of emergency in 39 out of its 47 prefectures, as of May 2020, its economic outlook remained gloomy. Reuters analysts expected the country's economy to shrink 5.6% in the fiscal year ending in March 2021. The emergency orders, however, returned in the summer of 2021, as a new wave of infections and hospitalizations associated with the Delta variant swept the country—reaching even higher record incidence than in 2020.

A $1 trillion stimulus package was instituted by the Japanese government, and in the spring, the Bank of Japan expanded its stimulus measures for the second straight month. Prime Minister Shinzo Abe has continued to fund spending initiatives to mitigate the economic damage caused by the pandemic.

The 2020 (2021) Olympic Games

Though the COVID pandemic caused Olympics losses by postponing the games until the summer of 2021, the negative effect of hosting the Olympics on Japan's economy will likely reach the tens of billions of dollars when all is said and done.

Cost overruns for building new venues and upgrading infrastructure, an Olympic bid that was arguably too high to begin with, and now the lack of any spectators will make these games one of the worst financial decisions in Olympics history. The expected windfalls from tourism failed to materialize amid the Delta variant COVID spike, and several Olympians were disqualified for testing positive.

Sales Tax Hike

In addition to the pandemic, consumers in Japan have also been subjected to a sales tax hike from 8% to 10% beginning in October 2019. The government increased the sales tax to fund social welfare programs including preschool education and to pay down the nation's massive public debt load.

Of course, higher sales taxes cause people to spend less. So, to mitigate the negative effects on spending, the government introduced measures including rebates for certain purchases made using electronic payments. Consumers were eligible for a 5% rebate on purchases made using electronic payments at some smaller retailers, negating the 2% tax rise. The government also hoped that the rebates would encourage electronic payments and lessen the nation's reliance on cash.

Dwindling Exports

Japan has been experiencing less global demand for its exports. For example, electronic equipment and car parts. Japan relies heavily on exporting and many of its biggest brands, such as Toyota and Honda, have endured a global sales slump. Global consumer demand has been severely impacted by coronavirus lockdowns worldwide.

Japanese manufacturers are falling behind because they rely on foreign demand. According to Deloitte Insights, exports and manufacturing production are highly correlated in Japan. "In May, manufactured goods exports fell 23.8% from a year earlier, while manufacturing production was down 25.9% over the same period," said Deloitte. Unfortunately, the pickup in global demand that Japanese manufacturers so desperately need seems unlikely any time soon.

Tourism is a large part of the Japanese economy, but this industry has also been hit hard as the pandemic keeps foreign visitors away.

The outlook for Japanese international trade is influenced by a wave of protectionism that risks lowering global trade volumes. There are also heightened geopolitical tensions that further threaten Japanese exports and foreign direct investments.

The Bottom Line: Outlook for Japan

As is the case for most countries' economies, the global pandemic means that the outlook is bleak for the Japanese economy in the short term. There is also increasing tension between Japan and China over disputed islands in the East China Sea where the previous conflict over the islands resulted in anti-Japanese protests and boycotts.

However, despite tensions with China and the fact of being the first of the world's top three economies to officially fall into recession, the country actually appears to be doing better than other major economies.

Overall, Japan’s policymakers have provided ample fiscal and monetary stimulus to cushion the fall in demand and support the economy during the worst times of the pandemic. However, consumer spending will remain low as the risks from the pandemic linger. Manufacturers will continue to struggle with weak global demand, a strong currency, and geopolitical risks. Japan’s economy should improve from here, but growth is likely to be slow.