Analysis: Japan loses title of second largest economy

Japan has officially lost its title of world’s second largest economy to China today.

Over the last quarter, Japan’s GDP grew by only 0.1%, down from 1.1% in the previous quarter.

Japan’s unadjusted GDP totalled $1.2883 trillion (£827 trillion) on a nominal dollar basis, compared with China’s second-quarter unadjusted GDP of $1.3369 trillion (£858 trillion).

GDP figures published by the National Accounts of Japan were much lower than expected. They suggest that Japan’s export-led economic recovery is wavering as the value of the yen appreciates.

Michael Taylor, a senior economist at Capital Economics, says the breakdown of growth is even more worrying than the headline number.

“Just last week, the bigger picture for Japan looked much more positive”

Japan’s domestic demand has turned negative and overall growth is down to exports. “But slower global growth and a strong yen will hit exports in the second half, making a return to recession ever more likely,” he writes in his Daily Note.

Domestic demand in Japan turned negative, falling by 0.2%, while net exports contributed 0.3 percentage points to growth. It was exports that prevented a fall in Japan’s overall GDP, which is still about 4.5% below its pre-recession mark.

However, even this source of growth may soon come to an end as demand from elsewhere in Asia slows. In Japan, incomes are declining and so is employment. Meanwhile, it seems likely that deflation will linger in Japan for some time. (article continues below)

Still, business investment rose by 0.5% and corporate earnings have recovered. However, Taylor says the ultimate driver of investment is expectations about the future. Demand and prospects look “distinctly poor” both in Japan and overseas.

Just last week, the bigger picture for Japan looked much more positive. Consumer confidence had fallen marginally but sentiment towards employment and inflation had improved.

Julian Jessop, the chief international economist at Capital Economics, says the fall in the headline measure of consumer confidence—to 43.4 in July from 43.6—was only small in the context of big increases seen over previous months.

Sentiment towards employment rose and the labour market seems to be much healthier than a few months ago.

Households’ expectations for inflation have also improved, based on Capital Economics weighted average of responses to an official survey edging back up in July—which is reassuring given the outright falls in actual core price inflation.

Jessop says this, in turn, is minimising the risk that consumers decide to hold back spending in anticipation of even lower prices in future.

“However, the huge amount of spare capacity left by the recession means it will be years, not months, before this risk is eliminated,” he wrote in last week’s Capital Daily.

Economic growth in Japan’s three big competitors—America, China and Germany —excelled over the past quarter.

America posted a quarter-on-quarter GDP growth rate of 2.4%, China one of 11.1% and Germany one of 2.2%.