Two reasons to be skeptical about 3.7 percent growth

Champagne corks are probably popping at Liberal Democratic Party headquarters in Tokyo.

The reason for the celebration: Japan’s economy grew 3.7 percent last quarter. It’s the equivalent of answered prayers for prime minister Taro Aso, who is expected to lose an Aug 30 election. Aso will no doubt argue his LDP deserves more time in power to continue its recovery efforts.

Aso and his cronies should keep the bubbly on ice. Investors, too. The growth surge reeks of aberration and those who get all excited about it may live to regret it. Yes, Japan, like France and Germany, is benefiting from the $2.2 trillion of stimulus spending by governments worldwide.

Aso’s administration alone spent $264bn. Exports, consumer spending and a big increase in government investment returned the second-biggest economy to growth. There are two bigger considerations to keep in mind, though.

One, the forces restraining Japan’s growth are stronger than those supporting it. Two, the complacency that longtime Japan investors know all too well may be returning.

Richard Jerram, chief economist of Macquarie Securities in Tokyo, has a point when he says you don’t want to be a “spoilsport” about Japan’s impressive gross-domestic-product figure. At the same time, he says, “you can’t really ignore that prices are falling.”

The deflation that took hold in the late 1990s had a devastating effect on household and business sentiment. And it never really ended. It took record price increases for food and energy over the past two years to produce a little inflation.

Once they reversed, prices fell anew. Consumer prices plunged a record 1.7 percent in June. Last month’s GDP report showed wages fell a record 4.7 percent from a year earlier.

Good luck getting savings-rich consumers to spend more in this environment. It’s quite simple, say economists such as Seiji Shiraishi of HSBC Securities Japan Ltd: Domestic demand is about 70 percent of the economy and it’s “very, very weak.”

Once government spending runs its course, weak income trends will take over.

If the opposition Democratic Party of Japan wins the August election, as pollsters predict, its options are severely limited. Public debt is almost double the size of the economy, and interest rates are near zero. It will need to think fast about cost-effective ways to restore economic confidence.

It’s easy to lose perspective on where Japan is right now. While not quite as impressive as China’s 7.9 percent growth, the figures are nothing to sniff at. Still, even after the second quarter snapback, Japanese GDP is only at 2004 levels. A sobering thought, isn’t it?

Japan is hardly destitute. Yet the global crisis has set back the nation in underappreciated ways. It has widened the gap between rich and poor. It has also led to huge companies such as NEC Corp, Panasonic Corp and Sony Corp announcing America-like mass layoffs, which Japan always proudly avoided.

Lifetime employment is being phased out for entire generations. While that may sound good to overseas investors looking for change at Japanese companies, the transition to part-time work contracts is spooking the nation of 126 million.

It is also hurting the female workforce disproportionately. And then there are the most extreme side effects.

Homelessness is on the rise in cities such as Tokyo and Osaka, albeit from a low base. The suicide rate increased 4.2 percent in the first half of this year during hard economic times. And hovering above all of this is a fast-aging population that threatens to overwhelm government coffers a decade from now.

Amid mounting gloom, the government’s focus is on raising the consumption tax. Such an argument is as ill-timed as it is damaging to already deteriorating household and business sentiment. It’s amazing that there isn’t more serious focus on lowering taxes to stimulate demand.

The theories of John Maynard Keynes are alive and well in Japan. Officials in Tokyo are tossing money at the economy. The spotlight must also be on cutting taxes for small to midsized companies to encourage job growth. It’s not supply-side economics that Japan needs, but a sharper focus on empowering entrepreneurs to do their thing.

William Pesek is a Bloomberg News columnist. The opinions expressed are his own.

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