In this report we examine the effect of the manpower shortage on Japan's economy: (1) The consumption tax hike, (2) The manpower shortage, (3) The export trend, and (4) The effect of the hot weather on business(No.182)

◆Main economic scenario for Japan: In light of the first preliminary Apr-Jun GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +0.7% in comparison with the previous year for FY14 (+1.1% in the previous forecast) and +1.5% in comparison with the previous year for FY15 (+1.5% in the previous forecast). Japan’s economy declined temporarily in the Apr-Jun 2014 period due to the effects of the increase in consumption tax, but is expected to get back on track and gradually move toward recovery during the Jul-Sep period. Japan’s economy is gaining support from the following positive factors: (1) The negative factors associated with the increase in consumption tax have pretty much played themselves out, and (2) Firming up of exports due mostly to the US economic recovery.

◆Four major issues facing Japan’s economy: In this report we examine four major issues facing Japan’s economy: (1) The consumption tax hike, (2) The manpower shortage, (3) The export trend, and (4) The effect of the hot weather on business.

◆Issue (1) The effects of the consumption tax hike: The effects of the increase in consumption tax in April of this year admittedly exceeded our original expectations. However, consumption in some areas is showing the beginnings of recovery, though performance is spotty. The economy hit bottom in April after the tax hike and has since been gradually recovering. Our current view is that the tax hike initially pushed the FY14 real GDP growth rate down by -1.33%pt, but we expect the FY15 real GDP growth rate to be up by +0.51% pt.

◆Issue (2) The effects of the manpower shortage on Japan’s economy: The supply and demand situation for labor is expected to continue to be extremely tight. This tight labor supply situation is expected to lead to an increase in wages and generally better working conditions, and this in turn will likely find more individuals searching for work under those improved conditions. The assumption is that this type of situation leads to an increase in labor force participation. Therefore the shortage in manpower in Japan is not expected to become a bottleneck to the degree that effects on the economy would become fatal, but if the above-mentioned mechanism does not work, the number of persons employed seen in FY2015 and FY2016 would each fall short by around 343,000 and 663,000 persons respectively. This would cause downward pressure on real GDP the equivalent of around 3.4 trillion yen in FY2015 and 7.2 trillion yen in FY2016. In order for growth in labor force participation alone to relieve the shortage, the labor force participation rate would have to grow by 0.4%pt in FY2015 and 0.8%pt in FY2016. Similarly, in order to patch up the holes with growth in productivity based on man hours worked, productivity would have to be raised by 0.6% in FY2015 and 1.3% in FY2016.

◆Issue (3) Will exports get back on track?: Japan’s exports are expected to gradually regain ground supported by the cyclical recovery in the US economy. However, of the 11.5 trillion yen trade deficit Japan carried as of 2013, approximately 7 trillion yen is due to the hollowing out effect, while another 4 trillion yen is attributed to the increase in imported oil and LNG after most of the country’s nuclear power plants were shut down. Considering factors like these, Japan’s trade balance will likely be bleeding red ink for some time to come.

◆Issue (4) The effect of extremely hot summers on business: According to our calculations, each time the average summer temperature rises by 1°C, nominal household final consumption expenditures on a GDP statistical basis also go up a notch. Household expenditures are expected to grow 67.6 billion yen in July, then 87 billion yen in August, and 66.4 billion yen in September. On average, the hot weather promises to push consumption up by around 70 billion yen each month.

◆Four risk factors facing Japan’s economy: Risks that will need to be kept in mind regarding the Japanese economy are: (1) stagnant personal consumption due to the decline in real income, (2) China’s shadow banking problem, (3) a surge in crude oil prices stemming from geopolitical risk, and (4) tumult in the economies of emerging nations in response to the US exit strategy.

◆BOJ’s monetary policy: We expect additional monetary easing measures by the BOJ to carry over beyond the 2015 Jan-Mar period. While there is still a chance that the BOJ might reach its price target, our outlook as of this point in time is that the growth rate in consumer prices will not reach 2%.

【Our assumptions】
◆Public works spending will grow by +3.1% in FY14, then decline by -9.1% in FY15. Another consumption tax hike is planned in October 2015.
◆Average exchange rate of Y102.0/$ in FY14 and Y102.0/$ in FY15.
◆US real GDP growth of +1.2% in CY14 and +2.6% in CY15.