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Despite Growth, Japan's Economy Still Faces Obstacles - 2004-05-19

Japan recorded 1.4 percent growth in gross domestic product for the first quarter of 2004. Despite the gain, there are some worries for the country's apparent economic recovery.

Although Japan's economy grew strongly in the first quarter, stock prices have plunged this month and machinery orders have been weak, prompting government officials to try to reassure the public that the economy remains on solid footing.

The Cabinet office says the economy is now on track to grow at more than 5.5 percent this year, the fastest rate in eight years and even greater than economists have predicted. Both business and consumer spending are on the rise as exports expand.

The growth is expected to continue into next year. And many Japanese companies are booking record earnings, making it appear that the country's climb out of its third recession since 1991 is sustainable. There are some worries, however, particularly because Japan's economy is increasingly linked to China.

The Chinese government aims to slow growth to seven percent this year, from last year's nine percent, in an effort to keep the economy from dangerously overheating.

JP Morgan economist Ryo Hino in Tokyo says Japan's near-term economic fate depends on whether China can gently slow growth without causing a steep slump. "The growth in exports to China is accounting for more than 80 percent of the total growth in Japanese exports," he says. "Now that's the key there. So if you see a dramatic slowdown in growth in China then that is going to have a substantial effect on total exports from Japan."

There are other risks. Mr. Hino at JP Morgan points out that the country's banks are still trying to shed hundreds of billions of dollars worth of bad loans. "There is still over-banking in the system - everybody knows that - so the competition among the banks will remain pretty fierce," says Mr. Hino. "That might actually impede progress in terms of normalizing the capital market structure."

Prime Minister Junichiro Koizumi is being criticized for being slow to make progress on his promises of economic and bureaucratic reforms. One of Mr. Koizumi's economic advisors, Keio University Professor Haruo Shimada, says reform is under way, although it might be hard to notice.

"Almost every month change is happening. You know any change in Japan takes a rather long time," says Mr. Shimada. "But when you watch the power of waves hitting the rock - one day, two days, three days, no change. But three years afterwards [the] rock will not be there."

Senior researcher Hiromi Murakami at the Economic Strategy Institute in Washington complains it is difficult to gauge any successes because of the lack of objective analysis. "Unlike [the] United States, Japan does not have [anything] like a third [party] entity to actually evaluate whether this policy worked or not," she says. "Mainly everything is done internally in [the] bureaucracy and therefore they can come up with any data, say anything about it, but it's not necessarily true."

Professor Shimada also acknowledges the frustration, agreeing with Ms. Murakami that Japan has many vested interests attempting to block reform. "Those enterprises subsidized and protected and restricted by the government feel a tremendous fear by the possible competition by the private enterprises," he says. "They're resisting strongly against the initiatives that the current government is trying to provide."

Ms. Murakami says, in the short term, Japan's recovery will rely on improving markets, as well as government spending. She says, however, that will not solve other troubles, such as the looming shortfall for the national pension system and the rising government deficit.

The combined deficits of the national and local governments have ballooned past $6.5 trillion. That is 140 percent of the gross domestic product, nearly double what it was a decade ago.

The Finance Ministry has cut some spending on defense, public works, education and foreign aid. But many in Japan worry that lawmakers and bureaucrats will further postpone dealing with big long-term issues, preferring instead to trumpet the economic recovery to voters.

Others, more optimistic, point to history - noting Japan was the first country to deliberately make fundamental changes solely to modernize its economy and society - which it did in the late 19th century. Another such radical transformation, they say, can happen again.