Economy

Germany, Japan and reform prospects

Written by Stephen Poloz

For years now, analysts have seen Germany and Japan as birds of a feather: ho-hum performers urgently needing reform. But recent political developments suggest that is about to change.

Consider Japan. When Prime Minister Junichiro Koizumi’s reform plans hit a brick wall earlier this year, he daringly called a snap election and made reform its centrepiece. Japanese citizens, exhausted by nearly 15 years of sluggish economic performance, handed him a landslide victory. No Japanese leader has been as well-positioned to enact reforms since the 1980s. Analysts are busy upgrading their forecasts for Japanese economic growth as a consequence.

Contrast that situation with Germany, where the recent election has produced a veritable stalemate. Some good reform initiatives had been enacted during the tenure of Chancellor Schroeder, including changes to taxes, health care and pensions. More reforms were being drafted, especially on the labour market front, where the need may be the greatest. But these plans have been thrown into doubt by the election outcome.

This stark contrast between these two economic powerhouses has analysts predicting a Japanese renaissance and a German slump. But it is important to note that the reforms that are so needed in Japan and Germany are not new, extending well back to the days when both countries were actually strong performers. This could mean that reforms, while always a good thing, may not produce the sort of instant growth breakthrough that many are hoping for.

The good news is that companies in both Japan and Germany have been quietly engineering an economic revival, despite their governments’ poor reform record. In Japan, this has meant dismantling the Keiretsu structure that protected inefficient companies from the rigours of competition. In Germany, it has meant ruthless cost-cutting and the development of efficient supply chains in emerging Europe.

Equity markets clearly agree. Although Japanese equities have been especially strong this year, rising some 19 percent since January, Germany’s stock market has also performed well, rising by 20 percent. This is all the more remarkable considering that both countries are heavily dependent on imported energy, and therefore likely to pay a high price in terms of slower growth and weaker profits in an era of high oil prices.

Nonetheless, prospects for accelerated reforms in Japan seem very likely to result in a pick-up in growth to nearly 2 percent, possibly a little higher. German growth, on the other hand, is likely to remain in the 1-1.5 percent range for now.

The bottom line? Increased global competition is exposing the need for reform in developed economies, notably in Japan and Germany. But reforms are not a panacea, either — what matters most is how companies play the cards they are dealt.

October 6, 2005

The views expressed here are those of the author, and not necessarily of Export Development Canada.

Originally appeared on PROFITguide.com