Japan turned in its best performance in 15 years in the final quarter of 2003, growing at an annualized 7% rate. Profits were up, exports soared, and even capital spending rose. This is great news for the world's second-largest economy and has raised hopes for a sustained recovery after many aborted liftoffs. But before investors and policymakers get carried away with the notion that Japan is about to become, once again, a global locomotive of growth, they should remember what's behind the country's surprising turnaround: China.
Japanese corporations are riding the Chinese boom, exporting steel for skyscrapers, machinery for new factories, and cars and electronics for China's rising middle class. It is classic Japanese economic policy -- to export its way to growth. And that same strategy makes sustained Japanese growth highly vulnerable in the months ahead.
The truth is that Japan has not yet cleaned up the financial mess of the boom-and-bust 1980s. "Zombie" companies are still being kept alive by banks that continue to lend to them (rather than to startups) and that carry their bad loans on the books. Gigantic public debts, equivalent to 160% of gross domestic product, weigh heavily on an aging population.
Perhaps most worrisome is the continued Japanese reluctance to embrace market capitalism and transparency. The initial public offering of Shinsei Bank, the once-powerful Long-Term Credit Bank that collapsed and was sold to Ripplewood Holdings, is causing a furor in Tokyo. Members of the Diet, the press, and CEOs are denouncing Ripplewood as a foreigner exploiting Japan and making too much money on the deal. This attitude explains why needed structural reforms in government and banking have yet to be made.
If China's property boom pops, if its factory overcapacity leads to trouble, or if the impending revaluation of the reminbi causes financial problems, Japan's economy could flounder once again. It would be wise for Japan to take advantage of its momentary prosperity to finish building a strong domestic foundation for sustained growth.