Economic Outlook for the New Year 2023

The need to rectify mounting inequality has been an ongoing issue since before the pandemic. Sights have turned to corporations to put excessive pursuit of profit behind them and build sustainable relationships with diverse stakeholders. In the U.S. and Europe, more companies are focusing on good workforce relations to retain talent amid serious labor shortages brought by the pandemic. Companies must also rethink the future of their businesses in facing economic sanctions and supply-chain disruption stemming from geopolitical conflicts due to the crisis in Ukraine.

Historically high inflation has taken hold as result of these trends surfacing in the economic domain. Economies face this situation because of upward pressure on prices attributable to greater costs for resources and food, the expense of decoupling from Russia, and rising wages; these run in tangent to a jump in demand coming off of the covid pandemic. Though both supply and demand on a global level recovered progressively during 2022, high inflation and monetary tightening in mainly the U.S. and European economies put a damper on economic growth worldwide.

With economic conditions and price fluctuations like none since the 1970s, the world is inching towards an era of extreme uncertainty—an era of Great Volatility¹ (Figure 1).

New leadership elected after the 2022 Chinese Communist Party Central Congress will formally take office at the National People’s Congress in March 2023. With Premier Li Keqiang and others stepping down, the focus will be on policy implementation in a political system where power is increasingly concentrated in the hands of President Xi Jinping.

In the short term, efforts will be centered on revitalizing the domestic economy, which has slumped under a deteriorating property market and policies to mitigate covid. However, the relaxation of regulations could result in worsening side-effects such as increased bad debts in the real estate sector and an exacerbated pandemic. The Chinese government is likely to enact policies aimed at striking a balance between such side-effects and economic growth.

Despite sub-par prospects for export growth due to a slowing global economy, we expect the Japanese economy to recover to growth in the mid 1% range, driven mainly by domestic demand.

Factors that should help boost growth include an expected recovery in out-of-home spending post-pandemic, the economic stimulus package passed in December 2022³, and a rebound in inbound traveler demand*.

Corporate capital expenditure should also see solid growth. Target areas include decarbonization, digital transformation, and bolstering supply chain resilience. The output gap has improved and is likely to shift to positive output in the second half of 2023.

Over 2023, we are likely to see both upward and downward pressure on prices. Recent inflationary pressures from a weak yen and high resource prices are likely to moderate through the latter half of 2023 as the U.S. rate-rise cycle pauses and prices on global markets lower once the world economy slows down.

Meanwhile, prices in Japan have long been characterized by upward price rigidity, but moves to raise prices are emerging on numerous fronts. Cost pass-through has been less prevalent in Japan than in the U.S. and Europe, but there are signs of change emerging.

According to Tokyo Shoko Research⁴, companies that are passing through at least 50% of input cost increases accounted for 40% of the overall total as of December 2022, up from 20% in February 2022. Corporate expectations for inflation five years down the line are also rising⁵, making the environment more conducive to price hikes.

Concurrently, the proportion of companies increasing wages has also reached a historical high⁶. The aim is to recruit and maintain workforces amid a labor shortage. While real wage growth has been negative YoY recently, it should turn positive in the second half of 2023.

One key to bringing this about is enhancing human capital. Improving productivity entails two pillars: digital transformation, or DX, which is using digitalization in business settings; and green transformation, or GX, which is decarbonizing society. These require workers who are skilled in the use of digital technologies and the redeployment of human resources to growth sectors related to decarbonization. If human resources are mobilized and organizations become more diverse, synergies from the integration of knowledge and collaboration should follow.

It will be vital to reform wage structures to fairly evaluate the innovative personnel who create new value. Employees will be more motivated to improve their skills if the irrational differences in the wages and benefits of permanent and non-permanent employees are eliminated and wage structures realigned to reflect job duties and responsibilities.

If wages and prices rise in an orderly manner—in a positive cycle—changing the current monetary policy comes onto the radar. A crucial element in such a case would be moving fiscal policy to a sound footing. If prices rise steadily, increases to short and long-term interest rate targets are in prospect. With government bond yields to be determined by the market, obtaining market confidence in government finances is vital in order to avoid a spike in interest rates due to loosened financial order.

This is the year of the rabbit in the Chinese zodiac, signifying dawn in terms of time of day and April, or the beginning of a new cycle, in terms of months of the year. We hope to see harbingers of the Japanese economy breaking free from its three lost decades and moving ahead on the way to recovery.