Economic Outlook for Japan and the World in 2024

Rising prices and interest rates prompted forecasts for a major slowdown in 2023 growth, but its foundations were more solid than expected. Labor shortage-induced wage increases and easing of semiconductor-supply constraints worked positively, and each country saw consumption and capital expenditure hold their own during the year. When the final numbers are in, two-thirds of the world’s 82 significant economies are on track to have done better than their potential growth rates*.

But there’s a dark side to how firm growth is: uncertainty about the future. And it’s growing. Behind it are three structural factors.

In the 1980s the G7 accounted for nearly 70% of the world’s GDP. Since then, the group’s share has dropped to 50%. Its ability to lead the world has weakened as some members have shifted their priorities to national interest as a means of quelling internal rocky politics. Moving in to fill the vacuum is the Global South—countries like India, those of ASEAN, and those in the Middle East now making their presence felt. They are carving out roles of their own, eschewing the worldviews purported by the G7, China, and Russia. Making up a third pole, we forecast them to account for nearly as much of global GDP in 2050 as the G7 (Figure 1). In a world polarized around these three groups, it will be all the harder to find common ground for working out challenges they need to tackle together.

Growing geopolitical rivalry is increasingly baring vulnerabilities in existing supply chains built on economic rationale. The advance of globalization means that countries have grown highly interdependent in numerous ways, including for sensitive technologies and essential resources. As this multipolarization progresses, countries have become more economically dependent on states with different political systems and values. The flip side of this is that these relationships are ripe for abuse if one country decides to leverage them to gain advantage over another, for instance by halting trade in a good over a dispute. Russia’s cutting off natural gas flows to European countries and the energy crisis it precipitated are still fresh in memory, and the US is tightening restrictions on exports and investments that could contribute to China’s ability to manufacture advanced semiconductors.

According to the Bank for International Settlements (BIS), the world’s non-financial sector private and public debt has ballooned to some 2.5 times global GDP. Markets have been increasingly concerned about government debt, whose rise quickened during the pandemic. On top of the UK’s “Truss shock”* of 2022, the US’s credit rating was downgraded^† in 2023, the first time in a dozen years. China and other emerging powers are seeing the pace of debt expand beyond the rate of economic growth. And further, structural pressures to expand government budgets—for things like decarbonization, economic security, and military expenditures—are rising. These developments fuel concerns over potential destabilization of financial systems due to greater losses at financial institutions if countries should default under their oversize debt loads, as well as worries about postponement of necessary investment when capital is diverted to cover repayment obligations.

In a world economy characterized by heightened uncertainty, Japan is one of the few countries likely to achieve growth higher than its potential growth rate in 2023 and 2024—i.e., two years running*. Two factors driving this growth are higher wages underpinning consumption and lively corporate capex from 2023. The four indicators the government set for determining whether Japan has left deflation behind are on track to settle in positive territory from the second half of 2024—for the first time in 33 years (Figure 2).

As Japan moves towards completely breaking free from deflation, keeping inflation from hobbling the economy will be crucial. To pull this off, Japan can not afford to have the international situation deteriorate. If conditions get worse for international trade^†, because of something like throttled oil supplies, it could siphon wealth out of the country and put further pressure on domestic demand. We believe that Japan needs to get three broad trends rolling to avert such downturn events.

The first is sustaining wage increases across the broader economy. Wage increases following the 2023 “spring offensive” of wage negotiations were epic, reaching levels not seen in three decades. But they lacked breadth in the workers they covered. According to a Ministry of Health, Labour and Welfare survey, wages rose by 4.0% at large corporations, but by a mere 2.9% at small and medium-sized enterprises (SMEs).^‡ If anything, the gaps between employees of large corporations and those of SMEs, and between “regular” full-time employees and “non-regular” employees, are widening. For example, if the wages of SME employees and non-regular employees could be lifted 10% across the board, Japan’s per-capita average wage would rise about 2%. But the labor share of SMEs’ costs is already high; so there are limits to sustaining wage increases over time amid rising prices. This makes it crucial for Japan to move forward with our next suggestion—passing higher wages through to prices—in tandem with sustaining wage increases.

The second measure Japan needs to implement is ensuring that increases in costs are reflected in the prices of goods and services. As things stand, large businesses have been able to raise their prices by more than the rate of input and other cost increases; but SMEs have not.^§ It is necessary, therefore, to overhaul existing trading practices to facilitate SMEs’ ability to pass higher costs on. The Japan Chamber of Commerce and Industry’s Partnership Building Declaration provides one example of how this could be done. According to a survey by Tokyo Shoko Research, the better enterprises are at passing higher input costs on, the better they are at giving their employees fatter pay packets.^¶

The third measure is investment to improve productivity. Businesses need to go beyond merely raising prices to cover higher costs. Enhancing their profitability by providing higher added-value products and services is also indispensable. A wind in the sails towards inward investment is afoot thanks to Japan’s relative stability amid international uncertainty. Further, in 2024 changes—such as a minimum wage hike and restrictions on overtime work—kick in that are designed to make it harder for businesses to engage in established practices for getting labor to work “on the cheap.” The hope is that, as well as pushing ahead with investment in labor-saving measures like digitalization, businesses facing higher labor costs will use the thus-gained leeway to allocate more investment in enhancing value added and in their human assets to enhance the quality of labor.

We forecast that, if Japan is able to facilitate these three ongoing trends, it will be able to avert an inflation-induced downturn and sustain a domestic demand-led recovery despite the high uncertainty informing the global economy. We believe chances are strong that the GDP gap will turn positive and Japan will be able to leave deflation behind in the second half of the year. Consumer prices will likely continue to rise at a pace of just over 2% throughout the year as higher wages make themselves felt in higher prices for services. And as consumer prices start to rise at a stable pace, around spring the Bank of Japan will start moving to normalize fiscal policy by abandoning negative interest and removing yield-curve controls.