Why Japan’s GDP will once again exceed that of Germany in the near future
Japanese academic Takao Komine explains the reasons behind Japan falling behind Germany in the GDP rankings and discusses the possible implications of this trajectory.
At the end of last year, it became a hot topic in Japan that Germany’s GDP in 2023 was set to exceed Japan’s.
In February this year, data showed that if the GDPs of Japan and Germany in 2023, announced in November 2023, are converted into dollars at the average exchange rate of the same year, Germany’s GDP would be US$4.46 trillion and Japan’s GDP would be US$4.21 trillion.
Since the late 1960s, Japan’s GDP had been the second largest in the world after the US, but in 2010, it was overtaken by China and fell into third place. With the latest figures, Japan now occupies the fourth position.
Germany’s overtaking of Japan in the rankings became a hot topic in Japan because it was seen as symbolising Japan’s relative decline in national power.
The fact that the economy of Germany, with a much smaller population, has surpassed that of Japan has made many people realise once again the declining status of the Japanese economy.
Not surprisingly, China’s GDP is larger than Japan’s. In 2023, China’s population was 1.4 billion, more than ten times that of Japan’s 124 million. This means that even if China’s per capita GDP exceeds only one-tenth of Japan’s, China’s economic scale will be larger than Japan’s.
However, Germany’s population of 84 million is about two-thirds of Japan’s. The fact that the economy of Germany, with a much smaller population, has surpassed that of Japan has made many people realise once again the declining status of the Japanese economy.
Size of GDP does not mean everything
That said, I have some doubts about making such a fuss about Japan’s GDP being surpassed by Germany.
First of all, just because Germany surpasses Japan in terms of GDP does not mean that the welfare level of the Japanese people will decline, nor does it mean that the German people will be happier. Above all, there is little point in focusing on the size of GDP.
Just because the size of the GDP is large does not mean that the welfare level of the people is high. Although the size of the GDP of the Nordic countries is much smaller than that of Japan, their welfare level is higher than that of Japan. This is because their GDP per capita is higher than that of Japan. What is important for national welfare is not the size of GDP, but the level of GDP per capita.
So why has Japan’s GDP been overtaken by Germany’s, and what challenges does this reveal?
Without this significant drop in the yen exchange rate, the GDP of Japan and Germany would not have reversed.
Impact of the Russia-Ukraine war
There are short-term and long-term reasons for this reversal in GDP relative to Germany.
The short-term reason is the depreciation of the yen. Comparing Japan’s nominal GDP in 2012 and 2023 in yen terms, it increased by 7.5% from 550.5 trillion yen to 591.9 trillion yen. However, if the same GDP is evaluated in dollar terms, it will decrease by 39%, from US$6.9 trillion to US$4.2 trillion. This is because the yen exchange rate fell 43% during this period, from 79.8 yen to the dollar to 140.5 yen. Without this significant drop in the yen exchange rate, the GDP of Japan and Germany would not have reversed.
This decline in the yen rate was brought about by Japan’s monetary policy. Japan’s interest rates remained at almost zero as the Bank of Japan pursued an unprecedented monetary easing policy in an effort to overcome deflation, where the rate of increase in prices was extremely low. Consequently, interest rate differentials with Europe and the US widened, funds flowed overseas, and the yen exchange rate fell sharply.
In particular, Russia’s invasion of Ukraine led to a surge in energy prices from 2022 onward, causing domestic prices to rise in each country. In response, Japan continued monetary easing to overcome deflation, while Europe and the US raised interest rates to curb inflation. As a result, the interest rate differential between Japan and Europe and the U.S. widened, causing the yen to depreciate further.
Due to this difference in long-term growth rates, Germany’s nominal GDP approximately doubled during this period, while Japan’s GDP increased by only 13%.
Long-term economic issues to tackle
The long-term reason is the slump in the Japanese economy. Comparing the GDP growth rates of Japan and Germany from 2000 to 2023 in their own currencies, the real GDP growth rate is 0.7% for Japan and 1.1% for Germany, while the nominal growth rate is 0.5% for Japan and 2.9% for Germany.
This long-term difference in growth rate has created a difference in the size of GDP. If we consider the difference between the nominal growth rate and the real growth rate as the rate of increase of the GDP deflator (average price increase rate), we can see that Japan’s average price increase rate was negative during this period.
Due to this difference in long-term growth rates, Germany’s nominal GDP approximately doubled during this period, while Japan’s GDP increased by only 13%. Japan’s nominal GDP growth rate was low over the long term because real growth was low due to sluggish underlying growth potential and because prices did not rise due to persistent deflationary trends.
In other words, the Japanese economy’s long-term challenges of sluggish growth and deflation have manifested themselves in a phenomenon in which the GDPs of Japan and Germany have reversed.
In light of the above, it is believed that Japan’s GDP will once again exceed that of Germany in the near future.
Scenarios will reverse
Lastly, let’s look at the future. As for the exchange rate, the yen is expected to appreciate gradually. Japan’s somewhat abnormal monetary easing is expected to gradually return to normal in the near future. This is due to the fact that prices in Japan have maintained a stable growth rate of around 2%. As a result, interest rates in Japan will rise and, conversely, interest rates in Europe and the US will fall as prices stabilise. This will narrow the interest rate differential between Japan and Europe and the US, leading to an appreciation of the yen.
In terms of Japan’s growth rate, both the real and nominal growth rates are increasing, with the real growth rate being 1.9% and the nominal growth rate being 5.7% in 2023. As the rate of price increases has been rising, the rate of increase in the GDP deflator should also rise in the future. At the very least, Japan can avoid being the only developed country with an extremely low growth rate.
In light of the above, it is believed that Japan’s GDP will once again exceed that of Germany in the near future. However, it must be fully recognised that this does not mean that the long-term challenges facing the Japanese economy, which include preventing a recurrence of deflation and increasing the economy’s underlying growth potential, will disappear.
