Japan and Britain slip into recession

Japan and Britain both slipped into technical recession in late 2023, according to fourth-quarter national accounts. Most headlines blamed the business cycle. That both shrank at once suggests a longer-running problem: rich industrial economies stuck in a low-growth equilibrium.

The contractions themselves were small. Each economy shrank in the third and fourth quarters, meeting the usual rule of thumb of two falls in a row, and neither saw the collapse in jobs that marks a proper downturn. The same week brought a humbling footnote for Tokyo: measured in dollars, Japan's economy slipped behind Germany's to become the world's fourth-largest, largely because of the yen's slide.

Two economies, one rut

In Britain, sticky services inflation and repriced mortgages have choked household spending, on top of the drag from Brexit. In Japan, a persistently weak currency has eaten into household incomes even as company profits soar. Each shows how hard it is to produce real growth when shrinking populations and slow productivity meet tight money.

They are not alone. Germany's economy shrank by 0.3 per cent last year, hit by the loss of cheap Russian gas and weak demand from China, and the euro area as a whole barely grew. America is the conspicuous exception, having grown by 2.5 per cent last year on the back of large fiscal deficits, rising immigration and its position as a net energy exporter. The contrast suggests that the rich world's weakness has more to do with structure and policy than with a synchronised business cycle.

How the squeeze works

Britain's channel runs through the housing market. The Bank of England has held its rate at 5.25 per cent since August, the highest in more than 15 years. Most British mortgages are fixed for two or five years, so higher rates reach households only as their deals expire, and the pain is still spreading as cheap loans taken out before 2022 roll over. Consumer price inflation was still 4 per cent in January, twice the Bank's target, which leaves little room for early relief.

Japan's channel runs through the exchange rate. The Bank of Japan has kept its short-term rate below zero while other central banks raised theirs, and the yen has weakened to around 150 to the dollar. That makes imported food and energy dearer for households whose wages have failed to keep pace, so real incomes fall and spending stalls. Exporters book fat profits in yen, but so far they have passed too little of them on as pay.

A lesson from the lost decades

Japan itself offers the precedent. After its asset bubble burst in 1990, the country spent years with growth that hovered near zero, falling prices and firms that hoarded cash rather than invest. Weak demand discouraged investment, and weak investment kept productivity and wages low. Britain's productivity has grown slowly since 2008, and the risk is a milder version of the same loop, in which households and firms both learn to expect little.

Italy offers a second warning. Its output per head has barely grown since it joined the euro at the end of the 1990s, despite periods of low interest rates and repeated reform programmes. The economist Larry Summers revived the term secular stagnation in 2013 to describe economies in which weak investment demand and high saving keep growth low even when money is cheap. Britain and Japan now face the harder version of that problem, with money no longer cheap.

Demography makes escape harder. Japan's working-age population has been shrinking since the 1990s and its total population for more than a decade. Britain's population is still growing, largely through migration, but it is ageing, and more of the state's budget goes on pensions and health care for the old. Economies in that position need faster productivity growth simply to stand still.

Who feels it

The burden falls unevenly. In Britain, younger households coming off cheap fixed-rate mortgages and renters facing rising rents bear the brunt, while older homeowners without debt and savers earning above 5 per cent on deposits have gained. In Japan, pensioners and wage earners have lost purchasing power while exporters and shareholders have prospered. Governments in both countries face higher interest bills and slower growth in tax revenue, which leaves less room for the public investment that might lift productivity.

The case for a cyclical dip

The strongest counterargument is that the numbers are too small to bear the weight. Contractions this shallow are routinely revised away, and both labour markets remain tight, with unemployment low by historical standards. Japanese companies are enjoying record profits, the Nikkei is close to its 1989 peak, and unions are pressing for the biggest pay rises in decades. Markets expect the Bank of Japan to end negative rates within months and the Bank of England to begin cutting later this year.

Those forces could produce a rebound in the next set of figures. A rebound from a shallow dip is not the same as a return to decent trend growth, though, and neither country has solved the demographic or productivity problems that cap its speed. Relief from lower mortgage rates or stronger wages would lift growth for a few quarters without changing the underlying rate much.

The signals to watch are the outcome of Japan's spring wage round in March, the Bank of Japan's next policy decisions, and Britain's Budget on 6 March. Business investment figures in both countries will show whether firms believe in a recovery enough to spend on it.

Britain and Japan show how fast tighter money exposes stagnation in ageing rich economies. Neither is likely to find decent growth again soon, whatever the next quarter's figures say, and trend growth in both is likely to stay below 1 per cent a year for the rest of the decade.