Japan’s Economy Rebounds as Borders Reopen, but Challenges Loom

After more than two years of some of the world’s strictest border controls, Japan is open for business again. The result? A surge in tourism and consumer spending is giving a much-needed boost to the world’s third-largest economy. Popular tourist destinations are packed, hotel bookings are surging months in advance, and reservations at the country’s top restaurants are becoming increasingly difficult to secure. However, while the reopening has been a boon for Japan’s economy, underlying challenges and global uncertainties present a complex picture for the country’s path forward.

Tourism Boosts Japan’s Economic Growth but Lags Expectations

The influx of tourists and the recovery of domestic consumption have driven Japan’s economic growth. Data from the Japanese government indicates that the country’s economy grew at an annualized rate of 0.6 percent from October to December 2022. Although this uptick is a sign of improvement, it fell short of analysts’ expectations of a 2 percent growth. The growth was primarily fueled by a rebound in private consumption and a surge in spending by international visitors.

This growth in the fourth quarter comes after a surprising contraction in the third quarter when inflation and a weakening yen resulted in higher import costs and a dip in domestic spending. The latest figures cap off two consecutive years of growth as Japan slowly recovers from the economic setbacks of the pandemic. Real-term growth for 2022 stood at 1.1 percent, following a 2.1 percent expansion in 2021. Despite these gains, Japan’s recovery has lagged behind other major economies due to lingering COVID-19 concerns that continued to suppress consumer demand.

The Shift to “Living with the Coronavirus” and Its Impact on Consumption

Domestic consumption is playing a key role in Japan’s economic rebound, according to Shinichiro Kobayashi, principal economist at Mitsubishi UFJ Research and Consulting. As the government encourages people to adapt to a new normal—living with the virus rather than avoiding it altogether—daily activities such as dining out and travel have seen a notable increase. Although Japan experienced a record-high surge in COVID-19 deaths in recent months, the populace has largely let its guard down, boosting economic activities and spending.

“The pent-up demand is steadily being unleashed,” says Kobayashi, pointing to the resurgence of government subsidies designed to stimulate domestic travel and dining as key drivers behind the growth. These subsidies, alongside the easing of border controls, have reinvigorated sectors that were hit hardest by the pandemic.

The Weak Yen: A Double-Edged Sword for Japan’s Economy

The yen’s depreciation against major currencies has proven to be both a blessing and a curse. While the weak yen has driven up the costs of imported food and energy—causing inflation to reach 4 percent in December, its highest in over 40 years—it has simultaneously acted as a catalyst for international spending within Japan. Saisuke Sakai, senior economist at Mizuho Research and Technologies, explains that the yen’s weakness is a net positive for certain sectors, especially tourism and retail.

With borders open, tourists have returned in droves, and “revenge spending” is on the rise. The term describes consumers, especially international travelers, making up for lost time and opportunities by splurging on luxury items, cosmetics, and other goods. The low exchange rate makes Japanese products more affordable for foreign visitors, leading to a surge in sales across multiple sectors.

Tourism Bounces Back: Opportunities and Challenges

Japan’s tourism sector has rebounded more quickly than expected, offering a much-needed lift to businesses ranging from hotels and restaurants to retail stores. The return of tourists, particularly those from neighboring Asian countries, is expected to continue to drive growth in the near term. With the Chinese government’s lifting of its “Zero COVID” policy, the potential return of Chinese tourists, who traditionally make up a significant portion of Japan’s tourism market, is expected to further boost the economy.

However, the impact of the weak yen is a double-edged sword. While it has made Japan more attractive to tourists and encouraged spending, it has also increased the cost of imports for the highly import-dependent nation. Rising prices of food and energy have hit consumers hard, cutting into purchasing power and adding to concerns about the sustainability of Japan’s economic recovery.

Inflation and Wage Stagnation: A Persistent Issue

Rising inflation, driven by increased import costs due to the weak yen, has taken a substantial toll on consumers. December’s 4 percent inflation rate—the highest in over four decades—exacerbates a longstanding problem of wage stagnation in Japan. Despite government efforts to encourage wage increases, salaries have seen little real growth for years, eroding consumers’ purchasing power and limiting domestic consumption.

Economic Outlook: Growth, Opportunities, and Uncertainties

Japan’s economic recovery remains fragile, and its future growth trajectory is subject to several external factors. The return of Chinese tourists is expected to further bolster tourism and consumption, offering a potentially significant lift to the economy. However, some restrictions on travelers from China remain in place due to COVID-19 concerns, which could affect the pace of growth.

While economists like Shinichiro Kobayashi are optimistic that “demand will continue to drive modest growth for some time,” others are more cautious. The potential for economic slowdowns in the United States and Europe poses risks to Japan’s export-driven economy. Takahide Kiuchi, executive economist at the Nomura Research Institute, believes that Japan’s economy could expand faster than those of the U.S. and Europe in 2023, as domestic consumption continues to rebound.

However, Kiuchi tempers his optimism by pointing to potential external shocks. “External factors may undermine the growth momentum of the Japanese economy,” he says, noting that economic challenges abroad could reverberate through Japan’s interconnected trade and financial systems.

Potential for a Mild Recession Amid Global Uncertainty

Despite positive indicators, the challenges to Japan’s economic recovery are not to be overlooked. Kiuchi forecasts a possible mild recession in the middle of this year, given the uncertain economic conditions overseas and the potential impact on Japanese exports. Global factors like rising interest rates, geopolitical tensions, and fluctuating energy prices could affect Japan’s export market, as well as consumer and business sentiment.

Japan’s reopening and resurgence of tourism have brought a welcome boost to its economy, driving domestic consumption and bringing new opportunities for businesses. However, the country faces challenges from rising inflation, wage stagnation, and global economic uncertainties that could hinder its recovery. While there is room for cautious optimism as Japan navigates its way through the post-pandemic landscape, the path forward is marked by both opportunities for growth and potential headwinds.