Retailers are bracing themselves for consumer reaction to the increase in Consumption Tax. Retailers may be worried, but some consumers are looking at a serious change to their spending patterns if incomes don’t increase soon. Although the last tax rise in 1997 caused relatively minor sales disruption in the end, it came at a time when deflation was lowering prices and incomes were high – the highest on record in fact. This time around, incomes are falling just when prices are rising, making a sudden, doubling in direct taxes a potential disaster for the average Japanese household. But the situation is already bad: in the past year there has been a 24% fall in cumulative net annual disposable income, with the average family finishing with a surplus of less than half that of 2007. The surplus will be wiped out by the tax increase.
The coming Consumption Tax hike in April is certainly going to hit retail sales but the question is for how long. The optimists say that, as in 1997 when the last increase came in, by September the increase will have been forgotten and retail sales will recover, but the pessimists look at the combined effect of inflation and stagnant wages and fear a much longer contraction. Indeed it is not so much the Consumption Tax alone which is the problem but the combination of tax hikes, inflation and stagnant wages.
Consumers are certainly worried. The wave of consumer confidence since the implementation of hawkish economic policies by the current government has largely been the result of wealthier consumers spending on high ticket items, with some advance buying by average income consumers where they can afford it. Many people today probably feel slightly more secure in their jobs than they did 18 months ago, but few have actually received any pay increase – this is the elephant in the room, growing in size month by month.
What distinguishes the tax rise this time round is the far lower incomes in real terms than back in 1997, with the average household having far less to play with at the end of the day. It is still true that households maintain large volumes of savings, but even that may well not be enough. Those savings are there to make up for shortfalls, both real and imagined, in pensions, health care and kids’ education, and even if they are used, will run out fast. Several facts are currently clear:
When the tax was first introduced in 1989 and later when it was raised in 1997, retailers did indeed have a bad year, but recession and other problems aside, recovery was visible within six months.
At the time, incomes were still rising, peaking in 1996, and the household surplus was at an all time high, with deflation also ongoing.
In 2014, however, incomes are down 12% from 1997 and inflation is rising, as the government plans, creating a classic consumer squeeze.
But its much worse: depending on the measure used, household net surplus in disposable income was down 24% in 2013, and a 3% rise in Consumption Tax will wipe that surplus out completely if no income increases appear.
Meanwhile, however, retailers today have evolved levels of independence, profitability and skills in marketing that will stand them in good stead over coming months, allowing the top chains to largely ignore the big picture and work on attracting customers with better value offers.
Tough at the top, much harder at the bottom
A recent Nikkei survey compared a group of 500 wealthy consumers, each with assets of at least ¥100 million, and 1,000 more average income consumers. The differences were striking. While a small proportion of each group (16.8% and 7.7% respectively) said they had enjoyed salary increases in the past 12 months, far more had suffered falls in income. Despite government policy and soaring company profits, 30.4% of the high income group said their income was lower in 2013 than 2012, with a worrying 40.3% of the average income group saying the same. While 11.5% of the average income sample said they were hopeful of salary increases in 2014 (compared to 16% of high income people), 35% said they expected salaries to drop further.
The significance of salary levels on average income consumers is overwhelming (see Chart 1). Asked what factors affected spending patterns, higher income consumers saw stock market prices as the main factor influencing their spending patterns – further confirmation that the policy driven stock market gains of the past 12 months have fuelled spending at the top end, and posing yet another danger should those gains reverse.
In contrast, close to half of the average income group relied on salary and bonus changes to determine spending patterns. Roughly a quarter of both groups put price changes next, but for average consumers, the Consumption Tax increase ranked third and was seen as a significant factor by 17.4% of the sample, compared to just 9.8% of those in the high income bracket. For average income earners, little else matters: just salary, prices and worries over the Consumption Tax.
The same survey confirmed that at all levels of income, consumers had begun to buy in advance to avoid increased taxes, with those needing or just wanting new homes and cars buying early. Higher income consumers have also splashed out on travel, both international and domestic, second homes and computers, while in contrast average income consumers increased spending mostly on mobile phones, but very little else.
Indeed, post April, higher income consumers feel they will only cut back spending to a small degree, but average income respondents expect to be hit hard. Dining out, apparel and utilities are the three biggest areas where they expect to have to make sacrifices (see Chart 2). Some lower priced retailers are hoping this may simply mean a shift from one level of price to lower priced alternatives, but the current consumer spending boom is clearly being driven by those who have money in the first place so, unless you’re already in the discounting business, there could easily be more losses than gains in terms of footfall. The mass market has also increased spending over the past year, but by a far smaller amount.
Abenomics not reaching 70% of Japanese public
The same conclusion was reconfirmed by another survey published by Kyodo News. The results suggested that 73% of Japanese feel that they are not experiencing any benefit from the government’s fiscal and economic policies. The failure of the government to convince companies, big and small, to raise salaries is a serious flaw in its plans. At the World Economic Forum, Abe said he expected wages to increase this Spring and that “higher wages, long overdue, will lead to greater consumption,” but unless the ministries have been leaning on corporate leaders recently, the lack of cooperation to date suggests Abe’s speech was just talk.
An increase in the Consumption Tax is unavoidable and necessary to help balance Japan’s precipitous fiscal budget, but it will hurt the majority of consumers just the same. The timing now, however, comes after a long period of income deflation and in a climate where companies are reluctant to pass on any short-term profit gains in terms of salary increases. This was bearable during the years of deflation, but with the government looking to cut national debt and raise GDP through inflation, higher prices and stagnant or falling incomes means a big squeeze. No one knows exactly how deep the post-April spending drop off will be, but without some income stimulus, for some retail sectors, the fall could be prolonged.
This conclusion was borne out by startling consumption statistics released at the very end of January for the full 2013 calendar year.
3% rise in tax will leave households in arrears
Since 2007, the annual net balance between disposable income and actual expenditure has dropped dramatically (see Chart 3). There are two ways to look at this.
The Consumption Tax was introduced in 1989 by another LDP government. The then PM Nakasone had led an election campaign on a pledge that such a tax would never be introduced, but then, as now, economic necessity dictated otherwise. Japan was coming to the end of a huge economic bubble, again backed by a significantly under valued Yen, and the initial 3% tax, applied as a single blanket over all transactions, came into force with remarkably little effect on either consumption or retail sales. Incomes were rising faster than expenditure at the time, and the household surplus grew significantly in the early 1990s.
In 1997, with unusual sincerity, another LDP government increased the tax to 5%. The year before the increase, consumers pushed up spending, but incomes were again on the rise, in fact peaking that same year, with the household surplus also hitting a peak of ¥142,000 in the next 12 months.
Here lies the biggest difference between 16 years ago and today. Average incomes are now 12% below that of 1997, far more than can be blamed on deflation, and the result largely of a relentless squeeze on salaries by business. Expenditure too has fallen slightly less, down 8.6%, but in turn the average household surplus for the 12 months of 2013 was 14.3% down on 1997 at just ¥106,962 per household, a fifth of one month’s income or just ¥8,900 a month on average. Everything else being equal, a 3% rise in consumption tax will raise average monthly expenditure by ¥12,500 leaving a typical household ¥3,600 in arrears.
These figures, however, rely on creating a second average of the monthly averages of the past 12 months. Taking the month to month cumulative totals of consumption expenditure and household disposable income, in 2007 total net disposable income exceeded expenditure by ¥393,493 for a typical two-person working household. This figure fell with the Lehmann Shock, but then rose slightly to ¥272,432 in 2011, still 30% down on 2007.
It has since dropped further. In 2013, the generally increased levels of consumption were coupled with further falls in overall average disposable income. With a net short-fall of around ¥130,000 per household as of November, double the same month in 2012, more optimistic observers expected large end of year bonuses to turn this deficit around. These did not materialise – bonuses did rise in December 2013 but by only 2.8%, way down on the 6.4% rise in the summer. The result was an astonishing fall in cumulative net annual disposable income of 24% in the past year, with the average family finishing with a surplus of just ¥160,418, less than half that of 2007 on this basis.
Japan may be quickly moving towards a situation more common in the US and Europe where net annual disposable income is actually negative. This might not be unique or even all that terrifying when compared to other countries, but for Japanese consumers, used to having large stocks of savings and being able to regularly top them up, the stress of losing that financial cushion could be devastating – not to mention the loss of the government’s consumer backed slush fund.
Some basis for optimism
But what actually happened to retail sales when the Consumption Tax was introduced and later increased for the first time? As already noted, the initial introduction came as Japan was reaching the peak of its bubble economy, incomes were rising and, on the whole, the tax introduction happened without retailers suffering anymore than they were from other factors (see Chart 4).
That is, at least at first. The bursting of the bubble and the natural rising in value of the Yen soon pushed retail sales down, as did the beginning of a long period of structural readjustment in the distribution sector.
The effect of the increase in 1997 is much clearer in the sales figures. Understanding the coming change in prices, consumers began spending more the year before the increase, just as they did in 2013. Sales recovered to their highest levels since 1992 thanks to this spending boost. The tax increase the following year in 1997 did indeed lead to marked declines in sales. Total retail sales were down 4.3% and apparel sales dropped 4.6%. Food did slightly better, dropping just 2.4%. Sales bounced back the following year, although only food matched sales levels from before the tax increase, so in real terms, overall retail sales actually fell.
Marketing protects against a downturn
Again, the current situation is not quite the same. Unlike in 1997, retailing today is organised, professional, profitable and growing. Following the economic downturn in 2008-9, most sectors and all the major formats have been improving – with even department stores recording positive results for the first time in more than a decade (see Page 9). This bodes well for the coming months. Top retailers are not only likely to drive more sales pre-tax increase through better marketing, branding and more targeted sales promotions, but these same skills should help some companies smooth out the downturn after 1 April.
It is worth noting that in at least two areas, spending after the last tax increase remained strong: luxury and discount. The top luxury brands succeeded in keeping customers interested in the late 1990s for precisely the same reasons leading retailers of all kinds do today: marketing. They provide a retail offer that has meaning to customers. In those days, this was relatively rare, and with little else to splash out on or enjoy buying, some luxury brands had a relatively successful time during the economic recession.
The other key change was the growth of Fast Retailing’s Uniqlo brand. Uniqlo was the first ever price competitive brand to come out of Japan and its low pricing and mass market appeal, backed by good marketing and branding yet again, led to massive popularity at the end of the 1990s. Suddenly price was an important buying factor for many consumers when previously all retailers had downplayed the pricing issue as much as possible. At the time, Uniqlo was the only player in the market aiming for a position that differentiated price but didn’t compromise on quality or store finish. Shimamura, of course, did equally well at the time, but in terms of marketing prowess, Uniqlo was in a different league.
Similarly, in 2014 there are numerous ways in which retailers could market themselves out of the spending decline, and there’s likely to be ample opportunity for profit orientated price hikes in some distribution channels too. On that basis individual companies need not worry about the big picture and just focus on convincing their target market that scarcer funds are worth spending at their stores alone.
On a macro basis, given the squeeze from inflation and flat incomes, the key to whether consumers come out of the post tax hike blues in the Autumn or much much later, will be employers and their willingness to increase pay levels. Right now, Japan’s domestic and export driven companies are enjoying the aggressive policies driving price inflation and a cheap Yen, but they have chosen to simply stash the money in the bank or invest overseas to help Abe beat down the Yen further.
If the domestic market isn’t to be hit seriously hard longer-term, these same companies, and the thousands of SMEs too, really need to pass on some of these gains to their hard working employees.
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