The victorious Democratic Party of Japan did not put economic growth at the heart of its electoral sales pitch. The party's manifesto mentions "growth" only once. The word "support", by contrast, appears 19 times.

Even so, there are reasons for optimism that the DPJ's softer and more nurturing policies are just what the economy needs.

The global slump provided a painful reminder of the dangers of Japan's export-oriented growth strategy. Output has fallen even faster than in other rich countries, leaving national income at roughly the same level as in the early 1990s.

After two decades of stumbling between recessions, policy makers need to convince their citizens to spend some of their vast cash savings, which are now equal to 1.5 times GDP. Making the Japanese feel more secure may be the best way of doing this.

There is plenty in the DPJ's platform that looks encouraging. If Japan's new government can enact election pledges, Japanese citizens would have fewer reasons to hoard cash.

Parents would benefit from a generous child allowance. High-school education would be made free and university scholarships more plentiful. For the elderly, there would be a minimum guaranteed pension of at least 70,000 yen (about $750) a month. The unemployed would get 100,000 yen (about $1,100) a month during job training.

There are two problems, however. The first is how to pay for this largess. The party's belief that its $180 billion social agenda can be financed by cutting wasteful spending has left some economists unconvinced. A good deal of the fat in the budget was cut out when Junichiro Koizumi was prime minister from 2001 to 2006.

Canceling public works may be easy. But reducing the cost of Japan's powerful civil service by 20 percent is a tall order -- especially when combined with a drive to strip senior mandarins of much of their influence.

Meanwhile the DPJ seems reluctant to privatize the government's giant postal savings and insurance businesses. An IPO could provide a large injection of cash without the need to trim costs or raise taxes.

If the Japanese feel the new social programs are unsustainable, they may be more reluctant to spend. With national debt at over 200 percent of GDP, a degree of skepticism would be natural.

The second economic headwind for the DPJ is even harder to overcome. Shrinking pay checks will make it difficult to tempt the Japanese into the shops. This year wages have been falling at their fastest pace on record -- 7.1 percent in the year to June.

Beyond the cyclical downturn, deeper demographic forces are at work. As highly paid baby boomers retire, they are being replaced by cheaper youths, according to Edward Lincoln, an economics professor at New York University. This is ratcheting down wages.

A decline in the working age population will also make economic growth more of an uphill struggle. Overall the number of Japanese citizens has been falling since 2005. This makes Japan an unlikely engine of global growth even if the DPJ gets everything right.

Promising as some of its policies are, Japan's new government will face strong headwinds. But it is good news both for Japan and the world that the country now has a leadership that seems inclined to put the interests of consumers before exporters.

(James Saft is a Reuters columnist. The opinions expressed are his own)

Investors met the news that Japan’s economy has emerged from a bone-breaking recession calmly and rationally: they sold shares quickly and in large amounts and made bets that consumer prices are going to be falling for years to come.

That’s because Japan’s recovery, coming as it does after a global bubble in the production of what I call, for lack of a more technical term, “stuff,” is really not sustainable.

The fact that the consumer portion of the recovery is only a reflection of income transfers from government to individuals isn’t very encouraging either.

More importantly, given that hopes for Japan were low anyway, the vulnerability of its recovery point to some important challenges the nascent rebounds in the U.S. and Europe now face.

Japan grew at a 3.7 percent seasonally adjusted annual rate in the second quarter, in data reported on Monday, quite a contrast with the almost 12 percent annual rate of contraction in the three months before.

The recovery was heavily dependent on consumer spending, goosed by government subsidies for buying hybrid cars and green appliances, as well as a heavy public works spending.

Public spending in a downturn is a good thing, but it needs to set the stage for private investment and consumption later, and in Japan this does not seem to be happening.

“Japan’s return to growth in the second quarter is a prime example of a ‘feel bad’ recovery,” Lombard Street Research’s Michael Taylor told clients.

“Recovery may prove to be rather short-lived, as so far there are precious few signs that Japan is capable of sustained, domestically-driven GDP growth. The continued accumulation of inventories in Q2, albeit at a more modest pace than in recent quarters, also casts doubt on growth prospects through the second half of the year.”

The underlying figures were ugly. Private capital investment fell 4.4 percent compared to the first quarter, and real investment in housing fell by nearly a tenth. Cash earnings for Japanese workers has fallen 7.1 percent in the year to June.

The recovery in Japan is like a long lost and reputedly rich uncle who, now that he has come home, proves to be a poor bedraggled thing who rather than bringing hope and gifts only really wants to cadge a meal and a place to sleep.

WHY THIS TIME IS JUST NOT NORMAL

In a typical economic recovery, inventories, having been run down are rebuilt. This should prompt companies to make capital investments to gear up new production. People get hired, they spend money and so do others who are less fearful for their jobs. Companies become more profitable and the cycle reinforces itself.

But in Japan, and perhaps elsewhere, this recovery isn’t really working that way. Capital expenditure isn’t coming back. Company profits are being hit. Whatever profitability improvements we see globally are largely down to cost cutting.

This squeeze hurts already nervous workers who in their turn aren’t spending much money. Unless, of course, they need to in order to get their share of a government handout.

Even with inventories being restocked, the amount of spare capacity in the global economy is very substantial. Company managers too will have been taught a lesson about leveraging up to expand: not only is demand not always there sometimes the banks want their money back unexpectedly and usually at the most inconvenient time.

Consumers, and not just in Japan, aren’t very confident in the future of property and decide that what once looked like a prime investment now looks like avoidable consumption.

Policy makers in Japan and elsewhere understand these dynamics and they have made heroic efforts to break the cycle. Up to a point, they have succeeded.

It’s not so much that the policies - huge increases in liquidity and massive stimulus - aren’t appropriate but that our expectations for what they can do has been too high. We are no doubt better off than we would have been, but we have shifted the burden of re-making the economy and paying down the debt out in time. It will be a longer, slower process and will disappoint many investors who think we are back to the good old days.

One advantage Japan does have is its position in Asia, where it may be able to benefit if Chinese domestic demand takes off. But overall Japan is linked to global trade, which while it has bottomed, has made its recovery due to government spending which some day soon will have to be replaced.

As for Japan domestically, the fiscal stimulus will peter out in the first quarter of next year. What will arrive to take its place I cannot tell you, but if nothing does it will prove to have been a brief, miserable recovery.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

– Christopher Swann is a Reuters columnist. The views expressed are his own –

People can be divided into three classes, it has been said: the haves, the have-nots and the have-not-paid-for-what-they-haves. The prevalence of the third category may be the biggest single source of vulnerability for the U.S. recovery.

A stress test of the consumer could reveal more distressing results than the one conducted on the banking system.

Debt is at high levels — 130 percent of disposable income, or more than twice its peak in the late 1980s. A slide in net wealth has reduced the collateral Americans can draw upon for emergency loans. Finally, it is now harder to borrow money for new consumption or to roll over existing debt.

Like a compromised immune system, this weakness makes consumers extremely susceptible to further shocks. Traumatic as the recent bout of retail restraint may have felt, worse may be in store. After all, consumption rose by 18.5 percent in the seven years to 2008. So far it has only fallen back by less than 2 percent.

There are several potential mishaps that could swiftly undermine consumer spending and set the recovery back to square one.

Among the most likely problems would be a continued slide in house prices. Even on the conservative measures used by the Federal Reserve, the value of residential real estate has fallen 18 percent since 2006.

With signs of recovery still tentative, a further 10 percent slide is well within the realm of possibility — inflicting a further blow on the balance sheet and sense of well-being of American households. (If nervousness over swelling government debt pushes up bond yields, the outcome could be still worse.)

Homeowner’s equity, already down to 40 percent from close to 60 percent, would plunge to 35 percent. This would send household wealth down to its lowest level since the mid-1980s. While Americans can’t immediately rebuild the $12 billion of net worth lost over the past 2 years — equivalent to more than a year’s worth of consumption — further losses will heighten their sense of caution.

A second threat is also looking increasingly likely — wage cuts. Fifteen percent of employers surveyed by the Society for Human Resource Management reduced pay in the past six months, a threefold increase from earlier this year. It is no longer implausible to imagine nominal wages starting to decline on a nationwide basis.

The Employment Cost Index is already rising at its slowest rate since the early 1980s. Wage deflation would make it even harder for Americans to repay the $10.5 trillion of mortgage debt they hold or the $2.5 trillion of consumer credit.

Martha Olney, a professor at Berkeley, envisages disproportionate cuts in spending if wages dip. “For households that are paying 60 percent of their income in mortgage and credit payments a 10 percent pay cut does not mean a 10 percent fall in disposable income,” she says. “It’s a 25 percent fall.” This is the danger of leverage.

Even under a rosy scenario it could take years for American consumers to repair their finances. If the savings rate rises to 8 percent of disposable income — about $860 billion a year — it will now take four years for debt to return to its 2002 level. This steady drain alone is equivalent to almost 10 percent of consumer spending.

After such a substantial loss of wealth, Americans will be pressed to be even more frugal. Along the way American will be hyper-sensitive to any jolts from weaker than expected employment, house prices or financial markets.

Consumer spending may not merely stagnate as most economists expect. It could yet decline more sharply. And like the banks, consumers will almost certainly need more support from the central bank and government before this economic malaise is over.

– James Saft is a Reuters columnist. The opinions expressed are his own –

The good news that the United States cannot keep contracting the way it has been is not to be confused with a return to robust expansion, a point financial markets eventually will grasp.

Consumers, the mainspring of the U.S. economy, will see the cash from government stimulus slip through their fingers but will still face very ugly personal balance sheets and a brutal job market. Their party is not going to get started again for some time.

And falling interest rates will have a hard time sparking investment by businesses until they become convinced that a recovery in manufacturing will do more than just take inventories from nearly empty to barely stocked.

The basic hope for the U.S. economy, that inventories are being run down so swiftly that a turn in the cycle must come, has been more or less confirmed by recent data.

The ISM manufacturing index advanced to 40.1 in April from 36.3, and especially encouraging is a sustained rebound in new orders, a leading indicator of forward demand, which having been more or less moribund in the early months of the year, now is in a sustained uptrend.

Inventories are still being cut, but this, optimists argue, is setting the stage for a recovery when managers see that their depleted stocks represent the threat of losing out on business.

There was also a surprising 2.2 percent increase in real consumer spending in the first quarter, as opposed to the shocking fall of four percent in the second half of last year.

We simply can’t fall at the same rate we have been if that keeps going. It probably will and we will probably see a sort of a recovery kicking off in the second half. Even now, billions in stimulus are sloshing through the U.S. economy. In May social security recipients will get an extra $250 and withholding rates for federal tax have been cut.

But the effect of government money will recede, and while stock markets have rallied, the balance sheets of many Americans are still very fragile. Remember too that the U.S. is aging, and many savers approaching retirement have seen zero investment gains in their portfolios over periods as long as a decade.

Their garages are full of junk they probably feel they don’t now really need, their employment prospects are as bad as in living memory and they face a very long retirement due to expanding life expectancy. Wages and salaries have fallen by 1.2 percent over the past year, an all-time record, and hardly an incentive for the average American to start splurging again.

Savings is here to stay and consumption will have to take a back seat.

TOO MUCH PESSIMISM

So, can business spending in the U.S. take the baton from exhausted consumers?
It probably cannot. First off, businesses are less interest rate sensitive than consumers, and so the effects of the official policy of driving market rates down will have less impact among them.

And while inventories are still low, so is final demand and most corporate managers, having just lived through the most gut-churning time of their entire careers, will not be likely to stick their heads above the parapet and make a lot of speculative investments in new capacity simply because things have stopped looking worse.

This may get to the heart of the problem that the economy will have in making a robust recovery: psychology. Just as people were too optimistic before the crisis, they are likely to remain too pessimistic for a time afterwards.

There is also the matter of sheer scale. Consumption is about 70 percent of the U.S. economy  while capital expenditure at about 8 percent will have a hard time being the engine of a robust recovery. That 70 percent must fall and will outweigh everything else.

Perhaps the proof of a turnaround in business activity will be corporate profits, which across the economy are still falling. Corporate profits allow businesses to expand and give them the cash to do it and the evidence needed to secure credit.

And finally we have a banking and financial system that, while improving, is still not able to intermediate credit properly. That the Federal Reserve is taking matters into its own hands is on balance good, but they are likely to make some ghastly mistakes, not to mention putting their very independence in jeopardy.

Balance sheet recessions, when cutting debt is a priority, take a long time and are characterised by disappointments.

We are past the worst of the crisis, but now moving on to something not as dangerous but just as hard: building a more balanced economy.