Europes Economic Woes Require a Japanese Solution
No policymaker, anywhere in the world, wants his or her national economy to be compared to Japan's. That's because the Japanese economy, though still the world's third-largest, has become a sad case-study in the long-term damage that can be inflicted by a financial crisis. It's more than two decades since Japan's financial sector melted down in a gargantuan property and stock market crash, but the economy has never fully recovered. Growth remains sluggish, the corporate sector struggles to compete, and the welfare of the average Japanese household has stagnated. The stark reality facing Europe right now is that its post-crisis economy is looking more and more like Japan's. And if I was Mario Draghi, Angela Merkel or Francois Hollande, that would have me very, very nervous that Europe is facing a Japanese future  a painful, multi-decade decline. The anemic growth figures in post-crisis Europe suggest that the region is in the middle of a long-term slump much like post-crisis Japan. Euro zone GDP has contracted in three of the five years from 2009 and 2013, and the International Monetary Fund is forecasting growth of about 1.5 a year through 2019. Compare that to Japan. Between 1992 and 2002, Japan's GDP grew more than 2 only twice, and contracted in two years. What Europe has to avoid is what happened next in Japan There, the "lost decade" of slow growth turned into "lost decades." A self-reinforcing cycle of low growth and meager demand became entrenched, leaving Japan almost entirely dependent on exports  in other words, on external demand  for even its modest rates of expansion. It is easy to see Europe falling into the same trap. Low growth gives European consumers little incentive to spend, banks to lend, or companies to invest at home. Europe, in fact, has it worse than Japan in certain respects. High unemployment, never much of an issue in Japan, could suppress the spending power of the European middle class for years to come. Europe also can't afford to rely on fiscal spending to pump up growth, as Japan has done. Pressure from bond markets and the euro zone's leaders have forced European governments to scale back fiscal spending even as growth has stumbled. It is hard to see where Europe's growth will come from  except for increasing exports, which, in a still-wobbly global economy, is far from a sure thing. This slow-growth trap is showing up in Europe today as low inflation  something else that has plagued Japan for years on end. Deflation in Japan acted as a further brake on growth by constraining both consumption and investment. Now there are widespread worries that the euro zone is heading in a similar pattern. Inflation in the euro zone sunk to a mere 0.4 in July, the lowest since the depths of the Great Recession in October 2009. Sadly, Europe and Japan also have something else in common. Their leaders have been far too complacent in tackling these problems. What really killed Japan was a diehard resistance to implementing the reforms that might spur new sources of growth. The economy has remained too tied up in the red tape and protection that stifles innovation and entrepreneurship. And aside from a burst of liberalization under Prime Minister Junichiro Koizumi in the early 2000s, Japan's policymakers and politicians generally avoided the politically sensitive reforms that might have fixed the economy. Europe, arguably, has been only slightly more active. Though some individual governments have made honorable efforts  such as Spain's with its labor-law liberalization  for the most part reform has come slowly as in Italy, or has barely begun France. Nor have European leaders continued to pursue the euro zone-wide integration, such as removing remaining barriers to a common market, that could also help spur growth. What all this adds up to is simple If Europe wants to avoid becoming Japan, Europe's leaders will have to avoid the mistakes Japan has made over the past 20 years. That requires a dramatic shift in the current direction of European economy policy. First of all, the European Central Bank ECB has to take a page out of the Bank of Japan's BOJ recent playbook and become much more aggressive in combating deflation. We can debate whether the BOJ's massive and unorthodox stimulus policies are good or bad, but what is beyond argument at this point is that ECB president Draghi is not taking the threat of deflation seriously enough. Inflation is nowhere near the ECB's preferred 2 and Draghi has run monetary policy much too tight. He should consider bringing down interest rates further, if necessary employing the "quantitative easing" used by the U.S. Federal Reserve. But Japan's case also shows that monetary policy alone can't raise growth. The BOJ is currently injecting a torrent of cash into the Japanese economy, but still the economic recovery is weak. Prime Minister Shinzo Abe finally seems to have digested that fact and in recent months has announced some measures aimed at overhauling the structure of the Japanese economy, by, for instance, loosening labor markets, slicing through excessive regulation, and encouraging more women to join the workforce. Abe's efforts may prove too little, too late, but European leaders must still follow in his footsteps by taking on unions, opening protected sectors and dropping barriers to trade and investment in order to enhance competitiveness and create jobs. If Europe fails to act, it is not hard to foresee the region slipping hopelessly into a Japan-like downward spiral. This would prove disastrous for Europe's young people  already suffering from incomprehensible levels of youth unemployment  and it would deny the world economy yet another pillar of growth.