Japan's 20 years of economic stagnation

Wednesday 12 October 2011 8:30AM

Why it is that Japan's economy, one of the most successful of the 20th century, has became a stagnant swamp?

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Mark Colvin PM [archival]: Japan has slumped into recession. Its economy shrank at an annual rate of 3.7 per cent.

Mark Willacy Lateline [archival]: To prevent a Greece-style meltdown, where Japan loses the confidence of the bond markets and its interest rates start to climb, Tokyo has to start cutting its $11 trillion worth of debt.

Stephen Long PM [archival]: First the GFC, then the earthquake, the tsunami and nuclear meltdown. Not quite the four horsemen of the apocalypse but enough to leave 1000 people dead... and scupper economic growth.

Annabelle Quince: The natural disasters that occurred in Japan earlier this year certainly didn't helped its economy, but they also weren't the cause of Japan's ongoing economic woes.

Hello, I'm Annabelle Quince and this is Rear Vision on ABC Radio National, streaming on the web and downloadable on your MP3 player. Today we're going to find out why Japan's economy, one of the most successful of the twentieth century, has became a stagnant swamp.

At the end of the 1980s, Japan's economy was booming and asset prices going through the roof. By 1995, small banks were failing, and by the end of the '90s, Japan was sliding into recession. Sound familiar? In many respects the current crisis engulfing Europe and the United States echoes what's happened in Japan.

So why has Japan spent 20 years in a state of economic stagnation? And are there any lessons we can learn from Japan's experience?

But before we get to that, let's just remind ourselves just how successful Japan's economy was post-World War II. Charles Yuji Horioka is professor of economics at Osaka University.

Charles Yuji Horioka: Japan was the first country in the world to experience a sustained period of double-digit growth in GDP from say the mid-'50s to the early '70s. Japan has been called the 'East Asian miracle' and Japan was regarded as one of the biggest success stories in economic history, so it's a bit of a contrast to what's going on now in Japan.

Michael Hutchison: Japanese growth really in the '50s, '60s and '70s and '80s was really quite remarkable. There was a rough patch in the '70s with the two oil shocks; the first oil shock in particular; but other than that, it had by far the highest growth in any advanced economy.

Annabelle Quince: Michael Hutchison is professor of economics at the University of California and the author of Japan's Great Stagnation.

Michael Hutchison: Towards the end of the 1980s people were talking about 'the Japanese century'. The Japanese banks and the production processes in Japan would sort of be the model for the whole new era of manufacturing and relationships between corporations, government, and banks.

Annabelle Quince: By the late 1980s, Japan's economy was booming, and both stock prices and real estate prices went through the roof. Takeo Hoshi is professor in international economic relations at the University of California, San Diego.

Takeo Hoshi: The Japanese economy had boom years in the late 1980s, so after they recovered from the oil crisis, actually in the late 1980s, the Japanese economy experienced a huge boom of high appreciating asset prices. At one point people talk about how the price of the imperial palace is the equivalent of the whole land of California in the US. And then at the end of the 1980s and early 1990s, all those asset prices started to fall. And that was the start of the trouble for the Japanese economy.

Journalist [archival]: Well, another sign of the deterioration of the Japanese economy today. Tokyo's stock market declined even further today, edging down 71 points, the lowest level in more than six years.

Michael Hutchison: The stock market was just remarkable. It peaked, the last trading day of 1989, the stock market peaked. And on the opening trading day of 1990, it started to fall. And it just kept falling and falling.

Journalist [archival]: But while the general Japanese economy may look bad, economic analyst Paul Summerville says that's not really the case:

Paul Summerville [archival]: We're going through a longer than expected adjustment because of the poison that was released in the economy from asset inflation. I mean, the economy is by any comparative measure quite strong.

Michael Hutchison: Initially people thought this would just be a temporary downturn, but it turned out to be a long-term problem. When you're in the middle of a recession, often the statistics don't even show it till a couple of years later. So Japan started to decline in economic activity in 1991 and it was clear by the mid-'90s that this was a really a long-term problem that wasn't soon to go away.

Takeo Hoshi: Within a year or so the stock prices lost about 50 per cent of the peak and continued to go down throughout the 1990s, and even continued into 2000. The land price depreciation was slower, but again started in early 1990s, around 1991, and continued to go down. And by mid-2000 the land prices in Japan lost about 60 per cent or 70 per cent of the peak.

Annabelle Quince: The dramatic loss in stock prices led to a banking crisis.

Michael Hutchison: Financial crises around the world often have an asset price and a banking component. In Japan it was particularly linked, because Japanese banks owned a lot of shares of the enterprises they lent to. So on the one hand, their enterprises are declining in economic activity; that hurts balance sheets of banks because there are more bankruptcies, there are fewer loans, repayment is more difficult.

But in addition, they own the equity, or a good deal of the equity of these firms, so when asset prices declined, they also lost share value; that is, their own balance sheets deteriorated, not just on the lending side but on their asset side. So the combination of the two really put Japanese banks in a very difficult situation.

Annabelle Quince: And did you actually see banks starting to fail?

Michael Hutchison: Absolutely. There were a number of bankruptcies of smaller banks, but the Japanese method was more to merge, try to find if you will a white knight, it was called, bank to try to merge. And eventually the Japanese financial system became on the edge of a precipice, if you will, in 1997, November. And at that point they really were on the verge of a full-blown financial crisis, and at that point the government really did step in to inject public capital, to insist on a resolution. So the government became much more active in the resolution of the problem.

Annabelle Quince: In lots of ways was it very similar to the crisis that we've seen in the United States more recently?

Charles Yuji Horioka: Very similar, yeah. In the past Japan had been a follower country, doing what other countries had done, you know, 10, 20 years earlier. But in this case I think Japan was the forerunner; that this financial crisis hit Japan first and then a very similar thing happened in other countries the US and other countries—a decade or two later.

Journalist [archival]: Japan's new leader doesn't have much time to stop his country's alarming slide into recession:

[Keizo Obuchi [archival] speaking (in Japanese)]

Translator [archival]: The pressing issue facing us is to reconstruct the Japanese economy and get rid of people's uncertainty.

Journalist [archival]: Mr Obuchi revealed no details about new policy initiatives. He did, however, pledge to push a banking reform bill through parliament as quickly as possible. There was some speculation he may name one of his leadership opponents, Seiroku Kajiyama, as finance minister. Mr Kajiyama was favoured by the financial markets, because he was seen as a more decisive leader, who said he was willing to let weak banks collapse.

Takeo Hoshi: It took some time for the government to figure out how to respond to those failures, because this was new to the Japanese banking system. Before that, as I said, when a small bank started to fail, the government found a bigger and healthy financial institution to absorb that. So there was no mechanism to push banks through the bankruptcy process, so to speak. So there was no mechanism to dissolve failing banks. So the Japanese government had to come up with some new mechanism to deal with the failing banks. So that took time.

Annabelle Quince: And what kind of mechanisms did they put in place?

Takeo Hoshi: Eventually they created a mechanism or a framework for the government to allow the government to nationalise failing banks temporarily and clean up their balance sheet and sell that back to the private sector. And they applied that in 1998 for two big banks Long-Term Credit Bank of Japan and Nippon Credit Bank and that was a turning point of the crisis.

Michael Hutchison: Politically, there wasn't a lot of support for it. And, as you know, the Japanese government often doesn't have the strongest leadership. What I mean by that is multiple prime ministers coming and going and a sort of emphasis on consensus can mean that things are very slow to be implemented at the governmental level. And initially there was a great deal of backlash against the public support of further financial institutions, so it really took a few years before the problem really became acute, until the government really did step in.

And that's really the opposite of what I saw as happening in the United States, where the United States banking system, there was... you know, the secretary of the treasury and the Federal Reserve board chairman were very aggressive in persuading congress to pass a massive bank bailout bill within a few weeks; even though it wasn't passed the first time, it was passed a few days later, the second time.

And that whole bill was not only unprecedented in size, but also was passed and pushed through very, very quickly; in fact, so quickly that major elements of the bill did not come to pass; that is, their plans initially to use the money on buying assets and auctioning them off just didn't really work out, so they utilised the funds, but for different ways of supporting banks.

Annabelle Quince: So in Japan, were they able to shore up the banking system?

Michael Hutchison: Yes. Eventually... it took really I would say ten years to work off the bad loans so that banks had enough capital and they could start lending and stronger. And at that time the real economy never really did. There were several jump starts. That period by the way is sometimes called the 'lost decade', because Japanese growth really never was restored to its potential, at least what people thought the potential was. And it sort of was limping along, if you will, for many, many years. And partly that was because the banking system was trying to build up capital, trying to have more conservative lending practices. I'd argue at least that that put a dampener on the growth prospects of Japan.

Annabelle Quince: You're listening to Rear Vision via ABC Radio National, audio streaming, or your MP3 player. Today we're looking at why Japan's economy, one of the most successful of the twentieth century, has been in a state of stagnation for 20 years.

By the end of the 1990s, the combination of falling asset prices and the banking crisis had pushed Japan into a recession.

Journalist [archival]: After a week of watching its currency go into freefall, Japan has been hit by another bad piece of economic news. Real gross domestic product figures released this afternoon confirm that Japan is in the middle of its worst recession since the oil shock back in 1974. Japan's economy shrank at an annual rate of 5.3 per cent during the first quarter of 1998.

Journalist [archival]: Up until now the Japanese government has attempted to avoid the word 'recession'. Officials have described the state of the economy as being 'flat', 'severe', and 'very severe' anything but the 'r' word. With the release of Japan's GDP figures today, however, Japan's recession is now expected to become official.

Annabelle Quince: Once the Japanese Government acknowledged the recession, they responded by dropping interest rates and trying to stimulate the economy. Michael Hutchison again:

Michael Hutchison: Essentially interest rates went to zero. If you look at short-term interbank lending rates in Japan, they're virtually zero. Long-term rates are the lowest in the advanced economies. And of course part of that is because you don't have inflation in Japan, you actually have deflation. It's not a question of recovering to anything near their former values, but I'm talking about continued declines.

So when you have a country with declining real estate prices for 20 years, people become very reluctant to invest in an asset where they have no confidence that it will maintain its value or increase in value. So, on the monetary side, once interest rates get to zero, then the question is what do you do more? So some have argued that Japanese monetary policy should have been even more aggressive; you know, quantitative easing should have been more aggressive in Japan, say.

But in any case, everyone agreed that in those circumstances, zero interest rates, monetary policy is in a difficult bind.

Mark Colvin PM [archival]: Japan has unveiled another economic stimulus package of staggering proportions. With a headline figure of 18 trillion yen that's more than A$250 billion, it's the biggest of the nine packages introduced this decade. Analysts agree that today's pump-priming measures are needed to stop Asia's biggest economy from slipping back into recession.

Peter McCutcheon PM [archival]: Over the past week, the headline figure of this stimulus package has grown bigger and bigger: special assistance to small and medium-sized firms; a new elderly nursing care scheme; and a string of big public infrastructure programs to help the ailing construction industry.

Michael Hutchison: Fiscal policy has been for years stimulative, but once you're up to a certain level of government budget deficit, once you get to that level there is really no room to raise it further. Japan has the highest debt of any large advanced industrial country far surpassing Italy's, for example and the only way they can maintain that level is because interest rates are so low in the country. If interest rates were to tick up in Japan, then they have serious debt servicing issues.

But the point is that they have tried to stimulate the economy through building projects, through sort of aggressive fiscal spending, but once that's injected it has a certain impact on the economy, but unless it keeps growing it won't have additional impact. And that's the thing. It's already a very substantial size, so it's difficult for Japan to do any further fiscal expansion at this stage.

And there's been a big debate in Japan about roads to nowhere, bridges to nowhere; many of the projects now are so marginal that fiscal spending may have relatively limited or very small impact. So fiscal has been stimulative, but now they're in trouble.

Mark Colvin PM [archival]: Australia may have inflation to worry about, but in Japan the problem is much more serious: deflation is pushing unemployment up to record levels and there were signs today that Australia's biggest customer, and the world's second biggest economy, may not be moving out of recession after all.

Peter Martin PM [archival]: Three-and-a-half million Japanese are now unemployed; more than at any time since figures were first collected, as Japan recovered from the devastation of World War II. At 4.9 per cent, the unemployment rate is now only one notch below the psychologically terrifying barrier of five per cent.

Charles Yuji Horioka: Of course there have been ups and downs, but basically from, you know, the 1990s until the present. So basically it's this more than two-decade period of poor economic performance. Initially people were talking about the 'lost decade' in Japan; now people are talking about the lost two decades, because it's been more than 20 years of relatively poor performance.

Growth rates have been quite low during this 20-year period lower than other developed countries so that's one sign that things are not right in Japan. Employment has been very bad, especially young people. New graduates and other young workers have not been able to find permanent jobs and they've had to... many of them are unemployed, or working at temporary or only part-time jobs, or as contractual workers.

Annabelle Quince: And I mean, I'm wondering what impact that's had on Japan, because one of the key features of the Japanese economic model was that whole notion of lifelong employment and a traditional relationship between employers and employees. And has that started to break down?

Takeo Hoshi: In a sense that started to break down for some people. Part of the problem was the lifetime employment system continued during the recession. So the companies tried hard to protect those jobs of incumbent workers, the people who were already employed. And in order to protect those jobs when the economy or the business is not doing well, they cut down on the new hires. So that's why the unemployment cost was concentrated on the young people. In a sense, the lifetime employment system benefited the people who already had a job, but created a tough situation for the people who had to find jobs out of college or high school.

Annabelle Quince: What's been the social cost of that?

Charles Yuji Horioka: I think the social impact was not as severe as in the US and other countries for a couple of reasons. First is that they didn't cut back on social spending as much as perhaps some other countries. Of course that led to the ballooning government deficits and the government debt, so I'm not sure it was the right policy, but they didn't cut back on spending programs as much and in fact they introduced various fiscal stimulus programs tax cuts, rebates and so forth to try to stimulate the economy, try to get more money into people's hands. So the social impact was not so great, but the impact on the government debt was quite large.

Another difference I think in Japan is that there's a sort of a family support system, so the young people who graduate from high school or college and can't find jobs, they continue to live with their parents. There's this type of family support system that of course it exists in other countries, but it may not be as strong as it is in Japan and that has also helped to minimise the social impact.

Mark Colvin PM [archival]: The government in Tokyo today confirmed what had been suspected for months; that the economy was in a recession. Japan's economic activity contracted by point one of one per cent in the September quarter. Japan's recovery from its lost decade of the 1990s has clearly stalled and since the worst of the global financial crisis still hasn't flowed through into Japan's statistics, it still has a way to fall.

Michael Hutchison: Of the banking crisis, serious recession, deflation, continued asset price decline, they came out of the worst of that. But it took them probably by 2004, 2003. By that time there were signs of growth in Japan, of increasing incomes and so on, but it was always very modest. Japan never reached its pre-crisis former growth path, but it was modest growth and welcome, until the most recent crisis.

Annabelle Quince: So what if anything can we learn from the Japanese experience?

Charles Yuji Horioka: There are several things we could learn. Let me just point out three things. The first one is in fiscal policy. As I said, Japan implemented fiscal stimulus in early 1990s and that was helpful in recovering the economy, at least temporarily. But a mistake they made was in 1996 when the economy started to recover; the Japanese government raised the taxes and cut the expenditure too quickly. So at least with hindsight, the economy went back into recession. So one lesson is it is important to address the fiscal problem which happens after the fiscal stimulus, but the too quick fiscal consolidation can put the economy back into recession. This is a part of the problem many European countries are facing today.

The second lesson is monetary policy. In several senses the Japanese monetary policy was not aggressive enough. They cut the interest rate slowly in early 1990s, and eventually they cut the interest rate to zero, but they were not aggressive enough to try some new monetary policy like buying assets that the Bank of Japan eventually did and Federal Reserve has been doing very aggressively after the global financial crisis. So I think the second lesson is that it is important for the monetary policy to be aggressive and that there is something the monetary policy can do even at the zero interest rate.

And finally, the third area is banking policy. Japan was very slow in responding to the banking crisis. Non-performing loans problem started in mid-1990s, but they were really slow to tackle the non-performing loans and it took them seven or eight years before they finally got to the point that government forced the banks to write off those loans. One lesson from Japan is it is important to act quickly to restore the health of the financial system and getting rid of the non-performing loans.

Leigh Sales Lateline [archival]: Japan has the largest public debt of any industrialised country and there are fears it could be the centre of the next global financial crisis.

Mark Willacy Lateline [archival]: Japan's public debt stands at $11 trillion that's an 11 with 12 zeros on the end. This year's deficit alone is estimated to be $400 billion, or 6.4 per cent of GDP.

Charles Yuji Horioka: Japanese government issued government bonds to finance all those fiscal stimulus and also a bank bailout as well. So back in early 1990s, the debt to GDP ratio for Japan was very small and even compared with other advanced economies; but now in 2010s, the debt to GDP ratio for Japan is above 200 per cent and that's much higher than any other advanced economy's. So this will create a problem in the future, as all of these costs show up as a government debt. We haven't seen really the cost of the accumulation of those costs yet.

Takeo Hoshi: The situation is basically unsustainable, so the government will either have to... well, there's basically two choices: you either raise taxes or you cut spending. But it's hard to cut spending because it's a recession and we just had this huge earthquake, now we're having these typhoons, and you need spending for these emergency situations. But it's also hard to raise taxes, because raising taxes will depress the economy, take money out of people's hands.

So it's basically a catch-22 situation. The government is in a very difficult situation about how to simultaneously maintain economic performance and reconstruct government finances, reduce the government debt, at the same time. That's a very, very difficult thing to do.

Annabelle Quince: Japan in essence has a different kind of debt to, say, countries like Greece and Italy, because with a lot of countries that are suffering from a sort of sovereign debt crisis at the moment, the debts actually belong overseas, or the money's been borrowed from overseas. Most of Japan's debt has actually been borrowed within Japan.

Takeo Hoshi: That's right. That's right. So I was sort of already saying this was the case when I said the figures for Japan are worse than Greece. The figures are worse, but as you point out, there's an important difference that a lot of the bonds, government bonds, are held domestically.

But that may not continue forever, because, for example, I don't know if you know, but the Japanese household, or personal saving rate, in the mid-'70s it was 23 per cent; people were saving one quarter of their income. Now the personal or household saving rate is three to five per cent. So it's like one-fifth or less of what it was at the peak. So individuals are hardly saving at all anymore. Of course they still have large amounts of assets, but they're not adding very much to that stock of assets.

By contrast, companies, they're showing a greater corporate saving, and so they might be willing to buy up these government bonds for a while. But I'm not sure higher corporate saving is a good thing, because it suggests that companies have become pessimistic about the future. So I think it has a good side as well as a bad side.

But what I wanted to say is that up until now, Japan has been helped greatly by the fact that corporations as well as individuals saved a lot and they were willing to buy up these government bonds so that they didn't fall into the hands of foreigners, but that situation could change. Households are saving a lot less and although corporations are still saving quite a bit, that may not continue forever.

Mark Willacy Lateline [archival]: For the country's new prime minister, tackling public debt and balancing the budget by 2021 is priority number one:

[Naoto Kan [archival] speaking (in Japanese)]

Translator [archival]: Japan is currently facing a difficult situation, with the worst fiscal situation among developed countries. We cannot sustain public financing that overly relies on issuing bonds. As we can see in the Eurozone confusion that started from Greece, there is a risk of default if the growing public debt is neglected.

Charles Yuji Horioka: Eventually Japan has to emerge out of this stagnation. And the important issue today I think is a fiscal issue; the government debt, how much the government debt problem can continue to weigh on the economy. And there is disastrous scenario that the government debt problem in Japan can create another financial crisis in Japan, because many Japanese financial institutions have large amount of government debt. So when the value of the government debt is lost, the financial system will get into the problem again. So it's important for the Japanese government to fix the budget issue, and without that I think that Japan will continue to stagnate, or even worse, Japan could experience another financial crisis and economic crisis.

Annabelle Quince: Charles Yuji Horioka, professor of economics at Osaka University. Our other guests: Takeo Hoshi, professor in international economic relations at the University of California, San Diego, and Professor Michael Hutchison, author of Japan's Great Stagnation.

Today's sound engineer is Steven Tilley and archival material came from ABC Archives.



Charles Yuji Horioka
Professor of Economics at Osaka University in Japan
Michael Hutchison
Professor of Economics at the University of California and the author of several books about Japan
Takeo Hoshi
Pacific Economic Cooperation Professor in international economic relations at the University of California San Diego


Japan's Great Stagnation: Financial and Monetary Policy Lessons for Advanced Economies
Edited by Michael M. Hutchison and Frank Westermann
The MIT Press 2006


Annabelle Quince
Annabelle Quince

Comments (1)

Add your comment

  • Sue Ni :

    12 Dec 2011 6:39:47pm

    "Roads to nowhere" seems part of the problem. Infrastructure that helps development and raises spirits like ecological repair and restoration of fisheries would have a bigger payback. Investment in renewables would similarly boost employment among the young because they are operated by new corporations with new skills therefore a bias towards new entrants into the workforce. At the end of the day renewables will make a more energy efficient cost efective economy.