Japan's Lost Decade

“What goes up must come down”

-Sir. Isaac Newton

Japan’s economic expansion preceding its asset bubble skyrocketed in three separate waves before tumbling faster than you can say jackrabbit.

During the late 1980s until the early 2000s, the Bank of Japan’s best efforts failed to stabilize and secure future economic expansion. Japan’s slouching recovery remained light-years behind recoveries seen across the world in different periods.

Today, this categorical catastrophe is best known as Japan’s “Lost Decade.”

This article uses the following five-point topical approach to discuss and analyze the events before, during and after Japan’s “Lost Decade.”

  1. The Surge Before the Purge: 1950s-1970s Investments

  2. The Bubble Explodes: Macroeconomics & The Lost Decade

  3. The Lost Decade: Building a House of Cards

  4. Doves v. Hawks: Japan’s Approach to The Asset Bubble

  5. The Spiel: Today’s Time For Yesterday’s Crime

The Surge Before the Purge

Following the end of World War II, Japan experienced three vastly different periods of economic expansion: (1) The Iwato Boom; (2) The Japanese Archipelago remodeling project; and (3) The Heisei Boom.

The Iwato Boom

The Iwato Boom reflected a “high-economic growth period” brought on by technological innovations that replaced Japan’s reconstruction demand prior to World War II, according to The Institute for Monetary and Economic Studies (IMES).

Japan’s real economic growth rates exceeded 10 percent from the end of 1958 until the beginning of 1962. Meanwhile, technological innovation replaced Japan’s reconstruction demand prior to World War II, according to The Institute for Monetary and Economic Studies.

But real economic growth rates only paint a portion of Japan’s economic picture.

Rising consumer prices is another critical portion to this portrait. In the Iwato period, consumer prices increased during the same time wholesale prices remained constant.

According to the The Institute for Monetary and Economic Studies, Japan’s combination of real economic growth rates and rising consumer prices created a portrait that showcased Japan’s fundamentally sound economy. And, as a result, led to a period of productivity difference inflation.

Archipelago Remodeling

Remodeling the Japanese Archipelago represented Japan’s second post-war economic expansion that occurred during the early 1970s. During the remodeling period, The Consumer Price Index (CPI) increased by more than 20 percent between 1973 and 1975. The CPI increase represented real economic horsepower for people such as homeowners who benefited from higher home values and increased wages. Earning more while paying the same on a mortgage meant that residents had more disposable income or could sell their home at a profit.

Shortly before 1975, real GDP tanked and thereby ended Japan’s economic expansion.

The Heisei Boom

Japan’s Heisei Boom reflected rapid growth during the late 1980s. Rapid growth coincided with the Bank of Japan’s policy to keep interest rates low, which spurred investment that led to a 60 percent increase in Tokyo’s property values in 1989. The Nikkei 225 recorded a record high of 39,000 in December, 1989, but by 1991, the Nikkei 225 fell to 15,000. This led to the bubble’s explosion shown on the graph below.

The Bubble Explodes: Macroeconomics & Japan’s Lost Decade

Analyzing Japan’s post WWII economic performance using macroeconomic statistics tells a story of how a country went from nearly total post war destruction to recording the third highest nominal Gross Domestic Product ranking in the world.

In order to compare Japan’s economic vitality relative to other countries, economists use Gross National Product (GNP) and Gross Domestic Product (GDP) as two of several macroeconomic statistics. GNP estimates the total value a country's residents produce from the products and services they deliver in a given period-- notwithstanding whether residents live within or outside of the country. In contrast, GDP measures the value of goods and services produced within a country’s borders.

Between 1950 and 1990, Japan’s real GNP per capita rose from $1,230 USD to $23,970 USD. Adjusted to 1990 figures, Japan’s real GNP represents a significant increase during this 40 year period.

Prior to the 1990s, Japan’s economy recorded three major macroeconomic achievements:

1. Japan’s GNP soared

2. Japan became the 2nd largest economy by the late 1960s (nominal GDP)

3. Japan generated massive surpluses through its export industry

Experts considered Japan’s rapid economic growth nothing short of a miracle.

But, again, as Sir. Isaac Newton stated: “What goes up, must come down.”

Japan suffered terribly when their stock market collapsed and they experienced a real-estate bubble in 1991. Following the asset bubble crisis, Japan’s GDP fell from $5.4 trillion to $4.5 trillion between 1995-2007, real wages fell around 5 percent and the country experienced stagnanted price levels. On a per capita basis, real GDP growth slowed markedly during the 1990s before rising again during the 2000s, shown in the graph below.

These numbers aren’t reduced to elaborate window dressing. And they’re not simply meant for fanciful charts and graphs. These numbers have real meaning.

A significant change in GDP typically affects the stock market. A decrease in GDP usually translates to dips in stock prices, which gives investors and economists pause because the conditions could be an indicator of a looming economic recession.

As the following graph shows, between 1991 and 2000, cumulative per capita real GDP grew by 6 percent, compared with 26 percent in the United States. In 1991 Japan’s unemployment rate was at 2.1 percent, and in 2002 reached a historical peak of 5.5 percent. The unemployment rate actually rose from 2.1 percent in 1991 to 4.7 percent at the end of 2000. Although an unemployment rate of 4.7 percent may seem low compared to most countries, it is an anomaly for Japan, given the prominence of a lifetime employment model and the fact that Japan’s unemployment never exceeded 2.8 percent in the 1980s.

The Lost Decade: Building a House of Cards

The following paragraphs examine the underlying causes leading up to Japan’s economic catastrophe, including: financial deregulation; investments; and non-performing loans.

Financial Deregulation

Japan's financial deregulation began in the late 1970s with reforms in the bond, foreign exchange and equity markets. These reforms allowed Japanese corporations to raise capital more cheaply from the capital markets, especially in the foreign bond market, while savers made investments in equity markets, thereby eroding the dominant position banks enjoyed in the financial system.

Prior to the deregulation, corporations that looked for capital depended on bank funding. According to the Bank of Japan, the shares of bank credit to the manufacturing sector fell from 49.7 percent to 14.9 percent between 1960 and 1995. On the other hand, the real estate, finance, construction and other service sectors increased their shares largely since 1980.

Investments

During the second half of the 1980’s investments grew rapidly. The combined effects of a boom in asset prices and banks’ lax lending policies galvanized excessive and imprudent investments. However, once the bubble collapsed investments started to decline. The slowdown of private investment also contributed to lower potential output growth. Due to the large decline in private investments, Japan's economy experienced an increase in savings. The decline in the growth rate of the working age population reduced the need to invest in capital equipment for new workers, thus exerting a negative impact on capital investment.

Non-Performing Loans (NPLs)

Land prices continued to fall throughout the 1990s causing many loans that dealt with real-estate to deteriorate. Prior to 1991, borrowers could borrow up to 90 percent of their real estate collateral, which dropped to 50 percent between 1991-1998, leaving 40 percent of such loans uncovered. Loans to industries with land as their collateral became non-performing loans, according to Takeo Hoshi’s article, What Happened to Japanese Banks, published by the Institute for Monetary and Economic Studies in 2001. This deterioration of loans is similar to what happened during the real-estate bubble in the U.S. during 2008 and 2009. Furthermore, any loans that were tied to the stock market were also classified as non-performing loans. Japan found itself in a poor financial position due to a lack of oversight for initial loans, corruption among the banking industry, government officials and financial firms.

The House of Cards Falls

A liquidity trap is an economic scenario in which households and investors sit on cash; either in short-term accounts or literally as cash on hand, according to Barry Nielsen’s “The Lost Decade: Lessons From Japan’s Real Estate Crisis.” (Nielsen). As noted above, households and investors in Japan during the “Lost Decade” lacked confidence that they would earn a high rate of return by investing and believed deflation was in the near future. During the 1980s, Japan saw their land and stock market prices triple. However, this growth couldn’t continue forever. In the 1990s, Japan's high personal savings rates, driven in part by the demographics of an aging population, enabled Japanese firms to rely heavily on traditional bank loans from supporting banking networks, as opposed to issuing stock or bonds via the capital markets to acquire funds. This, in conjunction with the lack of discipline when determining the quality of the borrower, helped inflate Japan’s economic bubble. The Bank of Japan began increasing interest rates in 1990 to help offset concerns over the bubble, and in 1991 land and stock prices began a steep decline andithin a few years, reached 60 percent below their peak, according to Paul Krugman’s “The Return of Depression Economics and the Crisis of 2008."

Doves v. Hawks: Policy After Invisible Hand Backhands Economy

Navigating the waves of a choppy national economy can be compared to steering an ocean liner—after heading in one direction, only a steady hand and considerable time allow you to reverse course.

Amid an economy in tatters, Japan’s government had to decide how best to steer toward a brighter future. Would they listen to the “Doves” or the “Hawks”?

The Hawks’ Approach

The Hawks, also called classical economists, operate under an“invisible hand” premise, which assumes that:

  1. Markets generally regulate themselves; and

  2. Private incentives align with welfare maximization.

When the invisible hand backhands an economy, Hawks tend to “wait-it-out” with less government intervention in fiscal policy.

The Doves’ Approach

The Doves, also called Keynesian economists, in times of turmoil, prefer to“wonk-it-out” with more government intervention over monetary policy. During a recession, Keynesian economists advance the idea that governments should stimulate their economy with:

1. More government spending and/or intervention; and

2. Lower taxes

Japan’s Approach

Japan tried the hawk approach, then they tried the dove approach.

Japan enjoyed a 2.4 percent budget surplus in 1991 that spiralled into a 10 percent budget deficit by 1998.

Economists traced the problem to businesses, largely banks, being overly leveraged. Banks held so much debt that they became unable to lend. Meanwhile, other firms simply borrowed too much and were at risk of going bankrupt due to ineffective operations.

Not until the mid-1990s, did Japanese banks start writing off bad debt—five years after its bubble burst. This represented their hawkish approach.

When catastrophe knocked at Japan’s doors, government refused to answer. Japan’s inaction caused Ben Bernanke to call Japan’s response "exceptionally poor monetary policymaking."

Japan’s first attempt to stimulate its economy applieda Dove-like approach, where they reduced interest rates to 0 percent. Nothing happened. Confidence in Japan’s economy faltered. Businesses refused to borrow and consumers decided to save their money rather than spend it—further contributing to economic stagnation.

Japan’s second stimulative attempt involved injecting trillions of yen into construction projects—new bridges, buildings, highways and the like. These actions extended Japan’s debt to GDP ratio to 100 percent.

Japan’s third action involved ending the stimulus amid concerns that the budget deficit was too big. This action led the economy to sputter once again—requiring another stimulus.

At the end, Japan attempted to galvanize its economy with more than 10 separate rounds of economic stimulus packages totalling more than 100 trillion yen. Yet they failed to end the recession.

Again, navigating the waves of a choppy national economy can be compared to steering an ocean liner—requring a steady hand and considerable time to reverse course. Japan’s delayed response to address their struggling economy and later constantly changing policy prescriptions might be akin to a captain’s unsteady hand at the controls.

The Spiel: Today’s Time For Yesterday’s Crime

What are the lasting consequences of Japan’s “Lost Decade”?

Lasting consequences of Japan’s “Lost Decade” have been chronic deflation and stagnation with GDP growth that was virtually flat. Following the “Lost Decade,” Japan implemented an interventionist monetary policy known as “qualitative easing” to free up credit markets, fight deflation, and reassure financial markets. Between 1992 and 2000, Japan applied 10 fiscal stimulus packages totaling more than 100 trillion yen, while progressively lowering its discount rate down to .25 percent after 2001, according to Daniel Harari’s “From the ‘Lost Decade’ to Abenomics.

Japan’s qualitative easing saw its greatest expansion following the 2012 election of Prime Minister Shinzo Abe and his “Abenomics” plan to revitalize Japan’s sluggish economy with “three arrows” of reforms: monetary easing, a robust fiscal policy, and policies for growth to spur private investment, according to an article published by Reuters’ author Linda Sieg titled “Japan’s Abe battles doctors’ lobby of “Third Arrow” reform.

Monetary easing is an attempt by the government, specifically Japan’s national bank, to flood the market with cash. With more money available through monetary easing, the prices of goods and services should increase in-turn. Increased price levels by creating more money will then break the deflationary cycle and spur consumers to stope saving and start spending.

Japan’s robust fiscal policy includes increased spending toward welfare of Japan’s aging population, servicing high debt, and public works projects. With already astronomically high debt levels, the Japanese government is reluctant to continue throwing money at its economy without finding new sources of income. To address this issue, Japan has increased the consumption tax to 10 percent in 2015, up from 8 percent in 2014.

To spur financial growth, the Abe administration has launched a number of policies. First, a lower corporate tax is meant to make the formation and operation of business easier. Second, there is a push to increase the labor participation of women in the workforce. With Japan’s population and labor force on the downslope, bringing women into the workforce is a way to plug the labor shortage. Third, Japan is trying to become more open to foreigners through permanent residency programs for skilled workers and making Japanese universities more attractive to outsiders. Finally, Japan has stripped away regulation that impeded free trade and lowered barriers to foreign investment.

The jury is out on whether Japan’s qualitative easing efforts have been successful. Japan’s government has pointed to a cumulative total of 4.2 percent GDP growth from 2012 to 2014. But despite Japan’s best efforts to combat deflation and slow growth, these policy measures failed to powerfully boost economic growth. As of 2015, Japan’s GDP grew by a modest 1.1 percent. A more lasting and less nebulous impact of Japan’s qualitative easing has been a mountainous debt burden. At 240 percent of its GDP, Japan has the highest level of debt of any nation on earth, according to The Economist in an article titled “Don’t mention the Debt.”

In a recent International Monetary Fund report, Japan has finally done enough to stimulate its economy and simply needs to keep policy loose until inflation rises, according to an article published by the Financial Times’ Robin Harding, titled “Abenomic a success.”

According to Harding, this IMF assessment comes after Japan enjoyed its longest sustained growth for more than a decade, cutting unemployment to 2.8 percent. Despite Japan’s current level of inflation close to zero, David Lipton, the IMF’s number two official, stated that the IMF was comfortable with the present stance of monetary and fiscal policy, and that he considered Abenomics as “something that has been successful.”

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© 2018 by Benjamin B. Bowman 

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