Japans Financial Crisis and Economic Stagnation - Research Paper Example

? Japan’s financial crisis and economic stagnation 01 November Introduction “In 1980, Japan’s financial system- and in particular its banking system – was the largest in the world. In terms of loan assets size, nine out of the world’ top ten banks were Japanese”1. However, the scenario has started to change completely from 1985 onwards. Japan has started to undergo a severe economic crisis from 1985 onwards. Growth in all sectors has been collapsed and deflation started to embrace Japan as a result of this crisis. According to Takeo Hoshi and Anil K Kashyap (2004), Japan’s Financial Crisis and Economic Stagnation may cost the “taxpayers is at least 20 percent of Japan’s GDP. The sheer size of the cost, along with the interaction among the related economic problems, has made a decisive resolution of the problems politically difficult”2. Some economists blamed the macroeconomic factors for Japan’s crisis whereas others blamed microeconomic factors for that. In fact, Japanese ministry of finance and its lack of transparency, delay in changing monetary policy, lack of rules based regulations and its links to corporations & banks have led to economic stagnation & will be difficult to reform the system. Japan’s financial crisis and economic stagnation “Non performing debt in the banking sector hampered the growth and recovery of the whole Japanese economy”3. As in the case of recent global financial crisis, Japanese financial crisis also started from the banking sector. “Even though the share of loans to the manufacturing sector has been decreasing, Japanese banks have expanded their overall lending business since 1970. As a result, the outstanding amount of loans to the manufacturing sector has been increasing”4. The huge outstanding amount in the manufacturing sector caused severe problems in the functioning of the Japanese banks. No banks can operate effectively unless the lending and repayment achieve certain equilibrium or balancing. However, in 1980’s, Japanese banks struggled to function properly because of the huge amounts of its money blocked in the manufacturing sector. Manufacturing units in Japan became financially sounder in 1970’s which encouraged them to use the internal resources more frequently rather than relying on banks for everything. “Major Japanese manufacturing firms drastically reduced their reliance on bank loans in the late-1970s from more than 30% to less than 10%”5. In other words, manufacturing units stopped their transactions with the banks and at the same time they had shown little interests in repaying its mortgages. In an attempt to increase the business, Japanese banks started to reduce the interest rates; however, the manufacturing units have shown little interests in taking or repaying loans which caused tremendous stagnation in the banking industry. Before the economic stagnation, Japanese banks sanctioned mortgages to all the people who approached them for assistance. People on the other hand have taken huge amounts of loans from Japanese banks and spent it for non-productive purposes. As a result of that Japan’s economic growth started to decline. “From 1985 to 1990, Japan experienced an asset bubble of unprecedented proportions. From 1990, the bubble began to burst. The bursting of this bubble left banks throughout Japan- both large and small- in financial distress”6. Real economic growth and strength of financial systems in any country are directly related. In other words, when real economy travel in one direction, financial system also travel in that direction and when the real economy travel in another direction financial systems also follow the same path. In other words, any problem occurs to either of one may affect the other one also. The above facts are true in the case of Japan also. Poor economy in Japan is hurting banking system in one way whereas poor performances of the banking system contributing heavily to the poor health of the economy in another way. There are certain controversies regarding which problem came first in Japan; banking problem or economic problem. Some people argue that “banking problems led to a credit crunch that depressed employment and investment”7. Majority of the industries Japan rely heavily on mortgages or loans from financial institutions for expanding their businesses. Credit crunch in financial sector caused severe problems in getting bank loans for business expansion and as a result of that industries started to collapse and unemployment rates started to increase. Moreover, banking crisis forced investors stay away from the market and the problems related to credit crunch started to increase. The role played by Japanese ministry of finance in causing this big economic stagnation cannot be neglected. “Japanese ministry of finance can be described as a bureaucracy within bureaucracy”8. It is one of the governmental bodies in Japan headed by the finance minister. It is regarded as the most powerful ministries in Japanese government. Because of the huge power enjoyed by the officials in this ministry, many corruption scandals were labelled against this ministry in the past. In other words, it functions like another power house in Japan even though the government has some control over it. Transparency in the activities of Japanese ministry of finance was very feeble. So, ordinary people got no information about what was going on inside the organization. Many of the officials working in Japanese ministry of finance were interested more in safeguarding the interests of the business people rather than that of the ordinary people. Japanese ministry of finance failed to implement suitable rules necessary to help the economic growth of the country. In fact their links with the banks and corporations prevented them from taking any stern actions which may spoil the interests of the Corporates. Instead of increasing the interest rates to attract the investments from the citizens, Japanese ministry of finance lowered the interest rates to help the business organizations. Moreover, the ministry set same interest rates for both high risk companies and low risk companies. In other words, big companies and small companies were equally benefitted from the financial policies of the ministry. The interest rate was lowered as the macroeconomic problem became obvious in the early 1990s and was already as low as 0.5 percent in 1995. The rate fell further and eventually reached virtually zero in February 1999. Since then, the call rate has been zero except for a brief period between August 2000 and March 2001. Of course, in the presence of deflation, the real interest rate was higher than zero. One can criticize the Bank of Japan for having been reluctant to try nonstandard monetary expansion such as money-financed fiscal transfers or targeted exchange rate depreciation, but by any conventional measure, Japanese monetary policy has been quite expansionary9. It should be noted that no other developed or developing country may keep the interest rates to zero for several years as did by Japan. Japanese ministry of finance thought that low or zero percent interest rates may stimulate the economic growth. They never thought about the closing down of banks which were running on loss or bankruptcy. The close relations between Japanese ministry of finance and financial institutions prevented the authorities from taking any effective actions against the underperforming banks. More surprisingly, even the worst banks in Japan got enormous encouragement from Japanese ministry of finance for helping their insolvent borrowers. They calculated that Japanese economic size is huge and it can withstand any problems in the banking sector or economic sector. “The regulators have also chosen not to enforce strictly the capital adequacy rules that should have forced the closure of weak banks”10. Japanese ministry of finance did nothing to tighten its policies during 1987-89, despite evidence of growing inflationary pressure, a failure that contributed to the creation of bubble economy. Moreover, the officials in Japanese ministry of finance failed to ease the policies during the 199-94 period during which asset price, banking system and the economy declined considerably11. Conclusions Japanese ministry of finance has to be blamed for the Japanese economic stagnation in 1980’s and 1990’s. It functioned as an opaque body and none of its operations were transparent to the public. It failed to take suitable measures when the economic bubble started to burst. It has some illegal connections with Japanese corporations and therefore it formulated policies in favour of the corporates and sacrificed the interests of the country’s economic progress. Bibliography 1. Amyx, Jennifer Ann. 2006. Japan's Financial Crisis: Institutional Rigidity and Reluctant Change. Princeton: Princeton UP, 2004. Print.  2. Bernanke, Ben S. Japanese monetary policy: a case of self induced paralysis. Institute of international economics. [Online]. http://www.iie.com/publications/chapters_preview/319/7iie289X.pdf p.150-151 [Accessed on 01 November 2011] 3. Hoshi, Takeo and Kashyap Anil K. 2004. Japan’s Financial Crisis and Economic Stagnation. Journal of Economic Perspectives—Volume 18, Number 1—Winter 2004. 4. Suzuki, Yasushi. 2011. Japan's Financial Slump: Collapse of the Monitoring System under Institutional and Transition Failures. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan, 2011. 5. Suzuki, Yasushi and Uddin, Sohrab S.M. What lessons can China learn from the Japanese prolonged financial slump? Journal of Contemporary Eastern Asia, Volume 10, No.1: 55-71 Read More