Japan's Economic Fall - Case Study Example

 JAPAN’S ECONOMY Japan is the world’s second biggest economy; its economic history is very important to our history. Indeed, it may be especially important in today’s economic turmoil. Even on its own, outside of this context, Japan is a fascinating country to examine. In the early 19th century it rose in spectacular fashion to become the first non-European power and set out to conquer most of East Asia in brutal fashion. Laid to ruins at the end of the Second World War largely by the air force and navy of the United States—and with two of its cities obliterated by atomic bombs—Japan thrived in the post-war period, matching and in some cases exceeding the economic expansion of the U.S. But this rise was not unending. After huge growth in the 1980s, Japan suffered a terrible “lost decade” during the 1990s, beginning with the world recession in 1990-92. Why was the recession so especially painful for Japan? Why did it extend for almost a full decade, causing so many lost economic opportunities? And perhaps more importantly, what can the United States and the global economy, currently mired in a serious recession, learn from this period of economic doldrums in Japan? This essay will try to get to the bottom of these important and timely questions. In the decade before the long drawn out recession of the 1990s, Japan experienced unprecedented growth. Its flagship industries—electronics and automobiles—were taking over the world. These companies had an impressive reputation of high quality and reliability and were dominating their markets. American automobile makers were taken aback; American electronic companies were being bought up. Because of savings programs implemented by the government and tariffs against investing in foreign companies, there was a lot of money in Japan available to invest in Japanese companies and other investments. The government was trying to depreciate the yen, which had soared in value in the previous years. In order to do this, they dramatically eased monetary policy and increased spending. This economic stimulus led to a lot more money in the marketplace. Many economists believe that this situation led to an asset bubble in the late 1980s—similar to what happened in the United States over the last few years. Real estate and art, for example, rapidly appreciated. As an example of how extreme this bubble became: in the late 1980s it is said that the land in downtown Tokyo occupied by the Imperial Palace (about 3.5 square kilometres) was valued at more than all of the real estate in California.1 No bubble like this is sustainable and just like the Internet stock bubble of the 1990s, all bubbles must burst. This certainly happened with the onset of global recession in 1990-92. To begin with, it is important to examine briefly the causes of the 1990-92 recession that affected the world economy, but Japan especially. Part of the problem began with the Gulf War. This caused a spike in the price of oil and led to rising inflation. Generally speaking, excessive public spending and debt, part of a hangover from the 1970s and 1980s made economies less flexible and dynamic. Unemployment rose. This exacerbated the problems caused by the bursting of the asset bubble (unique to Japan) and led to a long period of economic doldrums. Throughout the 1990s there was meagre growth, but none of the extraordinary dynamism that had characterized the economy in the decades previous.2 Here are some important statistics to consider about this unfortunate situation. In the early 1990s, The Nikkei stock market index fell more than 60 percent—from a high of 40,000 at the end of 1989 to under 15,000 by 1992. It rose somewhat during the mid-1990s on hopes that the economy would soon recover, but as the economic outlook continued to worsen, share prices again fell. The Nikkei fell below 12,000 by March 2001. Real estate prices also plummeted during the recession—by 80 percent from 1991 to 1998.3 With these facts as the background to the issue, the question can now be asked, “Why did this problem persist in Japan for so long?” There are many possible explanations offered to this important question by many different economists and scholars. To begin with, it is important to look at what the government tried to do to solve this situation. According to one economist, the Japanese government’s response to the problem was to spend money—but not all at once. Instead it was spread out over several years: “[D]uring the 1990s, Japan tried 10 fiscal stimulus packages totalling more than 100 trillion yen, and each failed to cure the recession.”4 There are some who believe that by spreading the stimulus out over so many years, this policy was effectively a series of half-measures. They argue that Japan needed one big stimulus at the beginning of the crisis rather than a series of small ones spread out over the decade. This argument suggests the Japanese wasted their firepower. Another important reason that the crisis lasted as long as it did in Japan, some argue was “due to the absence of effective, far-sighted political leadership.” The Liberal Democratic Party of Japan has ruled the country since the end of the Second World War. Many believe its leadership is old and sclerotic and out of touch (indeed, Japan is currently on its third unelected prime minister, who boasts record levels of unpopularity). With the brief interlude of the premiership of Junichiro Koizmu, the top levels of Japanese government have lacked imagination on how to deal with crises. As Daniel Okimoto argues, politics played a role in extending and deepening the crisis to more than a decade in Japan: LDP support from interest groups representing protected, inefficient sectors of the Japanese economy has contributed to Japan's economic malaise but has also made it difficult for the Japanese state to implement the reforms necessary to get back on track. Focused on staying in power, the LDP has been reluctant to implement far-reaching reforms or tackle the tough issues, such as the ominous overhang of nonperforming loans (NPLs). The LDP's coalition of interest group supporters, which supplies money and votes, has lobbied hard to sandbag or dilute reform measures. 5 In order to escape such a complex series of problems, dynamic and imaginative political leadership must look for and implement solutions. Doing politics as usual is not a successful strategy, as Japan in this period shows. Add to this lack of leadership and general inefficiencies, and it becomes clear that much of the stimulus was not reaching sectors of the economy that would actually help any Japanese. The money was just going to backrooms and fiefdoms and companies that did business with the government. There was little transparency or scrutiny. For example, in the words of Paul Krugman, “Japan's postal savings system which channels money into public works projects that have little if any social payoff, is monumentally inefficient; so is the practice of rolling over the debts of companies that will never regain profitability and hence keeping capital employed producing what nobody wants.”6 The United States has similar problems to Japan in the late 1980s. There has been so much liquidity in recent years that people felt that they could buy everything on credit without having the assets to back up their debt. They went on a spending spree. There was massive over-consumption. For a long time people thought nothing would ever go wrong. As everyone was getting rich, financial instruments became more complicated while at the same time people were massively over-extended in terms of credit. When homeowners with sub-prime mortgages began to default there was a huge crisis of confidence. Banks realized that many of their loans would not be repaid and that their own debts would be called in. The bubble has again burst. This is a good description, in the words of Newsweek magazine: Since the early 1980s, American economic growth has depended on a steady rise in consumer spending supported by more debt and increasing asset prices (stocks, homes). Just as the mid-1980s signalled the end of Japan's export-led growth, the present U.S. slump signals the end of upbeat, consumption-led growth. But its legacy is an overbuilt and overemployed consumption sector, from car dealers to malls.7 What can the United States do to avoid the situation that befell Japan? This is a very difficult question. Some suggest that the massive stimulus package signed by President Barack Obama is a good start as it is important to try to create more liquidity in the system as soon as possible and not spread things out over several years. Some suggest that nationalizing the banks might be a good solution and that the government made a serious error by not saving Lehman Brother Investment Bank from failing in the fall of 2008. However, I think there is an argument that many American banks and the American economy on a whole is much more adaptable and flexible than the Japanese one. That said, it is very concerning that the President has been warning that the United States may face a Lost Decade—a clear reference to the situation in Japan during the 1990s. As a critic in the New York Times put it, explicitly comparing Japan in the 1990s, to the United States in 2009: Instead, the Japanese first tried many of the same remedies that the Bush administration tried and the Obama administration is trying — ultra-low interest rates, fiscal stimulus and ineffective cash infusions, among other things. The Japanese even tried to tap private capital to buy some of the bad assets from banks, as Mr. Geithner proposed. One reason Japan’s leaders were so ineffectual for so long was their fear of stoking public outrage. With each act of the bailout, anger grew, making politicians more reluctant to force real reform, which only delayed the day of reckoning and increased the ultimate price tag. Japanese taxpayers are estimated to have recouped less than half what it cost the government to bail out the banks.8 One positive thing that the Americans have done so far is to make a big deal of the crisis. President Obama continues to warn of its dire impact and says it is one of the biggest challenges in the nation’s history. Some opponents suggest this is fear-mongering, but others say it is a useful way of focusing the mind and bringing people together to work on the recovery of the United States economy. There can be no doubt that the world is in a serious economic crisis. The United States and Canada, for example, recently posted huge drops in GDP. Many of the Eastern European countries appear to be on the edge of bankruptcy, and countries that were once seen as some of the most stable places in the world to invest are now nationalizing banks and dealing with massive drops in growth, rising unemployment, and threats of political populism and demagoguery. In the midst of these deeply unfortunate and frightening times, what can Japanese economic history in the 1990s teach us about the course of action countries should take to tackle this difficult problems. The answers are not simple. There are many things economists point to in the Japanese strategy—if it can be called that—to alleviate the problems of the Lost Decade. But the main point observers of the period seem to make is that the Japanese government was not nimble or flexible enough to deal with such a complex problem on such a huge level. They acted too slowly and in half measures. Some people say that President Obama is acting slowly, refusing to wipe out shareholders of failing companies and nationalize failing banks at the first sign of trouble. That may be true. However, there is an additional danger: seeing to close a parallel between the Japanese Lost Decade and the current crisis in the American economy. Though there are similarities between the two, the economies of Japan and America are also very different. By using Japan as a playbook to help deal with the current problems, American government officials and economists may be barking up the wrong tree and superimposing the solutions for one problem on another, different problem. That is the hard part: in this situation there are too many unknowable unknowables. Bibliography Cowie, Ian. “Oriental risks and rewards for optimistic occidentals.” Daily Telegraph. August 4, 2004. http://www.telegraph.co.uk/finance/personalfinance/2891993/Oriental-risks-and-rewards-for-optimistic-occidentals.html Helweg, Diana. “Japan: A Rising Sun?” Foreign Affairs. July-August, 2000. Hiroki Tabuchi. “Lessons From Japan In Stemming a Crisis.” New York Times. February 12, 2009. http://www.nytimes.com/2009/02/13/business/economy/13yen.html?ref=business Krugman, Paul. "Purging the Rottenness." New York Times 25 April 2001. Okimoto, Daniel. “Causes of Japan’s Economic Stagnation.” Sorenstein APRC. Stanford University. http://aparc.stanford.edu/research/causes_of_japans_economic_stagnation/ Powell, Benjamin. “Explaining Japan’s Recession.” Mises Institute. November 19, 2002. http://mises.org/story/1099 Samuelson, Robert. “Our Lost Decade.” Newsweek. February 17, 2009. http://www.newsweek.com/id/185116 Read More