The recent triple disasters of the tsunami, earthquake, and Fukushima nuclear plant meltdown means that the Japanese economy has put Japan back into recession. The 0.9 per cent contraction from January-March is larger than almost all analysts expected.
Natural disasters are unpredictable. But no one can blame bad luck for Japan’s two lost decades of economic growth that began from the 1990s onwards. Predictions in the 1980s that Japan was about to rule the world ignored evidence that the Japanese miracle from the 1960s to 1980s was too good to be true. Bad economic practices, political paralysis, bad demographics, and a failure to adapt and innovate still plagues the country. It is why the bubble burst and a large part of the reason why Japan is where it is today.
When President Bill Clinton first entered the White House in 1992, the Japanese economy made up about 18 per cent of global GDP, up from 7 per cent in 1970 and 10 per cent in 1980. The fact that it now constitutes only 8 per cent of global GDP means that, in relative terms, it is back to where it started when the country’s spectacular growth began 40 years ago. China’s spectacular rise has obviously eaten into Japan’s relative share of global GDP. But the United States has managed to maintain its relative standing at around 21 per cent of GDP growth over many decades. Which begs the question: Why Japan could not?
First, the recent history of Japan’s demise…
Before ‘Made in China’ became omnipresent, there was ‘Made in Japan’. Built on the back of an undervalued Japanese yen and an abundance of cheap labour, the so-called East Asian model of export-driven development (combined with ever increasing levels of fixed-investment based on a high national savings rate) was seemingly perfected by Japan in the 1970s and 80s. In a story that sounds eerily familiar to the US-China one today, the American Congress became increasingly agitated that the undervalued yen was destroying the country’s terms of trade and taking away jobs from Americans. After persistent pressure from Washington, the result was the 1985 Plaza Accord.
Over the next two years, the US dollar fell from 240 yen to 160 yen. The Japanese export sector suffered, and with it economic growth, which fell from 4.4 per cent in 1985 to 2.9 per cent in 1986. In response, the government drastically eased monetary policy and cut the discount interest rate from 5 per cent in January 1986 to 2.5 per cent in February 1987. With the flood of virtually free money came the real estate and stock market bubbles. Tokyo responded by tightening monetary policy and raised rates five times until they reached 6 per cent in 1989.
After these increases, the asset markets collapsed. The Nikkei stock market fell more than 60 per cent—from a high above 40,000 in 1989 to under 15,000 by 1992. It is currently under 10,000. Real estate prices also fell by 80 per cent from 1991 to 1998.
This explains how Japan got into trouble. But it doesn’t explain why it has not been able to emerge out of the malaise. To understand why this is the case, we need to identify the political economy’s enduring flaws that was always behind Japan’s rise, and which are still apparent more than two decades after its fall.
In basic economic terms, we achieve GDP growth in three ways: 1. Increased capital inputs; 2. Increased labour inputs; or 3. Increased Total Factor Productivity, which is the growth not accounted for by increased factor inputs.
The problem of Japan’s ageing demographics is well known. This explains the inability to simply throw more workers at the problem—Japan doesn’t have them.
In 1975, 7.9 per cent of the population was over the age of 65 years. In 2000, the figure was 17.2 per cent. In 2025, it will be almost 30 per cent. Neither could employers force workers to work any longer. The Japanese were already famed for being the hardest workers in the world.
What about increasing capital inputs? Unfortunately, this is part of the problem. In the 1960s and 1970s, fixed investment as a proportion of GDP was around 25-30 per cent. Japan grew very rapidly due to high rates of (inefficient) investment. When the asset bubbles burst, the government tried to do more of the same. From 1992-1995, Japan tried six spending programs amounting to 65.5 trillion yen. In 1998, another fiscal stimulus package worth 24 trillion yen was announced, with a further 18 trillion yen package in 1999, and an 11 trillion yen package in 2000. In the 1990s, Tokyo put forward 10 stimulus packages worth over 100 trillion yen. At least half the money went into big infrastructure and fixed investment projects. Unfortunately, there was little impact when it came to encouraging economic growth.
The problem with throwing money at the problem was twofold.
First, Japanese household savings rates were rapidly declining. The net household saving rate (savings as a percentage of net disposable income) fell from 16.5 per cent in 1985 to 11.9 per cent in 1995, to 2.4 per cent in 2005. Private households were losing the capacity to simply throw more capital into the economy. This meant that the increased reliance on public funds to make up any perceived investment shortfall simply increased government debt.
Second, there was always plenty of evidence that capital was misallocated—both before the stimulus packages of the 1990s and after. The rise of hugely successful and innovative companies such as Toyota and Sony hides the fact Japanese companies have long operated in protected environments and have little incentive to innovate and adapt. Because of rigid corporate structures and culture, promotion is based on seniority rather than merit or achievement. Japanese subordinates do not question their superiors even when decisions are clearly wrong, corrupt or irrational. In terms of the government stimuli from the 1990s onwards, much of it was directed towards construction and infrastructure companies with close links to the government and ruling Liberal Democratic Party, which had been in power almost continuously from 1955-2009. By throwing more and more money at the problem, Tokyo is inadvertently preventing the process of creative destruction from taking place.
More generally, the sources of Japanese growth were always inefficient and remain so, relying on increasing labour and capital inputs rather than improvements in Total Factor Productivity (TFP). Even before the economy began stagnating, Japanese TFP was only 60 per cent that of America’s in the 1970s and two-thirds that of America’s in the 1980s. Since 1990 it has remained at 75 per cent of American TFP. With an economic miracle based on ‘putting more and more in’ rather than ‘getting more and more out’, the good times were always going to end.
With ‘Japan hype’ on the rise and GDP still growing rapidly, almost everyone dismissed obvious ‘structural’ problems in the political-economy. They argued that the Japanese people were clearly ‘smart’ enough to work through the structural problems and ‘transition’ towards a more efficient economy. After all, Japan was unique and criticisms of its political-economy were not ‘nuanced’. In contrast to America, its autocratic social structures, and stoic, unquestioning people, were a virtue. While innovation and creativity in the west also meant chaos, Japan’s more rigid society brought economic, social and political discipline. Unlike squabbling Western politicians, Japanese leaders were known to take the ‘long-term’ view and were excellent technocrats.
When Japan began its decline, the myth that state-led political-economies based on an ancient East Asian wisdom could defy the laws of economics fell with it. Now we are resurrecting such an article of faith about its Chinese neighbour. Let’s hope that we are not being fooled a second time and that Japan’s predicament is not to be China’s future.