Satyajit Das: The World Turns Japanese
A review of the similarities -- and differences -- between the collapse of Japan's bubble economy and the post-global financial crisis economies of developed nations.
Japan’s two decades of stagnation and Prime Minister Shinzo Abe’s recent initiatives to revive the moribund economy may provide important insights into the world’s current economic problems.
Since the collapse of the bubble in 1990, policymakers have implemented a variety of economic stimulus programs. Japan’s public finances have deteriorated as the government has run large deficits, leading to an increase in government debt, which is now around 240% of GDP. Monetary policy has been highly accommodative, including zero interest rates and multiple rounds of quantitative easing since 2001.
Despite these measures, Japan remains trapped in a period of economic stagnation.
Policies designed to alleviate the slowdown have created anomalies and delayed essential structural changes, compounding fundamental problems.
Investments have increasingly been misallocated into expanding manufacturing capacity and excessive infrastructure spending, reducing returns and Japan’s potential growth rates.
The excessive manufacturing capacity and low domestic demand has exacerbated reliance on exports and a high trade surplus to balance production with demand. This puts upward pressure on the yen, reducing Japan’s ability to be competitive as an exporter. Much of the government-financed infrastructure investment is not productive. After the initial boost to activity, this investment – bridges, roads, and tunnels -- requires perpetual maintenance expenditure, absorbing scarce government resources.
Low interest rates allow debt levels to remain high. They reduce income for savers, decreasing consumption and encouraging additional saving for retirement.
Low rates have allowed weak businesses to survive in a zombie-like state, where they are free to continue to pay interest on loans. Banks avoided writing off loan assets, tying up capital and reduced lending to productive enterprises, especially small and medium enterprises (SMEs), which account for a large portion of economic activity and employment. The creative destruction necessary to restore the economy did not occur.
Correspondence and Divergence
There are similarities and differences between the collapse of Japan’s bubble economy and the post-global financial crisis economies of developed nations.
In both cases, low interest rates and excessive debt build-ups financed investment booms intended to drive recovery from recessions. Both ultimately collapsed. Both were characterized by overvaluation of financial assets and banking system weaknesses. Policy responses to the crisis have also been similar.
At the onset of the crisis, Japan had low levels of government debt, high domestic savings, and an abnormal degree of home bias in investment. This allowed the government to finance its spending domestically, assisted by an accommodating central bank. Currently, around 90% of Japanese government bonds are held by compliant domestic investors. The absence of market discipline, especially from foreign investors, allowed Japan to incur high levels of indebtedness. Many of the current problem economies have low domestic savings and are reliant on foreign capital.
Japan’s problems occurred against a background of strong economic growth in the global economy. Strong exports and a current account surplus partially offset the lack of domestic demand, buffering the effects of the slowdown in economic activity. The global nature of current problems means that individual countries will find it more difficult to rely on the external account to support their economies.
While its aging population has increasingly compounded problems, Japan's demographics at the commencement of the crisis were helpful. Its older population had considerable wealth. Low population growth meant that less new entrants had to be accommodated in the workforce during a period of slow growth, alleviating problems of rising unemployment.
Reflecting a homogenous society and a stoicism shaped by its history, Japan's citizens were accommodating of the sacrifices and transfer of wealth necessitated by the economic problems. But the demographic and social structure of other troubled economies may not accommodate the measures required to manage the crisis without significant breakdowns in social order.
In reality, Japan highlights the difficulty of engineering recovery from the effects of major deleveraging following the collapse of a debt-fuelled asset bubble. It reveals the constraints of traditional policy options – fiscal stimulus, low interest rates, and debt monetization.
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