Japan‘s debt-fuelled growth in the 1980s set the stage for 20 years of stagnation. The West seems to be moving along the same trajectory, with high levels of public debt and monetary easing.
Scientists study distant galaxies to gain a better understanding of our own planet. In the same way, Japan’s experience provides important insights into current global economic problems. Unfortunately, the lessons from Japan are largely being ignored. As John Kenneth Galbraith wryly observed: “There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
Japan’s post-war growth was originally driven by low-cost manufacturing and an undervalued yen. The artificially low currency emphasised growth in exports at the expense of household income and consumption. It also helped increase domestic savings rates.
On September 22, 1985, France, West Germany, Japan, the United States, and the United Kingdom agreed to the Plaza Accord, designed to devalue the yen by intervening in currency markets. Between 1985 and 1987, the yen appreciated by 51 percent against the dollar, moving Japan from an era of En’yasu, an inexpensive yen, to a period of Endaka Fukyo, an expensive yen.
Japanese exports and economic growth fell sharply, from 4.4 percent in 1985 to 2.9 percent in 1986.
Desperate to restore growth and offset the stronger yen, the Japanese authorities eased monetary policy with the Bank of Japan (BoJ) cutting interest rates from 5 percent to 2.5 percent between January 1986 and February 1987. The lower rates set off a debt-funded investment boom, driving real estate and stock prices higher. At the height of the “bubble” economy, the 3.41 sq km area of the Tokyo Imperial Palace had a theoretical value greater than all the real estate in the state of California.
Following the collapse of the bubble, policymakers have implemented a variety of economic stimulus programmes. Despite these measures, Japan has been trapped in a period of economic stagnation, known initially as Ushinawareta Jūnen (the Lost Decade). As the economy failed to recover and the problems extended beyond 2000, it came to be referred to as Ushinawareta Nijūnen (the Lost 20 Years).
Despite differences, the sequence of events, including the response to the crisis, resonates strongly with the present state of the global economy.
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 limitations of traditional policy options—fiscal stimulus, low interest rates and debt monetisation.
Since the collapse of the Japanese debt bubble in 1989-1990, Japanese growth has been sluggish, averaging around 0.8 percent per annum. In contrast, Japan enjoyed decades of strong economic growth—around 9.5 percent per annum between 1955 and 1970 and around 3.8 percent per annum between 1971 and 1990.
Nominal gross domestic product (GDP) has been largely stagnant since 1992. Japan’s economy operates far below capacity, with the output gap (the difference between actual and potential GDP) around 5-7 percent.
Japan’s public finances have deteriorated. At the time of collapse of the bubble economy, Japan’s budget was in surplus and government gross debt was around 20 percent of GDP. As the Japanese economy stagnated, weak tax revenues and higher government spending created substantial budget deficits, leading to an increase in government debt. Japanese government gross debt is now around 240 percent of GDP. Net debt (which excludes debt held by the government itself for monetary, pension and other reasons) is about 135 percent.
Monetary policy is ineffective with limited demand for credit. The BoJ’s attempts to increase inflation to reduce debt have been unsuccessful, with Japanese inflation averaging minus 0.2 percent in the 2000s, a decline from levels of 2.5 percent in the 1980s and 1.2 percent in the 1990s.
Policies designed to alleviate the slowdown have created anomalies and delayed essential structural changes, compounding fundamental problems.
Investment has increasingly been misallocated into expanding manufacturing capacity and excessive infrastructure spending, reducing returns on investment 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. Government-financed infrastructure investment has allowed politicians to channel funds to favoured projects. But much of the investment is not productive.
Low interest rates have allowed debt levels to remain high. They have also reduced income for savers, reducing consumption and encouraging additional saving for retirement.
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