Lost Decade (Japan) - Interpretations


Economist Paul Krugman has argued that Japan's lost decade is an example of a liquidity trap (a situation in which monetary policy is unable to lower nominal interest rates because these are close to zero). He explained how truly massive the asset bubble was in Japan by 1990, with a tripling of land and stock market prices during the prosperous 1980s. Japan's high personal savings rates, driven in part by the demographics of an aging population, enabled Japanese firms to rely heavily on traditional bank loans from supporting banking networks, as opposed to issuing stock or bonds via the capital markets to acquire funds. The cozy relationship of corporations to banks and the implicit guarantee of a taxpayer bailout of bank deposits created a significant moral hazard problem, leading to an atmosphere of crony capitalism and reduced lending standards. He wrote: "Japan's banks lent more, with less regard for quality of the borrower, than anyone else's. In so doing they helped inflate the bubble economy to grotesque proportions." The Bank of Japan began increasing interest rates in 1990 due in part to concerns over the bubble and in 1991 land and stock prices began a steep decline, within a few years reaching 60% below their peak.

In response to the recession, Japanese policymakers tried a series of government economic stimulus programs and bank bailouts. A 2.4% budget surplus in 1991 turned to a deficit of 4.3% by 1996 and 10% by 1998, with the national debt to GDP ratio reaching 100%. In 1998, a $500 billion bank rescue plan was implemented to encourage bank lending and borrowing. The central bank also attempted to increase inflation (which devalues savings over time but can also make debts easier to pay off), to encourage consumer spending. Krugman wrote that by 2003, the Japanese economy began to recover, helped by imports from the U.S. and China that helped Japan achieve a real growth rate of 2%. He wrote the recovery was "provisional" and there was significant risk of a return to a liquidity trap.

Economist Richard Koo wrote that Japan's "Great Recession" that began in 1990 was a "balance sheet recession". It was triggered by a collapse in land and stock prices, which caused Japanese firms to become insolvent, meaning their assets were worth less than their liabilities. Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Japanese firms overall became net savers after 1998, as opposed to borrowers. Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type Great Depression, in which U.S. GDP fell by 46%. He argued that monetary policy was ineffective because there was limited demand for funds while firms paid down their liabilities. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy.

Economist Scott Sumner has argued that Japan's monetary policy was too tight during the Lost Decade.

Economists Fumio Hayashi and Edward Prescott argue that the anemic performance of the Japanese economy since the early 1990s is mainly due to the low growth rate of aggregate productivity. Their hypothesis stands in direct contrast to popular explanations that are based in terms of an extended credit crunch that emerged in the aftermath of a bursting asset “bubble.” They are led to explore the implications of their hypothesis on the basis of evidence that suggests that despite the ongoing difficulties in the Japanese banking sector, desired capital expenditure was for the most part fully financed. They suggest that Japan’s sluggish investment activity is likely to be better understood in terms of low levels of desired capital expenditure and not in terms of credit constraints that prohibit firms from financing projects with positive net present value (NPV). Monetary or fiscal policies might increase consumption in the short tun, but unless productivity growth increases, there is a legitimate fear that such a policy may simply transform Japan from a low-growth/low-inflation economy to a low-growth/high-inflation economy.

Financial Journalist Eamonn Fingleton argues there was no lost decade or decades in Japan and the appellation is complete media-created myth perpetuated for the benefit of certain vested interests. In his articles “The Myth of Japan’s Failure” and “The Myth of Japan's Lost Decades'” he demonstrates that when one measures the success of the Japanese economy by standard of living and other types of economic indicators such as the strength of the yen and Japan’s trade surplus, a very different picture of Japan emerges. He states concerning Japan’s so-called “lost decades”, “… that presentation of Japan is a myth. By many measures, the Japanese economy has done very well during the so-called lost decades, which started with a stock market crash in January 1990. By some of the most important measures, it has done a lot better than the United States.

He argues that there is no such thing as “recovering” from a “crash” if stock prices and asset valuations were artificially high in the first place. The “crash” itself is the recovery, that is, recovering to sensible and rational levels of asset valuation. Specifically stating “In any case the implosion since 1991 has merely restored some sanity to valuations that had previously become -- very temporarily -- outlandish”. In terms of Japan’s allegedly slow “growth rate” averaging 1% per year over the past 20 years, he sees this as immaterial as the standard of living in Japan has been unaffected and has in fact improved over the ensuing years. Stating, “Japanese people have enjoyed one of the biggest improvements in living standards of any major First World nation in the interim ." In fact, he alleges that when proper accounting methods are used (i.e., adjusting gross domestic product results on a per-capita basis, and rejecting the “hedonic method” of adjusting for inflation as used by the United States) Japan actually comes out ahead of the United States in terms of economic performance.

According to Fingleton, the motives behind promoting the myth of the “lost decades” are manifold. On the Japanese side, Japanese officials benefit from the myth as it effectively mutes the opposition levied against the country during the 1980s. During that time, manufacturers in the West (most notably the American automobile industry) lamented Japan’s economic rise and claimed they were unable to compete fairly with Japanese exports, subsequently directing hostility towards Japan and the Japanese. The myth of the “lost decades” effectively deflects and mutes this economic animosity once levied towards Japan. That criticism is now levied instead against China. On the Western side, the myth of the “lost decades” makes it appear that the American and European economic situation is not as bad as it really is when comparing it to Japan’s economic malaise.

Further, from a geo-political perspective promoting the notion of Japan’s “decline” may be an attempt to foster fear and insecurity in the Japanese people in order to make them more susceptible to nationalist sentiments (thus keeping Asia divided and thwarting the formation of any regional economic bloc involving China); more accepting of the American military presence in Japan (as a “weak” Japan needs outside help to defend against China and North Korea); and finally more willing to enter into international trade agreements such as the Trans-Pacific Partnership (advocated by the United States) as the “cure” for Japan’s so-called economic decline. Specifically, Noah Smith stating, “Increased trade is probably Japan’s best bet in getting out of its current economic doldrums,” said Noah Smith, an assistant professor of finance and economics at Stony Brook University. “If Abe can actually push this through, this will be his economic legacy, and it will be a positive legacy.” However, some believe the Trans-Pacific Partnership will actually destroy Japan economically and seriously undermine Japan's standard of living especially in terms of health insurance. "A nationwide association of doctors opposes the pact, arguing that it will force Japan to open its state-controlled health industry to American-style health insurance, eroding its universal insurance system.".

Mr. Fingleton claims to have made an offer to the top ten advocates of the “lost decade(s)” theory if any of them would debate him in Washington D.C., he would donate $5,000 to their favorite charity. He also claims to have made an offer to U.S. ambassador to Japan, John Roos, offering him $10,000 to his favorite charity for a similar debate. There were no takers for any of his offers.

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