Special Case of the Japanese Economy
A SNEAK PEEK
Japan's economy continues to be one of the most efficient and dynamic globally. It has closed the gap between "an almost developing" country and “a leading industrialized nation” in a short time. It has aroused a wide range of reactions, including awe, suspicions of conspiracies, and even economic warfare. Let us delve deeper into how Japan became the world's second-largest developed economy.
DELVING INTO THE PAST
Post World War II—
After World War II, Japan's crippled economy swiftly recovered. So how did Japan rebuild its economy so quickly? Japan's post-war economy started with a lot of room for expansion. Its dynamic potential was a result of -
The technological gap between Japan and the rest of the world and a relatively large agricultural sector with low productivity.
The war's systemic reforms enabled the economy to realize its potential, experience fast expansion, and eventually catch up with the industrial West.
The Bubble to end all the Bubble, 70's to 90's —
This tale begins in 1979, the year of the second oil crisis brought on by the Iranian revolution and the war between Iraq and Iran. All major industrialized nations, including Japan, reacted by cutting their interest rates to protect their economies. This prepared the ground for one of the largest asset booms in history.
Indeed, the Japanese economy of the early 80s was characterized by massive investment in research and innovation, partially made possible by these low-interest rates but also by a financial strategy known as window guidance.
Unlike Western central banks, the Bank of Japan had a very innovative way of creating credit in the right strategic industrial sectors. The Bank of Japan would go to the largest banks in Japan and give them a quota. They were guided to create this much credit for the steel and automobile sectors.
The American & Japanese Trade War —
The United States feared Japan would surpass them as the world’s leading economic power. Fearing the demise of the American auto industry, Republican President Ronald Reagan limited the number of automobiles that may be imported from Japan and increased taxes up to 45% on Japanese vehicles.
In striking contrast to the present trade battle between the United States and China, something remarkable happened in 1985, the Plaza accords.
Politicians from Europe, the United States, and Japan agreed that global commerce was unbalanced and that the dollar was overvalued. As a result of these agreements, the Bank of Japan decided to sell significant sums of its dollar reserves, causing the Yen to strengthen while depreciating the dollar.
And it worked! The Yen began to rise against the US Dollar. To counter some of the Yen’s growing pressure, the Bank of Japan cut interest rates even further. As a result, borrowing became even more affordable, setting the stage for one of the giant nationwide bubbles in history.
Low-interest rates undoubtedly contributed to the late 1980s bubble phase, during which property and stock values skyrocketed. Only in 1989 did the Bank of Japan begin to hike interest rates, eventually bursting the Bubble.
This was the point at which the Japanese economy shifted from a miracle economy to stagnation and deflation.
90’s — THE LOST DECADE
As the Japanese Financial Ministry boosted interest rates in the early 1990s, the stock market collapsed, and a debt crisis began, halting economical growth and leading to what is now known as the Lost Decade.
What was the cause?
Economist Paul Krugman attributes the lost decade to individuals and businesses who over saved, causing the economy to stagnate. Other analysts blame the fall on the country’s aging population demographics. The Bank of Japan’s (BOJ) slow response to intervene in the market, in particular, may have aggravated the situation.
The reality is that many of these factors may have contributed to the lost decade.
Following the crisis, many Japanese residents responded by saving more and spending less, causing overall demand to fall. This led to deflationary pressures, encouraging consumers to save even more money, resulting in a deflationary spiral.
NEIGHBOUR ISSUES AND AGEING POPULATION
Japan had recovered from debt by the 2000s, but there was another down pull because of the rise of China. Earlier, Japan was the best place for low-cost mass manufacturing. But as China started with global trade, Japan could no longer compete with China in price or quantity in international markets.
Another issue was Japan’s aging population. The young working population of Japan was getting old, and they were no longer contributing to the economy.
Quantitative Easing —
To get positive inflation, the Central Bank tried Quantitative Easing. It is a monetary policy where central banks try to put money into a country’s economy. They buy government bonds and other financial assets like corporate bonds and shares. This puts money directly in the hands of whoever is selling these assets.
But this didn’t work, and the inflation rates in Japan didn’t increase and remained close to zero percent.
Is Japan Special?
The Japanese economy behaving this way could be because of the following dissimilarities from other economies —
1. Timeframe: Because quantitative easing happened over thirty years, the Japanese economy had more time to respond.
2. Supply Side of the Economy: Since Japan’s productive capacity has not changed significantly over the past three decades, prices have remained stagnant.
3. Professional and Consumer Culture of Japan: Asking for a raise, promotion, or switching jobs is uncommon. Therefore, wages in Japan have stayed nearly flat.
ABENOMICS
Prime Minister Shinzo Abe won the election in 2012 on a promise of radical economic reform, and the program he put forward was known as Abenomics.
When it was announced, Abenomics consisted of the so-called three arrows:
Monetary policy —
It meant a continuation of the past but amplified to the extreme. Consider the following propositions to get an idea of how extreme it is.
Are your interest rates stuck at zero? No problem, just make them negative.
Has quantitative easing not been super effective at bringing back inflation? No problem either. You probably did not do enough of it. How about you consider buying more, or even better, buying everything. This required the Bank of Japan to purchase more corporate, long-term, and short-term government debt, among other types.
Do you know Japan’s quantitative easing has been so aggressive that the Bank of Japan currently owns nearly 70% of all public debt? In comparison, After the Corona crisis, the Bank of England is anticipated to possess about 30% of the public debt.
Increased Government spending —
Shinzo Abe made significant promises on this front. And in fact, he did introduce several expenditure plans. Under his leadership, the Japanese government became the most indebted in the world, with debt approaching a startling 240% of GDP.
Abe may have appeared to be a big spender, but in 2014 and in 2019, he raised taxes on consumer items. These consumption tax increases are mainly well known since the economy fell back into a recession as soon as they were implemented.
And remember how the Bank of Japan was trying to shock the economy out of the low inflation expectations loop?
As a result of Abe’s vacillation on fiscal expenditure, inflation predictions hardly changed. Not very shocking, considering that the government debt growth rate slowed down under the Abe administration. Therefore, on this front, there was more bark than bite.
Structural reforms, What are they? —
- Allowing more shareholder activism to increase competition among corporations.
- Tax cuts for corporations.
- Deregulation for the corporations.
- And finally, lots of trade deals for corporations.
Even with broken promises on government spending, that should have been enough to re-awaken the economy of the rising sun, right?
Not quite. One major issue with corporate Japan is that, when given gifts like tax breaks, they frequently hoard the money instead of investing it or giving it directly to their shareholders, who then hoard it.
For the economy to re-activate and inflation to occur, the household and corporate sectors need to spend that stimulus rather than save it.
Unsurprisingly, even though inflation was undoubtedly higher under Abe than in earlier decades, the desired 2% level was never reached. Additionally, consumption had barely increased since Abe took office in 2012 at the beginning of 2020.
THE PREVAILING SITUATION AND FUTURE PROSPECTS
The Japanese economy is recovering from the pandemic due to lessening associated uncertainties, supply constraints, and rising demand.
However, the ongoing epidemic and the war in Ukraine pose significant dangers to the short-term prospects. Long-term economic challenges include an aging and declining population, slow productivity growth, and significant threats from climate change.
Importantly, digitization may provide growth momentum with a boost. It is behind other economies in adopting digitalization by enterprises, the government, and the financial sector, even though it is one of the world’s largest users of industrial robots and the location of significant electronics industry.
In the future, Japan will require growth that is both more robust and ecologically sustainable. A significant economic change based on major green investments and increased dependence on carbon pricing would both boost the recovery from the epidemic and build a new, clean economic engine for the future. Thus, the pledge by Japan to become carbon neutral by 2050 is significant and promising.
Conclusion —
The fundamental issue with the Japanese economy is that it is not very flexible, making it difficult for them to adjust swiftly to crises.
Some critical lessons from the Japanese economy:
1. Respond immediately to the crisis- The investor’s confidence was shaken due to the Bank of Japan’s slow response, which may have worsened matters.
2. Spending money is not always a solution- Japan attempted to engage in public works projects. However, this did not aid the country’s recovery from its economic troubles.
3. The inverse of demographics- Japan’s refusal to significantly raise its retirement age or taxes worsened the country’s demographic problems.
4. Avoid accruing debt- Japan's crisis and the “lost decade” were eventually caused by its staggering amounts of debt and the BOJ’s slow response to increasing rates.
Written By —
Khushi Tongia — IIT Guwahati
Shashwat Pandey — IIT Guwahati
Rimjhim Dewan — IIT Guwahati
