Think Again: Japan’s Lost Decade

Japan’s Economy Collapsed in the 1990s.

Not exactly. Decades of extraordinarily high growth in postwar Japan culminated in a huge asset price bubble that reached its peak in 1989. When the bubble finally popped in 1990, wiping out billions of dollars in accumulated wealth, the country’s growth rates turned anemic. Between 1990 and 2003 Japan dipped into and out of recession. Despite these troubles, though, Japanese GDP in the 1990s ultimately continued to grow at an average of about 1.5 percent per year, measured in real terms. That translates to a 10 percent increase in the size of the economy over the course of the decade, well lower than the much more robust rates of growth in many other industrialized economies during the same period, but hardly a Great Depression. What’s more, unemployment never rose over 5.5 percent — a rate that would be considered quite an achievement in the United States or Western Europe.

The Japanese do refer to the 1990s as the Lost Decade, but the label is a bit misleading. Productivity did slide, though not dramatically. If anything was lost in the course of those years, it was the sense of pride and exaggerated confidence that marked the previous era of frenetic growth. Japan lost belief in its own ability to create economic miracles. Yet its economy remained remarkably strong. Japanese automobile companies remained some of the world’s most profitable. Japanese consumer electronics manufacturers and machine tool producers continued to post good results despite the rise of low-cost rivals elsewhere in Asia.

The Government Made It Worse by Spending Too Much.

No. Government policy did exacerbate the slowdown, but the picture is much more complicated. Bureaucrats and politicians certainly spent too much on the wrong sorts of things, especially bridge-to-nowhere-style construction projects with limited usefulness. But economists have concluded that large chunks of the spending — particularly on useful infrastructure, healthcare, and education — brought substantial benefits. Adam Posen, deputy director of the Peterson Institute for International Economics, has argued that Japan’s 1995 stimulus package actually spurred growth the following year. When the government tightened fiscal policy again soon afterward, growth tailed off again. The lesson: Spend, but spend intelligently.

Many students of the period point to other crippling errors. The Bank of Japan maintained high interest rates for too long after the slowdown became apparent. At one point an overly optimistic government raised taxes prematurely, which certainly prolonged the slump.

Policymakers hobbled by a dysfunctional political system dawdled for years when it came to cleaning up zombie companies (bankrupt in all but name) and getting financial institutions to dispose of toxic assets. That failure to take decisive action may have shaved points off Japan’s overall growth rates and ended up leaving the country saddled with enormous public debt (peaking at 175 percent of GDP by one recent measure). Yet, a push to force banks to shed their nonperforming loans under the government of Prime Minister Junichiro Koizumi starting in 2001 had notably positive effects on growth.

Japan Has Been Permanently Crippled by the Slowdown of the 1990s.

Hardly. To be sure, Japan has been hit extremely hard by the recent turmoil. At first it looked as though the Japanese economy might have good chances to ride out the crisis better than the United States, because Japanese financial institutions had largely averted the securitized mortgages and dubious derivatives that sent the U.S. economy reeling. But the slump in the United States, China, and Europe — major markets for Japanese exports — soon rebounded on Japan with vicious force. In the past few months Japanese exports have collapsed, and growth has nose-dived correspondingly. Japan’s economy has been hit much harder than America’s.

It’s worth noting, though, that this slump comes hard on the heels of the country’s longest postwar boom — a period of growth from 2002 to 2008 that was driven by a strongly performing real economy rather than a credit frenzy.

Even now, Japan is still the world’s second-largest national economy. Japan boasts a highly skilled workforce and a powerful array of smart companies. Case in point: Companies like Toyota and Honda have slashed inventories as the demand for cars has plummeted. And yet, drawing on their ample reserves of cash, they’ve continued their funding of research and development for the next generation of green cars, extending an already formidable lead. When the world’s economy picks up again, they’ll be perfectly positioned to benefit.

Japanese infrastructure rivals that of any country in the world. The yen remains one of the world’s strongest currencies, and Japan remains one of the world’s primary creditor nations, a major advantage over the United States, which has chosen to finance its debt externally. One often hears China referred to as America’s banker, yet Japan holds almost as much U.S. Treasury debt as China.

The U.S. Today Is Like Japan in the 1990s.

Not really. To be sure, both recessions had their roots in the collapse of an asset price bubble based primarily on real estate. But there are some important differences.

For one thing, U.S. policymakers have so far acted much more decisively than Japan’s risk-averse bureaucrats in the 1990s. Economists have taken note of some of the most important lessons of Japan’s Lost Decade, such as the dangers of premature fiscal contraction and the need for swift action to clear away the bad debts clogging the financial system. Some economists argue that Japan’s corporate debt was actually much bigger than the one now facing Americans.

On the other hand, most of Japan’s bad debts were held by corporations, which arguably made the problem easier to tackle once the politicians got down to business. When the Koizumi government finally buckled down to the problem of getting banks to clean up their act, the economy responded with remarkable speed. By contrast, the present U.S. slump is the result of a culture of financial profligacy that enmeshed consumers and homeowners as well as major financial institutions. That could make it much harder to sop up the flood of bad debt.

Moreover, the United States’ credit binge has been financed largely by foreigners, adding another element of instability to an already bad situation. Funding the ambitious program of the Obama administration will require convincing overseas creditors — including the Japanese — as well as skeptical domestic taxpayers.

Japan Is Irrevocably Bound for Economic and Political Decline.

Don’t bet on it. To be sure, there are plenty of problems. Although many aspects of Japanese society have experienced profound change in recent years, the political system has remained remarkably static.

Politicians seem paralyzed — even as the global economic crisis poses a whole set of new challenges to Japan’s manufacturing-based economy.

And policymakers are even less effectual when it comes to what is probably the biggest threat to Japan’s future: a steady demographic slide. The Japanese government has estimated that the population of the country (now 127 million) will drop to less than 100 million by 2050. Thanks to high life expectancy, some forecasts say that the number of Japanese over the age of 65 will rise to 40 percent of the population over the same period. One likely solution to the problem: immigration. But that’s unlikely to happen, given the deep-seated Japanese reluctance to allow a large-scale influx of foreign workers.

And yes, the economy has some changing to do as well. Productivity could be dramatically increased by giving women greater work opportunities. Promoting foreign investment — still shockingly low — could also boost efficiency. Education reform, as well as measures to encourage entrepreneurship and creativity, would offer a needed dash of flexibility.

Don’t count Japan out, though. If there’s one thing the country has demonstrated throughout its history, it’s an ability to indulge in dramatic, if not downright revolutionary change when circumstances call for it. In the late 19th century, the nation’s ruling class drove Japan through a wrenching modernization process that transformed it from an isolated feudal kingdom into a global power in the course of a generation. Virtually overnight after World War II, the country turned its back on hypernationalist militarism and reinvented itself as a peace-loving American protg and economic powerhouse. In that sense, this latest economic storm could well turn out to be a blessing in disguise.