It is just one year ago that we were all celebrating Japan’s longest post-war economic recovery -- not the strongest, but the longest. But Japan has since taken a mega-hit with the financial crisis. Its GDP at the end of this year will be about the same as it was in 1992, almost two lost decades. And what’s more China’s GDP is set to overtake Japan’s next year.
The country has now fallen back into a state of Japo-pessimism. What’s been going on?
Japan is the true Asian miracle. From the 1950s through to the 1980s, Japan’s government guided the economy to a very rapid development, catching up with the West in the space of a few decades. This was helped by high levels of education, and cordial relations between workers and management. But it was also helped by a government promoted culture of familial capitalism where everyone helped each other. In tough times, workers were not fired, nor were suppliers. It was another form of socialism.
Following the Plaza Accord, the yen appreciated dramatically and loose monetary policy facilitated a boom in asset and land prices. Based on historical experience, everyone believed that neither stock nor land prices could fall. But in the early 1990s they did. It hit the banking and enterprise sector dramatically. Many banks and enterprises were paralysed until the government eventually tackled the problem. Mega fiscal packages to keep the economy afloat had many adverse effects – large government debt, wasted infrastructure expenditure and political corruption. During the decade of crisis, Japan’s GDP per capita fell from the fifth highest of the OECD countries to only 19th in 2002.
But eventually Japan seemed to have made it through the crisis by the early 2000s, just in time to catch the boom in Chinese trade (China now accounts for half of Japan’s exports). From 2003-2007, Japan achieved a good growth performance, although three-quarters of growth was thanks to exports and business investment, with help from a falling yen. And while Prime Minister Koizumi aggravated neighbouring China and Korea, Japan’s politics seemed to have found much-needed self confidence.
The corner seemed to have been turned. In 2005, the Economist published an optimistic assessment by editor Bill Emmott entitled “The sun also rises”. According to Emmott, a process of incremental reform had taken place over a broad range of policy areas during the previous decade. And that thanks to this, Japan was well placed to return to a higher growth path. In February 2006, the Australian-based Lowy Institute published an optimist piece entitled “Japan: Ripe for Re-assessment”.
Sure there were problems. Japan was saddled with the highest public debt of any OECD country, 170 per cent of GDP (it could hit 200 per cent by 2010!). Its population was ageing more than any other OECD country, and even started declining a few years ago. While productivity and innovation performance was good in the export-oriented manufacturing sector, performance was deteriorating in the regulation riddled service sector. As IMD's Suzanne Rosselet-McCauley argued, innovation is needed in the development and application of information technology, focussing on creativity, and entrepreneurship and the ability to apply technological breakthroughs to products and services. In particular, SMEs need to develop their own markets domestically and internationally, rather than just being dependent appendages of larger companies.
But then come the hit of 2008. Japan is now in a severe recession. It has experienced four quarters of declining GDP, starting in the second quarter of 2008. How did it happen? According to the IMF and other analysts, Japan has been hit hard by the slump in global demand for advanced manufacturing products like cars, information technology and machinery, which account for a larger share of Japan’s production than other major economies. Tighter financial conditions also affected domestic demand, especially business investment.
In addition, press reports suggest that for once some firms are reacting by laying off workers. The rise in non-regular employment has made shedding workers much easier. While this causes short term pain, it will help competitive firms survive and thrive in the future. Japan needs more corporate restructuring.
Japan had seemed the best prepared for a financial crisis of all the major economies, with its banks in good shape with low levels of toxic assets, unlike their European counterparts. And yet, Japan’s economic performance this year will be the worst of the G7!
What does the future hold? If world demand bounces back, so should Japan’s growth, although the appreciation of the yen won't help. The most recent figures for industrial production suggest a recovery. But, US markets are unlikely to return to previous growth rates any time soon. Financial institutions are unwinding their bad loans, while consumers are rebuilding savings and scaling back purchases of up-market consumer durables. And this process could take some years. Krugman fears an upcoming lost decade.
Can Japan generate its own growth? The government has launched big stimulus programs, which helps in the short term. But it will further increase debt. And, if the past is a guide to the future, it will finance white elephants.
Unfortunately, there is little evidence of domestic growth drivers. The services sector is strangled by regulation – even services in the medical, child and elderly care areas which could create new growth drivers. Innovation performance is weak. And older people are reluctant to spend their savings because they do not trust the government’s management of social security. Overall, the OECD estimates Japan’s potential growth rate at 1.4 per cent over the period 2004 to 2013, the lowest rate in the OECD area, reflecting a large negative contribution from a declining working-age population.
What's more, politics in Japan is a tired old game of factionalism, infighting and pork barrel. We have already seen three prime ministers since Koizumi. While a change of government is on the cards in the upcoming elections, there is little confidence that the opposition would do any better. A period of protracted instability is more likely. There is no possibility of new promises of hope like Obama in the US or even Sarkozy in France.
A Japan which is rich, complacent and self-obsessed is likely to dawdle into its future, while the rest of Asia rushes ahead. Japan may be the perfect example of the boiling frog theory, a well known metaphor for the inability of people to react to important changes that occur gradually. If a frog is placed in boiling water, it will jump out. But if it is placed in cold water that is slowly heated, it will not perceive the danger and will be cooked to death.
References:
Japan: 2007 Article IV Consultation -- Staff Report; and Public Information Notice on the Executive Board Discussion. August 2007. International Monetary Fund – www.imf.org .
Japan: Selected Issues. IMF Country Report No. 05/272. August 2005 – www.imf.org .
“The sun also rises”, Economist, 6 October 2005 – www.economist.com
“Japan: Ripe for Re-assessment”, Malcolm Cook and Huw McKay, February 2006, Lowy Institute for International Policy – www.lowyinstitute.org
"Will Japan Recover Its Place as World Economic Leader: Japan in World Competitiveness", by Suzanne Rosselet-McCauley, Research Fellow, IMD World Competitiveness Centre (October 2006) -- www.imd.ch
"Potential Competitiveness Ranking 2008", January 2009. Japan Centre for Economic Research -- www.jcer.or.jp/
“Why Has Japan Been Hit So Hard by the Global Recession?”, Martin Sommer, IMF Staff Position Note, March 18, 2009, SPN/09/05 – www.imf.org
Economic Survey of Japan, OECD Policy Brief – www.oecd.org/japan
Boiling frog -- http://en.wikipedia.org/wiki/Boiling_frog
“Paul Krugman’s fear for lost decade”, Interview with Will Hutton, The Observer, Sunday 14 June 2009 – www.guardian.co.uk.
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