Japan’s economic bubble burst 20 years ago. The country has since suffered weak growth and what became known as “the lost decade.” In recent weeks, a dominant question has been whether the US and European economies will suffer the same fate.
If anything, the immediate challenges the West faces are worse than they were in Japan when its bubble burst. However, although the West is looking at slow growth and low interest rates for the next few years, it can rebound. The West is likely to face up to the need for supply-side reforms, aimed at boosting productivity, and it would require some monumental policy mistakes for the outcome over the next decade to be exactly the same as Japan. For Western economies, the main message is to avoid deflation and boost demand, but an ominous lesson that cannot be ignored is that when bubbles burst economic pain cannot be avoided.
The West was struck simultaneously by its economic and financial crises, but in Japan it took about eight years for the full extent of its problems to materialize. Japan’s bubble burst at the end of 1989, yet from 1990 to 1997 employment rose as firms expected growth to rebound and were reluctant to lose skilled staff. Japan then had its financial crisis, in the fall of 1998, when Yamaichi Securities collapsed — at the time, the biggest corporate failure in history.
Perhaps the West should display a greater sense of urgency. Japan was the world’s second-largest economy and enjoyed a high standard of living. That, if anything, lessened Japan’s sense of urgency and willingness to take radical action. Japan’s lack of political debate did not help, either. Socially, it could handle slow growth, as income disparities were not huge. Some aspects of this could be seen seen this year in the ways Japan handled the aftermath of the tsunami. This social cohesion is in contrast to the US and some parts of Europe now.
In the early 1990s, I wrote that Japan faced four immediate Ds: debt, deflation, deindustrialization and deregulation. Alongside these, it faced the longer-term demographic challenge, thanks to its ageing population. There are, therefore, both similarities and differences with the West.
Japan’s debt problem was different than the West’s is now. Japan ran current account surpluses and was able to fund its debt easily at home. The US and the peripheries of Europe do not have that luxury and have had to face up to problems sooner than Japan ever did. Furthermore, when Japan’s bubble burst, people were big savers, and thus Japanese were able dip into their savings. In contrast, Western nations now in trouble have high personal debt. That makes the economic pain worse.
Deflation was Japan’s biggest problem and its stock market is still a fraction of its 1989 peak. Land prices peaked in 1991 and took until 2006 to stop falling, adding to collateral and bad loan problems for Japanese banks. As consumer prices fell, people delayed spending. The West must avoid the deflation trap, particularly given how high debt is.
The West faces a deindustrialization challenge now, as Japan did then. Japan’s industry “hollowed out,” moving production to lower cost centers elsewhere, feeding downward pressure on costs and margins at home. The same is happening in the West at the moment. This reinforces the need for growth to avoid a self-feeding downward spiral and the need to encourage firms to invest.
The deregulation issue is one big difference. Japan could never come to terms fully with the need for supply-side reform and structural change and was thus slow to change. Parts of Europe are showing similarities. The West cannot avoid weak demand in coming years, but there is reason to think US industry will be able to bounce back and boost productivity.
Then there is demographics. This is even more of an issue now for Japan than it was twenty years ago. There are similar situations in parts of Europe, but less so in the US, which has a relatively young population.
Japan faced both demand and supply-side problems. It focused largely on the demand side, but not well enough, and ignored for a long time any supply-side solutions. In short, it did not fully address its problems. Therein lies the challenge for the West.
The West needs to learn the right lessons from Japan. In monetary policy it has, acting more aggressively and over a far shorter time period than the Bank of Japan.
The fiscal lesson from Japan is more complex. Most worrying for the West is that just ahead of Japan’s financial collapse in 1997, the country had embarked upon tough fiscal tightening. From the bursting of the bubble in December 1989 through to 1997, Japan had various fiscal boosts. All worked, but 1997 marked a turning point. Fiscal policy was tightened. The consumption tax was hiked. Public spending was squeezed. The economy suffered, and the financial sector imploded. One lesson is that premature fiscal tightening is not beneficial to an economy that needs demand.
Another fiscal lesson has been learned over the subsequent 20 years: Avoid weak growth. Weak growth continued to push Japanese government debt up to the worrying levels it is at now.
In the West, there is much talk of inflating debt away. That proved hard in Japan. Its population was ageing and had savings, so there was no mandate to inflate. Also in Japan, the yen proved resilient and this reinforced deflationary pressures. A lesson for the West is that a strong currency policy does not help and that inflating debt away is a hard policy to implement.
The East, too, can learn from Japan by setting policies to suit domestic needs — something Japan did not always do. In the mid to late 1980s, currency policy dominated thinking and domestic interest rates were too low: It fed the bubble.
And in the 1990s, the debate that Japan needed to have to address the structure of its economy was sidelined as, in response to G7 pressure, it boosted fiscal policy.
The West faces a long, hard slog. Thus, the West can learn from Japan the need for more quantitative easing and further economic deregulation to encourage investment and growth, while avoiding premature fiscal tightening. The main message: Avoid deflation at all costs.
Gerard Lyons is chief economist and group head of global research at Standard Chartered Bank.
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