Fri, Sep 02, 2011 - Page 9 News List

Is the West fated to repeat Japan’s lost decade?

By Gerard Lyons

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.

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