Lost decade points to need for tough action

The following is my latest comment from Fund Strategy.

Although the West’s current predicament differs in some respects from Japan after the collapse of the baburu keiki (bubble economy) of the 1980s there are many similarities.

For those who are not old enough to remember, or who have not read the history, the Japanese economy was growing at a relatively healthy average rate of 4% in the 1980s. But the expansion was artificially inflated by surging equity and property prices. At the end of the decade asset prices crashed and the economy entered a period of slow growth. The average growth rate in the 1990s was only 1.7%.

The similarities between Japan in the 1990s and the West today are fairly apparent. In both cases the economy suffered as a result of the bursting of an artificially inflated asset price boom. And in both cases an indecisive and often gormless political leadership made the crisis worse than it needed to be. Rather than address the fundamental problem of a lack of growth in real productive capacity they simply attempted a fiscal stimulus.

There are also differences. Japan’s problems were partly centred on the industrial sector. Manufacturing in particular had reached a stage where it needed to restructure to be able to achieve a new round of investment. After spectacular economic growth in the 1950s and 1960s its once mighty industrial sector needed to be revamped. In contrast, the West’s downturn is focused on the consumption side of the economy. Manufacturing is now being hit but it was consumption that suffered first.

The situation also differs because the emerging economies play a far more important role in the world economy than they did in 1990. It is China, rather than America, that has become the largest source of economic growth globally.

If there is a lesson to be learned from Japan’s “lost decade” it is that decisive political action is a key part of solving the crisis. It is not enough just to spend money. Resources should be devoted to bolstering productive capacity. It is also necessary to involve emerging economies in the recovery process by acknowledging their increasing importance in the global economy