Japan’s failing a warning to West

This Perspective column was first published in Monday’s edition of Fund Strategy.

It is looking increasingly likely that other advanced economies will follow Japan in suffering a protracted downturn as a result of failing to promote economic restructuring.

The news that Japan is holding an election on 16 December reminded me of the biggest surprise I have ever encountered in covering economics. That is the extreme difficulty the Asian country has had in overcoming the effects of the bursting of its “bubble economy” of the 1980s.

This question is not simply of historical interest. Not only is Japan the world’s third largest economy but in some respects its past could signal the future for the other advanced economies.

It looks increasingly like the economic problems of North America and Western Europe could become protracted in a similar way to those of Japan. The Japanese authorities pioneered some of the main techniques being used to counteract the effects of the crisis, such as quantitative easing.

Clearly Japan has some features that mark it out from other advanced economies. For instance, the country was rebuilt by the US more than any other after the second world war. Japan’s traditional business conglomerates (Zaibatsu) were broken up by the occupation authorities and its old-style militarist institutions were replaced by a constitutional monarchy. But in many respects Japan’s more recent experience is similar to that of the other advanced economies.

To those without a long memory or a keen interest in history the story of Japan’s dramatic economic reversal is little known. Back in the 1980s it was widely argued that by about the turn of the century it would overtake the US to become the world’s largest economic power.

There were countless articles, books and television programmes predicting Japan’s imminent rise to global pre-eminence. It is hard to believe but back then China was seen as a mere footnote in the debate.

Such predictions were not entirely foolish. If the economic growth rates of the 1980s for Japan and the US had continued the Asian power would indeed have risen to a pre-eminent position.

To be sure there were clear signs of economic trouble emerging in Japan by the late 1980s. Property and equity prices became grossly inflated. That was where the term “bubble economy” came from. One of the most frequently quoted statistics at the time was that the grounds of Tokyo’s Imperial Palace were worth more than the entire state of California.

The surprise then was not that the bubble burst but that Japan had so much difficulty reinvigorating itself. Even now the economy is a long way from regaining the dynamism it exhibited before 1990.

Not that I was alone in being surprised by this failure to recover. Many fund managers have repeatedly predicted a Japanese revival while journalists have often written along similar lines. Typically the headlines of such articles have headlines such as “the sun also rises” or “the sun will rise again”. Sumo wrestlers are also a popular image used to suggest that the Japanese giant would fight back.

With the benefit of hindsight it is clear, at least in outline, what went wrong. The government did not comprise, as many western commentators assumed, of closet militarists who wanted to return to the imperial 1930s. On the contrary, it had an excessively timid political leadership which, if anything, was desperate to please the US. It was well suited to managing Japan during boom times but had no experience of dealing with a concerted downturn.

Japan’s problems began to become apparent in the 1980s. Back in 1985 Japan agreed at an international summit known as the Plaza accord to strengthen the yen against the dollar. The US was complaining that its economy was suffering as a result of unfair competition from Japan’s mighty export machine.

Japan’s corrective measures provided a short-term boost for the US but they also gave added impetus to the emergence of its domestic bubble economy. Tokyo’s decision to keep interest rates low helped bolster the country’s speculative frenzy.

But Japan’s biggest mistakes made were in the 1990s. The authorities seemed much keener on dealing with the fall-out of the financial crisis than tackling economic lethargy.

Relative to the substantial size of the economy there was little restructuring. Japan’s politicians were reluctant to move away from set of industries and practices that had proved so successful in the past.

Instead they pursued policies that should appear familiar to those in the West. Japan tried high public spending, low interest rates and, in 2001, introduced quantitative easing.

Yet it has remained trapped in what Richard Koo, the chief economist at the Nomura Research Institute, has called a “balance sheet recession”. Its firms are more interested in paying down debt rather than striving for future growth.

Over two decades since the advent of the crisis the country is still caught in an economic rut. This is despite the rise of China which, in economic terms at least, should have provided a large boost for Japan.

Japan’s plight cannot be explained adequately by pointing to its cultural uniqueness. It is rather simply an extreme form of the challenge already facing the other developed countries.

Japan has long suffered from sluggish growth, an indecisive political elite and a reluctance to promote economic restructuring. All of these failures should be familiar to anyone living in the US or UK.