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Japan’s economic disaster: addressing some misperceptions

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In Brief

Japan is currently facing the worst economic downturn since 1945.

Although this is a statement that is factually correct, it is also somewhat misleading. In the fourth quarter of 2008, the economy shrank at a stunning 12.1 per cent quarter-on-quarter annualized rate (that is, the amount by which the economy would shrink if the drop in GDP from the third quarter to the fourth quarter were to continue at the same pace for three more quarters).

The economy will certainly not continue to shrink at that rate, but economic forecasts for the calendar year 2009 are in the range of a decline in real GDP between 5 and 7 per cent. In terms of economic growth, this would clearly be the worst performance since 1945, and is larger than the expected decline in the United States.


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Previous downturns in 1974, 1993, 1998, and 2001 involved a fall of real GDP for the calendar year of 2 per cent or less (and some of these recessions actually involved no decline at all for the year as a whole). So this recession, like that in the United States, is outside the parameters of the experience of the past half-century, and appears rather serious. Nevertheless, we should be wary of calling this recession the ‘worst since 1945’.

Japan is one of the leading industrial economies of the world. Even when adjusted for differences in price levels, Japan has a level of GDP per capita that is about 74 per cent the level of that in the United States, and similar to that of Germany, France, and the United Kingdom. In fact, one could argue that these kinds of cross-country comparisons are inherently imprecise, so that the Japanese population could be considered to be at roughly the same level of affluence as that of the United States.

What does a 7 per cent decline in GDP imply for such an affluent society? As large as this drop appears to be, the answer is ‘not much.’ On average, the Japanese will have 93 per cent the level of output and consumption as in 2008. If one thinks ‘93 per cent’ instead of ‘down by a record 7 percent’ the outcome does not seem so dire.

This milder reality is the reason why all through the ‘lost decade’ of the 1990s foreigners visiting Japan were usually struck by the absence of many signs of economic distress. Only those familiar with Tokyo’s past noticed that restaurants were less full, more empty taxis cruised the streets as corporations cut back on expense accounts, and household real income stagnated. Big deal!

Employment figures, too, are drastic but not catastrophic. I fully expected to see that the employment impact of the current recession will be worse than in previous ones, and somewhat closer to the patterns of the United States. The media attention in Japan on the layoffs of temporary workers, the sprouting of camps of homeless people in Tokyo and other major cities, and the effort of the Diet to help temporary and part-time workers, certainly leads to the conclusion that job losses must be large. The data simply do not bear this out.

Politically speaking, fiscal stimulus is an appropriate government response to the current downturn in Japan, as is the case in the United States. Having lessened the government deficit over the past seven years, the government can afford to have the deficit widen again on a temporary basis.

Low interest rates indicate that the government should have no problem floating extra government bonds (and the Bank of Japan appears to stand ready to buy those bonds if necessary to keep interest rates low and money supply expanding). However, the approach of the government to this policy has been heavily affected by the messy state of politics, the result of which may well be an aggravation of both the problems facing Japan and the advertised policy responses.

In reality, Japan probably could use a fiscal stimulus package larger than that currently proposed (especially since true fiscal stimulus will be smaller than advertised), but Prime Minister Aso will do only what is necessary for his political purposes. Moreover, a prime minister who was truly serious about addressing the economic problem should have moved much more aggressively with a single large stimulus package in late 2008 rather than stringing the process out with multiple packages.

Those who lose jobs (or fail to obtain good jobs when graduating from school) will bear much of the economic pain this year. Nonetheless, they are not out marching in the streets (like some Europeans who are angry about their economic downturn). The government should care about their plight, and adopt policies to moderate the economic downturn and bring the timing of the eventual recovery closer to the present. But we should not hyperventilate about the economic or the social crisis in Japan.

This article first appeared in the Lincoln Log, and the full version may be found here.

One response to “Japan’s economic disaster: addressing some misperceptions”

  1. Dear Prof Ed Lincoln,

    I am amazed that 7 pc decline in GDP and lakhs of jobless and homeless people in the economy do not bother you; while since the Bubble burst of the late 80s, the Japanese economy has been in shambles, and several stimulus packages have been tried with very little improvement in the health of the economy;

    In my judgment, one has to look at the basic causes of the continuing malaise for the last 20 years and that in a country aspiring to be world no one in trade, finance ;

    I am dead sure that basic reason for the recession for years is that the govt bureaucrats, contractors and bankers – all are hand in glove to olot the economy and NPLs of more than 30pc still looming and tell a lot about the poor ethics in money and banking also; ; my layman observations also follow for your joy–

    While recession continues in the Economy even in ’09, moot question now is whether the Japanese model is facing extinction ; this depends on how it is defined. The macro-level model concerns governance of the economy, as Johnston’s ‘developmental state’ version (1982) assigned a key role to MITI bureaucrats general headquarters staff of Japanese capitalism. IN recent studies, the focus has been on Japanese financial institutions, the role of the MOF and policy-based finance.

    Japan has already frittered away a decade and half, but should the new one be any different? Only now the recent events have persuaded the Japanese people that without reforms, the situation can only get worse This new awareness was the force behind PM Koizumi’s election in 01 . Really the problem is that the institutions and practices forged to create the Japanese miracle still rule Japan.

    Of course several institutional changes are now essential. For persistence of each of these features of the Japanese model, various explanations have been offered and Aoki emphasized the inter-connections between various key features.-the rank hierarchy characteristics of several parts of the model reinforce each other and create a system in which ‘instead of facing perfectly competitive markets for factors of production, the firm is related to other agents- the worker, the investor and the supplier-through long-term relational contracting and agents on both sides of various relationships reciprocate economic benefits on a long-term basis.

    Recently observers like Horiuchi (2000) have criticized the role of financial structure and role of banks in encouraging over-borrowing and excess investment due to lax corporate governance and interconnected lending . The case here rests on a very rapid growth of investment in the bubble years of the late 1980s that brought the ratios of gross capital formation to GDP to very high levels indeed .

    Moreover there is little doubt that the measured rates of growth of capital productivity during the 1990s as also for several years since 2000 as well, were very low indeed. As OECD recently argued, there is a serious problem of excess capital for Japan and the capital-output ratios have only just reached the levels of most of the European counties.

    In spite of the alarming size of bad loans at the depth of the banking crisis, it is hard to find unambiguous evidence that the system was predisposed to encouraging excessive capital-stock build-up in aggregate. For most of the 1990s as also in early new century , the size of bad loans at the depth of banking crisis was no wore than in other countries which had experienced banking crisis. My hunch is that the nature of bank-firm relationships allowed a poor choice of projects in several industries. It is obvious, regulatory changes led to widespread changes in corporate financing patterns for some classes of firms( Hoshi and Kashyap,1999).

    As Gibson recently argued, forcefully, that the corporate governance system is directly responsible for low returns to shareholders’ wealth and the Big Bang reforms do not address the specific governance features responsible for this state of affairs. The catch really is that obstacles to growth also pillars of the political system Collusion, regulation and bank loans to the uncreditworthy, all serve as covert safety nets in a nation where only half the workforce is covered by unemployment insurance. All these unfair practices shore up moribund firms and industries, sustaining millions of unnecessary jobs( Katz,19998).

    I hold that the Japanese model( the micro-level variant) has been condemned to oblivion for as long as it has been recognized. Japans crisis is thus a crisis of governance in both government and business; a revival will require a fundamental overhaul of several institutions( even reformers are disagree among themselves as to what constitutes reform .)

    The outlook for Japan even in 09 is not very encouraging; some foresee neither reform nor muddling through; but slow meltdown.. IN the spring of 2002, many observers warned of bank runs again when government lifted full guarantees on all time deposits at the banks; it never happened..
    Even now it is difficult to judge the extent to which capital stock and balance sheet adjustments are taking place, but they also seem very modest.

    While the no of coys making restructuring announcements rose sharply in 1999, most of these contained very few concrete details and may never be fully implemented.(OECD,1999). Powerful vested interests are standing in the way of change, as observed recently by Noguchi(1996 and Ed Lincoln (19998). The slow pace of reforms in Japan for years has shown a reluctance to abandon past successful formulae. Hence Japanese savings will be at least partially bottled up at home, almost certainly condemning the country to a lower level of income than what it could otherwise have been achieved.

    Even now it is unlikely that the new PM will get the chance to pursue the five or ten-year program of reforms; ( he has now suggested wide circulation of comics to cheer up the masses; what a Joke indeed.

    Now Japan’s budget needs to shift to debt reduction by some 10 percent of GDP and this in an economy in recession for two decades indeed. As per Government estimates, the NPLs now total $ 500 billion or more than 10 percent of GDP but keen observes maintain that the real number is closer to 20 percent. Recent estimates suggest a 2-3 percent extra dip in growth rate, with no certainty that higher growth will ever follow. Moreover banks also need a new capital injection, this time with more stringent conditions than the failed efforts of 1999.

    Japan is in fact witnessing the most restructuring where it is least urgent and the fewest reforms where it is most urgent. Japan cannot gain greater competitiveness without more competition.

    Today Japan is like a patient that has abused the antibiotics so much that they no longer pack their punch .Tokyo is applying more fiscal and monetary stimulus than ever , yet getting fewer benefits then ever. Japan will never solve its chronic deficiency of demand until it shifts a greater share of national income to the consumers in the economy.

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