In 1989 Japan was widely viewed as an economic super-power. After three decades of robust economic growth it had risen to become the world’s second-largest economy. Japanese companies seemed to be obliterating entire American industries, from automobiles and semiconductors to earthmoving equipment and consumer electronics. Japanese companies were buying assets in the United States, including movie studios (Universal Studios and Columbia Pictures), golf courses (Pebble Beach), and real estate (the Rockefeller Center in New York).
The stock market was booming, the Nikkei index hitting an all-time high of 38,957 in December 1989, an increase of more than 600 percent since 1980. Property prices had risen so much that one square mile of Tokyo was said to be worth more than the entire United States. Books were written about the Japanese threat to American dominance. Management theorists praised Japanese companies for their strategic savvy and management excellence.
Economists were predicting that Japan would overtake America to become the world’s largest economy by 2010. It didn’t happen. In quick succession the stock market collapsed and property prices rapidly followed it down. Japanese banks, which had financed much of the boom in asset prices with easy money, now found their balance sheets loaded with bad debt, and they sharply contracted lending. As the stock market plunged and property prices imploded, individuals saw their net worth shrink. Japanese consumers responded by sharply reducing spending, depressing domestic demand and sending the economy into a recession. And there it stayed—for most of the next two decades.
Today the Japanese economy is barely larger in real terms than it was in 1989. In 2010, China passed Japan to become the world’s second-largest economy. The average price of a home in Japan is the same as it was in 1983, way below the 1989 peak. The Nikkei stock market index stood at 9,600 in early 2011, 75 percent below its 1989 high. And worst of all, Japan has been gripped by deflation for the best part of two decades.
Deflation is a situation where prices are falling. When consumers and businesses expect prices to be lower tomorrow than they are today, they react by putting off spending, by hoarding cash, since that cash will buy more tomorrow than it will today. Such behavior can result in a negative cycle.
Expectations that prices will fall can lead to reduced demand. Businesses respond by cutting prices further to try to get consumers to spend. Seeing this, consumers react by waiting to buy in expectation that prices will again fall in the future, and so demand continues to decline, which results in additional price cuts to try to stimulate demand, and so on. As businesses see their revenues and margins fall, they reduce employment and cut wages and salaries.
This further reduces spending power and adds to the deflationary cycle. To make matters worse, in a deflationary environment the real cost of debt goes up over time. While prices and wages fall, people still have to make fixed payments on their mortgages and car loans. Over time, this takes up an ever-greater proportion of their income, further limiting their ability to spend more on other goods and services. All of this has happened in Japan over the past 20 years.
For its part, after initially being slow to respond to falling asset prices, during the past 15 years the Japanese government has repeatedly tried to stimulate the economy and reignite consumer spending. Interest rates have been cut to zero and major investments have been made in public infrastructure. Not only has this not worked, but it has also left Japan with the highest level of government debt as a percentage of GDP in the world, amounting to some 200 percent of GDP (in contrast, the figure for the United States in 2011 was about 97 percent of GDP).
The high debt load is now a limit on the ability of the Japanese government to adopt additional expansionary policies. In seeking to explain Japan’s prolonged malaise, many economists also point to demographic factors. In the 1970s and 1980s birthrates in Japan fell below replacement levels, leaving it with one of the oldest populations in the world. The working age population peaked at 87 million in 1995 and has been falling since. On current trends, by 2030 it will be 67 million.
Every year there are fewer and fewer working age people to support ever more retired people—and Japan’s retired people are notorious for not spending. Japan could reverse this trend by increasing immigration or boosting the birthrate, but neither of these seems likely at the moment. Increasingly, young people are pessimistic about the future. All they have known is a world where prices for everything, including the price of labor, have fallen. They have diminished expectations.
Case Discussion Questions
In the 1980s Japan was viewed as one of the world’s most dynamic economies. Today it is viewed as one of its most stagnant. Why has the Japanese economy stagnated?
Similar to what happened to the collapse of the housing bubble in the US in 2008. Japan suffered the same during the eighties. Japan’s real estate and equity bubbles collapsed. Values of land and equity markets risen sharply prior to the crash, as Japan’s banks lent without much regard for the quality of the collateral or the ability of the borrowers to generate sufficient income to service the debt. While these lending dynamics raised equity and real estate prices, the boom in asset prices and increased leverage fueled consumption, mal- and over-investment, and growth. As the Bank of Japan started raising interest rates in the early 1990s, the elevated equity and real estate prices proved to be unsustainable and eventually the bubbles burst.
The 1985 Plaza accord that depreciated the US Dollar versus the Japanese Yen and the West German deutschemark. This had an effect of appreciating the Yen against the dollar which proved harmful the country’s export-driven economy as their products became more expensive. Growth measured in nominal GDP was flat for nearly 2 decades due to the combination of slow economic growth and deflation.
Stock Market collapsed – asset prices collapse due to the bursting of various bubbles. Property Prices Plunged – due to the oversupply of property and debt Banks sharply curtailed the easy lending practices that financed the boom – maybe in an effort to make themselves more liquid banks did not want to expose themselves to risky loans. Consumers stopped spending – consumer confidence dropped due to the economy. Consumers expect prices to continue to fall, delaying purchases – in an effort to sell products.
Company’s lowered their prices in an effort to make their products attractive to consumers. Consumers on the other hand realized the deflationary trend in prices waited until they could get a low enough price of goods. Government efforts to stimulate economy not effective – Japanese government tried to inject financial stimulus into the economy. They tried to finance the recovery with government debt.
What lessons does the history of Japan over the past 20 years hold for other nations? What can countries do to avoid the kind of deflationary spiral that has gripped Japan?
During the recession, Japan has been running government deficits. During the same time period, Japan has extremely elevated ratios of general government debt — both net and gross — to nominal GDP. These deficits were due to the automatic stabilizers and fiscal stimulus or public spending. The large deficits due to the stimulus prevented an economic depression.
However the expansionary fiscal policy failed to overcome the country’s stagnation or revive growth and employment. Sufficient regulation for lending practices – Banks had to increase their standards when pre-qualifying lenders based on the ability of lenders to repay the loan. Maybe government shouldn’t have tried to spend its way out of the slump by incurring public debt. – this just increase the government debt. Japans debt is now 200% of GDP
What do you think would be required to get the Japanese economy moving again? Supporting innovation and entrepreneurships.
Innovation leads to economic growth. Encourage more private spending on business rather than government. Increase immigration – expand the market and help support growing population. Since WW2, Japanese birth rate had declined. This had made shrunk the pool of consumers. Opening up immigration will increase the population
What are the implications of Japan’s economic stagnation for the benefits, costs, and risks of doing business in this nation?
- Opportunities: Money is cheap – Japanese government bonds yields have stayed exceptionally low since the mid-1990’s even as the country’s fiscal deficit remained elevated. This is due to: Japan’s debt is issued in Yen, its own currency The Bank of Japan can control government bond yields though its balance sheet and communication tools. The demand for public debt remains strong, as the country’s private financial institutions hold a majority of it. Wages are relatively low
- Challenges: Consumers unwilling to spend. Most probably due to the deflationary environment. Consumers waiting for lower prices. Companies keep lowering prices to spark demand for their products. Future government policies to spark economic growth could make it more difficult for businesses. The ruling elite in Japan have been quite divided on policy matters and have been unable to reach any policy consensus or political vision to overcome Japan’s economic stagnation and move the country forward.
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