The Japanese economy has undergone a decade of sluggish growth marked by three recessions, including the current one. This time, recession is accompanied by general price deflation, a situation unprecedented among industrialized nations since the Great Depression of the 1930s. Meanwhile, the financial sector sits on a rising mountain of bad loans. A serious financial crisis and deeper recession are real possibilities. How did Japan, the preeminent success story in the past half century, end up in this situation? How serious are the various problems facing the economy at the present time—is financial crisis a real danger?
How can the government restore the economy to a healthy growth path? These questions formed the core of the issues discussed at the Trezise Symposium on the Japanese Economy, held at the Brookings Institution in April 2002. The symposium was held in memory of Philip Trezise, a former foreign service officer and Brookings scholar who had been closely involved with economic matters concerning Japan during his long career. The meeting convened academics, present and former government officials, and business executives from Japan and the United States for a day of discussion on the principal problems facing the Japanese economy. This report summarizes the principal themes of that discussion.
The Causes of Japan’s Economic Problems
Japan is often misread. While the economy faces serious economic problems that could erupt into crisis, the situation for the past decade has, on the surface, been far from a disaster. As I noted in my opening presentation, the annual average growth rate in the past decade has been 1.1 percent, low but positive. Koichi Hamada of the Japanese government’s Economic and Social Research Institute noted further that demographics imply that the potential growth rate had diminished, though it is clearly well above one percent. But the main point is that the past decade has been one of underperformance, not outright decline, a situation Akira Kojima of the Nihon Keizai Shimbun aptly termed “the Big Stagnation.” The lack of outright decline explains why visitors to Japan are struck with the signs of affluence—crowds of well-dressed shoppers in urban areas, considerable construction on new high-rises in Tokyo, and few homeless people on the sidewalks.
This evaluation, however, generated some debate. Richard Katz of the Oriental Economist noted that had the Japanese economy continued to grow in the 1990s at the average rate of the 1980s (3.7 percent), Gross Domestic Product (GDP) would be 25 percent higher today than it is. That view of potential growth was challenged, but even at a lower 2.5 percent growth rate, GDP would have been 16 percent higher, still a considerable gap between the actual level of affluence and what Japanese citizens could have achieved. In addition, Mimi Sasaki-Smith of PwC Consulting in Japan pointed out that the poor economic performance of the past decade has had considerable social costs: unemployment, crime, and suicides have all been rising. Beneath the façade of affluence, economic and social stress has increased.
The principal event causing sluggish growth and other economic problems was the speculative bubble in the stock market and real estate market in the 1980s. The Nikkei stock market average tripled in value from 1985 to its peak at the end of 1989. Real estate values in the six largest urban areas of Japan also tripled from 1985 to a peak in 1991. From 1987 through 1991, rising asset prices were accompanied by high real economic growth, averaging almost five percent. However, after tripling in value, both the stock market and the urban real estate market have lost all of their gains and are back at 1985 levels. The aggregate loss in asset values, according to Robert A. Madsen of Soros Private Funds Management is ¥1.1 quadrillion (or $8.6 trillion). Banks were left with an enormous amount of nonperforming loans, including loans to real estate developers and to manufacturers who had over-invested in increased capacity on the presumption that high growth would continue indefinitely. The shock from the drastic drop in asset prices was prolonged by a series of policy mistakes over the decade: Decisions to use deliberate fiscal stimulus came slowly; the 1997 tax increase removed stimulus at the wrong time, pushing the economy into the recession of 1997-98; policymakers were slow to relax monetary policy; and the Bank of Japan mistakenly raised interest rates in 2000, helping to choke off a modest recovery. Finally, the government let the nonperforming loan problem in the banking sector fester in hopes that a renewal of economic growth would enable deadbeat borrowers to once again service their loans.
Underlying both the asset bubble/collapse and the policy blunders have been a variety of structural issues. A debate has occurred among economists as to whether the simple macroeconomic facts can explain Japan’s problems, or whether the explanation requires recourse to these structural features. The participants at this meeting sided with the structural view. That is, aspects of both the Japanese economic system and politics are crucial in understanding why the bubble occurred and why policymakers were unable to devise better solutions. Hamada said emphatically that Japan needs both structural reform and macroeconomic stimulus. Katz argued that if the macroeconomic solutions to Japan’s ills could be likened to gasoline, then structural reform was the engine; without fixing the engine, more gasoline was not going to make the economic car run faster.
What kinds of structural issues are involved? At stake is the set of rules and regulations leading to poor business decisions (such as lax accounting and disclosure rules), an overly intrusive government, and a political system with too many close ties to dysfunctional players in the economy. Akio Mikuni of Mikuni and Company argued that a key problem has been the behavior of Japanese banks, which have never expected borrowers to repay their loans (loans are routinely rolled over, so that borrowers need only meet the interest payments without ever repaying principal). He said that this led to low rates of return in the corporate sector, since corporations were not under pressure to earn higher profits. Furthermore, in a largely cartelized market, banks made no distinction (through either willingness to extend credit or in the interest rate charged) between safe borrowers and risky borrowers. Katz added that the lack of pressure from shareholders or bankers to maximize profits or pay out profits in the form of dividends led corporations to invest in unprofitable projects often unrelated to their core competencies (such as steel companies investing in flower shops to provide work for redundant employees). Therefore, the rules and regulations that led to this damaging behavior by both the banks and their borrowers is in urgent need of change.