What’s the Matter with Japan? The Japanese Economy from a Historical Perspective

After his resounding electoral success, the incoming prime minister Shinzo Abe vowed to revive the Japanese economy after almost two decades of economic stagnation and deflation by increasing government spending and instructing the Bank of Japan (Central Bank) to increase the yen’s monetary supply to raise inflation and spur exports.1 Abe’s goal was to target 3% economic growth per year. In order to get there, he will propose a public works program worth 200 trillion yen ($2.4 trillion) over ten years to strengthen the protection of buildings against earthquakes and tsunamis.2 This program has been announced despite the enormous debt burden facing Japan. Its public debt will increase to an estimated 237% of GDP by 2013.3 Japan has been the second largest economy of the world, but in February 2011 has given up the second spot to China.4 As a result of China’s growing economic strength, the Japanese political leadership has asserted a more decisive stance on the highly controversial Senkaku/Diaoyu islands off the Chinese coast. In his campaign speech, Abe declared the islands to be part of Japanese territory5, which the Chinese government also claims for itself.6 The dispute over the island has recently gained so much attention, because the Japanese government had nationalized the remote, uninhabited islands in September of this year7, leading to mass anti-Japanese protests in China.8 Some observers see Japan’s assertiveness over an uninhabited island as a distraction from its internal economic problems in order to boost national confidence and popular votes.9 While China’s economy grew by an average of 9.3% between 1989 and 201210, Japan’s economy only expanded by an average of 2.08% between 1981 and 2012. Japan’s economy contracted by 3.5% in the third quarter of 2012.11

It is fairly well-known that the Japanese economy has been struggling to retain its position for the last 20 years.12 The 1990s are also considered Japan’s “lost decade”, referring to its ongoing deep economic malaise.13 In order to gain some perspective on Japan’s economic and geo-political position, I want to shed some light on the historical development of the Japanese economy, especially since the end of World War II, when Japan quickly rebuilt itself to become the economic power house of East Asia in the 1970s. I will then describe the circumstances of the Japanese economy of the last twenty years to account for its weaknesses and challenges. I will conclude by tying my analysis of Japan’s economic history to the contemporary political challenges in East Asia.

The economic history of Japan since 1945 can be divided into four periods: a recovery period (1946-1950), a rapid growth period (1950-1973; 9.3% annual average growth), a moderate growth period (1976-1991; 4.3% growth) and a stagnation period (1992-2003; 1% growth).14 Following the end of World War II, Japan fell under U.S. occupation, and the Japanese economy was destroyed.15 Industrial production was severely limited due to a lack of raw material and finance.16 Japan faced an enormous food and fuel shortage.17 In order to handle the economic hardship, the government carried out a land reform, which gave distressed tenant farmers land, effectively expropriating the landlords.18 The workers were helped by a surge in labor union membership that rose to 46% of the industrial workforce by 1947.19 Japanese companies also developed a lifetime employment scheme, shielding employees from layoffs.20 Furthermore, the government implemented an active policy of developing the coal and steel industries, which went under the heading “priority production plan” (Keisha seisan hoshiki), using mostly domestically available resources.21 The government founded the “Reconstruction Bank” in order to finance the plan, and used price controls and resource allocations in order to tame the ensuing inflation. However, inflation continued to accelerate, as wages and prices were hiked.22 The United States, that oversaw the Japanese government, implemented the so-called Dodge Plan in 1949, which tied the yen’s exchange rate to the U.S. dollar, halted the Reconstruction Bank loans and reduced direct government subsidies. This policy produced a deflationary spiral23, which was halted by an increase in export demand created by the Korean War (1950-53).24

In the period between 1950 and 1973, Japan experienced a huge economic growth rate. It benefited from high worldwide growth rates, an increase in international trade, the Bretton Woods system, a stable political system supportive of growth, stable labor-management relations and low prices of raw materials (Japan is highly dependent on raw material imports). Furthermore, the strengthening Japanese industry was helped by the importation of foreign technology, a high savings and investment rate, and low defense expenditures.25 Japanese companies improved quality controls and implemented the just-in-time production system, making its manufacturing products competitive in the world market.26 As a result of the boom period, the unemployment rate reached a low between 1.1 and 1.4 % between 1961 and 1974.27 Between 1951 and 1960, Japan’s national income more than doubled, and tripled between 1960 and 1973.28 The boom period was only overshadowed by greater environmental degradation, overcrowding in metropolitan areas, high inflation, and poverty among non-workers.29

The economic growth was moderated by the early 1970s, because the impact of imports in foreign technology began to wear off.30 In addition, the oil shock, which drastically increased oil prices, put a halt to the golden age of the Japanese economy.31 Due to its resource poverty, Japan was highly dependent on cheap foreign resources.32 One major impact of the oil crisis was that thousands of workers were dismissed in a corporate effort to reduce labor costs. The resignation of employees (especially females) was accompanied by the intensification of the “just-in-time” production system to raise the productivity rates given the oil price increases and the economic slowdown.33

The 1980s were marked by a period of a speculative bubble. Over the course of the 1980s, Japan had a huge trade surplus with the United States, exporting far more than it imported. Japan benefited from a devalued currency, making export goods cheaper for the US. Japan’s exports were so flourishing during the 1980s that leading American policy scholars were concerned about Japan’s “disruptive force” in American economic life.34 In order to solve the US trade imbalance, the Japanese government allowed the yen to appreciate against the dollar in 1986, which temporarily generated an economic contraction and a reduction in the export-oriented electronics, steel, and automobile industry.35 In order to alleviate a weakening economy, the Bank of Japan (Central Bank) lowered the official interest rate, leading to historically record high stock prices that peaked in 1989. The huge trade surplus, the strong yen, and the low interest rates swelled the nation’s monetary supply. The Japanese auto industry, the stronghold of the country’s industrial economy, had saturated the markets, and sought speculative outlets for their enormous savings.36 Banks were eager to lend money to individuals for the purchase of real estate.37 In 1987, when Japan’s GNP (gross national product) was 345 trillion yen, financial assets increased by 382 trillion yen, while land assets grew by 374 trillion yen.38 Furthermore, the banks were committed to a policy of lending money to companies that were no longer profitable (also called “zombie firms”). The ensuing defaults led to enormous bank problems, requiring a government bailout.39 In order to save the banks the government had assumed the debt from the private banking sector, escalating the public debt to about 581 trillion yen in March 2010.40

In order to counter the speculative frenzy, the Bank of Japan gradually hiked interest rates in 1989, which reduced stock prices by 45% in 1992 compared to the peak. Restrictions on real estate loans were implemented, which led to a bursting of the real estate bubble, and a 53% decline in the price of land in 1996 compared to its peak in six major cities. The capital gains and money funds of businesses and corporations were wiped away. Real estate prices declined, consumer demand, employment and wages decreased, and the manufacturing sector built up an overcapacity. Given the enormous debt and the falling profits, Japanese manufacturers began to reduce their domestic labor force and replace them by cheaper overseas workers, hollowing out their domestic manufacturing sector. 41 China has been a prime destination for Japanese capital investments, because their wage costs are approximately one-thirtieth of Japanese wage costs.42 Outsourcing of jobs particularly occurred in the heavy industries such as steel, shipbuilding, machinery, automobiles and electric machinery.43 Layoffs frequently affect female workers and high school graduates.44 As a consequence of the reduced labor costs, standard (full-time) employment in Japan has decreased. The share of men in the standard (full-time) employment category decreased from 91.5% in 1991 to 84.5% in 2003, and the share of women decreased from 62.8% to 49.5% in the same time period.45 Recent data reveals that 33% of all Japanese employees are non-regular or part-time employees.46 The bottom two income deciles in Japan have seen their real wages decline between 1995 and 2000.47 The shrinking share of labor as part of the national income has contributed to depressed sales and aggregate demand, reducing investments and weakening the economy.48 The outsourcing process has also harmed the small business sector, whose profit margins have been reduced from an average of 3.5% in the late 1980s to zero between 1999 and 2002, and whose bankruptcy rates have been very high.49 The only beneficiaries of the changed business environment are the large corporations that are flush with cash. These large corporations have 60 trillion yen ($713 billion) in reserves, and have, thus far, spent $80 billion to purchase 620 different foreign companies.50

The 1990s were marked by an economic malaise as growth rates remained low, unemployment rates increased, and bank failures occurred.51 During the 1990s, all prefectures and industrial sectors have seen a decline in real output (15%), number of business establishments (15%), and employment (15%).52 An overhang of bad debt was burdening the Japanese economy, as indebted banks were unwilling to lend money to companies. In 1994, the government permitted banks to write off over $400 billion in debt and made the taxpayers provide new funds for the banks to continue lending.53 In an effort to fight the problem of bad debt incurred during the bubble period, banks received loan assistance. The number of banks receiving loan assistance sharply increased from seven cases in 1997 to 51 cases in 2002.54 The amount of bad debt disposition had reached a peak in 2001, and by the end of 2005 was lowered to 4.6% of total bank assets.55 In order to stimulate the economy, the government passed several fiscal spending packages over the course of the 1990s, totaling 122 trillion yen in stimulus.56 They were designed to create public works projects. However, the fiscal programs were not sufficient, and most funds only benefited the political clientele rather than the general economy.57 The Bank of Japan lowered the official interest rate from a high of 6% in 1991 to a low of close to 0.15% in 1999 in the hopes of halting deflation and stimulating the economy. It also pursued the strategy of quantitative easing, which increased the Bank’s balance of current account from five trillion yen in 2001 to 30-35 trillion yen in 2004.58 The policy of countering deflation had been a failure, and the zero interest rates have lost their effectiveness, because it could not go even lower.59 Japan was in a liquidity trap, because no interest rate was low enough for scared borrowers and reluctant lenders to engage in transactions, which is a pre-requisite to growing the economy.60 Deflation has weakened the Japanese economy, because it lowered investment spending. It raised the real rate of interest, making the Japanese debt burden even worse. Bankruptcies among companies and private individuals became more likely, making the banks less willing to lend.61

As the economy improved slightly in the mid 1990s, the Japanese government became worried about the ballooning deficit, and embarked on a fiscal austerity program, involving spending cuts and tax increases. However, this measure led to a sharp decline in GDP between 1997 and 1998.62 The government under Koizumi (2001-2006) implemented a policy of further government spending reduction, deregulation and liberalization. He privatized the postal services and the highway systems, reduced the number of public employees and delegated greater administrative responsibilities to the local governments.63 Despite those austerity policies that temporarily reduced the deficit, the deficit and debt continued to rise after 2008, following the collapse of the US housing bubble and economic crisis. By 2010, the government budget deficit increased to 10.5%64, and 43% of government revenues were devoted to debt service payments.65 Despite the debt commitments, interest rates on government bonds have been low. In July 2012, the 10-year yield on Japanese bonds decreased to 0.79%, the lowest rate since 2003, partly because the Bank of Japan eagerly bought government bonds.66 The main reason why Japan’s high public debt burden has not resulted in higher interest rates was because the Japanese people had a generally high savings rate, allowing the government to draw heavily from their savers without upsetting foreign investors, who are more sensitive to expectations about debt levels.67 However, the fairly stable fiscal position of the Japanese government might be upset by the fact that the nation’ historically high saving rate are shrinking. While Japan’s household saving rate has historically been high, averaging 14% of disposable income in the 1990s, this rate has shrunk to 2% in the last few years.68 Japan’s economic and fiscal troubles were compounded by the earthquake catastrophe in 2011.69 Some of the auto and electric industry’s operations were temporarily disrupted.70 Following the disruption in the energy supply, Japan also had to import additional costly oil from abroad.71

Despite the country’s growing fiscal problems, Japan is still the third largest economy in the world. Japanese big businesses still play a huge role in the world economy. Historically, Japan has been a strong exporter of manufacturing goods. It has also played a major role in East and Southeast Asia. The Asian economies have heavily depended on Japanese capital, technology and strategic guidance.72 While the public debt crisis is continuing to exacerbate, Japanese companies are said to have shaken off the effects of the earthquake and nuclear disaster. Publicly traded firms experienced an increase in the pre-tax profit of 24%.73

But the success of Japanese corporations that have greatly benefited from low-cost labor and technological advancements are overshadowed by six factors, including foreign competition, emerging trade deficits, low-wage domestic labor, weakening foreign demand, government debt, and an aging population. In terms of foreign competition, for example, Japanese steelmakers have seen their revenues shrink by over 50%, as Chinese steelmakers dramatically brought down steel prices.74 Japan’s status as primary exporter is also challenged by the country’s first trade deficit since 1963. Estimates suggest that by 2015, Japan’s overall current account will be in deficit.75 The wages of Japanese workers have also seen a drop, as unit labor costs in June 2012 were 3.6% lower than in the previous year.76 The corporate policy of wage reduction in an environment of diminished demand will have further negative consequences on total consumption. Given the debt-ridden European economies, foreign demand for Japanese products has sharply decreased, plunging by 8.1% in August 2012 compared to last year.77 The government debt that has thus far prevented a deterioration of the Japanese economy has increased to 237% of its GDP, raising fears among Japanese officials that the low interest rates on government debt bonds might rise sharply.78 Finally, Japan’s population is aging rapidly. One third of its population is over 60, which will increase to 42% by the middle of the century.79 The aging population explains the rising social and medical expenditures, which are counter-balanced by the relatively high labor participation rate of Japanese seniors.80

Japan’s economic history since the end of World War II reveals the changing nature of its economy. Immediately after the war, Japan was struggling to regain economic strength, and under the protection of the United States was capable to attain it. What followed was a 20-year economic boom phase, stretching from the 1950s to the 1970s, when Japan benefited from a stable international trading system, a favorable economic environment in Europe and the United States, technological imports and a skilled, disciplined population. But the oil crisis led to the end of the unrestricted growth period. Japanese policymakers remained, nonetheless, very persistent about sustaining economic growth rates. Japanese companies forcefully reduced their labor costs, and improved their manufacturing efficiency in order to boost exports. In the 1980s, the accumulated capital was then used to prop up a real estate bubble that was aided by the Bank of Japan, sending land prices through the roof, and promising short-term profits. By the early 1990s, when the Bank of Japan hiked interest rates, the property bubble inevitably collapsed as the borrowers defaulted, bringing the banks to the verge of bankruptcy. The government bailed out the banks with taxpayer guarantees, but the overhang of bad debts continued to plague the Japanese economy until the early 2000s.

Since the early 1990s, the government and the Bank of Japan have frequently intervened in the economy via stimulus packages and quantitative easing, often with limited results. Shinzo Abe’s current policy objectives fall well in line with the policies that had been tried from the early 1990s on. The problem remained that the bursting of the bubble forced companies to reduce their debt load and reduce investments, keeping the economy weak. Japan, furthermore, showed signs of a mature economy, whose demand stopped increasing, labor force started shrinking, and profitable investment opportunities began drying up.81 In the pursuit of growth, Japanese businesses have successfully resorted to increase their foreign investments. On the other hand, the enormous government debt load points to the limited capability of the government to further sustain the economy through intervention. In my view, it is the context of the rising economic pressures against Japan, especially in competition with China, that the Japanese government has sharpened its tone against China. This policy of greater political, and- in the worst case scenario- military confrontation in East Asia is proving to be a major international security challenge, which will require further elucidation among scholars and policy experts.82 The main economic challenges for Japan also reveal the general challenges facing mature capitalist economies that will require solutions that are different from the tried solutions of the Japanese government.


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One Response to What’s the Matter with Japan? The Japanese Economy from a Historical Perspective

  1. Pingback: Social Democracy vs. Democratic Socialism by Larry Liu | PROGRESSIVE ACTIVISTS VOICE

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