Deflating Japan

Fifteen years ago there was a highly publicized book written by Professor Paul Kennedy called “The Rise and Fall of the Great Powers”. On the cover was a cartoon showing an Englishmen shuffling off the world stage, with Uncle Sam on top but stepping down, and a Japanese figure in mid-stride to the top. The picture was the book’s thesis; just as America had supplanted Britain as world leader, Japan was set to do the same to America. How wrong it was.

After World War II, Japan went on an amazing 40-year run as it transformed itself into the world’s second largest economy based on the ingenuity of its own people, and not on natural resources such as oil (Japan is deficient in almost all natural resources, a major driver in the policies that led them to World War II). In the 1960s, Japan averaged over 9% per year growth in the economy, a record unmatched by any industrializing country. Japan made the leap from the poor to the comfortable faster than any other nation in history in the fifteen years after 1955. Even in the 1980s, Japan was growing close to 5% per year, while it enjoyed surging trade surpluses with the rest of the world, particularly America. For many observers, Japan looked unbeatable, and to many it seemed just a matter of time before America would lose its leadership to the Asian dynamo. Never mind that Japan had half the population of America, or that it had a very small military and was dependent on the US for security.

How bad has this depression been? Unlike the Great Depression in the US in the 1930s, there has not been a huge initial collapse in the economy. Instead, the economy has stayed basically flat, even as the government has pumped in huge amounts of deficit spending to get it to grow again. Deflation has set in the last few years, and there has been a slow but steady fall in prices. But compared with the American Great Depression, there has been no return to growth. After three years in the US, industry had contracted by 40%, but 13 years later (1942) industrial production was 40% higher than before the depression began. In Japan, industrial production stayed flat until last year, when it shrunk over 10%. Not only has Japan failed to catch up, America has sped away in the last decade.

Why has Japan remained economically paralyzed? Why hasn’t the government fixed the issues that hold them back? Too many sacred cows prevent reform is the short answer. In Japan, the banks are the main sources of finance for industry (in the US, major companies tap the bond and equity markets for financing), but the banks are stuck with a huge portfolio of bad loans made 10 or 15 years ago based on real estate and stock market collateral. The collateral has collapsed in value, but Japanese banks refuse to mark to market and write off the debt (not surprisingly, as it would bankrupt them to do so). As such, there is very little bank lending capacity in Japan. When America had the same problem in the 1980 s with the S&L crisis, the government forced the S&Ls into bankruptcy, paid off the creditors, and allowed the industry to re-capitalize. This is impossible in Japan as the citizens refuse to allow the government to bail out the banks from their bad debt.

The second problem is that Japan suffers from economic cartels to a degree most would find surprising. The domestic Japanese market is rigged and uncompetitive, with the government beholden to farmers, small shopkeepers, and the construction industry among others. This dampens the possibility of generating domestic growth, and pushes up the cost of production for Japan’s world class exporters. Japan, of all the rich countries, allows the smallest share of imports to the total economy, further limiting competition. The government has tried to spend its way out of this mess, but has only succeeded in pushing up government debt to 70% of GDP, from only 5% 10 years ago. That deficit spending spree bought nothing.

Japan was a great example to many Third World countries that a non-White nation could be just as economically advanced as any in Europe or North America. But its example has soured, as it failed to adapt to the times. Policies and politics that suited the country during the phase of industrial catch-up became an Achilles heel after prosperity was achieved.