Japanese Economy in the 20th century
Japan is remarkable for its sensational rapid rate of economic growth in the 20th century, especially in the first several decades after World War II. This growth was based on expansion of industrial production and the development of an enormous domestic market, as well as on an aggressive export trade policy. In terms of gross domestic product (GDP), Japan is the world’s third largest economic power, ranking behind the United States and China. It has developed a highly diversified manufacturing and service economy and is one of the world’s largest producers of motor vehicles, steel, and high-technology manufactured goods (notably consumer electronics). The service sector has come to dominate the economy in terms of its overall proportion of the gross domestic product (GDP) and of employment.
The emphasis on trade stems from Japan’s lack of the natural resources needed to support its industrial economy, notably fossil fuels and most minerals. In addition, the limited amount of arable land in the country forces Japan to import much of its food needs. However, Japan’s strong domestic market has reduced the country’s dependence on trade in terms of the proportion trade contributes to the GDP when compared with that of many other countries.
Post World War II
The Japanese economy lay utterly devastated at the end of World War II (1945). The immediate postwar period was one of hard struggle to achieve reconstruction and stability. Under the Allied occupation forces, land and labor reforms were carried out, and the plan for creating a self-sustaining economy was mapped out by American banker Joseph Dodge. The outbreak of the Korean War in 1950 created a huge demand for Japanese goods and set off an investment drive that laid the foundations for a long period of extraordinary economic activity. While investment in plants and equipment was spurred by an expanding domestic market, Japan also began pursuing strong export policies. Growing demand overseas for Japanese goods led to annual trade surpluses, which became perennial by the late 1960s.
By the early 1970s Japan’s rapid rate of economic growth had begun to slow down, as the price of imported petroleum rises, labor costs increased, the value of the national currency(Yen), rose against foreign currencies, and overall global demand for Japanese goods weakened. In addition, it resulting from the earlier quick pace of growth had begun to show Japan’s standard of living had not increased as rapidly as had the overall economy up to that point—in large part because of the high percentage of capital reinvestment in those years —but also Japan was under increasing pressure from its trading partners (US) to allow the national currency to appreciate even more in value and to liberalize strong import restrictions that had been enacted to protect Japan’s domestic market.
By the mid-1980s Japan’s standard of living had increased to the point that it was comparable to that found in other developed countries. In 1985 Japan agreed with its trading partners to let the currency appreciate against the U.S. dollar, which led to a doubling of the currency’s value within two years. This action and other efforts at restraining exports encouraged Japanese companies to begin moving production bases overseas. At the same time, a speculative “bubble” arose in the prices of stock shares and real estate, and its bursting at the beginning of the 1990s sparked a severe economic downturn. The Nikkei 225 average (the main stock price index of the Tokyo Stock Exchange), which had reached an all-time high in 1989, dropped to only half that much within a year, and housing prices in urban areas also plunged.
1989 Asset Bubble
First let us discuss the reason behind the formation of this asset bubble.
i) Monetary easing:
Monetary easing is the monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply and thus, stimulate the market activity. Due this lowering of interest rates bank got an opportunity to lend more and more money to the people. Due to the equity market growth the big lenders started avoiding taking loans from the banks. Moreover, due to the monetary easing banks started giving loans to the customers they shouldn’t. This increased the number of ill lending. In 1983 the assets price started rising and in 1986 it raised it a very fast rate. Along with asset price the stock prices also started rising. Monetary easing lead to rapid increase in asset prices.
ii) Monetary tightening:
In 1987 the government realized that the economy was rising at a very fast rate which would not be sustainable in the future. Government started thinking of monetary tightening but failed to implement on the correct time. After the implementation of this policy in August 1987 the short-term market rates gradually rose after September and in October. But on October 19 1987 Japan witnessed Black Monday as the stock market incurred a huge loss. The official discount rate was raised again in October and December 1989, by 0.5 percentage point each time, and then two more times in March and August 1990. The two hikes in 1990 were relatively large, 1 percentage point in March and 0.75 percentage point in August. The growth of money supply accelerated even after the official discount rate was raised and reached a peak in the second quarter of 1990. Stock prices continued to rise until end-1989, and in 1990 plummeted with a few rebounds on the way. After the official discount rate was raised in August 1990.
The relationship between the emergence of the bubble and the monetary policy is that as low interest rates were maintained under economic expansion, which led to strengthening the effects which led to rise in asset prices.
Bursting of asset bubble
After the World War 2nd, Japan started witnessing a growth in its economy. It became the world largest exporter of electronics item in the world market. Some Japanese companies like Sony and Hitachi were planning to buy the American based company Intel. But then a twist, Japan witnessed its infamous asset bubble burst in 1989. Asset bubble is created when the assets are valued more than its real value. In 1989 this asset bubble busted due to which there was a subsequent fall in the values of asset. Due to the monetary tightening policy stock market witnessed ups and downs but in 1990 the stock market crashed falling to 21,000 points which was around 37,000 in January 1990. Due to this the asset bubble busted.
Effects bubble burst
This resulted in the fall in the land prices in 1991. It also impacted Japan’s economy. Urban areas the asset rate witnessed a 1.7% decline in 1992. Land witnessed a major impact of this bubble burst, the commercial, residential, and industrial land prices witnessed a 15.2%, 17.9%, and 13% decline respectively, averaging to a total of 15.5% decline. This crisis also badly affected direct consumption and investment within Japan. Due to the continuous fall in the asset prices Japan witnessed a sharp decline in consumption which further resulted in a long-term deflation. Due to this bubble burst the household’s real income also declined which affected consumers’ confidence badly. Also, the monetary easing created lots of non-performing assets. As most of the banks gave huge loans backed by property and now the prices of land were falling, it also made the value of the assets kept by banks as collateral decreasing.
The Lost Decade of Japan
The lost decade of Japan was the time period from 1991 to 2001, when Japan went through severe economic stagnation, price deflation, liquidity crisis, and credit crunch. This was due to Japan’s asset price bubble collapse in 1991, which meant that their assets’ worth was increasing much more than their real value, creating a bubble. when the values suddenly fell, the bubble burst.
The decade till 1989 saw the emergence of Japan as one of the fastest growing economies in the world at an average growth rate of 3.89%, even surpassing USA, with 3.07%. During this period, the real estate prices increased to more than 4 times their earlier value. However, these insane valuations lead to a period of stagnation and deflation, and Japan’s growth rate fell to 1.14% during 1991 to 2003.
Stock market remained low, wages fell, and land prices saw a steep decline during the country’s lost decade. The rise in interest rates by the Bank of Japan led to a debt crisis as well.
1. Slow responses by Banking institutions
Bank of Japan made several mistakes which are said to have prolonged the crisis. They were concerned about inflation and asset prices, so they stopped money supply in late 1980s, which led to the bursting of the bubble. As values fell, the bank continued to raise interest rates as real estate values were still increasing. Though the higher interest rates, reaching up to 6%, did curb the rising land prices, but the also contributed heavily to the economy worsening.
In 1985 Plaza Accord, 5 nations including Japan signed a treaty to force USA to devalue Dollar due to the huge current account deficits in Japan and Europe. This increased the value of Yen and further led to growing of the bubble.
In 1991, as the prices finally fell, the BoJ suddenly began to cut interest rates. However, it proved to be too late and was not able to stop the liquidity trap and credit crunch that had already set in.
2. Liquidity Trap
A liquidity trap is a situation in which households and investors do not place their cash in the economy for the medium or long term. It might be due to low interest rates on investing, the possibility of deflation, or deflation already existing. In such a situation, low interest rates become ineffective to help people start spending.
Japan tried several fiscal policy measures to het out of their liquidity trap, but they were not well executed. Money was given to failing businesses and inefficient public projects, instead of directly being placed in the hands of the consumers and to let the natural forces of demand and supply guide the market.
In 2001, the BoJ began to work on the money supply instead of interest rates, which stimulated economic growth and lessened the deflation. However, the extra money in banks was not being lent out as loans. This led to a credit crunch.
3. Credit Crunch
A credit crunch is a situation in which banks drastically reduce lending. This happens because of several reasons including the need to repair their balance sheet to offset losses, and a reduction in risk taking in general. Japanese banks were given financial support by the Bank of Japan, but instead of giving loans and
kick-starting economic activity, banks kept this money with themselves mostly as reserves, to regain the balance in their final accounts after suffering huge losses by investing in real estate.
This unwillingness to lend hampered economic growth severely, as capital was not used to create jobs, increase spending, increase productivity, and ultimately grow the economy. However, as liquidity traps nurture deflation, credit crunch can help curb it as consumers have no money to spend so prices fall.
Negative Interest Rates
To battle the global financial crisis accelerated by the collapse of Lehman Brothers in 2008, many central banks cut interest rates to near zero. A decade later, interest rates remain low in most countries due to subdued economic growth. In April 2013, the Bank of Japan (BOJ) introduced an inflation target of 2% with the aim of overcoming deflation and achieving sustainable economic growth. But due to lower international oil prices, it was unable to achieve this target and was forced to take further measures. With little room to cut rates further, some major central banks have resorted to unconventional policy measures, including a negative rate policy.
Japan allowed rates to fall slightly below zero. Under a negative rate policy, financial institutions are required to pay interest for parking excess reserves with the central bank. That way, central banks penalize financial institutions for holding on to cash in hope of prompting them to boost lending. The Bank of Japan adopted a negative rate in January 2016, mostly to fend off an unwelcome yen spike from hurting an export-reliant economy. It charges 0.1 percent interest on a portion of excess reserves financial institutions park with the BOJ. The BOJ adopts a tiered system under which it charges 0.1 percent interest only to a small portion of excess reserves financial institutions deposit with the central bank. It applies a zero or plus 0.1 percent interest rate to the rest of the reserves. What does the Bank of Japan hope to accomplish? The bank is trying to lift consumer prices, which have been sliding for most of the past 20 years.
Falling consumer prices hurt corporate revenues, keeping companies from raising wages or spending on new projects. But the bank’s efforts are foundering. Its main tool has been an extensive bond-buying program, similar to policies adopted by the Federal Reserve in the United States and the European Central Bank. Bond-buying injects money into a country’s financial system. From there, it is supposed to flow to the rest of the economy. It worked for a while, but recently the effect has faded. Prices are falling again, and the bank needed to try something new.
Money was already cheap in Japan, and negative rates have succeeded in making it even cheaper. The yield on 10-year government bonds, for instance, fell below zero in February, meaning investors are lending the government money knowing that they will not be repaid in full. Yet deflation has not vanished: Core consumer prices fell 0.5 percent in July. Nor has there been an explosion of new bank lending, as businesses say they can’t find enough profitable uses for funding, even if the money is cheap. Still, people must be happy that money is cheap, right? Not the bankers. Between the new fees they are paying the central bank and a general decline in lending income, profits at commercial banks are being squeezed by negative rates. Some analysts also think negative rates hurt broader public confidence. Policy makers are trying to show creativity in finding ways to revitalize their economies — but out-there tactics like negative interest rates risk looking more like desperation.
Current situation of Japanese Economy
Japan - the world’s third largest economy was already struggling with low economic growth before the corona virus pandemic and after the pandemic it officially declared recession in May,2020 and become the first country to enter into recession after the pandemic .The state of recession came for Japan for the first time since 2015 when the economy reported two consecutive quarters of negative economic growth . The GDP of Japan shrank by an annual rate of 3.4% for the first three months of the year.
Reasons for Recession
Crisis in exports
The reason for the fall in output came because of a sudden decline in exports. Japan reported a decline of 28.3% in exports in May for the year 2020 which was the lowest since September 2009. Even before that Japan’s exports had fallen steadily last year because of US-China trade war and decrease in global demand. The US bound exports fell to 588 billion yen and the demand by china fell by 1.9 %. Apart from that Japan’s shipment to European Union fell by 33.8%. Even before the pandemic, Japan expected the year to be tough and was struggling to increase its global demand but the pandemic made it worse for the economy to tackle the decline in exports.
Increase in Tax
Besides from the decline in exports, the demand for the output fell when on October 1st 2019, the taxes on goods and services were increased from 8% to 10% by the Japanese government. After this increase in tax Japan’s GDP fell by an annual pace of 6.3% in the last quarter of 2019. The strain of the increased tax became worse for the consumers in the corona virus pandemic and it is a hurdle for Japan’s already struggling GDP.
Japan’s huge Debt to GDP ratio
Japan is known as a global leader in accumulating debt. At the end of the year 2019, Japan reported to have its debt to GDP ratio to be 240 %. A debt which is 240 % of the GDP is unfathomably large. According to a report by the BoJ, Japan’s debt stood at 1,328,000,000,000,000 Yen. Apart from this huge mountain of debt, it is estimated that Japan will be adding $2 trillion to its debt this year by introducing stimulus packages to tackle the impact of corona virus which will push the debt to GDP ratio above 250 %. The government of Japan finance this debt using government bonds known as JGBs (Japanese government bonds). Even after having low yield the JGBs are purchased by private and institutional investors who are reluctant to take risk and by senior citizens who prioritize stability over return.
By cutting public spending and boosting taxes the budget deficit can be reduced and the addition to the huge pile of debt can be avoided but this will hamper the growth of Japan’s economy which is already in recession. This clearly shows the dilemma Japan is facing at present.
In 2020, COVID-19 pandemic, with Abe announcing that Japan had encountered its worst economic crisis since the end of World War II. Japan becomes the first country which goes into recession since 2015. The gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualized basis. Japan was already struggling with low economic growth before the crisis. Economists even claimed, that halting of the Tokyo Olympics has severely affected Japan’s factor income from abroad.