Elliott Parker: What happened to Japan?
As our nation seems to be stuck in an economic inversion, with gray skies everywhere and nothing really moving, we wonder what to do and what the future will bring. It might be instructive to consider the case of Japan.
Japan was the world’s fastest growing economy after WWII, with an 8.1 percent annual growth rate in Gross Domestic Product per person from 1955 to 1973. After the oil crisis of the mid-1970s, this growth rate fell to 3.4 percent per capita through 1990, still almost twice the rate of U.S. growth.
After the so-called Heisei bubble economy crashed in 1990, much like our financial markets crashed a few years ago, Japan turned into a slow-growth economy. In spite of continuing technological improvement and strong export performance, Japan’s GDP per capita grew at an average rate of 0.4 percent for the next dozen years. By 2007, Japan’s economy was 13 percent below where it would have been, had Japan been able to grow at the same rate as the U.S. during those years. However, it was 30 percent below where it would have been, had kept growing at its 1973-1990 trend.
Why did Japan slow?
Some think that Japan had structural problems and delayed reforms that might have encouraged firms to become more efficient, while others think monetary policy was too tight and too slow to change. Indeed, Japan’s economy became deflationary, and there is good evidence that price deflation can worsen a recession considerably.
But I think the most persuasive argument for why Japan slowed comes from Richard Koo, the chief economist at Nomura Securities, who explained that Japan’s financial crisis was the cause rather than just a symptom of the recession. Japan’s big corporations had been heavily leveraged, and the financial crisis severely undermined their balance sheet. For the next dozen years they deleveraged, using their cash flow to pay off debts or buy financial assets, in order to reduce their risk and bring their debts down to match their assets. Interest rates fell to near zero, and still most Japanese firms preferred saving over borrowing.
Companies that put their income into savings are not hiring more employees and expanding production. With the collapse of both housing prices and financial markets, Japanese consumers were also much poorer, so they spent less too. The problem was not money or unwillingness to lend, Koo argues, and it was not a lack of supply. The problem was simply a lack of demand for goods caused by collapse of asset prices.
The fall in the value of Japan’s housing, stock market, and other assets was much bigger after 1990 than in the U.S. after 2006. Yet somehow Japan only had a couple of relatively small recessions, in 1993, 1997-98, and 2001. None of these were close to the depth of the recession in 2008-09.
Now that we know how bad a financial crisis can be, how did Japan avoid a deep recession? Koo argues that fiscal intervention by the Japanese government helped to stop the slide. Japan’s government intervened in many ways, for many reasons. Government borrowing offset increased private sector saving, and government spending offset the decline in private sector spending. The intervention was enough to keep the economy from declining, but not enough to return it to growth.
This sort of “balance sheet” recession is very different than the recessions we are used to. In most recessions, government fiscal intervention does not work well. The recession’s cause tends to be temporary, and the public sector is usually late to the game. Efforts to counteract the recession often get in the way of the recovery already in progress.
But in a balance-sheet recession, everything we know is upside down. The damage done is severe and long-lasting, and paying down debt even when interest rates are low pushes demand even lower. Without some public intervention to counteract the fall in private demand, the economy can spiral downward for quite a long time.
My own econometric research with my colleague Federico Guerrero confirms this. Before 1990, we find that government purchases had very little effect on Japanese GDP. After 1990, however, this changes dramatically, and government purchases had significant, positive, and long-lasting effects on GDP.
Not surprisingly, Japan’s slower economy led to lower tax revenue, and deficits led to a rising government debt. Many of the spending projects – especially in construction – were criticized for being wasteful. However, the data tells us this spending nonetheless prevented a serious recession, but it wasn’t enough to return Japan to its prior growth trend.
Sadly, our research also tells us that increasing growth in Japan led to premature reductions in government purchases. Every time the economy began to recover, Japan’s government put priority on reducing the deficit, which in turn halted the recovery. This stop-and-go pattern was a major contributor to dragging out the recovery so long.
When Japan tried to get the deficit down in 1997 by cutting spending, the result was a recession made even worse by the Asian Financial Crisis. Tax revenues fell, and the deficit grew. The government then reversed itself and implemented a fiscal stimulus plan. Revenues recovered, but new elections led to new leadership and a new effort to cap spending.
When the Tech Bubble in the U.S. popped in 2001, unfortunately, corporate debt repayments increased, and these spending caps made it impossible for the Japanese government to counteract the contraction. Once again Japan went into recession, and deficits grew for lack of revenues. When the government changed course, the economy began to grow again. Under the next prime minister, the official policy became “no fiscal reform without growth.” By 2007, Japanese firms were finally borrowing again and economists were optimistic. Then came the U.S. financial crisis, and Japan followed the U.S. back into recession.
Should we try to get our deficits down by cutting spending before our own firms have stopped paying down their debt, like we did in 1937? Or should we wait for signs that our businesses are borrowing again, and banks are lending again? Whether or not our current weak growth will continue for decades may depend on whether we learn the right lessons from Japan.
• Professor Elliott Parker is chairman of the Economics Department at the University of Nevada, Reno.