Pacific Perspective
Pacific Perspective
Japan's postwar economy has been remarkable. Rising from the ashes of war and achieving "Asian Miracle" status by the late 1980s, Japan then fell into an economic malaise that continues to the present. The 1990s are Japan's "lost decade," and many wonder if Japan is now at the start of another one. Japan could be looking
at another lost decadeThe remarkable performance raises three issues: What accounts for Japan's impressive growth and was it sustainable? Why has reform been so difficult? What is needed to avoid a second lost decade?
Japan's success depended on a bank-based financial system that limited bankruptcy through mutual support arrangements, encouraged high saving rates, and ensured credit was directed to domestic investment and exporting industries.
The system, however, was not sustainable. It required high rates of growth to mask inefficiency and placate the excluded household sector. Limiting bankruptcy insured inefficient firms would survive and eventually create economic drag. The system required international isolation, but success ultimately meant Japan could not remain a "hermit" economy. The system required consensus for industrial policy, but as the war generation passed it was no longer responsive to the wishes of most Japanese.
In the late 1970s, Japan initiated liberalization policies that were more rhetoric than substance. The collapse of asset prices in 1990-91 and the government's response to increasing distress revealed the system's fundamental weaknesses. At first, the response was denial and when denial was no longer credible, understatement. When action was finally required, the government adopted a policy of forgiveness and forbearance hoping the economy would grow out of the problem.
Japan found it difficult to abandon the mutual support system and adopt the "creative destruction" advocated by German economist Joseph A. Schumpeter because Japanese culture and economic institutions are inherently risk averse.
Despite a lost decade, Japan remains complacent. Japan is still a wealthy country, savings remain high, real GDP per capita has not declined, and though economic and financial distress are apparent, the overall quality of economic life remains high.
Nonetheless, a crisis is in the making. Nonperforming loans are higher than ever, the banking system is insolvent if assets are marked to market, and the economy is in recession and experiencing deflation. Further, Japan's population will decline starting in a few years and the ratio of nonworking to working population is projected to increase significantly. Only a dramatic increase in labor productivity, that is, a more efficient economic and financial system, will prevent the demographic changes from lowering the standard of living.
Prime Minister Junichiro Koizumi came to power last April as a "reformist" leader and stands in a pivotal position in Japan's history. Japan has the resources and understanding to solve its problems but lacks the political will to depart from the financial and economic system that served it well for five decades. Koizumi must convey the seriousness of the situation and speak plainly to the Japanese people. Unfortunately, the progress to date is mixed and, despite Koizumi's efforts, it is unclear at this time whether the political will for a transformation exists.
Thomas F. Cargill is a professor of economics at the University of Nevada at Reno and co-author of "Financial Policy and Central Banking in Japan." His column was based on remarks delivered at the 25th Anniversary of the Japan-America Society of Hawaii.