The Japanese Economy

Strategies to Cope with a Shrinking and Ageing Population

Randall Jones

• Publisher: Routledge
• Year: 2022
• ISBN:
  9781000566086
• Edition: 1
• Topic: Social Sciences
• Subtopic: Gerontology
• Index: Social Sciences

Japan has many unique strengths, but it also faces numerous challenges, many of which are related to population ageing. Rapid demographic change is projected to reduce Japan's population by one-quarter by 2060 while increasing the share of elderly people from 29% of the total population to 38%, which would be the highest share among advanced countries. This book analyses the Japanese economy and the challenges it faces, and suggests policies to promote wellbeing, high living standards, fiscal sustainability, social inclusion and environmental sustainability. The book's 24 chapters focus on key aspects of Japan's economy, including the labour market, innovation, education, women in the workforce, corporate governance, small and medium-sized enterprises, the service sector, agriculture, fiscal and monetary policy, income distribution and policies to address climate change.

The volume aims to increase understanding of Japan, the world's third-largest economy and a key player in the global economy. It will assist policymakers and serve as a resource for academics and students of economics and public policy. As Japan is a front-runner in population ageing, the book's analysis and policy recommendations are highly relevant to other countries that are, or soon will be, facing similar challenges.

1 From the collapse of the bubble economy to the COVID-19 pandemic

An overview of the Japanese economy from 1990–2020

DOI: 10.4324/9781003094555-1

The Japanese economic miracle made it ‘Asia’s New Giant’ (Patrick and Rosovsky, 1976) and the world’s second largest economy. Some experts designated Japan as ‘number one’ and a model for other countries to follow (Vogel, 1979). However, the collapse of the bubble economy in the early 1990s led to what is often referred to as the ‘two lost decades’. The period 1992–2012 was marked by slower economic growth and deflation. The advent of Abenomics in 2012 led to a renewed sense of optimism and improved economic performance, although many of Japan’s ambitious goals remain unfulfilled. This chapter provides an overview of the Japanese economy during the past three decades:

• The collapse of the bubble, followed by a long recession in the first half of the 1990s (Figure 1.1).
• The banking crisis in the second half of the 1990s.
• The long economic expansion under Prime Minister Koizumi (2001–06).
• The global financial crisis and Great Recession of 2008–09.
• The 2011 Great East Japan Earthquake and Fukushima nuclear accident.
• Abenomics’ three-arrow strategy during 2012–20.
• The outbreak of the coronavirus (COVID-19) pandemic in 2020.

The aftermath of the bubble economy

The collapse of the bubble economy led Japan into the two lost decades. A speculative bubble is defined as the deviation of an asset price from its fundamental value fuelled by the irrational exuberance of investors. At the end of 1989, the Nikkei Stock Average was nearly four times higher than at the end of 1983 (Figure 1.2, Panel A). Residential land prices in the six major urban areas nearly tripled during 1984–90 (Panel B). Commercial land prices increased even faster. At its apex, land in Tokyo sold for as much as US $139,000 per sq ft, more than 350 times the value of property in Manhattan. The Imperial Palace, an area measuring 3.4 sq km, was estimated to be worth more than the entire state of California (Forbes, 2010). High land prices in many parts of Japan made it impossible for average wage earners to purchase a home.

Figure 1.1 Japan’s real GDP growth performance from 1985 to 2020,

Note: In volume terms, using 2015 as the base year. Shaded areas reflect downturns, i.e. periods between a business cycle peak and trough. The Economic and Social Research Institute calculates the peaks and troughs based on a large number of monthly indicators.

Source: Author’s elaboration of data from OECD (2021), Economic Outlook No. 108 – December 2020, OECD.Stat, www.esri.cao.go.jp/en/stat/di/111019rdates.html (accessed 20 July 2021).

The bubble, which was built on the myth that land prices would always rise, emerged during an era of low interest rates, excess liquidity and rapid economic growth. Indeed, real gross domestic product (GDP) growth surpassed 5% at an annual rate during the upturn that began at the end of 1986 (Figure 1.1). The Bank of Japan (BoJ) halved its policy interest rate in 1986–87 from 5% to 2.5% and kept it steady until May 1989 (Figure 1.3). With consumer price inflation below 1% during 1986–88, the monetary authorities did not see the need for higher interest rates. The bubble burst after the BoJ quickly raised its policy interest rate from 2.5% to 4.25% during 1989 as inflation approached 3%, and boosted the rate to 6% by August 1990. The stock price index fell by more than half of its end-1989 peak by March 1992 and residential land prices began declining in 1991 (Figure 1.2). In addition to higher interest rates, the imposition of ceilings on lending to the housing sector and the introduction of new taxes on land contributed to the fall in land prices (OECD, 1991).

The bubble collapse led to the second longest downturn in Japan during the post-war era in 1991–93 (Figure 1.1). Japan recorded two consecutive quarters of negative growth in 1993 for the first time since modern GDP statistics became available in 1955. Public discontent led to the election of Morihiro Hosokawa in 1993 to lead the first non-Liberal Democratic Party (LDP) government since 1955. The authorities responded with fiscal and monetary stimulus packages. First, the government introduced four supplementary budgets during 1993–95 and cut income taxes by around 1.25% of GDP (OECD, 1994). Second, beginning in 1991, the BoJ implemented nine consecutive cuts in its policy interest rate, reducing it to 0.5% in 1995 (Figure 1.3).

Figure 1.2 The asset price bubble

Note: The Nikkei Stock Average comprises 225 stocks in the Tokyo Stock Exchange First Section.

Source: Panel A; author’s elaboration of Nikkei Inc. data, www.bis.org).

Figure 1.3 The Bank of Japan’s policy interest rate

Note: The policy interest rate was the official discount rate until 1998 and the uncollateralized overnight call rate since then.

Source: Author’s elaboration of Bank of Japan data, The Basic Discount Rates and Basic Loan Rates (Previously Indicated as ‘Official Discount Rates’), www.stat-search.boj.or.jp/ssi/cgi-bin/famecgi2 (accessed 7 May 2021) and OECD data, Monthly Monetary and Financial Statistics (MEI): Interest Rates, OECD.Stat,https://stats.oecd.org/index.aspx?queryid=6779 (accessed 21 May 2021).

However, the policy response was late. Moreover, the structural imbalances created by the bubble economy and its collapse blunted the effectiveness of stimulative policies. Manufacturing companies had substantial overcapacity due to overinvestment during the bubble economy. A sharp appreciation of the yen – 88% in effective (trade-weighted) terms during 1990–95 (Figure 1.4) – led to a decline in profitability and competitiveness, resulting in restructuring and further dampening corporate investment (OECD, 1994). The negative wealth effects from the fall in land and equity prices also slowed investment and consumption spending. In addition, declining land prices significantly increased banks’ non-performing loans (NPLs), as many construction and real estate developers stopped repaying loans. This reduced bank profits and capital, leading to more cautious bank lending behaviour (Ito and Hoshi, 2020).

The banking crisis

Supported by expansionary fiscal and monetary policies, the economy rebounded with annual growth close to 3% in 1995–96. Stronger growth fuelled hope in the banks and the government that land prices would rise and resolve the NPL problem. Such optimism was dashed as the economy fell back into recession in mid-1997, partly as a result of fiscal policy. The consumption tax (a value-added tax) was hiked from 3% to 5% in April 1997. In addition, the government reversed the 1994 tax cut and increased social security contributions. As expected, private consumption rose strongly in the two quarters preceding the consumption tax hike (‘rush demand’), followed by a sharp contraction in the second quarter of 1997. The tax hike aimed to reduce the budget deficits that emerged in 1993, driven by the fiscal stimulus to support economic growth and rising social spending due to population ageing (Figure 1.5). The tax increases and a cut in government investment exceeded 2% of GDP, weakening economic activity and strengthening deflationary pressures. In hindsight, the timing and size of the fiscal consolidation were problematic (OECD, 1998).

Figure 1.4 Exchange rate trends, annual average

Note: The effective exchange rate is trade-weighted vis-à-vis 55 trading partners.

Source: Author’s elaboration of OECD data, Statistical Annex, OECD Economic Outlook No. 108 – December 2020, www.oecd.org/economy/outlook/statistical-annex/ and previous editions thereof.

The impact of these fiscal measures was compounded by the Asian financial crisis that erupted in the third quarter of 2017. Some key trading partners – the Republic of Korea, Thailand and Indonesia – were hit hard by the crisis, leading to a negative effect on Japan’s exports and a disruption of supply chains. In addition, the yen faced renewed upward pressure (Figure 1.4).

The recession exacerbated the financial problems that had emerged following the collapse of the bubble. Banks were reluctant to disclose the increase in their NPLs and continued lending to troubled borrowers in order to enable them to make payments, a practice known as ‘evergreening (see Chapter 16). Such lending allowed zombie firms – unprofitable companies that would be forced to exit the market in a normal competitive environment – to survive (see Chapter 12). The survival of zombies depressed economic growth by preventing more competitive firms from expanding and discouraging potentially more efficient firms from entering the market. While evergreening can temporarily hide NPLs, it makes them larger over time (Ito and Hoshi, 2020).

Financial supervisors also hesitated to force banks to disclose their NPLs and capital shortages, fearing that it could spark a panic. Moreover, Japan did not have a mechanism to close insolvent banks in an orderly way. Giv...