Japan's Long Stagnation, Deflation, and Abenomics

Mechanisms and Lessons

Kenji Aramaki

• Publisher: Palgrave Macmillan
• Year: 2019
• ISBN:
  9789811321764
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

This book examines the struggles of the Japanese economy over the last 30 years, analyzing in detail the formation of the huge economic bubble in the 1980s, its collapse at the beginning of the 1990s, and subsequent two decade long economic stagnation and chronic deflation, with the aim of identifying the mechanism of such processes and drawing lessons for future economic policy management. The book also assesses the comprehensive policy efforts called "Abenomics" under the current Abe administration. As Abe continues into a new term, this book will be of interest to Japan scholars, economists, and policymakers around the world, particularly in Asia.

© The Author(s) 2018

Kenji AramakiJapan’s Long Stagnation, Deflation, and Abenomicshttps://doi.org/10.1007/978-981-13-2176-4_1

Begin Abstract

1. Introduction: Objectives and Main Arguments of the Book

Kenji Aramaki^{1, 2}

(1)

Tokyo Woman’s Christian University, Tokyo, Japan

(2)

University of Tokyo, Tokyo, Japan

Kenji Aramaki

Email: [email protected]

End Abstract

1 Objectives and Main Arguments of the Book

This book examines the experience of the Japanese economy over last 30 years, from the 1980s, a time filled with a series of difficulties not observed in advanced countries in recent years, including the formation and collapse of a huge bubble, a two-decade-long economic stagnation, and chronic deflation, with an aim of identifying the mechanisms and drawing lessons for future economic policy management.

The Japanese economy grew to be the second largest economy next to the United States through the period of rapid growth from the 1950s to the early 1970s, and its per capita income rose to among the highest levels in the world. Even after the end of the era of rapid growth, the Japanese economy overcame shocks arising from the collapse of the Bretton Woods fixed exchange rate system and the shift to the floating exchange rate, as well as two oil crises in the 1970s, and continued to be an object of envy with its very low unemployment rate and solid economic growth. Its financial presence grew larger still under continued high economic performance, and it even began to be regarded as an economic threat to other countries in the 1980s. However, the Japanese economy formed a huge bubble in the latter half of the 1980s, and after the bubble’s collapse at the beginning of the 1990s, it suffered from a long period of economic stagnation and deflation. Japan’s nominal GDP, after hitting a peak of 534.1 trillion yen in 1997, stopped growing altogether and was 545.1 trillion yen in 2017, only greater by mere 11.0 trillion yen (2.1%) 20 years later, after its peak in 1997.¹

Why did such a long stagnation, which nobody could have imagined, occur? Although there have been extensive arguments, there is no definite consensus on the mechanism of the stagnation, and therefore, views still diverge on the lessons to be drawn. As briefly described later in this chapter, while the US economy recovered relatively speedily from the Global Financial Crisis (GFC) that struck in 2008, the European economies continued to show weaknesses in their recovery, and worries about a fall into deflation were not entirely dismissed until rather recently. Furthermore, the Chinese economy, which had been growing rapidly for several decades, started to decelerate and while the situation has stabilized, concerns over the future course of its economy have not been eliminated entirely. Did these economies face the risk of falling into long stagnation and deflation (or low inflation) that the Japanese economy experienced? If there was such a risk, at least at certain point in time after the crisis, what was the mechanism of such a risk? Assuming that these economies have successfully emerged from such a risk, what worked? If the economies did not successfully avoid the risk, what are the remaining problems? In order to answer such questions, it helps to have an understanding of the mechanism of long stagnation and deflation experienced by the Japanese economy.

While attempting to explore the mechanism of the bubble, stagnation, and deflation in Japan from the 1980s throughout this book, we seek answers to the following concrete key questions:

• Why was the bubble formed? What could have been done to prevent it?
• How did the bubble collapse? What impacts did the collapse of the bubble have on the economy?
• Why did the financial crisis break out in the late 1990s, as much as seven years after the collapse of the bubble? Why were the non-performing loan (NPL) problems that underlay the crisis not resolved sooner?
• What impacts did the financial crisis have on the economy?
• Why did the vulnerability of the Japanese economy remain, even after the negative legacy of the formation and collapse of the bubble² and the shock of the financial crisis had been overcome by the mid-2000s? What are the fundamental problems the Japanese economy currently has?
• Will Abenomics be able to solve the fundamental problems of the Japanese economy?

The ultimate objective is to understand the mechanism of long stagnation and deflation and draw lessons for the future in Japan and for other economies through exploration of the answers to these questions.

The major characteristics of this book include the following:

• First, to capture the real cause of the anomalies and difficulties of the Japanese economy, we have taken an approach, based mainly on a thorough examination of data and facts. Since the early 2010s when we started examining the long stagnation of the Japanese economy, we did not espouse any theory or views in advance, but aimed to first study and analyze extensive arguments, data, and facts. This book draws on such work and tries to present a view that can most coherently explain what the data and facts indicate. This book has tried to comprehensively describe and understand the three-decade-long period of anomalies and difficulties of the Japanese economy, thereby offering a new perspective on the problem and contributing to the economic literature.
• Second, we present a view that it is appropriate to analyze the Japanese economy over 30 years by dividing the whole period into subperiods. The basic divisions are three: the bubble period from the mid-1980s to the beginning of the 1990s; the long stagnation period of more than 20 years from the beginning of the 1990s to the early 2010s; and the period of Abenomics from 2013. However, what is unique to this study is that the analysis of the long stagnation period is conducted by further dividing this period of more than 20 years into four subperiods. This view arose from the observation that the changes in the Japanese economy emerged suddenly after the collapse of the bubble, and the changes developed into a long-term phenomenon. In other words, the mechanism of stagnation is thought to have changed from one of an abrupt nature to the one with a perpetual or structural nature through the long process of stagnation. The mechanism of stagnation must have changed over time. As is explained in this book, the turning point occurred with the financial crisis in the late 1990s. Specifically, the periods of study are divided as: Period I, from the period when the bubble burst at the beginning of the 1990s to just before the financial crisis in the latter half of 1990s; Period II, from the financial crisis to the early 2000s when the longest economic expansion since the Second World War started; Period III, from the first half of the 2000s to just before the GFC erupted in 2008; and Period IV, from the GFC to just before the start of the Abenomics.
• Third, we place a significant focus on the analysis of company behaviors. This focus also emerged from the data-centered approach. The Japanese economy underwent very substantial changes with the collapse of the bubble and also with the financial crisis. These changes include, for example, substantial restraint of private investment after the collapse of the bubble and the decline of nominal wages and consumer prices after the financial crisis. Most of these changes are related to corporate behaviors, and therefore, the analysis of these behaviors has become a very important element of this book. We examine how corporate behaviors evolved over these respective subperiods, including in the bubble period, after the collapse of the bubble, and after the financial crisis, based not only on macroeconomic data but also on the combined balance sheet data of all the profit-making companies in Japan.

The analyses of company behaviors are mainly conducted in Chap. 6, and these analyses suggest that corporate behaviors greatly changed in the process of long stagnation. Corporate behaviors during Period I after the burst of the bubble and before the financial crisis may be described as a “passive response,” in which expansion of excessive asset holding and assumption of excessive debt, as well as a surge in labor costs developed. In the period from the financial crisis to the first half of the 2000s (a period broadly corresponding to Period II), companies tried to rapidly remove excessive assets and debt and cut labor costs in response to the financial crisis. Corporate behavior in this period is thus described as “crisis response.” The elimination of excessive assets, debt, and employment was completed by the mid-2000s, that is, 15 years after the collapse of the bubble. However, restraints on private investment and on wages by companies, which became conspicuous in the period of crisis response, remained unchanged, continuing into Period III (the long recovery) and Period IV (GFC and afterward), and even into the period of Abenomics. Such corporate behaviors since the mid-2000s may be described as “sustained defensiveness.” Why such defensive attitudes by companies continue is examined in detail in Chap. 6.

There are many inferences that can be drawn from the examination of the Japanese economy in this book. The most important is the danger involved in excessive asset holdings by economic agents. “Excessive” means a situation in which the asset concerned does not have sufficient demand (or revenue) for the goods and services that it produces. Hangovers of such excessive assets (low-profitability assets) bring about continuous pressures for the curtailment of asset holdings and restraint on investment. Low-profitability assets also compress profits and produce a pressure to cut costs such as wages and procurements. These pressures tend to reduce domestic demand through restraint on investment and consumption (through wage restraint), and may lead to a prolonged stagnation, possibly placing downward pressures on prices. Furthermore, when such asset holdings are financed by debt, costs and risk arising from excessive assets and debt may be shifted to the financial sector, raising the risk of a financial crisis. If a crisis does break out, it will likely leave an extensive scar on the economy. Furthermore, when an extended period of time is taken to eliminate excesses and overcome a financial crisis, behavior of economic agents can be substantially altered and the economy as a whole may shift to a different equilibrium situation (e.g., from a high- to a low-growth equilibrium).

Figure 1.1 shows development not in assets but in debt, in terms of the total amount of credit (i.e., debt if viewed from the private nonfinancial sector side) to private nonfinancial sector (corporate and household sectors combined) (in GDP ratio) for Japan, the United States, the Euro area, and China. The ratio for Japan rose from a level of 160% in the mid-1980s to above 200% at the end 1980s and reached a peak of 219.5% at the end of 1993. Thereafter, the ratio stayed above 200% until 2000, when the ratio fell below 200%, and it was in the mid-2000s when the ratio returned to the pre-bubble level of around 160%. During this period, the Japanese economy experienced a continued weakness in its economic recovery and the financial crisis due to NPL problems. In the United States, the ratio started to rise from a level over 120% in the latter half of 1990s to nearly 170% in mid-2008 just before the collapse of Lehman Brothers. The US ratio declined after that and became stabilized at a level near 150% since about 2012. The ratio for the Euro area rose from a level over 120% in 1999, to over 160% in the latter half of 2008, and has stayed at this level, showing no sign of decline. The ratio for China had been around 120% after entering the 2000s before a rapid increase, starting at the end of 2008. It rose over 200% in mid-2015 and has become flat more recently. It was at an extremely high level of 210.2% at the end June 2017.

Fig. 1.1

Total credit to private nonfinancial sector (in percent of nominal GDP).

Source: Bank for International Settlements (BIS)

Figures 1.2 and 1.3 show a breakdown of the ratio into that for corporate and household sectors. A rapid increase in debt in Japan took place in the corporate sector while debts of the household sector did not show a big increase. The problem of excessive debts (and accompanying excessive assets) was a problem of the corporate sector in Japan. A sharp increase in debts emerged in the household sector in the United States. As was indicated by the fact that the subprime loan problem triggered the GFC, the original problem in the United States was not with the corporate sector but with the household sector, and the figure shows that reduction in the debt level of the household sector progressed speedily. The relatively quick recovery of the US economy seems to have been founded on progress made in adjustments of debt level. By contrast, the problem in the Euro area was with the corporate sector, and there has been no progress in the adjustments of debt level, which seems to be the reason behind the weak recovery in that region. In China, while the debt level of the household sector is increasing, the corporate sector seems to have a more serious problem. The rapid increase in debt level was triggered by the economic stimulus package amounting to 4 trillion RMB announced at the end of 2008. There should have been an expansion of assets behind the increasing debt. If these assets are not accompanied by sufficient demand, then it is possible that the excessive assets could become a burden similar to those excessive assets formed in the bubble era in Japan and could depress economic activities in the future for a long period of time in China. The corporate debt level hit a peak at the end of 2016 after the rapid increase and declined slightly in most recent period. However, it is still at a level of 160%, which is higher than the level in the bubble period in Japan, and is a matter of great concern.

Fig. 1.2

Total credit to nonfinancial corporations (in percent of nominal GDP).

Source: BIS

Fig. 1.3

Total credit to households (in percent of nominal GDP).

Source: BIS

Figure 1.4 shows total credit to the government sector. Together with Fig. 1.1 that shows total credit (in GDP ratio) to the private nonfinancial sector (corporate and household), these figures show that Japan’s government debt increased by 121.8%, from 91.7% at the end of 1997 to 213.5% at the end of June 2017, while the private nonfinancial sector’s debt declined by just 50.3%, from 209.8% to 159.5% over the same period. Although the rise in government debt level was due mainly to growing social security expenditures arising from the aging of the population, falls in tax revenue due to stagnation, and repeated expenditure of fiscal stimuli, particularly in the 1990s, it may be said that the government bore much of the direct costs (such as the use of public funds to resolve NPL problems) and indirect costs (such as a rise in government expenditure in the form of unemployment allowances and economic stimulus, as well as revenue losses due to stagnation), which arose in the process of removing excessive debt (or excessive assets) from the economy. The US Government’s debt increased by 30.0%, from 68.0% at the end of June 2008 (before the Lehman collapse) to 98.0% at the end of June 2017, while the private nonfinancial sector’s debt declined by 16.9%, from 168.4% to 151.5% over the same period. The increase in government debt is about twice as big as the decline in the private nonfinancial sector’s debt.

Fig. 1.4

Total credit to general government (in percent of GDP).

Source: BIS

By contrast, while the Euro area’s government debt increased by 22.2%, from 66.9% at the end of June 2008 to 89.1% at the end of June 2017, the private nonfinancial sector’s debt also increased by 4.3% from 157.3% to 161.6% over the same period. Debt levels of both private and government sectors have been rising. As there is no progress in reducing the private sector’s debt, we need to determine if it is at a sustainable level or if adjustments are needed. In the case of China, the government debt increased by 17.9%, from 27.8% at the end of June 2008 to 45.7% at the end of June 2017, while the private nonfinancial sector’s debt increased by 94.9%, from 115.3% to 210.2% ove...