Japan's Economy
Japan's industrialized, free market economy is the second-largest in the world. Its economy is highly efficient and competitive in areas linked to international trade, but productivity is far lower in protected areas such as agriculture, distribution, and services. Japan's reservoir of industrial leadership and technicians, well-educated and industrious work force, high savings and investment rates, and intensive promotion of industrial development and foreign trade produced a mature industrial economy. Japan has few natural resources, and trade helps it earn the foreign exchange needed to purchase raw materials for its economy.
Japan experienced large asset price bubbles in its stock and commercial real estate markets during the second half of the 1980s. These bubbles peaked in 1989 and 1990, respectively. Subsequently, both Japanese share prices and land values fell, surrendering all of their gains during the bubbleyears by 1993 and 2000, respectively. After these bubbles popped, real GDP growth slowed abruptly. However, a series of fiscal and monetary blunders by the Japanese government transformed the inevitable post-bubble recession into a “lost decade” of deflation and stagnation.
During the second half of the 1980s, Japan enjoyed both rapid economic growthand low inflation (as recorded in price indices for goods and services). The Japanese yen appreciated from ¥260/US$ in February 1985 to a then all-time high of ¥150/US$ during the summer of 1986. Fearing a loss of price competitiveness for Japanese manufactured exports in the United States, the Japanese government changed the thrust of its economic policy from non-inflationary real GDP growth in Japan to containing the appreciation of the yen relative to the US dollar. Despite a booming economy, the Bank of Japan loosened its monetary policy to stem the appreciation of the yen by reducing its policy interest rate in steps from 5.0 percent in January 1986, to 2.5 percent in February 1987. This overly accommodative monetary policy fueled unsustainable price bubbles in the Japanese stock and commercial real estate markets.
To prick these bubbles, the Bank of Japan began to tighten its monetary policy, raising its policy interest rate from 2.5 percent in May 1989 in steps to a peak of 6.0 percent in August 1990. This tightening caused these bubbles to pop. The Nikkei 225 index, which was 13,000 at the end of 1985, peaked at 38,916 on the last trading day of 1989 and then fell by one-half in 1990. By 1993, all of the gains in share prices since 1985 had been eliminated. The Nikkei 225 index declined to a post-bubble low of 11,820 on March 13, 2001. The urban land price index rose by 199 percent from 35.1 in September 1985 to a peak of 105.1 in September 1990. The index then gradually declined over the next ten years to 34.6 percent in September 2000, eliminating all of the gains in real estate prices since 1985.
The 1990s have been dubbed Japan's "Lost Decade," during which the country's growth in gross domestic product (GDP) averaged a mere 1.6 percent, or less than half the 3.8 percent average of the preceding decade. Japan's growth has been impeded by its inability to recover from massive asset deflation in the wake of the burst economic "bubble" of the early nineties (manifested in numerous non-performing loans) and its failure to reform political, economic and social systems in order to adapt to the changing international economic environment. As is typical of highly regulated economies, the Japanese economy suffered from a serious misallocation of resources, a lack of investment, and a dearth of entrepreneurial innovation.
The collapse of these bubbles wrecked Japanese banks and other depository institutions. Japanese banks and other depository institutions were allowed to invest directly in stocks. The unrealized capital gains on these shares fell from ¥49.1 trillion ($355 billion) in 1989 to ¥5 trillion ($42 billion) in 2001, reducing bank capital. Japanese banks and other depository institutions secured almost all of their commercial and industrial loans through commercial real estate mortgages. As commercial real estate values escalated, credit standards deteriorated. Instead of examining whether non-financial firms could service their loans out of their cash flow from operations, Japanese banks and other depository institutions increasingly relied on rapidly escalating collateral values for repayment. Weak credit standards during the bubble years boosted problem loans and credit losses in Japanese banks and other depository institutions during the lost decade. This weakness in Japanese banks and other depository institutions had especially devastating effects on the non-financial business sector in Japan because Japanese non-financial firms were more dependent on bank loans than their counterparts in the United States and other developed countries during the 1980s.
Despite the adoption of a $172 billion stimulus package in November 1999, the ninth since 1992, Japan's economy has yet to exhibit clear evidence that a sustained recovery is underway. In 1999, the Japanese economy generated a growth rate of only 0.2 percent. Japan's economy continues to be hampered by problems in the financial sector, relatively high unemployment and excessive regulation. In addition, the burgeoning government budget deficit may limit further recourse to fiscal stimulus packages.
In 2001, Japan entered its third recession in a decade, after a short-lived recovery attempt failed to take hold. Japan's real GDP dropped 1.2 percent during the second quarter of 2001 and fell by another 0.5 percent in the third quarter. In November 2001, the Government of Japan reversed its economic projection for Fiscal Year (FY) 2001 (March 2001-March 2002) from 1.7 percent growth to a contraction of 0.9 percent in terms of real GDP.
After sustaining several consecutive years of growth earlier this decade, the Japanese economy began to slow in line with global economic conditions, and the country fell into its first recession in roughly six years in 2008 as worldwide demand for its goods tumbled. The Bank of Japan reported real GDP growth of -1.8% in FY 2008 and has forecast a decline of 2.0% in 2009.
