Scientists study distant planets to better understand our own. Similarly, the growth-focused initiatives of Japanese Prime Minister Shinzo Abe and the Bank of Japan (dubbed "Abenomics") are being carefully studied in the hope of providing important insights into global economic problems and potential solutions.
Since the collapse of Japan's economy in 1990, policymakers have implemented a variety of stimulus programs. Japan's public finances have deteriorated as the government has run large deficits, leading to an increase in government debt that is now around 240% of GDP. Monetary policy has been highly accommodative, including zero interest rates and multiple rounds of quantitative easing since 2001.
Despite these measures, Japan remains trapped in economic stagnation. The government's new efforts are more of the same, but on a larger scale.
But if Abenomics has a chance of success, Japan will have to overcome years of poor policies that only compounded fundamental problems..
Investment has increasingly been misallocated into expanding manufacturing capacity and excessive infrastructure spending, reducing returns on investment and Japan's potential growth rates.
The excessive manufacturing capacity, coupled with low domestic demand, has made Japan reliant on both exports and a large trade surplus to balance production with demand. This strengthens the yen, reducing Japan's ability to be competitive as an exporter. Japan launched this latest round of quantitative easing to devalue the yen.
Moreover, much of the government-financed infrastructure is not productive. After the initial boost to activity, this investment -- bridges, roads and tunnels -- requires perpetual maintenance expenditure, absorbing scarce government resources.
Low interest rates, meanwhile, allowed debt levels to remain high. This reduced income for savers and discouraged consumption.
Low rates also drove weak businesses into a zombie-like state, where they survive to continue to pay interest on loans. Banks avoided writing off loan assets, tying up capital, and reduced lending to productive enterprises, especially the small- and medium enterprises that account for a major portion of Japan's economic activity and employment. The creative destruction necessary to restore the economy did not occur.
Debt and discontent
There are similarities and differences between the collapse of Japan's bubble economy and that of other developed nations following the global financial crisis.
In both cases, low interest rates and excessive debt build-ups financed investment booms intended to create recovery from recessions. Both ultimately collapsed. Both were characterized by overvaluation of financial assets and banking system weaknesses. Policy responses to the crisis have also been similar.
At the onset of the crisis, Japan had low levels of government debt, high domestic savings and an abnormal degree of home bias in investment. This allowed the government to finance its spending domestically, assisted by an accommodative central bank.
Currently, around 90% of Japanese government bonds are held by compliant domestic investors. The absence of market discipline, especially from foreign investors, allowed Japan to incur high levels of indebtedness. In contrast, many of the current problem economies have low domestic savings and rely on foreign capital.
Japan's problems occurred while the global economy enjoyed robust economic growth. Strong exports and a current account surplus partially offset the lack of domestic demand in Japan , buffering the effects of the slowdown in economic activity. Going forward, the global nature of current problems means that individual countries will find it more difficult to rely on the external account to support their economies.
While its aging population has compounded problems, Japanese demographics at the start of the crisis were favorable. Its older population had considerable wealth. Low population growth meant that fewer new entrants had to be accommodated in the workforce during a period of slow growth, alleviating problems of rising unemployment.
Challenging changes
Reflecting a homogenous society and a stoicism shaped by its history, Japanese citizens were accommodating of the sacrifices and transfer of wealth necessitated by the economic problems. The demographic and social structure of many troubled economies may not accommodate the measures required to manage the crisis, without significant breakdowns in social order.
Both Japan and the world are relying on government spending and quantitative easing to try to reflate moribund economies. Despite optimism from Japanese authorities and foreign commentators, there is no evidence that the new round of measures will have any more success than in the past.
There is still little recognition of the real lessons from Japan for the global economy. As John Kenneth Galbraith observed: "There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present."
In reality, Japan highlights the difficulty of engineering recovery from the effects of major deleveraging following the collapse of a debt-fueled asset bubble. It reveals the constraints of traditional policy options -- fiscal stimulus, low interest rates and debt monetization. The Japanese experience suggests that the state can provide palliative care to an economy in crisis but may have limited ability to restore economic health.
The real lesson from Japan's experience is that the only alternative to a prolonged period of stagnation is to avoid a debt-fueled bubble and build-up of public debt in the first place.
AI
