Lost Decade

lost decade by S Kambayashi

The Lost Decade is the time after the Japanese asset price bubble’s collapse within the Japanese economy, which occurred gradually rather than catastrophically. The term originally referred to the years 1991 to 2000, but recently the decade from 2001 to 2010 is also sometimes included, so that the whole period of the 1990s and 2000s is referred to as the Lost Decades or the Lost Years.

The strong economic growth of the 1980s ended abruptly at the start of the 1990s. In the late 1980s, abnormalities within the Japanese economic system had fueled a massive wave of speculation by Japanese companies, banks and securities companies. A combination of exceptionally high land values and exceptionally low interest rates briefly led to a position in which credit was both easily available and extremely cheap. This led to massive borrowing, the proceeds of which were invested mostly in domestic and foreign stocks and securities.

Recognizing that this bubble was unsustainable, the Finance Ministry sharply raised interest rates in late 1989. This abruptly terminated the bubble, leading to a massive crash in the stock market. It also led to a debt crisis; a large proportion of the debts that had been run up turned bad, which in turn led to a crisis in the banking sector, with many banks being bailed out by the government.

Michael Schuman of ‘Time’ magazine noted that banks kept injecting new funds into unprofitable ‘zombie firms’ to keep them afloat, arguing that they were too big to fail. However, most of these companies were too debt-ridden to do much more than survive on further bailouts, which led to an economist describing Japan as a ‘loser’s paradise.’ Schuman states that Japan’s economy did not begin to recover until this practice had ended.

Eventually, many became unsustainable, and a wave of consolidation took place, resulting in only four national banks in Japan. Critically for the long-term economic situation, it meant many Japanese firms were burdened with massive debts, affecting their ability for capital investment. It also meant credit became very difficult to obtain, due to the beleaguered situation of the banks; even now the official interest rate is at 0.1% and has been for several years. Many borrowers turned to Sarakin (loan sharks).

This led to the phenomenon known as the ‘lost decade,’ when economic expansion came to a total halt in Japan during the 1990s. The impact on everyday life was muted, however. Unemployment ran rather high, but not at crisis levels. This has combined with the traditional Japanese emphasis on frugality and saving to produce a quite limited impact on the average Japanese family.

Despite the economic recovery in the 2000s, most of the conspicuous consumption of the 1980s, such as spending on whiskey and cars, had not returned. This was due to the traditional Japanese emphasis on frugality, and also because Japanese firms that had dominated the 1980s, such as Sony and Toyota, were fending off heavy competition from rival companies based in South Korea and Taiwan. Most Japanese companies began to replace their permanent work force with temporary workers who had no job security and fewer benefits, and these non-traditional employees now make up over a third of Japan’s labor force.

Economist Paul Krugman has described Japan’s lost decade as a liquidity trap, in which consumers and firms saved too much overall, causing the economy to slow. He explained how truly massive the asset bubble was in Japan by 1990, with a tripling of land and stock market prices during the prosperous 1980s. Japan’s high personal savings rates, driven in part by the demographics of an aging population, enabled Japanese firms to rely heavily on traditional bank loans from supporting banking networks, as opposed to issuing stock or bonds via the capital markets to acquire funds. The cozy relationship of corporations to banks and the implicit guarantee of a taxpayer bailout of bank deposits created a significant moral hazard problem, leading to an atmosphere of crony capitalism and reduced lending standards. He wrote: ‘Japan’s banks lent more, with less regard for quality of the borrower, than anyone else’s. In so doing they helped inflate the bubble economy to grotesque proportions.’ The Bank of Japan began increasing interest rates in 1990 due in part to concerns over the bubble and in 1991 land and stock prices began a steep decline.

In response, Japanese policymakers tried a series of government economic stimulus programs and bank bailouts. A 2.4% budget surplus in 1991 turned to a deficit of 4.3% by 1996 and 10% by 1998, with the national debt to GDP ratio reaching 100%. In 1998, a $500 billion bank rescue plan was implemented to encourage bank lending and borrowing. The central bank also attempted to increase inflation (which devalues savings over time), to encourage consumer spending. Krugman wrote that by 2003, the Japanese economy began to recover, helped by imports from the U.S. and China that helped Japan achieve a real growth rate of 2%. He wrote the recovery was ‘provisional’ and there was significant risk of a return to a liquidity trap.

Economist Richard Koo wrote that Japan’s ‘Great Recession’ that began in 1990 was a ‘balance sheet recession.’ It was triggered by a collapse in land and stock prices, which caused Japanese firms to become insolvent, meaning their assets were worth less than their liabilities. Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. Corporate investment, a key demand component of GDP, fell enormously (22% of GDP) between 1990 and its peak decline in 2003. Japanese firms overall became net savers after 1998, as opposed to borrowers. Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In his view, this avoided a U.S. type Great Depression, in which U.S. GDP fell by 46%. He argued that monetary policy was ineffective because there was limited demand for funds while firms paid down their liabilities. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy.

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