Echoes of the Great Depression: Japan

I was expecting “Japan’s lost decades” to be an easy story to tell. However, when I started researching for this post, I discovered a controversy existed on whether a lost decade for Japan even existed. For example consider this post on Forbes by Eamonn Fingleton. He claims that the population of Japan increased so slowly in the 1990s that Japan’s per capita GDP grew at a respectable rate. A response to this claim is given by Noah Smith in the Bloomberg View, in which he says the assertion Japan is now in its third lost decade is a myth, but so is the declaration that Japan never had any lost decades at all. He stipulates that Japan’s population was slowly growing in the 1990s and that it has been in decline since 2007. Therefore, as Fingleton has pointed out, even if the U.S.’s total GDP grows faster than Japan’s, Japan will look considerably better when its GDP per capita is plotted versus time and compared to the U.S. Smith then provides the following chart originally produced by Paul Krugman.

The green curve is for U.S. GDP, the blue curve for the Euro zone GDP, and the red for Japan. Note that the quantities plotted are actually the GDPs per working-age resident, but the difference between that and per capita GDP would seem to be minor. The evidence from these plots would seem to indicate that Japan significantly underperformed both the U.S. and Europe from 1993 to 2013. As you probably have already noted, the GDPs are plotted as multiples of their 1993 values. Perhaps if we plotted U.S. and Japanese per capita GDPs in absolute terms, matters might be clearer. Using data from the World Bank, Google has constructed an interactive utility for comparing the per capita GDPs of any number of countries. Click here to see such a comparison between the U.S. and Japan. From this chart you can see that the Japanese per capita GDP fell sharply in 1995 and did not exceed their 1995 per capita GDP (42,522 USD) until 2010 (42,909 USD), a period of 15 years. Any way you slice it, this amounts to a lost decade and a half, followed by two more years of growth (2011 and 2012) above their previous high per capita GDPs, before falling into recession again in 2013. Many would argue that Japan’s lost years began even earlier in 1989 or 1990 when the processes that slowed their growth began to become apparent. For a few years after 1988, GDP growth was no more that 1.2%, followed by a few years of strong growth before beginning their true lost years in 1995.

Now that we have established that Japan has indeed suffered a decade-and-a-half of lost economic growth, the important question, just as with Europe, is: why? And why after only a few years of growth have they fallen back into recession? It seems generally accepted (see here and here and here and here) that the proximate cause of the Japanese troubles was a very large asset bubble in both stocks and real estate. Does this sound familiar, given U.S. experience in the savings and loan crisis of the late 1980s and our more recent troubles beginning in 2007? Given their frequent appearance in recent history, the causes of asset bubble formation are an active and popular subject for research, academic and otherwise. (See here and here and here and here) A common picture  of bubble formation proceeds as follows:

1. A profitable asset in which to invest is identified during a period of vigorous economic growth.
2. Even though these investments occur during vigorous growth, the central bank maintains an easy money policy to encourage further growth. Low interest loans to investors for buying the profitable asset are available and are used to increase demand for that asset.
3. Euphoria over the increasing market valuations of the asset drive its price far above any fundamental value the asset has for the economy. The fact that the price of the asset continues to increase becomes the primary reason for buying more of the asset.
4. At some point some of the smarter investors, noting the increasing disconnect between the fundamental economy and market valuations, begin to take profits by selling the asset.
5. The bubble is pricked by increasing selling of the asset that turns into a panic. Once the bubble is pricked, it can not be re-inflated because by now no buyers can be found.

Any series of events as outlined above has the capacity, even the probability, of causing a general financial crisis. This is due to the easy money funneled into the economy by the central bank to inflate the bubble. The commercial banks then lend this money to the investors, who can not repay the loans when the market for their assets collapses. The nature of fractional reserve banking then puts the existence of the commercial banks in jeopardy, and the entire economy teeters toward the abyss. During the inflation of all major asset bubbles, the central bank bears a major degree of culpability; the bubble could not be inflated unless the central bank provides the fuel to inflate it.

The inflation of the bubble can be made even worse if government policies outside of the central bank encourage it. Prior to the onset of Japan’s lost decade, the Japanese government encouraged their citizens to save large amounts of their income in a system [the postal savings system(PSS)] that re-directed the savings to capital investment, primarily for producing products for export. However, under political influence they also allowed loans to non-competitive companies and supported public-works projects with negative returns. In addition large amounts of money were funneled into real estate (see here and here). Hence, the Japanese government, in a crony capitalist relationship with large corporation groups, helped inflate the asset bubbles.

Once the Japanese started their lost decade, Keynesians both outside and inside of Japan recommended their standard panaceas for recession: government spending stimulus programs. The Japanese, who seem to have an almost theological faith in Keynesianism, have tried one Keynesian stimulus program after another, all to no avail. The one major product of all this “investment” is a national debt that is 230% of GDP.

The common links between economic affairs in Japan with those in Europe and the United States, as well as with the Great Depression, are the deep intrusions of government into the workings of the economy and a child-like faith in Keynesian doctrine.

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