Published in Newsweek Japan 19/9/2018
Sometimes time seems to accelerate and a few weeks feel like several years. Such was the case in September 2008 when the American investment bank Lehman Brothers collapsed and panic instantly spread through the world financial system, leading to a plunge in global economic activity.
Japan bore no responsibility for the crisis, yet suffered one of the worst economic hits. Nominal GDP tumbled by 9% and it was not until 2016 that the shrinkage was fully reversed. Yet, counter-intuitively it was the man-made disaster of September 2008, together with the natural disaster of March 2011, that shocked Japan out of its fatalistic acceptance of post-bubble stagnation and paved the way to recovery.
Japan is now in its sixth year of economic expansion. The labour market is as tight as a taiko drum and the Tokyo stock market has comfortably beaten Europe and the emerging world (but not the U.S.) in terms of total returns over the period. Japan’s international profile has strengthened too – it is now the de facto leader of the Trans-Pacific Partnership – and many more foreigners are coming to Japan as tourists and students.
Even so, it would be a huge mistake to settle back into complacency and inertia. As the level of interest rates indicates, the developed world’s economic problems are far from over.
Prior to the crisis, Japan’s two decade malaise was considered, by both overseas observers and Japanese policy-makers themselves, to be a specifically Japanese phenomenon. What was happening in Japan had no lessons for the rest of the world and what the rest of the world was doing had no lessons for Japan.
Japanese policy-makers convinced themselves that consumption was weak because, as one senior politician put it, Japanese households already owned all the goods they wanted; that shrinking demographics meant stagnation was inevitable; that any attempt to stimulate the economy through fiscal or monetary policy would lead to financial Armageddon.
Meanwhile, as far as many foreigners were concerned Japan had become an incomprehensible, through-the-looking-glass world where the normal rules of economic life had been suspended. Real estate and stock prices went down year after year, instead of up; investors carried on buying government bonds with microscopic yields, perhaps out of some bizarre sense of patriotism. Strangest of all, when Western central banks were congratulating themselves on finally defeating inflation, Japan had slid into deflation, a condition not seen in most developed countries since the 1930s.
The Lehman shock changed all that. Suddenly, the Western world became painfully aware that “turning Japanese” was a real possibility. Indeed, as time went on a new “revisionist” view of Japan’s “two lost decades” began to take shape. Given the scale of the bubble collapse and banking problem, hadn’t Japan actually performed quite well, even in economic terms? Yes, GDP had stagnated, but it hadn’t collapsed and ushered in years of mass unemployment as in the parts of the Eurozone.
In political and social terms, the achievement was even more impressive. Social cohesion had been maintained, with no backlash against globalization or emergence of populist politicians.
Nobel-prize winning economist Paul Krugman even went as far as to declare, in 2014, that “Japan used to be a cautionary tale, but the rest of us have messed up so badly that it almost looks like a role model instead.” As Professor Masazumi Wakatabe of Waseda University, and now Deputy Governor of the Bank of Japan, pointed out, Krugman’s comments should be seen in the context of America’s political divide. We should not underestimate the human damage – exemplified by the sharp rise in the suicide rate of middle-aged males – wrought by Japan’s long economic malaise.
Yet there is a crucial point at stake. Always and everywhere the aftermath of a severe financial crisis is fraught with uncertainties and unexpected outcomes. Nobody can be confident they have a surefire remedy, not even Professor Krugman. The best approach is not to have a financial crisis in the first place, but that is easier said than done. In the words of Paul Sheard, former Vice-Chairman of S&P Global and Chief Global Economist at Lehman Brothers at the time of its collapse, the possibility of financial crises is not a bug in the modern financial system; it is a design feature.
If Western policy-makers had to change their thinking, so did their Japanese equivalents. Unfortunately, institutional pride and inertia meant that Japan was well behind the U.S. and Europe in adopting a quantitative easing programme. Until the election of Prime Minister Abe in late 2012, the Japanese policy debate was dominated by fiscal and monetary hawks. The idea that Japan had “too much debt” – even though it was, and remains, the world’s largest creditor nation – was to prove especially pernicious.
Even with yen at 80 to the dollar stifling Japanese manufacturing, the Nikkei Index at 8,000 and the job-offer-to-applicant ratio at the weakest level in 40 years, the talk was of fiscal consolidation and the dangers of reflation. The conventional wisdom amongst policy-makers was that “painful structural reform” was the path to prosperity, as if Japan’s economic problems were akin to the supply-side constraints that bedevilled inflationary, low-savings Britain under Margaret Thatcher.
That had been the prevailing ideology under the administration of Prime Minister Koizumi in the years leading up to the Global Financial Crisis. At the time, economic conditions seemed good, but appearances were deceptive. Large exporters were doing well, but domestically the deflationary undertow was still strong. When the Lehman shock hit, the extent of the dependence on overseas growth was cruelly exposed.
Today Japan is in a much better place. Non-manufacturing industry – nearly all domestic – is experiencing the highest profit margins in sixty years. The labour shortage is stimulating capital spending on automation and innovation. The small reform of loosening visa restrictions for Asian visitors has had a huge effect on inbound tourism.
Yet there are some worrying signs of backsliding amongst policy-makers. Old school Bank of Japan hard-liners and their associates in the media and academia are lobbying for an end to quantitative easing. It looks as if the financial bureaucracy have browbeaten Prime Minister Abe into an unnecessary consumption tax hike.
Previously, such moves have been made with the worst possible timing. The last BoJ tightening took place on the cusp of the global financial crisis. The consumption tax hike of 1997 was implemented during the gathering storm of the Asian crisis and Japan’s own banking crisis.
We can only hope that it will not take another major downturn to convince policy-makers in Japan and elsewhere that growth, not austerity and hard money, is the only way out of what is still very much a post-Lehman world.