Three part study in 1994
Congressional Research Service: Report for Congress, 94-226E
-ti- Japan's Economy: From Bubble to Bust
March 8, 1994
By James K. Jackson
Specialist in International Trade and Finance
Economics Division
Japan's Economy: From Bubble to Bust
Summary
In the 1980s, Japan's economy posted strong economic growth, in
stark contrast to the more pedestrian growth other developed
economies experienced. In this period, referred to as the "bubble"
economy, Japan experienced a sharp increase in the values of land
and stocks. The fast paced growth came to a halt in 1991, however,
as the Ministry of Finance grew concerned over prospects of a
rising rate of inflation, and, accordingly, tightened the nation's
money supply. Since then, Japanese economic growth has fallen
sharply and the economy has experienced asset deflation, rising
levels of unemployment, and falling corporate profits and
investments.
For the United States, the speed and timing of Japan's economic
recovery could affect the strength of economic expansion in the
United States in 1994 and 1995. If the Japanese economy recovers
too quickly, capital markets likely will tighten and interest rates
rise in Japan and in the United States, dampening the U.S.
recovery. More plausible, however, is that Japan's economic
recovery will be tepid and add little to economic growth in the
region and in the United States. The Clinton Administration is
encouraging Japan to adopt a more vigorous package of stimulative
measures than it has proposed so far. As long as the two economies
are out of sync, with the U.S. economy growing quickly and the
Japanese economy lumbering in recession, the bilateral merchandise
trade account likely will continue to post large deficits for the
United States.
Most economists believe the Japanese economy is fundamentally sound
and that it will recover from its current recession. The economy,
however, appears more vulnerable than it did in the 1980s, when
some observers viewed it as a behemoth set to conquer other
economies around the globe. Successive Japanese governments have
produced five economic packages since 1992, the latest in February
1994, to stimulate the economy, so far with little visible success.
The Hosokawa government, preoccupied with political issues, delayed
adopting its widely expected cut in taxes to boost the economy. The
economic stimulus package announced February 1994, just prior to
the scheduled Clinton-Hosokawa summit, is not expected to give the
Japanese economy much of a boost, but may prevent it from sliding
further until recovery can begin in late 1994 or 1995.
Opinions differ over how the current recession is affecting Japan's
economy. Some economists believe the Japanese economy is going
through the same kind of the U.S. economy experienced in the 1980s,
but that by the mid-1990s its economy will be well-positioned for
another burst of fast-paced growth. Others believe the cyclical
contraction is having a structural impact on their economy that
will remain long after their economy recovers because the
structural changes are altering elements of the economy that have
characterized Japan's post-war growth.
Japan's Economy: From Bubble to Bust
Japan's "bubble economy"--the period in the late 1980s
characterized by a sharp increase in the rate of economic growth
and the pace of business investment spending--screeched to a halt
in 1991. This shift from boom to bust was triggered by Japan's
Ministry of Finance (MOF), which put the high-flying economy on a
monetary diet to stem inflation. As a result of the Ministry's
measures, business investment and consumer spending plummeted,
sapping the economy of the two most important domestic sources of
growth.
The Ministry's actions worked all too well. In fact, since 1991 the
government has adopted a series of monetary and fiscal policy
measures to prop up the economy, so far with no visible success.
Most economists, however, believe the economy remains fundamentally
sound and that it should recover in 1994 or 1995. Still, opinions
differ over how extensively the cyclical contraction is affecting
the economy. Some economists believe the recession is a necessary
correction to the fast-paced growth the Japanese economy
experienced in the 1980s, that it will have only a short-term
impact on the economy's long-term rate of growth, and that by the
mid-1990s the Japanese economy will be well-positioned for another
burst of rapid growth. Others believe the cyclical recession will
have a lasting effect on the economy because it is altering
structural elements--such as lifetime employment--that have
characterized the post-war economy. The recession also may mark the
end of the high rates of economic growth Japan experienced during
the 1960s, 1970s, and 1980s.
BACKGROUND
Japan's economy fell into a recession in 1991. That much is clear.
What is not clear is when the recession will end, how strong
economic growth will be after recovery begins, and what long-term
impact this recession is having on the economy. Some economists
believe the Japanese economic miracle has been brought to an end.
They argue that the recession is quickening the pace of change in
the Japanese economy and that these changes are undermining the
basis upon which Japan's economic miracle was established.(1)
Other economists believe the economy is experiencing merely a
cyclical contraction that stems from the fast-paced, and ultimately
unsustainable, growth of the 1980s. One such economist argues that
Japan,
is purging itself of the excesses of the 1980s, that is
cleansing its economy, and that is melting off the fat
accumulated during ... years of record smashing economic
expansion. All this is positive. By the mid-1990s, once the
economy is brought down again to its rock-hard, competitive
core, Japan will be poised for another powerful leap ahead
through to the end of the decade.(2)
This recession is notable for a number of reasons. First, the
recession follows the second longest expansion in the post-war
period and, if current predictions hold and the recession continues
through May 1994, it will be the longest recession the economy has
experienced in the same post-war time frame. Second, this
recession is the first in the post-war period that originated
primarily from internal, rather than from external, forces.
1. The Japanese Economy: From Miracle to Mid-Life Crisis. The
Economist, March 6, 1993. p. 3-4.
2. Courtis, Kenneth S. Japan: The Heisei Cycle. Japan
Close-Up, September 1992. p. 13.
As figure 1 shows [PLEASE CONTACT GATEWAY JAPAN FOR THIS FIGURE],
during the 1980s, the growth of Japan's real gross domestic product
(GDP) averaged above the 4-percent rate most economists believe the
economy is capable of sustaining without risking a rising rate of
inflation. By 1991, Japanese firms had invested more in new plant
and equipment, in absolute terms, for four consecutive years than
did U.S. firms, with about one-third of this investment going
directly into rationalization (eliminating redundant or
nonessential activities or equipment) and productivity
improvements.(3) These investments helped sustain the economic
expansion in the 1980s, but have left many Japanese firms with
excess capacity that is now inhibiting current attempts to "rev up"
the economy.
3. Courtis, Kenneth S. Japan in the 1990s. Business & The
Contemporary World, Winter 1992. p. 63.
The drop in Japan's GDP growth in 1992 and 1993 reflects primarily
the delayed effect of monetary tightening imposed by the Bank of
Japan in 1990 and the generally tight, or neutral, fiscal policy
Japan has followed since the early 1980s. These policies combined
initially to raise interest rates in Japan, which cooled business
investment spending and consumer spending, especially for housing.
Based on latest estimates, GDP growth was negative for all of 1993,
the first time since the oil price-induced recession of 1974 that
the Japanese economy has experienced an annual negative rate of
growth.
THE ECONOMIC "BUBBLE"
Japan's current economic troubles largely stem from economic and
financial policies the government pursued in the 1980s. In
particular, the way the Ministry of Finance (MOF) sought to
liberalize the nation's financial sector and the mix of monetary
and fiscal policies it pursued provided the catalyst for the
speculative boom of the 1980s and the slowdown of the 1990s. After
incurring large budget deficits in the late 1970s and early 1980s,
the Japanese government adopted a stringent fiscal policy to
eliminate the need for issuing bonds specifically intended for
financing its budget deficits.(4) At the same time, the MOF
liberalized most capital outflows, while moving in a piecemeal
fashion to loosen internal controls over domestic financial
markets.(5) This combination of policies sparked a rush of capital
out of Japan at the same time the United States adopted a mix of
monetary and fiscal policies that worsened the Nation's
savings-investment imbalance. The U.S. imbalance, in turn,
attracted a large portion of the capital flowing out of Japan.
4. The Japanese government's budget has a capital account that
is financed through general revenues and construction bonds
geared toward public works construction projects; the other
part of the budget includes spending on current items and is
financed through general revenues. The Government is
prohibited by law from issuing bonds to cover current expenses
unless the Diet, or Parliament, approves the issuance of such
"deficit-financing" bonds.
5. For additional information, see: U.S. Library of Congress.
Congressional Research Service. Japan's Financial
Liberalization: Effects on the United States. CRS Report No.
89-102 E, by James K. Jackson. Washington, 1989.
The large flow of capital from Japan to the United States pushed
the value of the dollar up nearly fifty percent between 1980 and
1985. To bring the value of the dollar back down, the United States
and Japan struck the Yen/Dollar Agreement in 1984. Then, in 1985
and 1987, the United States, Japan, and West Germany, reached a
number of informal agreements to stabilize the dollar and to
coordinate economic policies. These agreements effectively sowed
the seeds for much of Japan's speculative boom in the last half of
the 1980s by shifting the composition of demand in the economy away
from net trade (exports less imports). Given Japan's commitment to
reducing its central government budget deficits, it used monetary
policy as its main economic coordinating mechanism by increasing
the growth rate in its money supply in order to bring down domestic
interest rates and to stem yen appreciation.
Double-digit increases in the annual growth rate in Japan's money
supply (defined as M2+CDs) [M2 is M1 (currency in circulation +
deposit money) + private deposits and public deposits less demand
deposits with financial institutions.] were the standard throughout
the 1960s and 1970s when the Japanese economy also was growing at
double-digit rates. Such increases, however, occurred only once in
the 1980-1987 period. Following the Louvre Accord in February 1987,
Japan pushed its money growth up to double-digit rates and its
official discount rate down to 2.26 percent, as indicated in figure
2. [PLEASE CONTACT GATEWAY JAPAN FOR THIS FIGURE] With interest
rates low, the money supply growing, and financial liberalization
progressing slowly, Japanese firms and individuals found themselves
with excess cash to spend and invest. Japanese firms used the funds
to invest in plant and equipment and to acquire foreign businesses
and financial assets. Japanese firms, for instance, invested
heavily in U.S. businesses and real estate during the 1980s and by
1993 had displaced British firms to become the largest foreign
direct investors in the United States.(6) Individuals found
themselves with few choices: they could either place their savings
in low-yield savings accounts with officially controlled interest
rates, or they could invest in stocks and land where prices and,
therefore, returns were not controlled.
6. U.S. Library of Congress. Congressional Research Service.
Foreign Direct Investment in the U.S.: Japan as Number One.
Report No. 93-704 E, by James K. Jackson. Washington, 1993.
What followed was a period of economic expansion and asset price
inflation that is unprecedented in modern Japanese history. This
period, termed the "bubble economy," is characterized by an
increase in the growth rate of the money supply that fueled a rise
in business investment spending and personal consumption. In turn,
the increase in business and consumer spending ignited a
speculative boom in real estate values and in stock prices. As
figure 3 shows [PLEASE CONTACT GATEWAY JAPAN FOR THIS FIGURE],
residential land prices in Japan's six largest cities tripled
between 1984 and 1990. By 1989, rising real estate prices
effectively excluded a whole segment of the Japanese population
from buying a home and sparked concerns among some political and
business leaders in Japan over a growing disparity in income
between groups in Japan.
For anyone owning land, however, the inflated land values proved
easy to parlay into loans or into other assets, such as stocks.
Between 1984 and 1989, for instance, the bellwether Nikkei index of
225 selected stocks nearly quadrupled from 10,000 to nearly 40,000.
This rise in stock prices inflated the value of the stocks and
encouraged firms to boost their capital investments and consumers
to increase their spending. Many investors, in turn, used the
inflated values of their stock holdings as collateral to purchase
additional real estate. Consequently, real estate and stock prices
fueled each other in an upward spiral.
THE END OF THE BOOM
The speculative boom and the imbalance it created in the Japanese
economy, was curbed in 1990 and 1991 when the Ministry of Finance
slowed the growth rate in the money supply and began gradually to
ratchet up the official interest rate to 6.0 percent. Through 1990,
GDP growth remained strong, while real estate and stock prices
nosedived in response to the monetary tightening. By the second
half of 1991, the MOF started easing up on the economy, apparently
out of concern that the correction it precipitated was getting out
of hand and that a series of declines in stock market prices was
damaging the financial stability of banks and brokerages. Between
July and December 1991, the Bank of Japan lowered the official
discount rate three times.
RESPONSE BY FIRMS
Japanese gross domestic product (GDP) data indicate that the growth
rate of the Japanese economy fell sharply in 1992 to about 1.1
percent, or about one-fourth of the rate in 1991. (See appendix
A.) This decline in GDP growth was matched by an equally sharp drop
in business investment spending. Despite rising interest rates
between 1989 and 1991 and a decline in the growth rate of the money
supply, Japanese businesses continued to invest heavily through
1991 in real terms, before curtailing their expenditures on new
plant and equipment, as figure 4 shows [PLEASE CONTACT GATEWAY
JAPAN FOR THIS FIGURE]. Production remained strong through 1991,
despite rising inventories and declining profits. Since 1991, all
the major indicators of economic performance in the manufacturing
sector have turned negative: production, profits and plant
operating rates have declined, while inventories have increased,
causing firms to reduce their investment spending and the number of
hours their employees work.
Industries oriented toward consumer products have been especially
hard hit during the prolonged recession by the decline in consumer
spending. Two of Japan's most renowned industries, consumer
electronics and automobiles, face severe restructuring problems
that are spurring firms to shift parts of their production abroad
and may well reduce the total number of firms in those
industries.(7) The appreciation of the yen in 1993 and again in
1994 has compounded the problems of these and other industries that
have significant export activities. Retailers, auto dealers, and
even beer producers are attempting to coax consumers to spend by
offering deep discounts on their products, a practice that is most
uncommon in Japan. While such a tactic yields sales in the short
term, some analysts expect that it will retard Japan's economic
recovery because discount sales do little to enhance retailers
profits or to help them pay off debt.(8) Moreover, since wage and
salary increases are tied informally to rises in consumer prices,
a deflationary movement in consumer prices likely will spur firms
to press labor unions for smaller salary increases in their annual
spring negotiations, further restraining consumer spending.(9)
7. Corporate Shake-Out Around the Corner. Tokyo Business
Today, Jan./Feb. 1993. p. 3845.
8. Oishi, Nobuyuki. Deflation Seen Sapping Potential Growth.
The Nikkei Weekly, January 31, 1994. p. 3.
9. Ibid., p. 3.
Firms are responding to the recession by reducing their employment
rolls. In general, employment adjustment in Japan begins by firms
placing restrictions on overtime hours, followed by cuts in hiring,
and then cancellations of all new hiring. If adverse economic
conditions persist as they have, firms follow up these moves by
firing part-time employees and seasonal workers, relocating
employees to other firms, and finally, inducing employees to take
voluntary early retirements.(10) For instance, Japan's TDK Corp.,
the world's largest manufacturer of magnetic tape, decided to keep
about 60 managers over the age of 60 on "standby" at home at 80
percent of their salary until they reach the mandatory retirement
age of 60.(11)
10. On the Corporate Dole: Japan's One Million "Working
Unemployed." Tokyo Business Today, May 1993. p. 10; and Evans,
Robert, Jr. The Japanese Labor Market. In: U.S. Congress.
Joint Economic Committee. Japan's Economic Challenge.
Washington, U.S. Govt. Print. Off., 1990. p. 240-254.
11. Japan's "Full Employment" Myth Bites the Dust. Tokyo
Business Today, May 1993. p. 9.
Firms take these actions in large measure because the Japanese
government, through the Ministry of Labor, favors labor stability
over labor mobility and provides subsidies to firms to
retain their employees.(12) While such measures may have served the
Japanese economy well when it was experiencing rapid rates of
growth in the 1960s, 1970s, and 1980s, these policies likely make
it more difficult for Japanese firms to respond rapidly during
periods of extended slow growth and potentially extend the length
of a recession. In early 1994, the Labor Ministry was providing
subsidies to 4.7 million workers, or about 7 percent of Japan's
work force, in 224 designated industries. This subsidy funds
personnel wages and other costs, including retraining and
transfers. Companies can use the subsidy program for one year and
then reapply for a second year. The Hosokawa government announced
in late December 1993 an enhanced program that pays 80 percent of
certain staff expenses through March 1996 for workers undergoing
retraining.
RESPONSE BY CONSUMERS
Personal consumption--spending by individuals--is a major component
of economic growth, but Japanese consumers are showing little
willingness in leading the economy out of its recession. Despite
the measures taken by the Japanese government and businesses,
Japan's official unemployment rate reached 2.9(13) percent in
December 1993. Also, the sluggish economy has caused firms to
reduce the semiannual bonuses they give their employees, reducing
discretionary spending by consumers.(14) As figure 5 [PLEASE
CONTACT GATEWAY JAPAN FOR THIS FIGURE] indicates, wages and
salaries have declined, and consumer spending in large retail
stores, an indicator of consumer confidence and consumption
behavior, has dropped annually since 1991. Consumers also have
grown concerned over job losses or layoffs as the number of jobs
available to the number of those seeking jobs fell to 0.6 in
December 1993. What this ratio means is that for every ten persons
seeking employment, there were only six jobs available. This is a
sharp contrast from the late 19808 when the ratio was 1.4, meaning
that for every ten persons seeking jobs, there were 14 jobs
available. In 1994, Japan's labor unions, which traditionally
have pushed for wages increases, are pressing instead for job
security.(15)
12. Suzuki, Yasuhiro. Labor Ministry Criticized For Narrow
Jobs Focus. The Nikkei Weekly, January 24, 1994. p. 1.
13. According to analysts with the U.S. Department of Labor,
Japan's unemployment rate is only slightly underestimated in
relation to most U.S. concepts. These analysts attribute the
underestimation to differences in institutions, attitudes, and
economic and social structures which tend to push Japanese
slack labor into underemployment and hidden unemployment.
However, when Japan's unemployment rate is recalculated to
incorporate workers that are underutilized or discouraged
(persons outside the labor force who want a job, but are not
seeking one because they believe their search will be futile),
Japan's unemployment rate jumps from 2.9 percent to the range
of 8.0 to 11.0 percent. Sorrentino, Constance. Japan's Low
Unemployment: An In-Depth Analysis. Monthly Labor Review,
March, 1984. p. 18-27; Sorrentino, Constance. Japanese
Unemployment: BLS Updates Its Analysis. Monthly Labor Review,
June 1987. p. 47-54; Sorrentino, Constance. International
Comparisons of Unemployment Indicators. Monthly Labor Review,
March 1993. p. 3-24.
14. Sumiya, Fumio. Year-End Bonuses Expected to Fall for 2nd
Straight Year. The Nikkei Weekly, Dec. 6, 1993. p. 1.
15. Kato, Hidenaka. Job Security Moves Up on Agenda. The
Nikkei Weekly, January 17, 1994. p. 2.
The prolonged recession and poor retail performance are starting to
affect Japan's retail sector in ways that may benefit Japanese
consumers and foreigners attempting to export to Japan as the
economy recovers. Consumers are starting to benefit from the effect
an appreciating yen has on lowering prices of imported goods and
from discount retail prices,(16) although such changes are
unlikely to be a prime source of recovery. Some retailers also are
starting to offer Japanese consumers discounted prices on their
regular merchandise, and lower prices on imported goods are
beginning to filter through Japan's tightly controlled distribution
system. Japan's utility companies, for instance, import most of
their fuel and, therefore, have seen their costs fall as the yen
has appreciated. The utility companies, however, still calculate
their energy costs at rates similar to those in 1989, when the yen
was 124 to the dollar, compared with the current rate (March 1994)
of about 103. As a result, the average Tokyo household is spending
$600 to $700 a month on utility charges (water, electricity, and
gas).(17)
16. Japanese manufacturers are prohibited by law from imposing
minimum prices for their products on wholesalers or retailers,
termed resale price maintenance. Despite this prohibition,
resale price maintenance is alleged to occur quite widely in
Japan's distribution system, to support prices and profits for
Japanese manufacturers. See: U.S. Library of Congress.
Congressional Research Service. Japan: Resale Price
Maintenance. Report No. 91-289 E, by Dick K. Nanto.
Washington, 1991.
17. Thomson, Robert, and William Dawkins. A Sorry Spectacle in
Tokyo. The Financial Times, February 16, 1994. p. 15. |
