Japan as Number Three
The envelope was stiff with ice. It sat in the icebox of the Tokyo house I moved into in the winter of 2001. On it, in neat, handwritten characters, were the words ‘Cat Money’. Inside, as crisp as the day they were printed, were three Y10,000 notes, at the time worth around $250. The envelope in question had been left by the previous residents of the house in Higashi Kitazawa, a lovely, upper-middle-class neighbourhood of little lanes, topiary pine and walled-off homes in central Tokyo. Sometimes, when they were gone for the weekend, they would ask neighbours to look after the cat. The money was for anything the indulged feline might require while they were away.
Two things occurred to me about the cat money. The first was how expensive it appeared to be to feed a pet in Tokyo. Many people in the capital, even in those supposedly straitened times, maintained an extravagant attitude towards money. Certainly, well-to-do Higashi Kitazawa, known for its artists and authors, was not typical of Tokyo living standards, let alone those of Japan’s more economically depressed regions. Still, I had been struck by how willing even ordinary people – secretaries, students, telephonists and office workers – were to spend quite large sums on little luxuries. Some seemed happy to splash out $200 per head on an exquisitely prepared meal or $400 a night per person for a room at a hot-spring resort. Luxury goods makers such as Louis Vuitton had made a killing in a country where young women would line up for hours just for the privilege of purchasing an overpriced handbag. Naturally, such outlays were only occasional. Naturally, too, many Japanese – including the increasing number without work, those retired on meagre pensions or people in the new category of ‘working poor’ – could never afford such items. Japan felt much more economically divided than before. Even so, though I arrived in what was said to be the midst of a deep recession, many Japanese appeared to have a lot of money. A visiting MP from northern England, on seeing the bright lights of Tokyo and throngs of people waiting outside overflowing restaurants and bars, remarked, ‘If this is a recession, I want one.’
The second thing that occurred to me was less obvious, but more important. Although the cat money lay forgotten in the refrigerator, it was actually appreciating in value. Because of the deflation that had been gnawing at prices since the mid-1990s, the crisp notes could acquire more goods the longer they remained in their frozen vault. If, for example, someone had stashed Y100,000 in the fridge in 1995, by 2012 its purchasing power would have risen to Y112,000. By contrast, if that money had been invested in the Japanese stock market, it would have halved in value to just Y50,000.1 At the time I moved to Higashi Kitazawa, the interest rate on a typical Japanese savings account ran to a derisory 0.01 per cent. That made the refrigerator a better bet than the high-street bank, since the refrigerator had neither withdrawal charges nor account fees.
I came to think of the cat money as a metaphor for the strange, almost Alice in Wonderland state into which the economy had slipped since the burst of the bubble. Because of prolonged deflation, normal economic assumptions no longer applied. Companies didn’t want to borrow money even if they could do so for free. A worker’s wages might fall, but he or she could still feel better off. In a normal economy, it made no sense to hoard cash. Besides the risk of theft – admittedly negligible in Japan – the value would be constantly eroded by inflation. In Japan it was the reverse. The longer you held cash the more it was worth. For years, the central bank had kept interest at zero in a losing effort to get prices moving. They kept edging downwards anyway. ‘We’ve been suffering deflation for twenty years and no doctor has diagnosed it,’ one frustrated Bank of Japan official told me. The Japanese had a similar concept to my cat money, though they spoke not of the icebox but of tansu savings, named for the traditional wooden chests in which they kept their kimonos and family heirlooms. One economist calculated that by 2003 as much as $300 billion – roughly the annual output of Denmark – had simply vanished into people’s cupboards and under their futon mattresses.2
No economy can function properly when all the incentives are to hoard cash. ‘The most significant fact about Japan is that prices are falling,’ Martin Wolf, a celebrated economics commentator, once wrote. For him, deflation was the root of all Japan’s post-bubble evil. Deflation was ‘a sorcerer’s apprentice of debt – a machine for making a bad situation worse’.3 If prices are falling, past debts – including the national debt – get progressively larger relative to current income. That is the opposite of what happens in a normal economy when mild inflation steadily erodes the value of past borrowings, making it easier to pay off a mortgage, a business loan or government borrowing. With deflation, debts incurred in the mad bubble years became increasingly hard to repay, clogging up the banking system with the detritus of long-forgotten exuberance. Companies stopped borrowing to invest, concentrating instead on paying back loans. Besides, if future revenues were to be continually worn away by the drip-drip of deflation, debts taken on today would inevitably become harder to repay in the future. Deflation was sapping what economists call ‘animal spirits’, the expectation of future growth that encourages investment and risk-taking. ‘If Japan cannot ever get out of deflation,’ says Takatoshi Ito, an economist at Tokyo University and former government adviser, ‘that means stagnation and slow death, right?’4
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Deflation may be the underlying cause, but the litany of economic woes now associated with Japan does not stop there. While thirty years ago the country inspired awe as an economic trailblazer, today it is more likely to elicit a sorrowful shaking of the head. Among bankers and businessmen especially, ‘What has happened to Japan?’ has become a common refrain. So low has its economic reputation sunk that Japan has even become a verb. Like Americanization, we now have ‘Japanization’, at least on the pages of the business press. But unlike Americanization, which carries both positive and negative connotations, Japanization is all bad. It means to stagnate, to shrink, to stop competing, to lose one’s entrepreneurial and industrial edge and to be crushed by a mountain of debt. It means to suffer permanently falling prices. It means a stock market that hasn’t budged for years and property prices that make the US housing market look buoyant. It means a shrinking population, fading international visibility and domestic policy drift. It means lack of innovation, insularity and a broken political system. Ultimately, it carries with it, as Ito says, an intimation of death. An economy that cannot grow surely must eventually die. One so indebted must eventually default. Japanization is a disease that no other nation in its right mind would wish to catch.
Such an interpretation – the strong consensus – is overblown. Japan’s policymakers have undoubtedly made many mistakes and its economy has fallen into a rut. High public debt and rapid ageing do, as pessimists suggest, make the future uncertain and, quite possibly, not all that rosy. But Japan’s economic performance has not been as grave as the economic obituaries make out. As we shall see, measured in per capita terms and accounting for deflation, Japan’s growth compares reasonably well with that of other rich nations. It has also managed to maintain a level of social cohesion, reflected in fairly low unemployment and extremely low crime, that contrasts with the social friction in supposedly more successful economies. Certainly, the go-go years of the 1980s, when the Japanese were living a credit-fuelled fantasy, are gone. Its economy overshot, crashed and has paid the price in subdued growth ever since. That much is true. Before long, though, we could be saying much the same thing about the once credit-enhanced economies of the US and Europe, still struggling several years after the 2008 financial crisis.
In one sense, Japan’s slowdown tells an obvious story. It is much easier to catch up with rich countries than to overtake them. Predictions in the 1980s that Japan’s economy would outstrip that of the US were always implausible. Now that Japan has fallen, there is a hint of Schadenfreude in seeing an upstart challenger brought low. The Japanese compounded the problem by believing the hype themselves. The drunken salaryman giving the western visitor a bar-stool lecture on Japanese superiority is a cliché for a reason. Edwin Reischauer, a scholar and former ambassador to Japan, once said jokingly that Japan as Number One, the 1979 book proclaiming Japan’s formidable strengths, should be required reading in the US – and banned in Japan.
If we take a longer-term view, Japan’s post-war economic performance remains impressive. Its income per head5 jumped from a fifth of US levels in the 1950s to nearly 90 per cent in 1990, a spectacular, indeed unprecedented, catch-up. Japan is the only Asian economy, outside the city-states of Singapore and Hong Kong and the smaller countries of Taiwan and South Korea, to break out of what economists call the ‘middle-income trap’. By comparison, China is still at about one-fifth of US income per head, roughly where Japan was in the 1950s. It is commonly heard today that China’s leaders are desperate to avoid Japan’s post-bubble catastrophe. The truth is that China will be lucky if it can engineer the same standard of living, quality of life and social wellbeing that exist in Japan today.
It is true, though, that, when the bubble imploded, Japan’s convergence on American living standards went into reverse. By 2010, its per capita income had fallen to about three-quarters of US levels. It is not hard to make the case, then, that Japan entered the economic wilderness in 1990 and has stumbled about in the dark ever since. It has suffered, by this account, not one but two ‘lost decades’ in which its economy has barely grown and its industry has lost its competitive edge. A few data points appear to settle the case. In nominal6 terms, Japan’s gross domestic product – the total value of its output of goods and services – has been treading water since 1991. To be exact, Japan’s economy grew from Y476 trillion in 1991 to Y477 trillion in 2012, an increase of a staggeringly low 0.2 per cent in two whole decades. By comparison, the US economy – again measured in nominal terms – grew from roughly $6 trillion in 1991 to $15.6 trillion in 2012, an increase of 160 per cent. Britain’s economy, which went from £600 billion to £1.5 trillion, did nearly as well, expanding 152 per cent.7
Those nominal figures don’t tell the whole story. But they do explain why Japan is diminished internationally. In the mid-1990s, its share of global GDP was 17.9 per cent, a proportion that had halved to 8.8 per cent by 2010.8 Over roughly the same period, its share of world trade has fallen just as steeply to around 4 per cent. The fact that Japan’s economy has stood still while others have raced ahead (in nominal terms) has a real impact. It affects Japan’s global visibility and influence. It is the reason that, in 2010, China surpassed Japan as the world’s second-largest economy.9 Japan was Number Three. In terms of international prestige nominal GDP clearly counts.
Another measure of Japan’s decline can be found on the stock market pages of any business newspaper. As we have seen, the Nikkei 225 average, which tracks the share performance of Japan’s largest listed companies, peaked in December 1989 at 38,916. By July 2012 it was around 9,000. The fall of share prices, coupled with an equally precipitous collapse of land values – now roughly 60 per cent below their 1991 peak10 – has destroyed wealth, or at least the illusion of wealth, and sapped confidence. If we measure an economy’s performance in terms of returns to investors, again Japan’s performance has been catastrophic. The fall in asset prices also crippled companies and banks, both of which bought shares and property in the 1980s when prices were in perpetual upward motion. Banks extended loans to companies in return for collateral backed by overvalued land. When prices collapsed, the fantasy was exposed. As well as being saddled with bad loans, many banks owned huge portfolios of near-worthless shares. Since those shares were counted as capital, it left banks effectively bankrupt. Rather than owning up, most maintained the fiction their loans were good. Some even lent money to indebted companies so they could repay interest. The banks and their borrowers were like two drunks leaning up against each other for support. As a result, banks virtually stopped lending to new businesses. That made sense for individual institutions. For the economy as a whole it was disastrous. In the ten years from 1995, total bank loans shrank by a third.11 By 1997, the crisis bubbled into the open and some large institutions started collapsing.
Even if banks had wanted to lend, companies were in no mood to borrow. When they realized the good times were over – and many assumed for years that the stock market crash was a blip – they battened down the hatches. Companies cut overtime, bonuses and even wages. That took money out of the pockets of consumers, exacerbating a chronic lack of demand. Today, businesses hire far fewer permanent staff, taking on lower-paid part-time workers instead. As a result, nearly one in three Japanese employees is now temporary, compared with one in five in 1990. The creation of a labour underclass is hardly unique to Japan. But it has wounded Japan’s sense of having an egalitarian society and put a cap on consumer spending.
Tadashi Yanai, president of the clothing company that makes the Uniqlo brand and a specialist in provocative statements, told me, ‘Japan is shrinking. It will become like Greece or Portugal.’ In their comfortable affluence, the Japanese were living a fantasy, he said. ‘People who believed that they were middle class will realize they are poor. Japan has been in a slump for twenty years. So that day will come soon.’12 Many outsiders agree with his assessment. Not untypical was the prognosis of Nicholas Eberstadt, a political economist at the American Enterprise Institute in Washington, who went so far as to suggest that Japan’s young and old alike should consider abandoning their blighted archipelago altogether. ‘Given the cost of ageing, Japan might establish “health care colonies” in places like India or the Philippines, spots where large populations of elderly Japanese could enjoy a good quality of life at a fraction of the cost at home,’ he wrote cheerily. ‘Younger Japanese, for their part, might find it attractive to embrace new opportunities abroad, rather than stay in a shrinking, dying Japan.’13
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Viewed through a different lens, Japan’s post-bubble experience has been less ghastly. First, let’s look at growth on a real basis, adjusted for inflation and for population. That is a sensible thing to do if we want to know how individual Japanese have fared. Adjusting for inflation – or in its case deflation – makes Japan’s numbers look better. That’s because deflation means people can afford to buy more with the same amount of money. Japanese incomes may have been falling, but the price of everything from newspapers and haircuts to housing and sushi have been stuck at 1981 levels.14 Likewise, Japan’s population has not grown much in the past twenty years. Since 2007, it has even started shrinking, albeit still very slowly. Some countries look ‘richer’ in aggregate merely because their population has grown. But unless growth outstrips population increase, individuals don’t feel better off. So, if we’re interested in standard of living rather than investor returns, we should look at growth on a per capita basis.
In nominal terms, you’ll remember, Japan’s economy has barely budged in two decades, while the UK and US economies have grown 152 per cent and 160 per cent respectively. Much of that increase, it turns out, is down to the simple fact of rising prices and a growing population. Adjusted for both, Japan still underperforms, but not by nearly as much. If the size of the three economies in 1989 is rebased at 100, Japan’s economy reached 127 by 2013, compared with 137 for the US and 144 for Britain.15
Japan had a genuinely lousy 1990s. But it turns out that, relative to other rich countries, the last decade has not been quite so bad. As we shall see in the next chapter, during the years Junichiro Koizumi was prime minister (2001–6), the country actually went through a mini-growth and productivity boom. Even after the Lehman shock, which devastated Japan’s export markets, and the tsunami, which destroyed production and hit the energy supply, remarkably Japan has done marginally better than either Britain or the US on a real per capita basis in the past decade. Expressed as an average growth rate, Japan’s real per capita income has risen 0.9 per cent a year since 2002. That compares with 0.8 per cent for the US and 0.7 per cent for Britain and 0.5 per cent for Norway. If we are to describe Japan’s past decade as ‘lost’, perhaps fairness dictates that we do the same for both the UK and the US.16
Other numbers also suggest Japan has not done quite as badly as widely assumed. Unemployment, 4.1 per cent at the end of 2012, never rose above 5.5 per cent even in the dog days of recession. That is much higher than the full employment Japan is used to, but it compares favourably with other advanced countries. According to statistics from the Organisation for Economic Co-operation and Development, in March 2012 the US had a jobless rate of 8.1 per cent, France 10 per cent and Spain a massive 24.1 per cent.17
Sceptics, pointing to overstaffed Japanese construction sites and department stores, argue that headline numbers hide underemployment. That is true. In more market-oriented societies, excess workers might indeed have been sacked. Instead of the company paying them, they would then have needed support either from the state or from their family. Japan’s low unemployment is, then, arguably achieved at the cost of suppressing productivity or, to put it another way, subsidizing work. One can disagree with such a policy. Shareholders would undoubtedly prefer companies to increase profits by laying off workers. But Japan’s ‘stakeholder’ capitalism, which has similarities with continental Europe, is a legitimate policy option. The Anglo-Saxon model, which favours capital above labour, has sometimes helped investors at the cost of higher unemployment.
Economists might counter that the reluctance to sack workers hampers creative destruction. Only by allowing uncompetitive businesses to fail can labour be directed to more productive parts of the economy. There is some truth to that. Japan’s ‘zombie banks’ have indeed propped up ‘zombie companies’. But different economies reorganize in different ways. In Japan, there has been more corporate restructuring than is widely recognized, often behind closed doors and with less resort to bankruptcy or hostile takeovers. This may be slower and less efficient than in more market-oriented economies. Yet persistently high, and long-term, unemployment may be the inevitable price of the creative destruction process in many western countries – certainly if sacked workers are not properly retrained to move into new industries. In Japan, the industrial re-engineering process, though slow, and perhaps inadequate, is more likely to take place within a large company, at least for those fortunate enough to have a full-time job. Thus Canon shifted its emphasis from cameras to photocopiers without being taken over by a rival company or private equity firm and broken up as might have happened in a more aggressively capitalistic country. Japan’s low unemployment figures, sceptics will point out, also mask ‘discouraged’ workers, who do not bother looking for non-existent work. Nor do they tell the story of high youth unemployment, now at 8 per cent. Such phenomena, though, are hardly unique to Japan. The headline unemployment numbers may disguise the true picture, but they are broadly comparable across nations. However you make the comparison, Japan has lower unemployment than most advanced economies.
Japan has never been quite as egalitarian as it likes to think, but its income gap has widened less sharply than in some other advanced nations. In the US, the top 1 per cent of earners has captured nearly all the economic gains of the past thirty years.18 Everyone else has stood still or fallen behind. The same is broadly true of Britain, where the share of the top 1 per cent of income earners rose from 7.1 per cent in 1970 to 14.3 per cent in 2005. That means that most of the growth in the UK and the US has brought little benefit to the bulk of the population. In Japan, what growth there has been has been more evenly distributed. In the mid-1990s, the average income of the top 10 per cent of Japanese was eight times higher than the bottom 10 per cent, a ratio that widened to ten times by 2008.19 Japan’s inequality has widened, but not to the extent of many other nations. Nor has its equality deteriorated as much as the Japanese themselves imagine. Yoshio Sugimoto, emeritus professor at La Trobe University in Melbourne, says the fast-growth years produced an ‘optical illusion’ of equality since everyone was moving up the escalator. Now the escalator has stopped, he says, ‘it becomes difficult for the illusion to be sustained’.20
Quality of life is hard to quantify. It is also largely subjective. But in some measures, Japan does extremely well. One is the safety of its citizens. By international standards, Japanese crime rates are ridiculously low. In Japan – where it is an offence to own a gun, another to own a bullet, and a third to pull the trigger – you are ten times less likely to be murdered than in the US.21 You are thirty-six times less likely to be robbed.22 Dropped wallets are almost invariably returned, cash untouched. Violent crime is very rare. Japan feels safe not because all the criminals are locked up. In fact, Japan imprisons very few people. It has some 80,000 prisoners compared with 2.3 million in the US.23 Even as the country’s economy has slowed, its society has held together remarkably well. In 2009, newly laid-off workers built a ‘tent village’ amid the fountains and shrubbery of Hibiya Park to draw attention to their plight. But there have been no sprees of burning and looting as there were on the streets of London in 2011, nor the mass demonstrations prompted by a collapse of living standards seen in Greece and Spain.
One mustn’t get carried away. To say Japan has done better than generally acknowledged is a useful antidote to some of the more hysterical analysis. That is not to say everything has been fine. Far from it. Japan has gone from being the fastest of catch-up economies to an also-ran among mature ones. That has caused national soul-searching at home and lessened Japan’s prestige abroad. ‘A nation is happiest when you are chasing someone and there’s no one behind you,’ says Richard Koo, a well-known economist resident in Japan. Since the bubble burst, Japan has stopped chasing, he says. ‘It’s been pretty horrible.’24
We must also take into account the huge public borrowing, which has softened the blow for the current generation but left a huge bill, and a potentially massive problem, for future ones to deal with. In the words of one economist, ‘Living standards have been propped up by an unsustainable accumulation of debt.’25 Japan’s ‘solution’ to its slowing economy has tended to favour the older over the young. Deflation has preserved the savings of baby-boomers at the expense of creating a vibrant economy for younger generations. In a later chapter we will see how youth, deprived of the certainties and the job opportunities enjoyed by their parents and grandparents, has borne the brunt of Japan’s strung-out economic adjustment.
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In 2005, the finance ministry helpfully drew my attention to the fact that, if Japan’s debt were stacked up in Y10,000 notes, it would reach 1,400 times higher than Mount Fuji. Why anyone would want to do such an odd thing was never adequately explained. But the point was clear: Japan’s debt mountain was unsustainably high. That was back then, when gross public debt amounted to Y538 trillion, about $4.5 trillion at the time, and equal to 150 per cent of Japan’s GDP. The government was constantly adding to the pile. For every Y100 it was spending, it was obliged to borrow Y40 by issuing yet more debt, since taxes – depressed by years of deflation and non-existent nominal growth – were insufficient to meet its spending needs. Now it is borrowing even more. By 2012, more than half of what the government spent was being borrowed. Gross public debt had ballooned to more than 230 per cent of GDP.26 I didn’t dare go back to the finance ministry to discover how high the debt mountain reached now.
‘Things that can’t go on for ever, don’t,’ an old economists’ adage has it. As long ago as 1999, Japan’s then prime minister Keizo Obuchi pronounced himself the ‘king of the world’s debtors’.27 Debt as a proportion of GDP has more than doubled since then and some economists believe it is only a matter of time before the whole house comes crashing down. For several years, the ratings agencies have put the country on notice. A decade ago, Moody’s infuriated Japan by downgrading its sovereign debt – an assessment of the likelihood of defaulting – to the same level as Botswana.28 More recently, ratings agencies downgraded Japanese debt again. Standard & Poor’s, which in 2011 caused a furore by removing the US AAA rating for the first time in seventy years, gave Japan an AA-minus rating. That still meant Japan had between a ‘very strong’ and a ‘strong’ capacity to meet its financial commitments. But the downward trend suggested its position was becoming less tenable. Moody’s went so far as to say that the shock to the economy of the March 2011 tsunami and the vast rebuilding costs could push Japan’s bond markets towards a ‘tipping point’. Kaoru Yosano, the minister of economic affairs whom I met in his office in the immediate aftermath of the earthquake, warned that Japan ‘faced a dreadful dream’.29 Ito of Tokyo University said issuing more and more bonds merely staved off the inevitable. The fundamental problem was that the government spent more than it raised in taxes. ‘Who is going to pay?’ he asked. ‘You can’t just keep shifting it to the next generation.’30 Ito had long been a thorn in the side of the Bank of Japan, urging it to set an inflation target. Modest inflation, he argued, would help Japan to float off the rocks of perpetual deficit. In a normal economy, public debt would fall as the economic pie grew. One of the main reasons Japan’s debt had risen so quickly as a percentage of GDP was that nominal GDP itself had been stuck in a rut – at 1990 levels.31
However it got out of its current bind, Ito said, Japan would not be able to rely for ever on the huge savings amassed by previous generations. As things stood, those savings provided the state with an easy source of cheap finance. Companies and individuals deposited savings in banks – when they were not under the mattress, that was. The banks, in turn, bought government debt. Ito said that merry-go-round couldn’t go on indefinitely. Pensioners would start to spend down their savings, reducing the pool of assets to be recycled. Younger people were saving less. ‘Once you hit a ceiling, it is all quite easy to unwind. And once people start selling [government bonds], the prices will go down, there’ll be more selling and the price will go down further.’ Then there would be capital flight as Japanese rushed to safety overseas. ‘It’s a giant Ponzi scheme. I think the end is near.’
That is plausible. Yet people have been saying much the same thing for years. The markets – imperfect though rational people must now accept them to be – have resolutely refused to endorse this pessimistic view. Bond prices have not crashed as so long predicted. Instead, they have done quite the reverse. The markets regard Japanese government bonds not as a time bomb but as a safe haven. As bond prices have risen, yields have fallen. The Japanese government can borrow money for ten years at below 1 per cent, more cheaply, says Peter Tasker, a Tokyo-based strategist, than any government since Babylonian times. That means Japan’s debt repayments are actually pretty low. ‘For the past decade the Japanese bond market has been making monkeys out of not just the credit rating agencies, but also academics, trigger-happy short sellers [who seek to profit by selling Japanese bonds] and politicians and bureaucrats who see fiscal austerity as a virtue in its own right,’ Tasker says. ‘All have been proclaiming that out-of-control public debt has set Japan on the road to fiscal perdition.’32
One reason things haven’t blown up yet is that, contrary to common perception, Japan is far from being the world’s biggest debtor. In fact, it is the world’s biggest creditor. It has vast claims on foreign assets. According to Jesper Koll, an economist at JP Morgan who calls himself ‘the last Japan optimist’, every week $4 billion more flows into Japan than flows out. The country’s private sector runs a financial surplus large enough to cover the government’s deficit and still have plenty of capital to export abroad. Japan’s much talked-about public debt, then, is not money that Japan owes the rest of world, but money that the government has borrowed from its own people. For most of the past two decades nearly 95 per cent of Japanese debt was domestically owned, although this had fallen (perhaps worryingly) to a record low of 91 per cent by 2013. Still, in the case of Greece and nations that have defaulted in recent years, such as Argentina and Russia, most of their debt was owed to foreigners who wanted their money back. It is possible that Japanese banks and individuals will also develop a sudden craving for their cash. Yet, even at that point outright default is unlikely. One way the Japanese state could default over time would be to cut pension payments or health benefits, something that – in common with governments everywhere – it has begun to do. If push came to shove, the government could also resort to the aggressive use of the printing presses, hoping to float the debt away through inflation. The danger would be that inflation might get out of hand, turning into hyperinflation.
Still, nothing of the sort has happened yet – not, anyway, until Shinzo Abe came along with his deflation-busting plan in 2013 (see Afterword). And with prices still falling, it seems premature to worry about excessive inflation. Some economists have even gone so far as to argue that Japan’s debt pile is not so bad, but actually evidence that the government has been doing more or less the right thing. Richard Koo, an economist at Nomura, talks about a ‘balance sheet recession’.33 As he sees it, ever since the bubble burst in 1990, massively overstretched companies have dedicated themselves to paying down debt. Even those that have managed to restore healthy balance sheets are so traumatized they have no more desire to borrow or invest. Their unwillingness to borrow makes conventional monetary policy useless. Richard Jerram, now chief economist at Bank of Singapore, compared Japan’s failure to reboot the economy through monetary expansion to a pub where endless free beers are lined up at the bar, but whose customers are so past the point of inebriation, they are in no mood to imbibe further.
We should not forget the magnitude of the shock caused by the bursting of Japan’s bubble. According to Koo, so deep was the fall in land and equity prices that it cut the value of all Japanese assets by a sum equal to 2.7 times the country’s entire 1989 GDP. That is bigger than the loss sustained by the US after the 1929 Wall Street crash.34 For all its problems, in Japan there has been no Great Depression. The big mistake was allowing the bubble to inflate and pop in the first place. But having done so, according to this reading, Japan’s authorities were correct to compensate for a massive fall in private sector spending by ramping up government spending and loosening monetary policy. It is a classic Keynesian argument for counter-cyclical spending.
For many years, arguments about Japan’s strange economic circumstances were a matter mainly for Japanese specialists and academic economists. That is no longer the case. After the collapse of Lehman Brothers and the subsequent global financial crisis, nearly every western government faces similar problems to Japan. They too are suffering balance sheet recessions. Their companies and households have also stopped spending. Their central banks have lowered interest rates to practically zero and started printing money to buy bonds, a policy known as ‘quantitative easing’ that was pioneered by Japan from around 2003. In seeking to learn the lessons of Japan, economists have drawn diametrically opposite conclusions. The debate has been particularly shrill in the US, which now has gross public debt above 100 per cent of GDP and, like Japan, borrows more than 50 cents for every dollar it spends.35
At the Republican National Convention in Tampa in 2012, a giant clock showed the national debt ticking ever upwards towards $16 trillion. Mitt Romney, the Republicans’ presidential candidate, even said the US should consider a return to the gold standard, a policy that would severely restrict the Federal Reserve’s ability to print money. Many Republicans have also opposed spending to compensate for the fact that the private sector is in sharp retrenchment. In a Wall Street Journal opinion piece called ‘Arigato for Nothing, Keynes-san’ (‘Thanks for Nothing, Mr Keynes’), the US business newspaper said the lesson of Japan was that Keynesian fiscal stimulus didn’t work, precisely the opposite of Koo’s conclusion. Japan was a ‘rebuke to those who argue Keynesian sprees help unleash private-sector-led growth down the road’.36
Japan’s debt, however, has not risen primarily because of spending on ‘bridges to nowhere’ as its critics often say. Undoubtedly, there has been some of that, though most such spending happened before the bubble burst, not after. Big stimulus packages ended in the late 1990s. Under Koizumi, as we shall see in the next chapter, public works spending was sharply scaled back.37 In fact, there are two main reasons for Japan’s ballooning debt: falling tax revenues and the stagnation in nominal GDP. Government tax revenues have halved since 1990, an extraordinary fact that reflects the prolonged slump in nominal growth – a sign of how damaging deflation can be. The pay of many workers has fallen below the income tax threshold, corporate tax revenues have dropped and the slump in land prices has hit inheritance tax. That suggests that Japan’s main problem has not been too much spending (and printing), but too little growth. With the mildest of inflation over the past fifteen years, Japan’s debt problem would not look nearly so bad.
Paul Krugman, the New York Times columnist, is famously on the Keynesian side of the debate. In one column he characterized the ‘debt worriers’ in his country as misunderstanding the nature of national debt. They thought of it as if a family had taken out a mortgage it would have trouble repaying, he wrote. That was a bad analogy. While families had to pay back their debt, governments didn’t. All they had to do was ensure that their debts grew more slowly than their tax income – precisely what Japan has failed to do. US debt from the Second World War was never repaid, Krugman said. It just became increasingly irrelevant as the economy outgrew it.38
Some economists regard Krugman’s analysis as fantasy. For Japan, like the US, they argue, the only way back from perdition is to cut government spending and raise taxes. Cranking the printing presses will merely lead to hell down the road. In Japan’s case, one reason for saying that is the assumption that it has a bloated state, with an overly generous social security system and an unsustainable penchant for laying concrete. Money is wasted, no doubt. But the size of the Japanese state is not especially big compared with other advanced countries. According to the OECD, general government spending, which includes central and local outlays, was 43 per cent in 2013. That compared with 40 per cent in the US, 47 per cent in Britain and an average of 49 per cent in Europe. Still, no state can go on for ever spending more than it can raise in revenue. Japan’s finance ministry has been advocating higher taxes for years. Political realities and economic emergencies mean it has mostly not had its way, although the government of Yoshihiko Noda, prime minister from 2011 to 2012, passed legislation preparing for a doubling of sales tax to 10 per cent by 2015. ‘Our thinking is that economic growth and fiscal consolidation are compatible rather than contradictory,’ Koji Omi, a former finance minister, once told me.39 The logic is that, if the public knows the national finances are on a sound footing, it will be less inclined to make precautionary saving and more relaxed about spending.
Japan has never been able to test out that hypothesis since it has never got its fiscal situation under control. But in Britain, David Cameron’s government put the theory into practice by implementing what has been called ‘pre-emptive austerity’. Rather than increasing government spending to counteract the effects of falling private investment, it has sought to cut expenditure.40 So far the results are not encouraging. By the summer of 2012, Britain’s GDP was marooned at 4.5 per cent below its 2008 peak and the country had entered a double-dip recession. (It’s true that by this time Japan was into recession number three.) Anatole Kaletsky, an economics commentator, declared the UK’s experiment in fiscal tightening a failure. From 2010, when Cameron’s government started cutting, Britain’s performance diverged sharply from the US, which had continued to relax its fiscal policy. Since the UK adopted austerity, the American economy had done almost three times better, Kaletsky wrote. As a result, Britain’s debt had risen more as a proportion of a diminished GDP. His conclusion was that ‘any country determined to control public borrowing should forget about fiscal austerity and instead do everything to grow as fast as it can’.41
So what, if anything, should the Japanese government have done differently to revive its flagging economy? It has been lambasted for ponderous policy decision-making, but there is no clear consensus, even among professional economists, as to quite what it should have done. It’s a little like the Woody Allen joke about the restaurant with lousy food and overly small portions. Japan should have moved faster, though there is no real agreement as to which direction it should have taken. The sharp divide in opinion about how the US and Europe should tackle their own economic crises suggests that, even today, we don’t really know – even with the benefit of twenty years’ hindsight. Should Japan have cut spending and refrained from printing money? Or should it have printed and spent with greater abandon?
Of course, there were other steps it could have taken to breathe life into the economy, whole swathes of which were protected for the benefit of vested interests. As we shall see, even Koizumi, the only prime minister to take on the issue seriously, was better at talking about economic revolution than delivering it. ‘What we need are opening and deregulation. Electricity, nursing, childcare, agriculture, fishery, forestry,’ says Sahoko Kaji, the economist at Keio University. ‘We are doing none of it.’42 She thought that Japan’s economy could be spurred to much greater efficiency and innovation through competition if Tokyo allowed the private sector a more unhindered role and signed meaningful free trade agreements with international partners. But because of strong opposition, particularly from the conservative and influential farming lobby, Japan had failed on both counts. Meanwhile, South Korea, a direct competitor, had concluded trade deals with both Europe and the US, giving its manufacturers preferential access to those huge markets.
One clear lesson from Japan’s twenty years of economic difficulties is: don’t get into a mess in the first place. Once the bubble burst in 1990, the government failed to recapitalize the banking system, leaving the Koizumi administration to clear up the mess finally more than a decade later. Many, though, reserve their severest criticism for the Bank of Japan, which they blame for allowing the economy to fall into a deflationary funk. Here the lesson also seems clear: the central bank should have acted earlier and more aggressively, pulling out all the stops until the economy was back on track. It did lower interest rates to near-zero, but since companies didn’t want to borrow, that did little good. The bank, however, refrained from unorthodox policies – such as printing money to buy bonds – until much later. It even briefly raised interest rates in 2001, suggesting it didn’t take the deflationary threat seriously enough.
In 1999, Ben Bernanke, who would later take over the US Federal Reserve, lashed out at Japan’s central bank for what he said was the country’s self-induced paralysis. He urged the bank to experiment more boldly in an effort to stimulate demand and slay deflation. It could, he said, print money to buy government bonds, foreign currency or any number of assets – anything to get things moving. Japan’s central bank did eventually undertake unorthodox measures, even at one stage printing money to buy shares. Some sceptics said the limited effect of those measures proved that quantitative easing didn’t work. Others said it was a case of too little too late. Whatever the faults of Japan’s central bank, Bernanke found dealing with an economic crisis harder in practice than when he was lecturing Tokyo on monetary policy theory. The US recovery has been painfully slow. Four years after the Lehman shock, real median annual household income had fallen 5 per cent.43 Bernanke is said to have privately admitted that he had been too hard on Japan.44