Japan's Lost Decade

By Rishabh Dev Sharma

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Lost Decade refers to the lost 10 years during which the economy of a country goes through economic stagnation. Japanese economy over the period of 1995 till 2007 had fallen 1 trillion in terms of GDP. Thus, often this period is also known as lost score or lost 20 years. In this piece, we will learn about the causes, effect and lessons from the economic stagnation.

Behind the lost decade there were several events which ignited the recession and chronic deflation. But for that we need to understand the Japanese economic bubble. The Japanese asset price bubble was characterised by accelerating asset prices and stock market rise as well as untimely and uncontrolled policy decisions. The events that contributed to the fall of Japanese economy are as follows:

Plaza Accord (1985) which doubled exchange rate of US dollar against Yen, resulting in US exports being more competitive against the export driven economy of Japan. This strengthening of yen brought recessionary effects which incentivized the need for expansionary policy which fuelled the speculative asset price bubble.

Asset Price Bubble (1985-1991) emerged as a cause of the rising land prices. The demand for commercial spaces in Tokyo (Tokyo was important due to high concentration of financial corporations) exceeded supply which resulted in sharp increase in prices.

Stock Prices (1985-1991) in Japan are largely determined by the land prices. The unusual stock market rise was due to the rise in land prices since the corporations’ net assets increased. The soaring land prices fuelled the speculation in the stock market.

Window guidance was a mechanism used by Bank of Japan to dictate excessive loan growth quotas on Japanese banks without considering the quality of the borrower. This added to inflating the bubble to a great extent.

Demographic of an aging population was depended more on traditional banking to acquire funds for businesses which reduced the lending standard which consequently led to the real estate ruling the stock market price.

To counter the speculation over the asset inflation and keeping a check on inflation, the Bank of Japan tightened the monetary policy by hiking the discount rates in late 1989. This tightening caused the bursting of the bubble. Real estate prices plunged, stock markets crashed and banks were debt ridden. Banks were bailed on central bank loans, but this was not the end; the banks again loaned unprofitable businesses and became so debt ridden that even credit was not available.

The after effects were unpleasant with job insecurity with fewer benefits till 2009, with a third of the labour workforce being non-traditional employees. Consequently, real wages had fallen leading to labour inefficiency and real output falling below outputs of countries which were behind Japan before the crisis. Furthermore, continued fiscal deficits lead to the debt-to-GDP ratio being 240% as of 2013. Also, corporate investment which had previously accounted for 22% of GDP fell enormously due to balance sheet recession. In addition, the liquidity trap persisted because the consumers had no confidence that they can earn return by investing, thus deflation and low growth of the economy continued due to debt deflation.

Many economist blame Japan’s Government and the Bank of Japan for their inefficiency in handling the crisis. The uncertain economic environment around the globe and uncontrolled and untimely expansionary and contractionary policy decisions by the Government and Bank of Japan ultimately caused the deflationary environment that plagued Japan in the 1990’s.

Now, it has been around 30 years and Japan still feel the effects of Lost Decade. There was a need for reformation of the economic structure. In 2012, PM Shinzo Abe introduced ‘Abenomics’ which focussed on three pillars which were raised by Japan’s lost decade. These were deflation, workers aggregate productivity and the demographic issue. Abenomics has been successful in many ways as Japan’s currency is now around 30% cheaper than it was in 2012. Nikkei 225 is up more than by 150% , Japan’s GDP has risen, Private investment has gone up by 18%, employment has also increased, whilst unemployment had fallen to 2.7%.