Yen Bloc: Toward Economic Integration in Asia

Chapter 5: Revitalizing the Japanese Economy

The 1990s will be remembered as Japan’s lost decade, with economic growth lagging far behind not only the high level it achieved in the past but also that of other major industrial countries. Several factors contributed to the stagnation of the Japanese economy during this period. Falling asset prices had an immense negative impact on domestic spending; macroeconomic policies failed to restore production to its potential level. The traditional “Japanese model,” which worked so well when Japan was catching up with the West, became impotent once that phase was over. It is also widely recognized that structural reform is essential for Japan to cope with a new environment characterized by globalization, an aging population , and the transition to a postindustrial society. In an attempt to revitalize the Japanese economy, in late 1996 the Hashimoto administration initiated a comprehensive reform program covering six major areas. Led by the financial Big Bang, major efforts were made to enhance competition through deregulation. Japanese companies responded by changing business practices, with more emphasis on the market mechanism as the guiding principle. Mergers and acquisitions (M&As) across corporate groups and national borders, for example, have become a common tool of restructuring. As the new millennium unfolds, there are early signs that the worst may be over for the Japanese economy, with structural reform finally bearing fruit. 83 5 Revitalizing the Japanese Economy    The Aftermath of the Bubble Economy The bursting of the asset price bubble was by far the most important event determining the course of the Japanese economy in the 1990s. At its trough in October 1998, the benchmark Nikkei average index was down to onethird of its peak level, recorded in late 1989 (figure 5-1). Prices of land for commercial use and residential use dropped 70 percent and 45 percent, respectively, since 1991. The government tried to boost the economy with several rounds of fiscal stimulus packages, and the Bank of Japan allowed interest rates to fall to a historic low level. The overall impact on economic growth, however, has been disappointing, with GDP expanding only 1 percent a year between 1992 and 1999 (figure 5-2). The Disappointing Macroeconomic Performance Ten years after the asset price bubble burst, the Japanese economy was still struggling with its aftermath. During the boom years of the late 1980s, banks and other financial institutions provided vast amounts of credit collateralized against land and stocks, whose values surged to levels totally out of line with economic fundamentals. The day of reckoning began in 1990, when stock prices plummeted, soon followed by real estate prices. Most financial institutions were left holding very large volumes of nonperforming loans, forcing them to take a much more cautious stance in extending new loans. Households and companies also suffered immense capital losses, prompting them to cut spending in an attempt to repair their balance sheets. The Japanese economy experienced two recessions during the 1990s, interrupted by two years of relatively strong growth in fiscal year 1995 and fiscal year 1996.1 The second recession was deeper than the first, with the banking sector driven to the brink of a major crisis. The first recession started in 1992 and lasted for three years, with the economic growth rate averaging a disappointing 0.5 percent between fiscal year 1992 and fiscal year 1994. When the economy began to show clear signs of slowing down in 1992, both the private sector and the government perceived the downturn primarily as part of a normal business cycle and expected it to be short-lived. Falling asset prices notwithstanding, capital gains (particularly on assets acquired before the bubble period) and retained earnings accumulated during boom years 1. The Japanese fiscal year runs from April 1 to March 31 of the following year.      10,000 20,000 30,000 40,000 2000 1985 1990 1995 Figure 5-1. Nikkei Average, 1985–2000 Yen Source: Tokyo Stock Exchange. –2 0 2 4 6 2000 1985 1990 1995 4.5 1.0 Figure 5-2. Japan’s GDP Growth, 1985–2000 Percent Source: EPA, National Income Statistics.    were still large enough at this stage for Japanese companies to take a waitand -see stance instead of implementing drastic restructuring. Japanese banks also wrongly believed that their deteriorating bad debt problem would be easily solved as the economy recovered and asset prices picked up again. The authorities were slow in responding to the looming banking crisis partly because they failed...