"The markets can stay irrational longer than you can stay solvent."
- J. M. Keynes
The Japanese economy is one of the largest and most robust economies in the world. It still holds a world ranking of third in terms of GDP (O'Neill, 2020). However, that wasn't always the case - Japan's economy has faced several ups and downs over the years. From the isolationist policies of the Tokugawa era that unified the country in the 16th Century to the Meiji Restoration of the 19th Century and its rebirth and growth after World War 2, the Japanese economy has a long deep history embedded in domestic and international roots. One of the recent events of this economy is its bubble that occurred close to the end of the 1990s. However, the effects of this economic failure persist to this day, despite its solid financial standing in the world economy.
The 3 Pillars of Japanese Success
Our story begins a few decades after Japan's loss in the Second World War. While Japan did suffer from several problems after 1945, it had a strong and "miraculous" economic growth till the 1990s. The common misconception to justify this growth revolves around reasons like 'a dedicated workforce' and 'a sturdy cultural system that encouraged the society to work for the country's good'. No doubt they had a role to play in this growth. But to say that these are the only causes for development is a grave mistake since it ignores the parts played by the government and industries. The three pillars refer to the leading players that had the most significant impact on the economic growth:
I. Government
One of the government's most important decisions was to stimulate the private sector by providing subsidies, protectionist policies and trade expansion incentives.
The government also made a point to invest in human resources such as infrastructure and, most importantly, education. Even today, literacy rates are close to 99%.
II. Workforce
The workforce from the 1950s onwards grew up to be highly skilled and educated, mainly due to the government's human resource investment. Apart from these, Japanese culture gave the society a strong value system and personality development.
The increased skill and productivity of the workforce meant increased productivity. Now, Japan could function on the global market by exporting goods and importing better technologies.
While the workforce was skilled, the companies themselves were highly selective in recruitment. They hired only the most competent and efficient of the crew, further amplifying the output productivity.
III. Large Company Blocs
Popularly known as keiretsu, they refer to Japanese companies of different industries with interlocking business relationships and shareholdings.
They led to higher efficiency since these companies were working together instead of against each other.
A few more points need to be considered, which can't be put precisely under one of the above pillars. One was the influence of the USA on Japan - the currency was fixed at ¥360 to the U.S. dollar from 1949 until 1971 (Japanistry, 2021), providing a considerable boost for exporters. Japan was seen as backward by Western standards, and so, for the early years at least, superior technology could be imported and duplicated. U.S. military presence in the country—especially with the onset of the Cold War—meant that Japan's military spending was comparatively small. On the note of the Cold War, the Korean War (incited by USSR and USA) provided a significant stimulus to Japan's economy due to the demand it created, involving multiple industries.
The Plaza Accord of 1985 (And Effects)
The story of the Plaza Accord of 1985 is relatively simple: the US dollar appreciated, so the States (predictably?) decided to make that everyone's problem. The dollar appreciated by 50% between 1980-85, primarily due to the actions and policies of the Federal Reserve Bank. This meant that USA exports would fall sharply, accompanied by a rise in imports (Clifford & Hill, 2015). To devalue the dollar, the USA signed an accord with other countries like Japan, West Germany, France and the UK at the Plaza Hotel in New York (hence the name). By this accord, the governments would actively manipulate the exchange rate market to depreciate the dollar.
It is crucial to understand Japan's position in the world economy at this point. Not only was it a growing economy, but it was also a growing exporter; 40% of its exports went to Uncle Sam. The devaluation would, and did, have a significant impact on its economy. As the relative value of the dollar fell, exports reduced, and the economic machinery began slowing. It was at this point that the Japanese Central Bank came up with a solution that seemed to make sense at the time but eventually led to economic downfall:
Its first idea was to boost the domestic demand to replace the fall in exports. This would stabilise the economy while also making it self-reliant.
To support this idea, the Bank reduced interest and tax rates, resulting in a rise in the public's spendable income and, consequently, public spending.
The Bubble Expands
In the simplest terms, an economic bubble refers to the phenomenon where the prices of something like stocks, real estate etc., rise very sharply, reaches a peak, and then falls very sharply (Segal, 2021). At that time, Japan was known as one of the world's largest savers and largest creditors. Extensive spending by society was unheard of. However, the tables completely turned with these policy decisions by the Japanese Central Bank. With all the money people had in their pockets, they started investing in stocks and real estate, causing the economy to skyrocket, popularly known as the "Japanese economic miracle".
As the people started to purchase land, its demand began increasing, resulting in a rise in the land rates. The average price of houses rose by 300% just between 1985-89. As a characteristic of a bubble, people do not necessarily behave rationally. There was no proof that the real estate market would continue rising, yet people kept investing money in it and demanding more land. It was a gamble between pulling your money out too early while the market was still rising and pulling out your money too late when the market fall had already begun. At the same time, Japanese companies, who had taken several loans (often to repay previous loans), were losing their competitive edge in the international market and thereby losing out on profits. This meant that company debts kept rising while it was not making enough profits.
Meanwhile, the rise of land prices reached a point where the property cost of the Japanese Imperial Palace in Tokyo (1.15 sq. km) had a greater valuation than the entire state of California (430,970 sq. km). The Central Bank foresaw a looming problem as the younger generations of society could not afford housing or property due to its high rates. The economy had settled into high inflation. To counter this and prevent a disaster, the Central Bank withdrew its expansionary policies and tried to set high tax and interest rates; unfortunately, it was too late - the economy's downfall had already gained momentum.
The Bubble Bursts
Despite the best efforts of the Bank and the Government, Japan fell into a financial crisis two years later, in 1990. The Tokyo Stock Exchange fell by a whopping 23,400 points (60%) as the Japanese people rushed to pull their money out of the market. Due to the economic crash, most Japanese companies faced liquidity and solvency problems. The economic decline continued for another decade.
Of the several attempts to save the economy, the most noteworthy and influential were large-scale capital injections with public funds, temporary bank nationalisations, government bank debt guarantees, and massive liquidity provisioning by the Central Banks. The overall effects of the bubble's burst involved a prolonged decline in the asset prices, a sharp decline in consumption, which resulted in long term deflation in Japan.
Why is the story of Japan's economic bubble so important? It helps put in perspective the current conditions and policies of the Japanese economy. It teaches us the 'how' and 'why' Japan's economy works the way it does. I believe that this story also shows us the fragility of the economy - that the current economic highs (and lows) are often temporary. In 1985, everyone believed that Japan would take over as the world's largest and most powerful economy; nobody predicted the downfall in the 1990s. But more than anything, I believe this is a story inspiration of how a country of such small size and resource base has fought to rise to the top, despite facing such immense adversities. Today, the effects of the bubble are felt only in the form of a slightly stagnant economy. Yet, Japan's market continues to grow and expand. It still stands next to giants like USA and China as one of the world's largest and most robust economies.
REFERENCES
O'Neill, A. (2020, September 29). Japan GDP 1986-2026. Statista. Retrieved October 31, 2021, from https://www.statista.com/statistics/263578/gross-domestic-product-gdp-of-japan/.
Japanistry. (2021, June 12). The Post-War Era & Modern Japan. japanistry.com. Retrieved October 31, 2021, from https://www.japanistry.com/the-post-war-era-modern-japan/.
Crash Course Economics. (2015). Imports, Exports and Exchange Rates. YouTube. Retrieved October 31, 2021, from https://youtu.be/geoe-6NBy10.
Segal, T. (2021, September 8). 5 Stages of a Bubble. Investopedia. Retrieved October 31, 2021, from https://www.investopedia.com/articles/stocks/10/5-steps-of-a-bubble.asp.
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