The Economist on Japan's Economic Recovery

"As Japan emerges from an era of a zero interest rate," the Economist recaps its long economic downturn and its rising prospects for recovery. Here are a few excerpts.

Japan's experience is unique. The country's decade and a half of stagnation stands in bleak contrast to the blistering growth that preceded it and that enjoyed more recently by many other rich economies, notably America. Japan is not alone in having had a banking crisis brought on when an asset bubble burst. America had its “savings-and-loan” mess in the 1980s. Sweden had a crisis like Japan's in the early 1990s. And in 1997-98, a financial typhoon tore through most of Asia. Yet in all these instances, action was, on the whole, fairly swiftly taken to write off bad debts, clean up banking systems and restore economies to growth. By contrast, Japan was mesmerised. For too long, instead of seeking to bring its financial system back to health, it appeared to place its hopes in great dollops of spending on public works to get the economy moving....

Japan was lucky. It began its long malaise as one of the richest societies on earth. But its subsequent performance was abysmal. Between 1990 and 2005, real growth averaged just 1.3% a year. Without the malaise, Japan's GDP would have been about 25% higher in real terms than it is now. In nominal terms, Japanese GDP remains below its 1997 level, thanks to deflation (see chart 1). Over that same period from 1997, the nominal GDP of neighbouring South Korea, which bore the full brunt of the Asian financial crisis, has risen by 65%; America's is up by 50%. Japan's stagnation, then, represents a great squandering of wealth and opportunity....

Why did the recovery not arrive earlier? One reason must be that, with the real level of non-performing loans in the banking system undeclared for so long, huge provisioning by the banks merely aggravated a state of financial disruption: banks could not afford to make fresh loans, even to good prospects. Another related reason is that until the banks had cause to deal with their loans, the troubled companies that had taken the loans out had little incentive to restructure. Japanese companies are now in much ruder health, but that is largely because of measures taken only in the past few years.

At the policy level, the government made two huge blunders. The first was to raise the consumption tax in 1997, which wrecked economic confidence. Just as confidence appeared to be recovering in August 2000, the BoJ declared an end to deflation and raised rates. The economy again went into a tailspin and the bank decided to retreat to zero six months later. But with prices falling, the expansionary effect even of a zero rate was lost, since real interest rates remained positive. A radical new measure was tried by the BoJ: in effect, printing money by stuffing the accounts that banks hold at the central bank with free cash. That super-loose liquidity, known as “quantitative easing”, was withdrawn this spring.