Why did the Japanese miracle crash in 1990? How could the same system deliver such strong growth for 35 years and fail to recover after 1990?

Japan is renowned for its bullet trains, electronic gadgets, anime and comics, vending machines, frequent earthquakes, charming Geishas, and the colossal Mt. Fuji. The country suffered catastrophic damage at the hands of allies during World War II but went on to become one of the world’s largest economies since the same allies that devastated Japan granted them unrestricted access to their markets to aid in the country’s reconstruction. Between 1955 and 1973, Japan saw an average yearly growth rate of 9%, which was an economic miracle, especially for a war-torn country. From 1973 to 1990, it grew at an average annual rate of 4%, and this sum of three decades of economic success transformed Japan into a financial superpower. This era might be described as Japan’s golden age, since the country dominated sectors, including autos, semiconductors, entertainment, and consumer electronics, which ranged from cameras to video games and walkmans to pocket radios. Japan’s businesses prospered, paid on a piece-work basis, and most importantly, people’s living standards improved and their savings increased. Japan attained a GDP close to that of the United States at the time, which was remarkable for a country with half the population of the United States and a population smaller than the state of California. Japan’s extraordinary growth rate inspired hopeful forecasts that it would eventually surpass the US economy to become the world’s largest economy. However, that did not happen; instead, the country suffered an economic crisis that brought growth to a standstill. So, what went wrong? This piece is going to analyze how a policy introduced by the Bank of Japan of increasing the interest rates on loans acted as a catalyst for the fall and stagnation of the unprecedented growth of the Japanese economy. I am going to start with an agreement called the “The Plaza Accord” made between the United States and its close allies which included Japan to lower the dollar value in order for America to increase their exports. Then, I’m going to explain how the Plaza Accord resulted in a fall in exports for Japan due to an immense increase in the value of the Yen which led to lowering the interest rates for export-oriented companies and at the same time stimulating domestic consumption by the Japanese government to counter the situation. The Japanese government didn’t anticipate the actions of the public as people took money from them to invest in stock and property which led to the forming of a large bubble that was burst by the policy introduced by the Bank of Japan. Lastly, I’m going to dive into some of the causes like the ageing population, the Japanese employment system, low turnover rates, etc., on why the economy is still failing to recover from the 1990 crash and has stayed in economic stagnation.   

The Plaza Accord

In the early 1980s, the US dollar appreciated significantly against the Japanese yen, making US exports more expensive and imports more affordable. This had a negative effect on the US trade imbalance and businesses in the US that had difficulties selling their goods to the rest of the world protested. What was the connection to Japan? To be sure, the US did something to sway the outcome in their favour. The G5 countries met in the Plaza Hotel in New York. This includes the United States of America and Japan, the United Kingdom, Germany, and France. The meeting’s objective was to depreciate the dollar against the Japanese yen and West Germany’s mark. This was a watershed moment: the rapid increase in the yen’s value had a significant but unforeseen and unintended consequence. It had a detrimental effect on Japan’s export business, as a large portion of its overall exports went to the US consumer. Businesses in the United States were ecstatic, but businesses in Japan were less so. How has the country dealt with it? There are two approaches to monetary and fiscal policy: The central bank implements monetary policy, which entails altering interest rates, whereas fiscal policy is concerned with government expenditure through taxation. The Japanese central bank recognized the impact that a 50% depreciation of the dollar versus the yen in only a few months may have on Japanese firms’ competitiveness. Not only was the dollar devaluation detrimental to the export industry, but the yen appreciation cut the cost of imports, resulting in lower inflation and a trend toward deflation. Central banks typically aim for a little bit of inflation, often about 2%, to keep the economy going, while deflation is a nightmare that central banks do everything possible to avoid. To address the problem, they used monetary policy to reduce interest rates, which is a perfectly logical and common response in such situations. The objective was to elevate inflation to a healthy level through increasing domestic demand and consumer expenditure.

The Lost Decade

What occurs when interest rates are reduced? Simply said, more individuals desire to take out loans for automobiles, houses, companies, and other purposes since they are simpler to repay; this money exchange and consumer spending boosts the economy. Encouraged by the authorities, Japanese banks began lending money more freely to businesses and people, allowing borrowers to spend and invest in the economy, therefore stimulating growth. Japan’s citizens are characterized as savers and the country was already a significant creditor. They borrowed this money and invested it mostly in the capital market and real estate. Due to the ease with which people could borrow, they increased their borrowing, causing the value of real estate in stock to skyrocket. Large corporations, including those directly impacted by the Plaza Accord Agreement, also became involved in taking large loans and investing them in stocks and the real estate market. The more people earned, the more they borrowed, and the prices continued to rise, and a bubble began to form. Although it appeared on the surface that the economy was thriving. At this point, the economy resembled a lovely geisha, but it was rapidly devolving into a giant bubble the size of a sumo wrestler, the debt continued to grow, prices skyrocketed and became unaffordable to younger generations, and businesses’ competitiveness and export industry continued to deteriorate. The central bank recognized that it was developing into a bubble and attempted to intervene by updating monetary policy, but things had already spiralled out of control, as the Tokyo Stock Exchange lost much of its value, and companies saw their profits decline as they focused their efforts on the stock and real estate markets rather than on selling their products. The economy stalled over the next decade, from 1991 to 2001, often known as the lost decade, which ended up being several decades due to the persistence of stagnation and the economy’s snail-like pace for three decades. Its effect has persisted to the present day, making it one of the most discussed subjects in economics.

Failed Recovery

Japan has the world’s greatest life expectancy, at 85 years. It boasts the world’s largest ageing population, with “around 25% of the population over the age of 65”, or more than 30 million individuals. The ageing population reduces the demand component in the economy since older individuals do not purchase new vehicles, homes, or consumer goods at the same rate that younger people do and get more retirement benefits than the government collects in taxes from the working population, the decline in population growth will be a significant issue in the coming years. It is commonly believed that the Japanese corporate sector’s poor productivity, particularly in the service sector is due to low firm turnover. As noted previously, the reduction in the working-age population has stifled economic development since the mid-1990s, but labour input is not the only factor at play. Other variables remained stable, while marginal products of labour and capital saw declining returns. Takeda pointed out in her article that, “innovation rather than simply catching up with the frontrunners” attributed to Japan’s economic miracle post-war. Keeping this in mind, some may identify low turnover and a scarcity of start-ups as the primary impediments to economic growth in the present Japanese economy, contributing to the downward trend in TFP. Older businesses with poor productivity often remain in the market, whereas newcomers with high productivity are seldom disadvantaged. As a result, production on average falls. Japan’s employment system is unique in that it integrates synchronized recruiting of fresh graduates, a seniority-based salary structure, and lifelong employment.  “Freshmen who join large firms as regular workers are generally expected to remain there until retirement.” Millions of workers rely on this system for their perks without upgrading their skill sets and remain in the workforce until retirement, which is counterintuitive in an era of rapid technological advancement where skills become obsolete quickly, and while companies in Japan have reduced this approach to a significant degree, its effects remain. This combination of a seniority-based salary structure and lifelong employment has harmed the Japanese economy’s growth significantly. Takeda explained in her article that in

“the lifetime employment system and the seniority-based wage system, individual workers have less incentive to invest in their human capital. This creates a problem of moral hazard,  which has increasingly distorted workers’ incentives as the restriction on dismissals has been enhanced over time. In an extreme case, the status quo system is protecting those who shamelessly (by the Japanese standard) stick to positions in Gulliver firms, even if they are less motivated and the least productive.” 

In conclusion, Japan will remain relevant for a long period; increasing borrowing to promote the economy would not restore freedom. Certain individuals believe Japan has recovered and entered the post-bubble era. This stock market appears to be performing well, employment is low, and so forth, but stagnation remains and there has been no spectacular development, signalling that its economy may trend toward growth unless dramatic steps are taken.

Takeda, Yoko. 2017. “Will the Sun Also Rise? Five Growth Strategies for Japan

Tiberghien, Yves. 2005. “Navigating the Path of Least Resistance: Financial Deregulation and the Origins of the Japanese Crisis”