Written by Marek Becker, BSc 2018
Measured by GDP, Japan is the world’s third biggest economy. Taking a look at the Nikkei 225, the major stock index of Japan, one can see something odd: the all-time high didn’t occur within the last few years, but in December 1989. The following article will at first take a look at the Japanese history and major events related to the economy and will then conclude with today’s challenges.
For roughly 250 years, from the 17th to the 19th century, the Sakoku policy effectively isolated Japan (besides very little trade with the Chinese and the Dutch). It did that by inflicting the death penalty on foreigners entering the country or nationals leaving it. Such a policy was “feasible”, because on the one hand, the agrarian economy was autarkic, and on the other hand it was the logical result of the fear of domestic instability, foreign conquest and Christianity.
While preserving the national identity, isolation widened the technological gap between Japan and the West. After several, more or less conflictual, yet unsuccessful encounters with Western powers that tried to engage with Japan, the US Navy arrived with four warships in 1853, marking the beginning of the end of the seclusion. The Japanese were intimidated and had to face that they hadn’t kept pace. They had to sign humiliating trade agreements similar to those signed in China after they had lost the Opium war. On the positive side, the image of an enemy provided for an even stronger identity.
Before 1853, power in Japan was in the hand of local lords, called Daimyo. Following revolts all around Japan, the Imperial Throne was restored in 1886. In that way, the political system was consolidated. The emperor became (in terms of actual power) a rather symbolic, yet very important figure. Around him, modernizers could build a sense of national pride. Japan was effectively on its way to become one of the most modern nations in the world.
Compulsory military service was introduced, all children had to go to elementary school, public transportation was built as well as many other things that provided the Japanese with further ground for their nationalism.
By 1904 Japan had become the first modern Asian nation to ever win a war against a European nation. Along with the respective victory over the Russian Empire, they initiated to take a path of rapid economic expansion, which nearly lasted until 1990.
This is even more impressive considering the fact that Japan is not just the only country ever attacked with nuclear weapons, but that in the aftermath following the attack on Pearl Harbor (1941), 8 million were killed or injured, a third of its industrial machinery and more than 80 percent of its ships were destroyed. When they ultimately surrendered in 1945, the production and national wealth were approximately equal to those of 1930.
The rapid recovery was enabled by certain politics, especially guaranteed lifelong employment for many workers and organization of entities in the Keiretsu structure.
Keiretsu was the unofficial replacement for Zaibatsu (introduced 1886), a structure of companies in conglomerates. A Zaibatsu is a family-owned holding company. What was striking is that those conglomerates were vertical monopolies: they controlled all aspects of the production, distribution and sale of their products and also had wholly owned banking subsidiaries that provided the required financing. In the early 20th century, the four largest Zaibatsu represented about 15% of the capital of Japanese incorporated business.
This structure was prohibited by the Americans, which interpreted the Zaibatsu as communistic. What they failed to notice was the extent to which the Zaibatsu was representative for the groupistic culture of the Japanese. (Marangos, 2013)
Keiretsu is similar to the old structure, with the difference that the companies along the supply chain are not owned by one big holding. Their goal was not to create only short term profits, but to gain market share as a unit. The competition among different Keiretsu was fierce and the result was that companies were striving to become ever more efficient, by e.g. integrating robots and developing techniques such as total quality control, lean production and cross-functional product development.
It took the Japanese economy 10 years to get back to its prewar level. After the recovery in 1955, the Nikkei 225 closed at 425.69 points. 13 years later in 1968, Japan became the second largest economy in the world after the United States; the Nikkei 225 closed 1,714.89. The Nikkei 225 is the major stock market index for the Tokyo Stock Exchange, comprising 225 different stocks, excluding ETFs, REITs, preferred equity contribution securities, tracking stocks (on subsidiary dividend) etc. other than common stocks. What makes it special is the fact, that rather than ranking the included shares by market capitalization, they are ranked by share price.
As mentioned in the introduction, the all-time high of the index was in 1989 – in December of that year, the Index closed with 38,915.87 points. That is the value of 34 years before, times 90. This so called “Japanese economic miracle” was possible because of the fact that they spend only 1% of GDP on their military (because they benefitted from American military protection) and focused on the technology branch.
The tremendous growth was driven by companies widely known, such as Mitsubishi, Toyota, Sumitomo, Honda or Sony, to name a few.
The reason for the high in 1989 was a bubble in real estate and the stock market, fuelled by excessive money supply, over-confidence and speculation. An important impact had the Plaza Accord in 1985, which was signed by the G-5 nations to manipulate exchange rates by depreciating the U.S dollar relative to the Yen and the Deutsche Mark. The reason for the agreement was that the dollar had appreciated about 50% in recent years and U.S. companies had problems to export their goods. After the accord was signed, the Yen took off from 236.91 a Dollar to 134.45 a Dollar within only 3 years. The bubble burst when the Japanese central bank, the Bank of Japan (BoJ) tightened their monetary policy after two years of unchanged low discount rates and when asset prices began to fall. The Nikkei plunged from 38,915.87 points in December 1989 to 7,607.88 points in March 2003. In 2004, property within the financial district of Tokyo fell below 1% of its peak. The aftermath of the bubble was called the “lost decade”. The economic growth in Japan after 2000 then continued to be rather modest.
It got worse. When the subprime crisis hit the U.S., it had an especially hard impact on Japan. In 2009, the industrial production fell by 38% in the year to February – effectively to the lowest level since 1983.
Keeping in mind Japan’s background this is easily understandable:
As a country with only few natural resources, Japan heavily relies on exporting high technology goods. When the financial crisis hit U.S. demand, the highly price-elastic goods from Japan became unappealing. Instead, cheap imports from China prospered. In Q4 2008, overall U.S. imports fell 9% (Japan -16%, China +1%) and in Q1 2009 30% (Japan -41%, China -10%). Overall Japanese exports fell by 47% in Q1 of 2009. (Wakasugi, 2009)
GDP growth in 2009 was less than negative 5%, cancelling out the positive of the prior five years. This also means, that the overall economy has grown just a little more than 0.6% a year since 1991. At this point, the lost decade became the “lost 20 years”. (“The incredible shrinking economy”, 2009)
The flipside of this sharp decline was, that based on the price elasticity, Japan was poised to recover relatively fast, as soon as other countries would begin to recover. An indication for this fact is the company Toyota which became the world’s largest car manufacturer in 2012.
But before it was time for that celebration, Japan had to face a “Triple Disaster” in 2011, when an earthquake triggered a tsunami that demolished a nuclear power plant in Fukushima. 138,000 buildings were destroyed and damages of $360 billion in economic damage were caused. The public outcry forced the shutdown of every nuclear power plant by May 2012. Substituting nuclear power with oil caused a temporary all-time high in trade deficit amounting to approximately ¥1,500bn.
The economic miracle after WW II was possible partly because of lifetime employment and the vertical integration of companies. Nowadays, with Japan facing a vast demographic change (attributable to the high life expectancy, where Japan ranks first worldwide, and low fertility rate, where Japan holds the 188th place), and the Keiretsu becoming less feasible with increasing pressure from global competition, a soon upswing is not particularly expected. The recent crises left marks; for example, a huge government debt of roughly 250% of GDP as a result of running a budget deficit for over 20 years. Even though this is a lot, large financial assets on their balance sheets reduce the net debt to 130%, and rock-bottom interest rates ensure that Japan is spending the lowest percentage of GDP on interest payments among the G7.
Since 2012, Shinzō Abe is the Japanese prime minister, after previously holding the position from 2006 to 2007. He proposed three arrows, which together are called “Abenomics”: monetary stimulus, fiscal flexibility and structural reform. One big goal of these policies is to achieve an inflation of 2% – and the numbers of the second quarter of 2016 do not look promising, with a current core inflation rate of -0.5%. Prices rising by 2% is the general level striven for by developed countries, because it is seen as the optimum for consumers to spend and companies to invest. The BoJ forecasts Japan’s potential growth rate currently at just 0.21%. They predict that the 2% target will not be reached until the fiscal year of 2017/18.
A huge obstacle to this goal is the low oil price. Japan paid 41% less for oil in 2015 than in the year before. It is true that they imported less, but the 35% drop in price for Brent crude is the main reason. When increasing inflation is the goal, paying close to $48 billion less for an important source of energy is everything but supportive. (“Three-piece dream suit”, 2016)
Joining forces with Haruhiko Kuroda, the governor of the BoJ, there is now a negative interest rate for financial institutions of -0.1% on cash which is deposited overnight – but banks are reluctant to pass on the negative rates to customers. Furthermore, they introduced an asset-purchase program with no declared limit, which increases amount of money in Japan by about $941.1 billion annually. Additionally, the BoJ is handing out ¥15,000 to 22 million people with a low income. (Warnock, 2016)
The BoJ buys a lot of Japanese government bonds, increasing demand and pushing down the yield of 10-year bonds to -0.17%. In July 2016, BoJ owned nearly 40% of Japanese government bonds, measured in value. But they also buy corporate bonds and equity: they are estimated to be a top 10 owner in 90% of the companies comprised in the Nikkei 225. (Nakamura, Kitanaka, Sano, 2016; Nakamichi, 2016)
Frankly, Abe is doing what he can. He postponed an increase in the consumption tax that was passed in a bill before he took office from 2015 to 2017. Later, the bill was even delayed to 2019. The bill was meant to help reducing the staggering government debt. After the shutdown of nuclear power plants and the resulting trade deficit following the catastrophes in Fukushima, Abe also dared to reopen a few plants against the will of many citizens.
Another big problem is that the Japanese are reluctant when it comes to employment (de)regulations. Looking at the cultural history it should not surprise that even employers do not sympathize with the idea of short term employment. A mechanism that fuels economic growth on the cost of job certainty could help, but is just not accepted in wide parts of the population. Another important thing is sexism in Japan. Compared to the female quota in Germany, Abe’s efforts to put women into supervisory roles failed completely; even when the government offered money to small companies for promoting women into supervisory roles, no one was willing to do so.
Money does not seem to be the motivation behind corporate actions: non-financial firms hold more than $9.5 trillion in financial assets. Large firms hold $2.2 trillion in cash, or about 50% of GDP. (“When easing gets hard”, 2016; “Overhyped, underappreciated”, 2016)
In the spirit of social conformity, the reluctance to invest and the consideration of labor market deregulation, decision makers in Japan act in face-saving manors, and tend to rather improve what they are already doing, instead of initiating a much needed change by themselves. On the one hand, changes brought by movements among younger generations are facing an uphill struggle, because of the low fertility rate and the social order of strong respect for elders. And on the other hand, immigration is not really encouraged, with a high language barrier, racism and sexism issues and the historical rooted tendency of the Japanese to isolate themselves from foreigners. Today, foreigners account for less than 2% of the population in Japan.
Furthermore, another trend is observable: not only is the BoJ contributing to the nationalization of the economy, but Reporters without Borders ranked Japan’s press freedom globally 72nd – down from the 11th place five years ago. The government is perceptibly widening its influence. But looking at the past, maybe that is just what Japan needs to restore its former glory.
Marangos, J. (2013). Consistency and Viability of Capitalist Economic Systems. Retrieved from link.springer.com
Wakasugi, R. (2009) Why was Japan’s trade hit so much harder? published in Baldwin, B. The Great Trade Collapse: Causes, Consequences and Prospects. Retrieved from https://books.google.de/books?id=OsGokPMG5aIC&printsec=frontcover&dq=The+Great+Trade+Collapse:+Causes,+Consequences+and+Prospects&hl=de&sa=X&ved=0ahUKEwiovrDTk4_PAhVROMAKHYM1B9UQ6AEIJDAA#v=onepage&q=The%20Great%20Trade%20Collapse%3A%20Causes%2C%20Consequences%20and%20Prospects&f=false
Warnock, E. (2016) Japan Economy Nearly Stalls in Second Quarter. Retrieved from http://www.wsj.com/articles/japan-economy-nearly-stalls-in-second-quarter-1471219536
Nakamichi, T. (2016) Bank of Japan Faces Pressure to Act, but ‘Brexit’ Vote Looms. Retrieved from http://www.wsj.com/articles/bank-of-japan-faces-pressure-to-act-but-brexit-vote-looms-1465875505
(2016) Overhyped, underappreciated. Retrieved from http://www.economist.com/news/leaders/21702751-what-japans-economic-experiment-can-teach-rest-world-overhyped-underappreciated
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