Japan is the world’s second-largest economy and accounts for more than one-tenth of the world’s economic activity. So the evidence that the Japanese economy appears to be on the verge of slipping back into recession would be cause for concern in its own right. The fact that this is occurring against the background of a sharp slowdown in the United States is even more worrying for the rest of us.
What has gone wrong in Japan? For much of the post-war period it was the miracle of the industrialised world. As manufacturing productivity caught up with the United States and Europe, Japanese living standards rose rapidly. When this high growth rate continued in the 1980s, the initial assumption was that Japan was continuing on the same high productivity growth track. But the underlying reality was different.
Major Japanese companies were beginning to expand abroad – elsewhere in Asia, into the US and Europe – diverting manufacturing investment away from Japan. Competition from other Asian economies, such as Korea, Taiwan, Malaysia and Thailand, was increasing. And established Western manufacturers, such as the US automobile industry, were fighting back in the face of strong Japanese competition.
In fact, 1980s Japan was a “bubble” economy, driven by sky-high stock markets and rising land values, against which companies and financial institutions raised further capital for increasingly speculative investments. The turning point came in the early 1990s when this virtuous circle began to run in reverse. As asset values collapsed to around a third of their peak value, a legacy of bad debt was exposed. That, in turn, eroded consumer and business confidence, preventing any substantive economic recovery.
As unemployment rose and the economy struggled to recover, the government sought to remedy matters with large capital spending packages of its own. These have had a limited effect on economic growth. In only one year since 1991 has growth risen significantly above 1.5% and that was in 1996, when the economy was boosted by reconstruction after the Kobe earthquake. Instead, the private debt mountain has been supplemented by an explosion of public sector debt.
There appears to be no easy way out for Japan. Interest rates have been slashed to zero. But, as if the government is pressing the accelerator to the floor in a car with no fuel in the tank, the economy has responded feebly. The long-term remedy lies in a programme of economic reform, designed to open markets to competition, improve the transparency and effectiveness of financial regulation, and release the power of enterprise and innovation. But Japan has made little progress in implementing this reform agenda.
The faltering progress of the Japanese economy is likely to have severe implications in the Asia-Pacific region. In 1997-98, Japan’s lurch into recession aggravated the Asian crisis, and with the US economy also weakening, we should expect to see a sharp slowdown in the Asian economies again this year.
But the most worrying implication of Japan’s economic problems is the parallel being drawn between the Japanese financial “bubble” of the late 1980s and the growth of the US economy in the late 1990s. Both were supported by a strong growth of investment in speculative ventures: in the case of Japan driven by rising property values; in the case of the US driven by optimism about the “new economy”. Both booms saw a fall in household saving and a soaring stockmarket. Neither was accompanied by much inflation, but both saw the emergence of major financial imbalances.
The underlying strength of the US economy means we should not expect the prolonged weakness in the US that we have seen in Japan. However, the Japanese experience does remind us that cycles generated by major financial imbalances can have more prolonged and serious effects than the inflationary cycles we have become accustomed to in the major Western economies.
We therefore need to be wary about projections that the US economy will bounce back quickly as long as interest rates are reduced soon enough. The financial imbalances that have built up over the long boom in the US also need to unwind. Forecasts that the US economy will return to growth of 3% plus in 2002 after a slowdown this year could prove too optimistic.
Continued growth in UK retail sales in February suggests that the UK consumer economy is one of the most robust in Europe. A 6.3% growth in non-food retail sales was the strongest since January 1998. Food retail grew by 6.0%, mainly due to foot and mouth panic buying. Consumer confidence is expected to cushion the effect of the US slowdown.
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UK unemployment fell by over 10,000 in February. It now stands at less than 1 million for the first time in 25 years.
January’s headline rate of earnings growth remained at 4.4%, stalled by increasing gloom about the US economy. The Bank’s Monetary Policy Committee, which sets interest rates, considers an earnings rate of 4.5% compatible with stable inflation.