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The Great Stagnation of the Japanese Economy

🕑 3 min

By Mariusz Rzepa

1. Background Information

Japan is the 3rd largest economy in the world, just after the United States and China. However, despite this comfortable position, its GDP, which was 5.5 trillion US$ in 1995, declined to reach 4.94 trillion US$ today. Such an observation outlines Japan’s lack of growth for the past 30 years, which, in the contemporary growth-oriented world, is seen as a severe problem.

2. What are the reasons for the slowdown?

Japan has the oldest society in the world, as 28% of the population are 65 or older. This trend is expected to increase, as in 2036 people aged 65 and over are expected to represent a third of the population. Japan's demographic crisis is the consequence of high life expectancy and low fertility rates. This means that the amount of pensions is going to grow tremendously, therefore forcing the government to allocate more of its budget towards the funding of these pensions. However, if the workforce doesn’t grow along with this increase, the economy will certainly soon face serious budget issues.

Another reason for Japan’s slowdown is that the country’s biggest industries have been challenged by other competitors that appeared in developing countries over the past few decades. For instance, 30 years ago, companies such as Panasonic or Sony were dominating the worldwide electronic commodities industry. Nowadays, the appearance of new and rapidly growing competitors from South Korea (Samsung, LG) or China (Lenovo, Huawei) makes the market increasingly competitive, and puts the Japanese companies a lower market share. This has a direct consequence on the Japanese companies, as they are no longer able to satisfy the same amount of consumers, hence decreasing their sales and revenues.

What were the actions taken by the government?

Throughout the last decades, major events have influenced the Japanese economy. In the mid-90s, at the peak of the nation’s economic boom, the Japanese Central Bank’s (JCB) interest rates amounted to 5%. Today this statistic orbits at -1%, showing that, despite such a drastic change in the interest rate, the JCB was unable to boost its stagnating economy. This can be further perceived by analyzing the evolution of goods’ prices in the Japanese market, which displays stagnating price, or even diminishing ones. In general, one could expect that this is a good thing; “goods are cheaper, how can that be bad?”, but from an economic point of view, it is not. This is because it caused deflation, the opposite of inflation, which is a clear sign that the economy is retracting. This is a terrible sign for the country, as Japanese citizens, with the thought of decreasing future prices, would rather save than spend, thus effectively worsening the nation’s economy stagnation.

With the fear of this possibility in mind, the JCB had imposed certain unconventional policies. The most popular example of such a policy is quantitative easing (QE), which is the situation in which the Central Bank of a country purchases securities from it's national open market, such as bonds or other financial assets, in order to increase the domestic money supply and stimulate economic activity. In the early stage of its implementation, the policy fulfilled its primary goals, as the inflation increased to the annual level between 2 and 3%. However, as it turned out, this increase was not followed by the intended economic growth. Stagnating economic growth, with increasing inflation along, is a sign of a weakening economy, and effectively the failure of the QE strategy.

Without the intended success of its monetary policy, Japan focused on its fiscal one to stimulate economic growth. A new idea, named the Fiscal Structural Reform, was then introduced, which intended to decrease taxes and governmental spending. However, adding to this decrease in government budget the increasing healthcare and social security costs, Japan's debt began to swell at the end of the 1990s, reaching the equivalent of the country’s GDP. In 2010, it hit 200% of debt to GDP, and according to IMF this percentage is likely to reach 260% by the end of 2022.

3. Conclusion

The growing mountain of debt shows that, even with extremely low interest rates, the economy cannot recover based on this only regulation. The problem is the amount that the Japanese government pays for repayments, as it is its second-largest budget cost. This ongoing cycle must stop, and the only way to achieve this is to reduce budget shortages by increasing taxes or cutting public spending. This will, however, most likely cause the already struggling economy Japan to suffer a hard, but necessary recession.

Sources: World Bank, Think Tank, Trading Economies, The Economic Times, Ihori

Written By Mariusz Rzepa

October 2022

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