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Wednesday, 31 October, 2001, 11:53 GMT
Japan's fading economy
Evan Davis

Two years ago, at the height of the bubble, when there were already worries that the US boom would end in tears, it was argued that the world needed Japan to start growing again before the US stopped doing so.

It didn't quite turn out that way.

In actual fact, Japan has been suffering worse than any of the big industrial nations, including the US itself. It is forecast to grow - sorry shrink - by 0.5% this year, and by 0.4% next year.

Prices have fallen for 24 consecutive months. And all this comes not at the end of a roaring boom, but at the end of a decade of stagnation.

Excess savings

The cause is fairly clear - and it comes back to the post-war baby boom, which means there is now a huge cohort of pre-retirement workers in their 50s saving like crazy for their pensions.

Absorbing those savings has been a challenge for the world - first they led to an investment boom and bubble which burst in Japan in the late 1980s, and then to a boom and bust in Asia in the late 1990s.

At the same time, falling prices that set in before the recession have exacerbated the woes of the country.

Consumers think "why buy now, if prices will be lower next month?".

Or, to put the same point another way, it is hard to relax monetary policy as far as you would want, because when prices are falling, even Japan's near-zero interest rates still mean that the real rate, over and above inflation, is positive.

Then there is one other serious problem: Banks have had too many bad loans to be confident of lending again. No matter what the authorities do to stimulate growth in the money supply, the banks just sit idle, too scared to do their bit.

If bankrupt companies signal a recession, and bankrupt banks signal a depression, one might reasonably call Japan a depressed economy, even if it is very affluent, and still quite vibrant in atmosphere in the urban centres where the young do still shop hard.

Policy dilemmas

So the key question is, what should Japan do?

Tokyo shopping street
Price deflation has made people reluctant to spend

American economist Paul Krugman says the authorities should pledge themselves to create some inflation.

Tell everybody that prices will rise by 4% next year, and the deflationary mindset will be broken; people might start spending again in anticipation that future bargains will disappear.

The only problem with Krugman's idea is how can you stimulate inflation in an economy like that. If you could answer that, you probably have a solution to the problem of depression straight away.

The best chance might be to print yen by the trillion, and hand them out to the public until they feel rich and secure enough to actually spend some of their reserves.

It might be a good idea. One might term the Krugman plan "super easy money". It is probably best described as the exercising of monetary policy, but not via low interest rates.

Bank rescue

Perhaps an alternative to the Krugman approach is to look more closely at rescuing the banks.

The problem for the financial sector is that they don't want to admit the size of their bad debts, for fear that if they did, they would then be insolvent.

The solution is probably something akin to nationalisation of the banks - put them in public ownership, write-off the bad debts, and re-establish solvency by injecting new capital before re-floating them.

The problem with this approach is that the government does not want to be seen to be doing anything to bail out banks who behaved with such wanton disregard of normal prudential standards in the 1980s.

And the public do not want to help crony-capitalist institutions that are now suffering from their own mistakes.

The Japanese could take a leaf out of the UK government's approach to Railtrack : what the UK has done is to show you can bail-out a railway, without bailing out the company or the people who own or run it.

Similarly, in Japan, you can bail out a loan book, and a branch network, without necessarily bailing out the shareholders or executives.


Without a drastic measure of this kind, the Japanese leadership are likely to persist in believing - often at the behest of western governments - that the answer to all their problems is to become more "Anglo-Saxon", more deregulated, and more brutal in their choice of capitalism.

Maybe that is a good idea - but I have to confess to extreme scepticism that an economy paralysed by the headlights of an approaching catastrophe is best served by a set of measures designed to increase redundancies, and make everybody feel yet more insecure.

Thatcherite reform in Japan may be necessary, but now is surely not the time.

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