The Lost Decade — Story of the Japanese Economy

The Second World War ended with a completely unspeakable disaster in Japan. Hiroshima and Nagasaki left the entire country in shambles. With millions dead and damage unfathomable, it was a time that will never be forgotten from the history of Japan. With such a huge a huge loss in terms of property and lives, nobody would have every imagined the economy of Japan to see the kind of growth and development that it did in the succeeding years. Japan was not only able to recover from the trauma, but also managed to become the second largest economic entity in the world by the 1960s.

This massive economic recovery of Japan was a result of the economic intervention of the Japanese government and also due to the aid and assistance of the US Marshal Plan which was an American initiative passed in 1948 to aid the western European nations economically. Post-WWII, the US massively invested in Japan to limit the influence of the Soviet Union in the Pacific. The rising distress among the lower income groups in Japan threatened the rise of communalism in Japan which would have made it easy for the Soviet Union to extend its influence over the Pacific. To prevent this, the US invested and boosted the Japanese economy and this led to the rapid economic growth in Japan, termed as the phase of economic miracle.

However, this economic miracle ended at the beginning of 1990s when the asset bubble burst led to a prolonged period of economic stagnation in Japan. During this period, economic growth in Japan was halted for almost a decade. This period adversely impacted the entire Japanese economy. In nominal terms, the GDP fell from $5.33 trillion to $4.36 trillion, real wages fell by around 5% and price levels were stagnant. This stretched for a period of 10 years, commonly know as the Lost Decade. Just like all recessions follow a period of economic boom, this recession, too, was triggered due to speculations made during the period of economic miracle in Japan.

During the economic boom period in Japan, all sectors of the economy were prospering, and there was optimism among the consumers. Investments were on the high and a lot of credit was available in the economy to fuel this investment spree of the agents. In many ways, this crisis was very much similar to the subprime mortgage crisis of 2008 in the United States. In that too, the rapid increase in investment in the housing sector led to an increase in prices of houses and real estate. When the Fed found out that this bubble is unstable, they increased interest rates thus discouraging investment. All of a sudden banks and other financial institutions which had lent large sums to further investment in this segment and also held large amounts of subprime mortgage-backed securities found themselves under massive losses. Thus, the financial sector crashed, and this led to the crash of the entire economy.

Something very similar happened in the Japanese real estate market during the economic miracle period, and when the Japanese government realized that the bubble of prices was unstable, interest rates were hiked leading to a crash of the financial sector. The Japanese banks suffered under the weight of unrecoverable losses from the bad loans that they now held. The Fed, during the US crisis of 2008, had responded to the bubble quickly by increasing interest rates, but the Bank of Japan wasn’t that prompt in its action. They waited for about 17 years before they took any action, which led to the intensity of the crash becoming much greater than that in the US.

By the time the Japanese government began pumping money in the economy to revive it, the second largest economy in the world had already slumped in a prolonged period of distress. The Japanese government’s bail-out packages for the debt-ridden banks did not take hold until 1999 when the Resolution and Collection Corporation was formed to handle the disposal of bad loans. The consumers had lost faith in the system and began saving much of their incomes rather than spending it, which led to a massive loss in aggregate demand in the economy. Even now, consumer confidence in the Japanese economy is shaken.

The current state of the economy of Japan is better than that in the late 1990s. However, pre-recession levels have still not been reached. The Japanese stock index is still 70% below its peak value in 1989, and real estate prices are also about 40% below its value in 1990. It is because of the fact that the economy hasn’t yet been able to completely revive to its peak level, that few economists are of the opinion that Japan has faced not a lost decade but a lost score. From this, India as a developing economy can draw some lessons. Whenever there is an asset bubble being created, the governments have to act sooner than later. The sooner they act, the lesser is the effect when the bubble crashes. It might not always be possible for the economy to prevent the building up of a bubble. But through proper policy implementation, it is possible for the governments to protect the economy from severe impacts when the bubble bursts.

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