Japan’s Lost Miracle

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The Bank of Japan has, after a decade, finally begun to take a more hawkish stance on monetary policy. In the last year, while the rest of the world was combatting up to double-digit inflation, Japan was beginning its ascent to a target of two percent. In recent decades Japan has suffered frequent bouts of deflation, accompanied by high government debt and below-average growth. This has prompted the central bank to make money as easy to access as possible, in an attempt to reinvigorate economic activity – albeit with little fortune. Facing these ails, it may seem counterintuitive that Japan remains the fourth-largest economy in the world. It is thus important to examine how Japan arrived at such a situation. Understanding the successes and failures of Japanese management provides a useful benchmark when observing the development of nations in the future, and when examining the policy flaws of larger countries.

By the end of World War II, the Japanese Empire was decimated. Their unconditional surrender followed the deaths of almost three million Japanese, including over 100,000 in the atomic bombings of Hiroshima and Nagasaki. The economy was in tatters, with the war costing $56 billion and the Allies inflicting the burden of reparations on the beleaguered nation. Average wages had fallen from a peak of $5,000 to under $3,000, while industrial production had fallen to 27.6% of the pre-war level. The nation, which had previously relied too heavily on food seized from other Asian nations, was also on the brink of famine. As more than six million Japanese returned in the coming years, either expelled from liberated territories or repatriated from POW camps, pressure on the already limited supply of food worsened. At its height, nine people were dying a day from starvation. Japan had surrendered sovereignty too, with almost 500,000 American soldiers stationed on the island nation.

Fortunately, the American occupation under General MacArthur was benign. Loans amounting to almost $100mn were provided for food relief in 1946, and plans were laid down for distribution infrastructure. Moreover, to reduce the future threat of war, MacArthur encouraged democratisation. He took a unique approach to this; instead of demolishing the imperial political structure, MacArthur made friends with Emperor Hirohito. While other Allied powers called for the emperor to be charged with war crimes, MacArthur reasoned that Hirohito commanded the hearts and minds of his subjects, and held the key in winning over the support of the Japanese people. Through Hirohito, MacArthur was able to make dramatic social and economic changes. On 1 January 1946, the emperor gave a nationwide address declaring that he was not divine, nor were the Japanese people destined to rule the world, breaking down old, strongly held conceptions. During this time, the Japanese cabinet unanimously voted to grant women suffrage, allowed trade unions to form, and redistributed land to peasants. When the Korean War broke out, demand for Japanese equipment also soared, stimulating industry. With previous production outlets destroyed or depreciated beyond use, innovation became the norm.

Between the 1950s and 1970s, Japan’s economy grew by almost 10% per year. This was driven by a combination of protectionism (reducing foreign imports), a large money supply, and technological improvements, leading to strong exports. Virtually all imported non-technological products were subject to high tariffs or government quotas to protect Japan from international competition until the 1960s, despite strong pressure from the International Monetary Fund to liberalise. Subsidies and tax breaks aided the development of new technology, such as in chemical engineering. This interest in scientific research was evident; in 1963 alone, the Japan Information Centre for Science and Technology wrote 210,000 abstracts of foreign scientific papers. In addition, the government reduced borrowing costs, funded by extraordinary savings, so that businesses could be set up as easily as possible. Exchange rates were manipulated through buying reserves, allowing the Japanese Yen to fall in value and making Japanese goods cheaper. With all these conditions, Japan was able to adapt to changing patterns of demand; in the 1950s, they produced textiles and cheap manufactures – by the 1960s, they had begun producing cars, ships, and machines.

In the next 10 years, growth slowed to around 5% per year. This was to be expected as recovery no longer drove growth figures. Moreover, in 1973 the global oil crisis saw the price of oil quadruple from $3 a barrel to $13, resulting in inflation and a decline in production. The second oil crisis in 1978 further exacerbated this, as the price rose to almost $40. However, Japanese businesses showcased their adaptability, as they were efficient in reducing energy wastage and adopting alternate sources. With the strong technological growth of the decades prior, Japan continued pushing the bounds of productivity improvement with the creation of just-in-time production; advances in semiconductor microchips were fed by subsidies and were produced so efficiently that in 1978, Japan was able to sell them to the USA at a price cheaper than America could produce themselves. The 1970s showed the resilience of Japan’s economy. It managed to avoid the double-digit inflation other developed countries suffered and grew at a higher rate throughout.

In the 1980s, Japan restructured its economy. Despite being the third largest in the world in terms of size (after America and the Soviet Union), Japan began worrying about its dependence on exports. It saw a decline in international demand, with the US, Korea, and Taiwan all competing towards semiconductor hegemony. Moreover, after the end of the Bretton Woods system and the Gold Standard, the US led the 1985 Plaza Accord, an agreement that depreciated the dollar against the Yen and other currencies. This caused Japanese exports to the US to become more expensive. Thus, domestic demand drove new growth; people had entered an age of consumerism, where households all owned ‘three treasures’ – a television, a refrigerator, and a washing machine. With interest rates below 0.1%, people were having spending sprees, resulting in massive overinvestment in real estate and the stock market – some houses reached $1.5 million per square metre. At one point it was even suggested that the imperial palace in Tokyo was worth the same as all the real estate in California.

However, this cheap credit brought severe problems. Banks lent without regard for the quality of the borrower, leading to many ‘zombie’ businesses. Savers preferred putting money under their beds than in savings accounts due to how low interest rates were. Ultimately, in late 1989, the Japanese central bank hiked rates to stop the malign inflation. Unfortunately, poorly operating companies were unable to return their debts, and Japan entered an economic crash. Government bailouts were introduced to sustain banks across the country. Yet even with this support, the banks struggled to offer credit, and eventually had to be nationalised into four large firms. In 1989, 32 of the 50 largest companies in the world were Japanese. Over the next three decades, only Toyota remained in the list.

After Japan’s asset bubble burst, its response was to once again reduce interest rates, aided now by quantitative easing – when the central bank buys government bonds to inject money into the economy. However, this yielded little success. Government spending was increased significantly without raising taxes, leading to Japan’s debt ballooning to 260% of its GDP. Furthermore, Japanese consumers have displayed extremely low consumer confidence since the crash; the average Japanese saves 16% of their income, which is 10 percentage points more than the average American. This is partly why Japan has been in deflation since 2001 – an incredibly harmful trait in any economy, as falling prices encourage people to postpone spending, causing prices to fall further. This vicious cycle entrenched the expectations of deflation in Japanese minds, making all policies aimed at ending it far less effective. An aging population has also naturally decreased demand for goods, further fuelling falling prices. But Japan’s economy hasn’t only suffered from internal issues; it has also taken severe financial beatings in the 21st century, losing 5.2% of GDP in 2009, compared to a global loss of 0.7%. Then, in 2019, Typhoon Hagibis destroyed $10 billion worth of infrastructure. Although demand has not yet begun to increase in a significant way, it should be noted that the past year has seen prices once again rise in Japan.

Japan provides a strong case for protectionism. It successfully allowed its infant industries to develop in the absence of foreign competition, leading Japan to dominate strategic industries. The importance of research and development is also highlighted. But how much of this can be applied to developing countries today? Although technological gaps in the 1950s were significantly smaller than they are now, we can still learn from Japan’s hardships. The example of absurdly cheap credit from both before and after Japan’s decline highlights the dangers of extreme malinvestment that come with it. As Japan may begin to recover, its journey will also be paramount for the study of history and economics. It is a unique case, whose policies can be analysed in new ways, and perhaps utilised to make other countries more prosperous in the future.

Chang, H., 2002, Kicking Away the Ladder

Werner, R., 2002, Monetary Policy Implementation in Japan: What They Say versus What They Do

Krugman, P., 2008, The Return of Depression Economics and the Crisis of 2008