Japan’s Lost Decade (EN)

At present time, Japan holds the distinction of having one of the highest public debt-to-GDP ratios in the world, but, quite the opposite from what is happening in Italy and other European economies, this does not seem to be worrying global finance. Historically Japan’s public debt has been on a steady rise since the 1990s, and by 2021, it has passed well over 200% of its GDP, making it the highest among developed nations.

Let’s deep dive a bit into this, and why it’s not been that much concerning, at least up to now.

HISTORY & ROOT CAUSES: THE LOST DECADE

Japan’s “Lost Decade” is a term commonly used to describe an extended period of economic stagnation that the country faced starting in the early 1990s and, by some accounts, lasting for two decades into the 2000s. This led to reduced tax revenues and increased government spending in a bid to stimulate the economy.

Before the Lost Decade, during the latter half of the 1980s, Japan experienced an economic bubble. There was a rapid inflation of asset prices, particularly in real estate and the stock market. The Nikkei stock index reached its all-time high at the end of 1989. The bubble burst in the early 1990s, leading to a severe crash in asset prices. Property values plummeted, and many companies faced huge losses due to their investments in inflated assets.

The burst of the bubble also impacted the banking sector. Banks had lent heavily during the bubble period, often without sufficient collateral (we have seen elsewhere this, haven’t we). When asset prices fell, they were left with non-performing loans. Despite these bad debts, many banks were reluctant to recognize their losses, leading to a banking crisis.

Japan entered a period of deflation, where prices were continuously dropping. This made debt more burdensome in real terms and discouraged consumer spending, as people expected prices to fall further. There were underlying structural problems in the Japanese economy, such as rigid labor markets, an aging population, and a lack of significant economic reforms, which made recovery even more challenging: something we know very well, unfortunately, in my home Country Italy.

The Japanese government and the Bank of Japan took measures to combat the stagnation, including fiscal stimulus packages and reducing interest rates. However, these measures did not lead to a robust recovery, and by some opinions, might have even prolonged the stagnation due to resulting increased public debt. The Lost Decade(s) had also profound implications for Japan’s position in the global economy. Before the 1990s, Japan was often seen as an unstoppable economic powerhouse, but the prolonged stagnation led to it being overtaken by other rapidly developing economies, particularly China.

The Lost Decade is frequently studied by economists and policymakers as a cautionary tale of asset bubbles, the risks of prolonged deflation, and the challenges of reviving an economy amidst structural and demographic challenges. The U.S. and European responses to the 2008 financial crisis were, in part, influenced by lessons drawn from Japan’s experience, representing a live example of the complexities of managing macroeconomic policies and the repercussions of financial bubbles.

WHAT ELSE?

Japan has one of the oldest populations in the world. This demographic challenge means increased government spending on healthcare and pensions while facing declining revenues due to a shrinking workforce. Also the deflationary pressures have made debt servicing more expensive in real terms and have discouraged consumer spending, further complicating economic recovery efforts.

In this contest, the Bank of Japan (BOJ) has maintained low interest rates for extended periods, which, while aiming to encourage borrowing and spending, has also made it relatively cheap for the government to borrow locally instead of funding the debt with international loans, reducing then the risk exposure index.

Despite the high debt levels, Japan has been able to service its debt without significant issues. A large portion of the Japanese government’s debt is held domestically, which means the country is less vulnerable to external financial shocks. Additionally, to further support the current situation, Japan’s status as a creditor nation with significant foreign reserves provides it with financial stability.

Interest rates in Japan have been extremely low for decades. This has allowed the government to borrow at very low costs. The Bank of Japan’s aggressive monetary easing policies, including negative interest rates and quantitative easing, have kept these rates at bay.

WHAT IS NEXT?

While the high debt level is a point of concern, several factors mitigate the immediate risk of a debt crisis. The large domestic ownership of debt, the country’s strong external position, and the Japanese yen’s status as a reserve currency provide some buffer. However, in the long term, structural reforms are needed to address the demographic challenges and revive sustainable economic growth. We cannot also ignore the slippage of the Yen against US$, that is making more expensive for for the Country to import goods, while, the other way, securing additional advantages in the export prices.

In recent years, discussions on Japan’s fiscal health have centered around strategies for fiscal consolidation, economic revitalization, and measures to counter the aging population. The COVID-19 pandemic has added another layer of complexity, as it has for many countries, with additional fiscal measures required to support the economy.