After being ravaged by two atomic bombs that ended World War II, the Japanese economy saw a historic resurgence. With an annual growth rate of 10% starting from the late 1960s, Japan became the first Asian country to witness massive economic growth. Riding the wave of globalization, the country quickly became the world’s hub for manufacturing—boasting a reputable car and consumer electronic industry. In addition to the sustained growth, Japan invested heavily in infrastructures such as bullet trains, metros and airports making their economy even more efficient. All this led economists to believe that the country would soon replace the United States as the world’s largest economy until it didn’t.
The GDP of Japan, which currently stands at $4.9 trillion, has pretty much remained stagnant in the last thirty years. In a world that assumes growth to be forever continuous, Japan's economic stagnation poses an interesting anomaly. While it is difficult to pinpoint the cause, scholars generally view three main reasons for this slowdown. Firstly, Japan experienced an extremely low birth-rate and high old age, so much so that its population has actively been on the decline. As a result, more private and public money was diverted towards healthcare and pension/security benefits to support the ageing population. Secondly, at the turn of the century, the primary industries of Japan were being challenged by other Asian economies that experienced their own economic booms. For example, South Korea began to lead in the automobile industry and China transformed into the hub for electronics. Finally, the country’s economic slowdown was partly exacerbated because of the unusual Japanese work culture. In a country where customer loyalty was highly valued, large corporations used the low-interest rates to pay their shareholders instead of investing. Since the money was not invested back into the business, it was unable to expand or increase its output. Therefore, all these factors cumulatively resulted in deflation—the decline in the prices of goods and services.
While the term may sound harmless to an average consumer, it presents a very tricky scenario for central banks. If the value of money (purchasing power) increases, people would save their money and be reluctant to spend it. Why spend now to buy a Lenovo Laptop when the same money can buy a MacBook Pro next year?
However, people not spending their money on goods and services has a cascading effect on the economy. It would lead to lower sales for businesses which in turn would lead to lower wages for employees. The lower wages would reduce the demand for goods, lowering the prices of goods (deflation) even more. This cascading effect is what happened in Japan. As one can imagine, deflation pushed the economy into a vicious cycle of decreasing consumption, bringing it to a grinding halt.
Abe to the Rescue
The Japanese government used the mechanisms of monetary and fiscal policies to combat the slowdown and stimulate growth. While fiscal policy refers to changing government expenditure and tax rates, monetary policy is raising or lowering interest rates by the central bank. If the bank were to lower interest rates, then consumers and businesses would be encouraged to take out new loans for various purposes, thereby fueling consumption and reviving the economy. Yet, the problem here was that interest rates in Japan were already very low – as low as 0% – and government debt was also starting to rise.
At this critical juncture, Shinzo Abe took office as the new Prime Minister of Japan. Promising to revive the economy, he introduced three mechanisms, later referred to as Abenomics.
First, Shinzo Abe focused on monetary policy. While this may have been a traditional move, he took it to the extreme. He lowered the interest rate even further to a negative 0.1%! This meant that the central bank will essentially pay the other private banks for borrowing money! He further introduced a concept now called Quantitative Easing. This entailed the Bank of Japan, the county’s central bank, to create excess reserves and use the same to buy government bonds and securities. The excess money supply lowers interest rates across the economy and incentivizes businesses to invest, helping to boost economic growth. Second, by focusing on fiscal policies, Mr. Abe increased government spending to such a large extent that under his rule, the total approached a shocking 240% of the Japanese GDP. Finally, he brought in some structural reforms such as allowing more shareholder activism to increase, tax cuts for companies, deregulation, and trade deals. Apart from these, he countered the ageing population by encouraging women's participation in the labour force as well as promoting higher fertility by expanding parental leave.
However, these reforms were not entirely successful. It was observed that when large corporations were given incentives, like tax cuts, they tended not to invest in future operations, but rather pass the savings on to shareholders. Therefore, while inflation was higher under Mr. Abe than in the previous decades, it did not hit the desired rate of 2%-3%. Similarly, the sudden increase in sales taxes in 2014 and 2019 did not sync well with the government agenda of lowering interest rates and enforcing a deflationary expectation on people.
Japan’s stagnation might represent something far more than just a case study. For as long as economists have studied productive national economies, an underlying assumption is that growth, however limited, will go on forever. However, despite a near-zero growth rate, Japan's economy appears to be doing well for its citizens. Its cities are beautiful and clean, its industries are still world-class, crime is low, and the quality of life is extremely high. And as someone who understood the faults of the Japanese economy and tried his best to revive the country to its former glory, Shinzo Abe was a true statesman to look up to!
(Written by Sashank Rajaram and Edited by Prakhar Singhania)