After the Bubble: Is Japan's Recent Past America's Future?

Date June 12, 2003
Speaker Allan I. MENDELOWITZ(Director, Federal Housing Finance Board)
Moderator KATSUNO Masahiro(Manager, International Affairs, RIETI)


Talking Points

Japan in the 1980s was perceived as on its way to world economic domination:

  • Rapid economic growth
  • Growing wealth
  • Large and growing trade surpluses
  • Rapid asset price appreciation (land and share prices)
  • Rapidly rising stock of Japanese owned foreign assets

The United States in the 1990s was perceived as not only the world's sole military super power, but an unbeatable economic power as well:

  • Longest economic expansion in history
  • Record high employment levels and low inflation
  • Rapidly rising productivity
  • Growing wealth and economic well-being
  • Rapid technological change
  • Rapidly rising stock market and real estate values

Japan since the 1990s has been perceived as in economic decline

  • Bursting of the asset price bubble
    • Tokyo stock prices have fallen to a 20-year low
    • Real estate prices have plummeted
  • Loss of international competitiveness (especially relative to Asian competitors)
  • Banking system plagued with Non-Performing Loans (NPLs) and on the brink of collapse
  • Economic stagnation and recession
    • Rising unemployment and little opportunity for new entrants into the labor force.
  • Zombie corporations kept functioning while functionally insolvent
  • Heroic macroeconomic policies fail to stimulate economic recovery:
    • Enormous budget deficits and
    • Zero interest rate monetary policy
  • Government weighed down with massive levels of national debt and unfunded social obligations

The United States since 2000 has been perceived as exhibiting some of the same symptoms as Japan since the 1990s

  • Bursting of the stock market bubble (NASDAQ index at 1/3rd of its year 2000 high)
  • Slowing economic growth
  • Rising unemployment (about 2 million jobs lost in the past 2 years)
  • Collapse of the high tech sector and rising bankruptcies
  • Rapidly rising trade deficit
  • Strongly expansionary macroeconomic policy has failed to get the economy moving - it is not growing rapidly and nor is it creating new jobs.
    • Easiest monetary policy in decades and 40-year record low interest rates
    • Large and growing federal government budget deficits

Many of the symptoms are the same.

  • Does this mean the causes are the same as well?
  • Does this mean the United States is entering a long period of economic decline?

One key to understanding the source of the problem is understanding what preceded the decade of rapid growth and economic strength in Japan and in the United States:


  • The years leading up to the Japanese economic miracle of the 1980s were a period of rapid economic development under active direction from the Japanese government:
    • Economic policies encouraged saving and investment over consumption
    • Government direction determined considerable share of capital flows to favored industry
    • The cold War imperatives made possible export led growth helped by asymmetrical access to an open U.S. market, while shielding the domestic Japanese market from import competition
    • Incomplete development of the financial sector
    • Weak social safety net, with unemployment hidden as redundant labor in uncompetitive, inefficient industries - i.e. distribution, etailing, agriculture, and manufacturing industries shielded from competition

  • Many economists agree that in the "catch up" phase of economic development, rapid growth can benefit from government intervention. However, few believe that government direction and extensive intervention is a good policy approach for a developed economy.

  • The decade of the 1980s: Throughout the decade of the 1980s the Japanese government continued to use interventionist economic policy.
    • The expansion of the 1980s was fed by low interest rates and government guidance to financial institutions to continue to lend for investment.
    • Optimism and growth were fed by the asset price bubble, which had no technological or economic basis: that is, there was no substantive reason for the bubble.

  • Consequences for Japan: Japan missed the opportunity to transform its economy in the 1980a into a modern, market-based economy relying on internal demand as the primary driver of the economy.

United States:

  • The years leading up to the U.S. economic miracle or the 1990s were very different: The 1970s and 1980s were decades in which the U.S. economy underwent dramatic restructuring:
    • Massive Deregulation: government regulation of broad swaths of the U.S. economy came to an end, leading to the substitution of competition for government regulation in the provision of a broad range of goods and services - telecommunication, energy, finance, surface transportation, civil aviation
    • Internationalization of the U.S. Economy flowing from a fall in trade barriers and an over valued dollar: U.S. economy opened to competition from best in class producers (many from Japan) which forced U.S. industry to face intense competition based on price, quality, and service
    • Tight monetary policy squeezed inflation out of the economy and waste and inefficiency out of the business sector
    • Collapse of Savings and Loan industry and government response was to close insolvent institutions and promptly dispose of the assets so that they would not be a depressing overhang on the market and so they could be redeployed in productive undertakings
    • Dramatic rise in foreign direct investment in the United States brought best in class management systems and technologies to less competitive U.S. industries. In addition, such investors provided a powerful demonstration effect on "How to do it better."
    • Considerable efforts spent learning from others, especially Japan

  • The 1980s ended with a sharply intensified level of competition in the U.S. economy, and sustained restructuring of whole sectors of the economy. Only the best-managed and innovative companies could survive in that environment.

The result of the restructuring and rise in competitive pressures, coupled with newly responsible macroeconomic policy, made the U.S. expansion of the 1990s very different than the Japanese expansion of the 1980s

  • U.S. budget deficits were brought to an end
  • Monetary policy accommodated the tighter fiscal policy with lower interest rates
  • Despite the longest economic expansion in history, U.S. industry continued to restructure
    • There was a continuous stream of announcements from successful, profitable companies that they were restructuring, laying off workers and lowering their cost structure
    • The intense competition within the U.S. economy did not permit the development of "fat and sloppy" businesses.
    • Adoption of new technology and business processes became a key element in reducing costs and raising productivity
    • U.S. economy benefited from the stock market bubble. However, that bubble was fed by the belief in the value of new information technology (the Internet) and its contribution to rising productivity.

Key Role of Networking Technologies in General and the Internet in Particular

  • Prior to the development of the Internet, the major contribution to productivity of computers was seen in manufacturing.

  • However, manufacturing represents only about 10% of the labor force. While computers were used in the 90 percent of the labor force engaged in service functions, they did not lead to significant changes in business processes that could form the basis of significant productivity improvement.

  • It was the coming together of the PC, cheap and ubiquitous networking technologies, the graphical user interface, and the Internet that for the first time made possible dynamic new ways of doing business that raised productivity in service functions - sales, distribution, supply chain management, customer support, medical services, government services, finance, education, and many more - including opening of many service functions to international competition for the first time, i.e. customer support, computer programming and software engineering, medical diagnostics.

  • The significance of the Internet for ongoing and continuous productivity improvement has been blurred by the collapse of the Internet bubble. (The failure of a rash of start-up companies without viable business plans or revenue models made the collapse inevitable.)

While it is not possible to predict the future with certainty, it is highly unlikely that the United States has entered a period of sustained economic stagnation

Where does this leave Japan?

  • When heroic macroeconomic policy fails to return an economy to economic growth, attention and action must be directed at the structural problems.

  • Japan cannot return to strong economic growth without addressing the major structural issues that prevent a successful economic expansion:
    • The most important issue is undertaking the painful changes that would permit the reallocation of resources - capital and labor- from inefficient, low productivity, uncompetitive undertakings to higher productivity uses.

What is needed?

  • Solving the banking problem is necessary, but not sufficient. If the massive overhang of NPLs were addressed by the government, and the banks returned to financial health with sufficient public infusions of capital and, if necessary, new management, the problem would not be solved. To whom would the healthy banks lend?

  • More aggressive across the board transformations that permit the movement of capital and labor to more productive uses is critical.

Why is the transformation progressing slowly?

  • Economic transformations are disruptive, costly, and painful in human terms.
    • The demise of functionally bankrupt, but operating companies raises unemployment and forces the recognition of non-performing debt.
    • Human and financial costs are high

The political structure of Japan makes it difficult to mobilize government action to solve the structural problems.

  • Long history of government direction of the economy and the allocation of capital
  • Over-representation of rural, agricultural, and older citizens in the Diet
  • Long history of suspicion of market-based competition as the allocator of resources
  • Result: inability to overcome history and political factors to aggressively address the problems

There is a robust literature that addresses this type of problem: Economic Rent

  • Definition: Economic Rent is the payment for an input that is in excess of the minimum payment required to have that input supplied.
  • Sources of economic rent:
    • Market-Based - innovation
      • Serves as a stimulus to innovation and change
    • Power Based - monopolies
      • Market power makes possible high prices and supra-normal profits or rents.
    • Government Based - government intervention used to provide benefits
      • Government connections/power (such as, regulation, import protection, export subsidies, subsidized credit) used to extract benefits and sustain businesses that would be much smaller or would not exist without government protection/restrictions.

The role of economic rent in economic history:

  • "Economic History is the history of the creation and destruction of economic rents."

  • That is, the pursuit of economic rents explains much about how economies develop.
    • Economies, in which the major source of economic rents is innovation, tend to be dynamic and creative.
    • Economies, in which the major source of economic rents is government intervention, tend to develop rigidities that make it hard to adjust to changing circumstances.

No alternative to addressing the structural problems: Every economy faces problems and periodic crises. The test of a healthy economy is the effectiveness of the response to the crises.

Some lessons from the U.S. Experience

  • Resolution of banking crisis during the great depression of the 1930s.
    • Role of RFC
    • Jesse Jones
      • Write off bad loans at realistic values
      • Judge the character and capacity of management and make changes if necessary
      • After 2 above, inject new capital

  • Chrysler Bailout (1980)
    • Assure a business basis for the turn around
    • Require all who stand to gain from the turnaround to contribute to financing the turnaround
    • Public funds have to be matched by other contributions, and no public funds permitted to flow through the company as rents to constituent interests
    • Government first in line in the event of a default - a lien on everything
    • Government received warrants as compensation for the risk borne by the public sector

  • Resolution of the S&L industry (1989)
    • Act promptly before a problem becomes a bigger problem
    • Close insolvent institutions
    • Role of RTC - dispose of overhang of assets quickly so that they can be redeployed into productive undertakings and so they will not be an overhang on the market that depresses new investment.

  • Role of international trade
    • Import competition forced U.S. industry to compete or go out of business.
      • The result is that in the 1980s there was a massive restructuring of industry that first turned the industrial heartland of the United States into a rust belt, and then into new industrial patterns. Pittsburgh, which at one time was the center of the U.S. steel industry, has no steel-making industry today. It has become a high tech center with some of the cleanest air in America.

  • Role of foreign investment
    • When U.S. industry lost over a quarter of the U.S. market share to Japanese competitors, every explanation in the book was offered, except that the U.S. companies had lost fundamental competitiveness. The arrival of the transplants showed the role of better management - Japanese companies building cars in the United States with U.S. workers, and using parts and component from U.S. suppliers, achieved the same efficiency and quality levels realized in plants in Japan. U.S. industry had to compete or exit!
    • Japan can also benefit from foreign investors who specialize in corporate turnarounds. Such investors bring not only the needed capital, but also the management, legal and accounting talent needed to do the job. (Nissan is the most famous, but not the only, example.)

Japan Today: The solution cannot be put off forever.

  • Japan has taken many small steps at reform, but all of the small steps do not add up to enough:
    • Too little deregulation,
    • Too few Non-Performing Loans dealt with (despite all of the write offs, the size of the NPL problem continues to grow).

  • Failure to act effectively means the problem will just get bigger. Either deal with the problem today and pay the price, or continue to temporize and pay a higher price tomorrow.

  • Current economic performance depends on large government deficits. Government debt as a share of GDP is continuing to grow rapidly. This path is not sustainable. And, what is not sustainable will not be sustained. At some point - and no one can say when - the tipping point will come and a crisis will develop quickly and painfully.

Japan has great resources:

  • Some of the best managed corporations in the world
  • Excellent technology
  • Well educated and productive labor force

The best of Japan deserves to have the problems fixed and to have the country return to a path of strong economic growth, wealth creation and economic optimism.

*This summary was compiled by RIETI Editorial staff.