Posted on March 25, 2011

Japan: The Forgotten Economy

Following four decades of unprecedented growth, Japan suffered the consequences of an asset bubble that was fuelled by easy credit, overinvestment, and speculation.

So much money readily available for investment, combined with financial deregulation, overconfidence and euphoria about the economic prospects, and monetary easing by the Bank of Japan in the late 1980s, resulted in aggressive speculation, particularly in stocks and the real estate market. Banks granted increasingly risky loans and by late December 1989, the Nikkei hit its all-time high.

Real estate values were wildly inflated as Tokyo became the most expensive real estate market in the world. When the crash hit in 1990, tens of trillions of dollars worth of assets were wiped out with the combined collapse of the stock and real estate markets. It was not until 2007 that property prices started to rise again, only to fall in late 2008 with the global financial crisis. For four decades, overall real economic growth had been spectacular, with an average annual growth rate of 10% in the ‘60s, 5% in the ‘70s, and 4% in the ‘80s. Growth slowed markedly following the asset-price collapse, averaging only 1.5% annually in the 1990s, and less than one percent in the past decade.

The 2010 GDP level in Japan was the same as in 1992. Monetary policy was largely ineffective in spurring growth because the economy was in a liquidity trap and fiscal policy was insufficiently bold or consistent. Japan faces severe fiscal and demographic challenges. The labour force participation rate fell from an average of 63.5% between 1973 and 1999 to under 60% recently. Although the official jobless rate is only 4.9%, the rate that includes discouraged workers is 10.7%. Despite all of the bad news in the past twenty years, Japan remains a major economic power.

Now that it has been disrupted, the role Japan plays among the world’s largest providers of specialized machinery and equipment, industrial robotics, optics, electronics, transport equipment, autos and parts, chemicals and semiconductors is more fully appreciated. Without Japan, the supply chain has been broken, causing temporary layoffs and slowdowns around the world. Despite the two lost decades, Japan remains the third largest economy in the world, behind the U.S. and China, and is more than 60% bigger than Germany. Japan is also a huge net exporter of capital, with the second largest current account surplus. Japan is the second largest investor in U.S. Treasuries—second only to China—and is able to finance its own debt internally. It also holds the world’s second largest reserves of foreign exchange and gold and has the third highest market value of publicly traded shares. Japanese companies represent 71 of the Fortune Global 500 firms with overseas assets worth more than $100 billion. The workforce is highly skilled, well educated and loyal.

Japan is a large consumer of imported energy and luxury goods. It is third in the world in its imports of oil and natural gas. Japan’s major export partners are China (18.9%), the U.S. (16.4%) and South Korea (8.1%). Its major import partners are China (22.2%), the U.S. (11%), Australia (6.3%), Saudi Arabia (5.3%) and UAE (4.1%). Japan is also a leading nation in scientific research, particularly technology, machinery and biomedical research. Nearly 700,000 researchers share a $130 billion research and development budget, the third largest in the world. Japan is also the world leader in fundamental scientific research, having produced fifteen Nobel laureates in physics, chemistry and medicine, three Fields medalists and one Gauss Prize laureate. Government spending on R&D as a percent of GDP is third highest in the world (behind Israel and Sweden) and is 2.2 times higher than China. It holds a similar position in business expenditure on R&D as well. In 2010, Panasonic retained the top spot in international patent filings. In 2009, Japan was granted the second largest number of U.S. patents in the world (behind the U.S.), 3.7 times more than Germany and 13.3 times more than China. Japan is a high-tech powerhouse in a low-tech, low-wage region.

China’s manufactured exports are largely built using Japanese machine tools. Japan is a large investor in China; the stock of its direct investment in China has grown at an annual average rate of 21% since 1990. Its large firms have enormous financial muscle and leading-edge technology and its financial sector is sophisticated and well capitalized.

The Bottom Line: Japan will rebuild rapidly and come out of this tragedy stronger and more advanced than ever.

The scars will, no doubt, linger, as a significant region of the country may well be taken out of economic use. But the Japanese are quite capable of moving onto an even higher level of global competitive competency as they have shown their resilience and strength.