Macro Economics-Principles & Policies

PROJECT REPORT

JAPANESE ECONOMY
“FROM MIRACLE GROWTH TO THE
LOST DECADE”

GROUP MEMBERS
10FN-022 Anurag Pandey
10FN-026 Arun Koul
10FN-126 Brijendra Dubey
10DM-037 Chandrabhan
10IB-031 Arpit Khullar
10FN-127 Debanjan Das

IMT
Institute of Management Technology
Ghaziabad
 Acknowledgement
We are thankful to Dr. Subhajit Bhattacharya for providing us with valuable guideline in the
course of this project.
We are very proud of our teacher Dr. Subhajit Bhattacharya whose help and instructions
enabled us to complete this project.

Anurag Pandey
Arun Koul
Brijendra Dubey
Chandrabhan
Arpit Khullar
Debanjan Das
 Table of Contents
Introduction 4

The 80's or the Bubble Economy 5

 The “Bubble Economy”, General facts 5
 financial system 5
 the cause of the crisis to come 8

The 90's, period of crisis and causes 12

 The consequences of the “Bubble Economy” 13
 Fiscal Policy 14
 Monetary Policy 17
 Failure of traditional growth model 19

Recommendations 22

Conclusion 23

Appendix 24
 INTRODUCTION
The success of the Japanese economy in the period of the after war is undeniable. It has gone
from almost nothing to a vast exporting market invading the international trade markets with
its new technologies. Thus, the economy of the country soon became reckoned as one of the
most powerful and successful in terms of competitiveness and welfare. Many people soon
attributed Japan's success to a combination of factors:

Government-industry cooperation, a strong work ethic, mastery of high technology, and a

comparatively small defence allocation (1% of GDP) have helped Japan advance with
extraordinary rapidity to the rank of second most technologically powerful economy in the
world after the US and third largest economy in the world.

One characteristic of the economy was the working together of manufacturers, suppliers, and
distributors in closely-knit groups called keiretsu. A second basic feature has been the
guarantee of lifetime employment for a substantial portion of the urban labour force. Both
features are now eroding. Industry, the most important sector of the economy, is heavily
dependent on imported raw materials and fuels. The much smaller agricultural sector is
highly subsidized and protected, with crop yields among the highest in the world.

This report has intent to analyse the causes of the actual crisis and to try to give some
possible recommendations for the aftermath.

As a matter of fact, for three decades overall real economic growth had been spectacular: a
10% average in the 1960s, a 5% average in the 1970s, and a 4% average in the 1980s.

But that growth slowed markedly in the 1990s largely because of the after effects of
overinvestment during the late 1980s and contractionary domestic policies intended to wring
speculative excesses from the stock and real estate markets.

In later dates, the Government has been trying to revive economic growth but has met little
success and was further hampered in late 2000 by the slowing of the US and Asian
economies.
 The 80's or the Bubble Economy
Here, we will see some aspects of the “bubble economy”, which lasted from 1987 to the
beginning of the 90's. First of all, it could be convenient to give a brief definition of the so
called “Bubble Economy”. It is the period during which speeding of the growth of japans’
money supply, fuelled massive increases in Japanese land and equity prices. The purpose
here is to understand why it led to the crisis that Japan knows ever since 1990. So to speak,
the crisis that happened in the early 90s has something to do with what had been done
previously and this is precisely what we are going to see there in after.

The “Bubble Economy”, General facts

In the mid-1980s, Japan became the world's largest creditor and Tokyo a major international
financial centre. Four of the biggest banks in the world were Japanese at that time, and Japan
had the world's largest insurance company, advertising firm, and stock market. In the
remainder of the 1980s, Japan's financial and banking industries grew at unprecedented rates.

Japan’s financial system

The main elements of Japan's financial system were much the same as those of other major
industrialized nations: a commercial banking system, which accepted deposits, extended
loans to businesses, and dealt in foreign exchange; specialized government owned financial
institutions, which funded various sectors of the domestic economy; securities companies,
which provided brokerage services, underwrote corporate and government securities, and
dealt in securities markets; capital markets, which offered the means to finance public and
private debt and to sell residual corporate ownership; and money markets, which offered
banks a source of liquidity and provided the Bank of Japan with a tool to implement
monetary policy.

Japan's traditional banking system was segmented into clearly defined components in the late
1980s: commercial banks (thirteen major and sixty-four smaller regional banks), long-term
credit banks (seven), trust banks (seven), mutual loan and savings banks (sixty-nine), and
various specialized financial institutions. During the 1980s, a rapidly growing group of
nonbank operations, such as consumer loan, credit card, leasing, and real estate organizations,
began performing some of the traditional functions of banks, such as the issuing of loans.
Japan's securities markets increased their volume of dealings rapidly during the late 1980s,
led by Japan's rapidly expanding securities firms. There were three categories of securities
companies in Japan, the first consisting of the "Big Four" securities houses (among the six
largest such firms in the world): Nomura, Daiwa, Nikko, and Yamaichi. The Big Four
played a key role in international financial transactions and were members of the New York
Stock Exchange.

Japanese insurance companies became important leaders in international finance in the late
1980s. More than 90 percent of the population owned life insurance and the amount held per
person was at least 50 percent greater than in the United States, for example. Many Japanese
used insurance companies as savings vehicles. Insurance company’s assets grew at a rate of
more than 20 percent per year in the late 1980s. These assets permitted the companies to
become major players in international money markets. (Nippon Life Insurance Company, the
world's largest insurance firm, was reportedly the biggest single holder of United States
Treasury securities in 1989.)

The Tokyo Securities and Stock Exchange became the largest in the world in 1988, in terms
of the combined market value of outstanding shares and capitalization, while the Osaka Stock
Exchange ranked third after those of Tokyo and New York. Although there are eight stock
exchanges in Japan, the Tokyo Securities and Stock Exchange represented 83 percent of the
nation's total equity in 1988. Of the 1,848 publicly traded domestic companies in Japan at the
end of 1986, about 80 percent were listed on the Tokyo Securities and Stock Exchange.

Two developments in the late 1980s helped in the rapid expansion of the Tokyo Securities
and Stock Exchange.

 The first was a change in the financing of company operations. Traditionally large
firms obtained funding through bank loans rather than capital markets, but in the late
1980s they began to rely more on direct financing.

 The second development came in 1986 when the Tokyo exchange permitted non-
Japanese brokerage firms to become members for the first time. So that by the year
1988 the exchange had sixteen foreign members.
Japan's stock market dealings exploded in the 1980s, with increased trading volume and
rapidly rising stock prices. During a six-month period in 1986, total trade volume on the
Tokyo exchange increased by 250 percent (which is quite a big figure), with wild swings in
the Nikkei. After the plunge of the New York Stock Exchange in October 1987, the Tokyo
average dropped by 15 percent, but there was a sharp recovery by early 1988. In 1990 five
types of securities were traded on the Tokyo exchange: stocks, bonds, investment trusts,
rights, and warrants alone.

40000
35000
30000
25000
20000
15000
10000
5000
0
1985

1988
1989

1991
1992

1994
1995

1998

2001

2004

2007
2008

2010
1983
1984

1986
1987

1990

1993

1996
1997

1999
2000

2002
2003

2005
2006

2009
(Nikkei Stock Average 225)
 (1982 = 100)
400

350
300
250

200

150
100

50

0
1982

1985
1986

1989
1990

1993
1994

1997
1998

2001
2002

2005

2009
1983
1984

1987
1988

1991
1992

1995
1996

1999
2000

2003
2004

2006
2007
2008
(Urban land price index)

The cause of the crisis

The most powerful institution in Japan is definitely, the Ministry of Finance (MOF). The
power of the MOF has inhibited the development of true financial markets in Japan. Presently
capital is allocated on the basis of who knows whom instead of economic effectiveness. The
commercial success of Japanese manufacturing has led to Japanese banks of enormous wealth
but without the corresponding level of financial skill and expertise. Japanese banks typically
rely upon the guidance of the MOF and consequently do not exercise sufficient independent
judgment and have not learned to cope with financial difficulties. Banks have lent heavily
with land as collateral.

In 1985 interest rates on deposits began to be deregulated. Prior to that time bank were not
allowed to pay interest on deposits. The removal of this prohibition led to competition
between banks for deposits and hence to interest payments. Japanese banks did not raise
interest rates they charged borrowers and offset the effect of the higher costs of their funds.
They made up for the drop in their profits by selling the shares of stock they owned for a long
time and counting the realized capital gains as profits. But because of the obligation of cross-
holding of stock among the members of keiretsu they immediately bought back the shares at
the new higher price. This meant that they were able to count the capital gains as a profit, but
they had to pay tax on the capital gains. They thus experienced a net loss of cash flow on the
operation. Furthermore a decline in the stock market then meant a disguised capital loss.
The Bank of International Settlements (BIS) has rules which are critical for Japanese banks.
According to BIS rules, bank capital consists of two parts. Tier-one capital is the stockholders
funds and retained earnings. Tier-two capital consists of such things as loan-loss reserves and
"hidden assets." Forty five percent of unrealized capital gains on stocks can be counted as
"hidden assets" and part of tier-two capitals. This was a compromise of the BIS to
accommodate Japanese banking. Some members of the BIS did not want to allow any
unrealized capital gains to be counted as part of bank capital. Although counting unrealized
capital gains accommodated the Japanese banking system, it made them vulnerable to price
fluctuations in the stock market. If the stock market goes down then the Japanese banks must
scurry to raise capital to meet BIS standard of an 8 percent ratio of capital to liabilities.

During the bull market in Japanese stocks banks issued new shares which allowed them to
increase their assets. Between 1987 and 1989 city banks issued 6 trillion Yen of equity and
equity-related securities. But when the Tokyo stock market crashed in 1990 these banks had a
hard time maintaining the BIS required 8 percent capital ratio. Only one bank, Kyowa Bank,
could maintain this ratio. The number of regional banks that could meet the 8 percent ratio
declined from 50 in March of 1990 to 4 in September of that year.

During the "Bubble Economy" Japanese banks borrowed extensively in the Euro-dollar
markets, 186 trillion Yen by June of 1990. Despite being the largest banks in the world these
Japanese banks had to pay a premium in their borrowing, the so-called "Japanese rate".

From the borrowed funds Japanese banks lent extensively. They opened American branches
which earned very low rates of return, about 2 percent on equity. They did most of their
lending in the peak of the American real estate market and consequently suffered extensive
losses when property values declined and loans went bad.

The collapse of the Tokyo stock market collapsed the bank’s tier-two capital and put them
under pressure to find capital. They no longer could find easy capital to borrow and had to
liquidate many of their overseas holdings, often at a loss.

Japanese banks were also adversely affected by the decline of property values in Japan. In
1990 Japanese banks held about 22 percent of the mortgages in Japan. In addition, many of
the loans to small businesses are backed by property and 75 percent of the bank’s lending is
to small businesses.
There were other financial intermediaries in the property-backed loan market. The Housing
Loan Corporation, a government agency, provides interest rate subsidized mortgages.
Employers also sometimes provide subsidized home loans. There are also leasing companies,
consumer-finance companies, and mortgage companies active in the mortgage market but
these institutions are generally dependent from the banks for their funding so they represent
the indirect participation of Japanese banks in the mortgage market.

In addition to the above financial institutions there are also secondary regional banks
called sogo banks and shinkin banks. In Japan banks are not only not required to establish
reserves for bad loans, they are effectively penalized for not doing so. Setting aside funds to
cover bad loans would reduce the tax liability of the bank and so the banks have to obtain
permission from taxing authorities to create bad loan reserves. Consequently in 1991
Japanese banks had reserves of only 3 trillion Yen for total loans of 450 trillion Yen.
Japanese banks tend not to report that a loan is in default because it makes the accounting
profits look bad. Banks pressure the borrowers to come up with 30 percent of the interest
owed because this allows them to avoid reporting their loans as being bad. This practice of
not admitting problems or trying to solve them using gimmickry has become a concern of the
Bank of Japan, the central bank of Japan.

The land market in Japan is heavily influenced by tax rules. Years ago, the Japanese
government established high taxes on capital gains on land to discourage speculation. For any
land held less than two years after purchase the capital gain is multiplied by 150 percent and
this amount added to current income in computing the seller’s income tax. If land is sold two
to five years after its purchase then 100 percent of the capital gain is added to income for tax
purposes. Effectively this is a 90 percent tax rate on property held less than two years, a 75
percent tax rate on property held two to five years, and a 50 percent tax rate on property held
more than five years. This tax system discourages people from marketing land and
consequently those who need land for some project find they have to pay exorbitant prices to
get someone to part with it. Very little land changes hands and then as often as not to
relatives. Consequently the valuation of land is artificially inflated. This artificial valuation of
land would not be of much significance if it were not for the fact that people borrow money
based upon their holdings of land. This begins to qualify for the term "astronomical." In
November of 1991 the Ministry of Construction reported that houses and apartments in
metropolitan Tokyo had in the preceding year lost 37 percent of their value and plots of land
in the suburb of Saitama had lost 41 percent. The bubble in property values would not have
been significant except for the fact that the use of land as collateral for loans and the fact that
the taxing authorities tend to use those peak prices in valuing property subject to the
inheritance tax.

Life insurance companies around the world are partly involved in providing insurance
against risk and partly in providing savings programs. In both activities they end up having to
invest heavily in financial securities. Life insurance companies in Japan own more stock than
does any other type of financial institution. For example, in 1990 they owned 13 percent of
the stock on the Tokyo stock market compared to 9 percent held by banks. The rates of return
on managing their portfolios of stock could be quite misleading for them. There is a special
problem for Japanese insurance companies. Japanese law requires that they pay policyholders
out of income rather than capital gains. This has led to some strange financial operations,
such as trading stock for bonds that paid high interest but gave little payment at maturity.
Japanese insurance companies were at risk in the property market also. Six percent of
insurance assets were property and many of their domestic loans were backed by property.
When Japanese insurance companies became involved in foreign investment they subjected
themselves to considerable risk. One such risk had to do with fluctuations in exchange rates.
 Percent
10

Real GDP
5

0
Bubble
Nominal GDP
-5

-10
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09

(GDP-1980 TO 2010)

The 90's, period of crisis

As we saw over the first part of the report, the bubble economy of the 80's would drive Japan
right to the point it reached at the beginning of the last decade. As a matter of fact, the way
people played, the economy was obviously going to lead to an economic problem.

Only a few years before, Japan was viewed as an exemplary economic success story and a
model of successful economic long-run growth. People talked of “Japan Inc.” and the
Japanese growth model was being suggested as a case study to be followed by other
developing and developed countries. As we saw, this general thought was due to the fact that
the country had known a dramatic growth during more than 3 decades.

But, as we often refer to: after a boom comes the crisis. As a matter of fact, it is not rare in
economy to see a national economy following the scheme of the so called business cycle. In
other words, there are some periods of growth and some periods of crisis. Thus, in the case of
Japan it seems a little bit different. As was pointed out in the first part, something was going
wrong in the financial system Japan supported way before the crisis.

However, we understand the Japanese economy suffers of severe problems that are not only
cyclical but more structural in nature. Such structural problems are the most serious
impediments to economy as a whole.

The consequences of the “Bubble Economy:

The “Bubble economy”:

- Low interest rates (about 0%)

- Firms over borrowed

- Banks over lent

- Asset prices proved unrealistic

- Banks couldn't collect on their loans

- But pricing long-lived assets was hard

-Real estate grew faster than economy

-Stock prices grew faster than economy

-Growth industries grew very fast indeed!!

- Interest rates can't be pushed below 0%

- Falling prices falling

- Banks (rightly) fear bad assets

- Liquidity Trap

Fiscal Policy
In the last 10 years, Japan has put together a string of fiscal stimulus packages that have
caused the economy to grow, but not in autonomy. 2/3 of that growth was caused by the
actual spending of the yen stipulated in the package. Only 1/3 of the growth came from
growth caused by externalities like higher level of aggregate income, consumption, etc. The
failure of fiscal policy in a flexible exchange rate system has been examined by Keynes. In
the case of a recession, short run equilibrium settles below the level of full employment. This
tells us that the Japanese production resources (capital and labour, etc) aren't being used in
the most efficient manner. So in this case, government intervention is seen as the key to
moving out of the recession.

The rise in consumption by the government acts to stimulate the domestic interest rates. As
the interest rate rises above the world level it induces an appropriate rise in the inflow of
capital. Because of the higher demand of the yen (domestic currency) it will begin to
appreciate against other currencies. The export sector will be hit the hardest as their products
become relatively more expensive versus other goods. As the export sector becomes less
competitive, cheaper imports will begin to infiltrate the economy, thus undermining the
domestic sector. So, although the government raises its consumption, the decline of the
export industries and the increased imports will tend to offset the gains. With a fixed money
supply, the government is just changing the composition of aggregate consumption by
crowding out the private sector's consumption and investment. As interest rates rise, this will
make borrowing money and investing more expensive. So, as the negative effects of an
appreciation of the domestic currency drives the economy back to the initial equilibrium
point.

As the asset bubble deflated and Japan began to inject fiscal stimulus, the yen did appreciate
for 5 consecutive years from 1991-1990. The yen climbed as high as 85 yen to the
dollar...way up from 360 yen to the dollar. Despite the appreciation, the trade surplus
remained intact for two reasons...innovation by the exporting industries and the tight business
ties within the keiretsu.

The exporting industries found new ways to cut costs. They shifted production to the US
where the Yen was strong and therefore foreign asset prices relatively cheap. Japanese auto
manufacturers such as Toyota and Honda were able to avoid losses in foreign exchange by
assembling the cars cheaply in America and other dollar-pegged countries in Asia. This
served to offset rising yen-related costs as production moved offshore. To cut costs even
further production of commodity-type goods declined. Commodity-type goods are
characterized as being very price sensitive. Goods that have little or no differentiation except
for the price are considered part of this group. Textiles, metals and agricultural goods are
examples of this. As sales declined, more of those resources began to shift into what is called
the high-value goods. These goods' demand is less sensitive to price changes as it is with
quality and technology. Electrical machinery, and transportation equipment, etc are examples
of this. Because not every country is able to produce high-value goods, they are seen as price
makers, whereas the former are referred to as price takers.

Keiretsu ties have been very effective in keeping lower priced imports from entering the
Japanese market. The keiretsu are a mixture of vertical and horizontal integrated companies.
A bank is at the centre to provide finance and support for investments. It is standard to have
input manufacturers of an export good be part of the export industry's keiretsu group. Auto
parts manufacturers are often part of the same group as their auto manufacturer. The auto
parts company's demand will come largely from this auto manufacturer in return for not
buying cheaper foreign auto parts. Because the companies within the keiretsu hold a certain
percentage of each other companies' stock, it is in their best interest to buy from their member
companies to keep them afloat and keep the value of the stock high. This has been successful
in keeping out imports. Profit margins are generally lower, but that is an insurance premium
during times of economic hardship.

In 1991, there was a fiscal surplus of 3% of GDP, and government debt was below 10% of
GDP. By 1996, however a 1 ½ % budget surplus was turned into a 3 ½ % budget deficit. This
was mainly caused by 6 different fiscal stimulus plans implemented throughout the first half
of the decade. In 1996, as the debts mounted, Japan felt that the recent growth in the economy
was an indication of self sustain-ability and decided to consolidate the debt and begin to pay
it off. The government implemented three policies.

 The social security tax was raised in 1996.

 A tax cut of 25% of GDP was taken away.

 The consumption tax was raised from 3% to 5%. During this time 3% of what made up
GDP was taken away from the economy. The Japanese government was criticized not for
trying to rid itself of debt, but in the manner in which it went about doing it. At the time key
policy decisions were made, Japan had experienced only about a year of solid recovery after
four years of near stagnation. With that year of recovery boosted by substantial fiscal
stimulus, there was reason to question whether economic expansion had yet been put on a
strong, self sustaining basis, capable of bearing a sudden withdrawal of fiscal support. The
need for fiscal consolidation over the medium and longer term was undisputed, and there
were good reasons to start, at a gradual pace as soon as possible." Because politically, the
shift from consolidation to once again fiscal easing was unattractive, it would have been hard
to convince law makers of its necessity. This delayed the reaction to the Asian Crisis. This is
why three major institutions failed in November of 1997 and there was no monetary and
fiscal response until April of 1998.

Overall, fiscal policy's effectiveness has been hampered by the deflation in the price of assets,
the appreciation of the exchange rate from 1991-1996, the credit crunch brought on by the
debt laden banks and a severe decline in the confidence in the banking industry. It has been
noticed by IMF officials that the government spending multiplier is between 1-1.2, whereas
the tax multiplier is only .5-.8. This may seem at face value that government spending is the
more effective tool; however tax cuts better fulfil the role in the long term growth model.

Monetary Policy
Monetary policy is viewed as effective in the short run in boosting output in an ailing
economy. Investors looking for higher returns on their investments look outside the country
for a higher interest rate and sells domestic currency which will depreciate the value, making
the export sector more competitive. This in turn makes foreign goods relatively more
expensive and consumption shifts to domestic goods. This shift in consumption coupled with
a competitive increase in exports leads to an increase in aggregate income and an increased
demand overall.
The ability for expansionary monetary policy has been greatly diminished in recent years.
The official discount rate was lowered from 6% in 1991 to a level of 4.5 % in 1992. Again in
1993 it was lowered to 1. 25 %. The last time it was lowered was in 1995 when interest rates
were targeted at an all time world low .5%. Short term bank lending rates haven't declined as
far. Most banks are lending at a current rate of 7%. However, lowering the interest rates isn’t
the only condition to easing monetary conditions. As inflation was falling, the real interest
rates were falling as well, but at a rate slower to that of the nominal interest rates. So, real
interest rates were higher than the nominal rates.

Also, in the aftermath of the bubble economy, deflated asset and real estate prices resulted in
a lot of bad debts. So, as nominal interest rates declined, to protect themselves, banks lowered
their lending rates at a much slower pace.

In 1993 and 1995, as signs of growth entered economic indicators, monetary policy was
quickly tightened to lessen any signs of inflation. This caused the yen to continue to rise once
again. As this began to take place again, the Bank of Japan was too late in lowering interest
rates as economic conditions began to further deteriorate. It was a case of "too little too late".

Expected inflation within an economy has both positive and negative outcomes.

 Inflation would cause real interest rates to decline. In today's Japanese economy
inflationary expectations would push real interest rates below zero, in effect making it
profitable to borrow money and either spend or invest.

 Higher product prices would stimulate growth in production. Producers would see the
potential for higher profits. With real wages decreasing in the short term due to contractual
negotiations done in the past, producers would see an increase in worker productivity in the
short run...or at least until new wage contracts are worked out.

 Expected higher future prices would alter future consumption (present savings) to present
consumption.

There are however detractions to the use of monetary policy. A weak yen will cause other
countries to tighten their monetary policy, which will offset some of the benefits to Japan.
Household confidence could be undermined because of the stigma of inflation as bad. This
could lead to further declines in spending. Business investment could be muted by other
external factors which detract from the economy, such as the bad debt crisis within Japanese
banks. So in conjunction with raising inflationary expectations, it is necessary to also solidify
external markers of confidence within the economy such as banks, stock market, government,
etc while raising incentives to spend and invest.

Failure of Traditional Growth Model

The old growth model does not work anymore because of four fundamental new trends in the
world economy:

1. Structural change in the nature of technological innovation.

2. Greater global trade competition

3. Deregulation that is fostering competition

4. Corporate restructuring.
1. Structural change in the nature of technological innovation.

First of all, it has been argued that the nature of technological innovation has changed. From
the 1950s until the early 1980s, innovation took the forms of already existing technologies
and goods that had to be improved in quality (examples are: cars, stereo systems,
photographic equipment, and other consumer electronics goods). The Japanese were best at
doing this as being the best in “process innovation”, “quality improvement” and “product
imitation”.

Today, technological innovation is very different because of qualitative changes in

technologies and the rapid appearance of new and very different products (computers,
software, Internet and information technologies, advanced chip technologies,
telecommunication goods and services, new financial instruments and services). These
products are appearing and changing at such at dizzying pace that an imitator cannot catch up
with the product and technological leaders. The product cycle of innovation has become
drastically shorter. Extreme example: the Internet Browsers and the war between Microsoft
and Netscape. So, today you either innovate or remain on the cutting edge of the
technological wave or you will remain forever behind.

To put it bluntly, a mainstream view in the United States right now is that in all these new
technologies and products Japan is completely behind the US and will be unable to catch up.

2. Greater global trade competition

Increased global trade has led to global competition and the need for industrial restructuring.
Japan until recently didn’t liberalize trade as such and delayed this structural adjustment. The
strong Yen trend until 1994 led to significant import penetration, loss of manufacturing jobs
and the export of jobs to other East Asian countries through a major process of outward FDI.
However, domestic corporate restructuring has been very slow. In this regard, the significant
fall of the Yen since 1995 is a bad omen for Japan because, while giving short-run breathing
room to the battered industrial sector, it dilutes the incentives for structural restructuring and
slows significantly the drive to change. Also, the regulated and non-competitive non-traded
sector of services has not been affected by the external trade liberalization pressures as much
as the traded manufacturing sector. So the global trade pressure to reform has not hit the
service sector.
3. Deregulation policies causing competition

While there are a lot of talk and policy proposals for major deregulation of the economy in
Japan, this has not occurred yet in any significant scale.

4. Corporate restructuring

The combined forces of technological change, trade competition, deregulation of the

economy led to major corporate restructuring in the US that took the forms of

a. Re-engineering

b. Out-Sourcing

c. Large scale Downsizing of firms

d. Massive corporate control restructuring through Mergers and Acquisitions

Because of this dramatic restructuring over the last decade the US economy is now highly
productive, with low labour costs, highly innovative and very competitive in world markets.
Of course, there were very high social costs of this restructuring process first for blue-collars
and now for white collars and managers:

a. Major job turnover

b. Great job insecurity

c. Need for disrupting occupational and regional mobility

d. Depressed real wages for average workers

e. Significant increase in income and wealth inequality

However, such corporate restructuring has led to higher productivity growth, a resurgence of
manufacturing, high employment growth and low structural unemployment rates.

In Japan instead the strong Yen of the early 1990 led to outward FDI, the hollowing out of
the manufacturing sector, significant jobs losses but no major structural reform of the
economy. Reform has been very slow because of the following factors:

a. The lack of major economic deregulation

b. The persistency of oligopolistic structures and lack of market competition

c. The still relatively protective trade policies and inward FDI policies

d. The recent weakness of the Yen

While these factors have sheltered Japan in the short-run from the brutal logic of the new
world economy, they have also significantly slowed down the pressures for reform. Therefore
deindustrialization in Japan may become more permanent than transitory.

In Europe, there is a welfare system where the “insiders” are guaranteed jobs and high real
wages but they have to pay high taxes to support the “outsiders” (i.e. unemployed). While
differing from Europe in many respects, Japan has a number of similar structural rigidities in
labour markets.

Probably, the different social culture and history of Japan suggests that Japan will not and
should not follow the brutal “Wild-West” American model of restructuring and reform.
However, there is need in Japan for major structural reforms and economic deregulation in
order to foster entrepreneurship, risk taking, innovation and long-run growth. Japan will have
to find its own national path to reform and change but the process is going to be painful.
Also, delaying these reforms will not help because short-run reduction of the pain might lead
to more serious problems in the long-run as the persistence of the recession for over four
years now suggest.

RECOMMENDATIONS
a) Rectify Banking System-

Japanese banking system needs to undergo reforms at a structural level. Banks should
use discretion while selecting candidates for granting loans and prudence should also
be shown in selection of collaterals in lieu of the loans. Lessons have to be learnt from
the past mistakes and a proper provision needs to be maintained for securing against
bad loans. A strong policy needs to be at place which dissuades banks from fudging
balance sheets to avoid showing bad loans.
 b) Deregulation and fostering of competition in domestic markets:

Improve services productivity through deregulation and competition. Right now the
low productivity service sector is a main drag on the economy and negatively affects
the competitiveness of the export sector as well. Sectors requiring deregulation
include retail, transportation, telecommunications, and telephone service.

c) Administrative and political reform:

Reduce the powers of the bureaucracy. Reduce the power of the Ministry of Finance
and dismantle it into several smaller agencies. Get competent people on board who
can take right decisions.

CONCLUSION
Structural problems lie at the heart of Japan's economic difficulties and a sustained rebound
in private demand will remain elusive until these factors are decisively addressed. For more
than a decade Japan has adjusted too slowly to the forces of globalization, lagging behind in
innovation and productivity growth. The country must now remove the obstacles to
efficiency in the domestic sectors of the economy, unwind the excess capacity and debt that
was built up during the bubble years, and curb the rapid expansion of public-sector debt.
 APPENDIX
a) Jacques Gravereau, “Le Japon au Xxe Siècle”, Edition augmentée 1994.

b) David Flath, “The Japanese economy”, Oxford University press 2000-

c) Instituto Español de Comercio Exterior (ICEX) : http://www.icex.es/fichas/japon

d) The Evolution of the Japanese financial system and monetary
policy”: http://netec.wustl.edu/BibEc/data/

e) Final Paper : The Japanese Economy in the 80's and the 90's