Pop Goes the Bubble!
Updated: Mar 11, 2020
As per the Organisation of Economic Co-operation and Development, Japan is the third largest economy by nominal Gross Domestic Product (close to USD 6 Trillion), is the fourth largest as per Purchasing Power Parity and is the world’s second most developed nation. Further, it is the 3rd largest automobile producer and boasts of the biggest Electronic Industry. As a matter of fact, USA owes USD 1.1 Trillion to Japan, making it the second largest lender to the US, after China. Despite these rosy figures, the naked truth is undeniably clear: Japan’s economy is facing its worst crisis till date, a crisis which threatens to dislodge Japan from its No. 2 Position on the list of developed nations.
The Japanese Economy, in the 1970s, was one to envy, because the period was characterised by high economic growth, despite the near-zero inflation rate. 1981 marked the highest real GDP growth rate of 6.4%. The second half of the 80s depicted moderate growth, and it was the period of 1985-1991 which was called the ‘bubble phase’, characterised by high asset price levels and credit expansion, and further expected increases as well. Following this, Japan’s real GDP growth rate fell from 5.6% to 2.4% in 1991 and further to 0.7% in 1999, from which it obstinately refused to budge until 2012.
Why did this happen, one might ask. For starters, financial deregulation- the process of removing state induced regulations on sourcing funds by the Japanese corporations- did not bode well for the economy. The corporations no longer had to depend on banks for their funds and could raise cheaper finances abroad, by means of bonds. With fewer beneficiaries for their loans, Japanese banks changed their target group from manufacturing firms to real-estate, housing and other smaller, but riskier firms. The discount rates (rates at which banks borrow from the Bank of Japan) were still very low, held here in an attempt to push up inflation which was nowhere close to even inching upwards from its zero-mark. These low rates stimulated the raising of capital reserve ratios by the banks (the maximum amount necessary to ensure liquidity for the banks) and encouraged creation of money through real-estate backed loans. The stocks of firms in the financial sector increased in value- due to investor valuation- and with them rose the value of other stocks as well.
Secondly, the price of land, viewed by the Japanese as a precious and scarce commodity, increased threefold during the 1980s. This was because of the increase in demand for loans which asked for land as collateral, as well as the Government raising short term property gains to 150% which made buying land lucrative to even the common man. The loans dispatched were not being given to manufacturers and this led to fall in output levels, along with a bolstering of asset price inflation, instead of the much-desired general price inflation.
Thirdly, between 1985 and 1988, the Yen appreciated enormously and the Government responded by monetary easing to help indigenous producers face competition from imports and in order to retain their market share abroad. This step further fuelled the already overheated real-estate market.
The Bank of Japan (BOJ), was cognizant of the fact that an asset bubble had formed and in order to slowly bring down prices, the discount rates were raised. However, this measure led to the burst of the asset bubble and crash of the Japanese Nikkei 225, in retaliation to which, the Government slashed discount rates again to prevent prices from falling, but these efforts were in vain.
Abenomics to the Rescue
Shinzo Abe, elected as Prime Minister in December 2012, hopes to change the course of his moribund economy by lifting it from the deflationary quagmire and improving growth statistics, and he plans to achieve this daunting task through his three-pronged weapon, commonly called ‘Abenomics’. As part of his strategy, Abe introduced the three fierce policies of monetary easing, fiscal reforms and structural reforms. The first prong (monetary easing) is at work to increase inflation to the BOJ’s new revised target of 2%. Once production picks up, real wages (wages adjusted for inflation) are expected to increase, leading to increase in consumption expenditure and rise in value of stocks. Moreover, the Government and the BOJ have been on a stimulus-package releasing spree, which hopes to create liquidity in the economy, at least in the short term. Through Fiscal reforms, Abe, wants to induce higher government Expenditure, which is expected to lead to an upsurge in the GDP by 2 percent points. Finally, structural reforms include measures like liberalisation of various sectors like agriculture and health care as well as encouraging more women participation in the workforce of the country.
While there is consensus that the first ‘two arrows’ have hit the nail on the head, critics, especially the IMF, feels that the structural reforms, which were to become the linchpin of Abe’s reforms, are long overdue. Despite attempts at monetary easing, the Government has introduced a very high consumption tax of 8%, which many fear might discourage spending and lead to further appreciation of the Yen. Though this method was devised to reduce Japan’s massive debt (233% of its GDP) by raising tax revenue and which it has as well, of around USD 8 Trillion, this is in sharp contrast to the government’s policy of providing large stimulus packages. It recently provided a package of USD 5 Trillion, which left the government richer by a mere USD 3 Trillion. Moreover, constant devaluation of Japan’s currency accentuates fears of hyperinflation as well as that of currency wars, with different countries vying to devalue their own currency in order to boost exports.
Is Modi India’s Abe?
Amid speculation leading to Modi’s elevation as Prime Minister, it was touted that ‘Modinomics’ will help India gain a new economic resurrection. However, Modinomics isn’t as well defined as Abenomics is, though it definitely is on the right track. Modi has spiked prices of many consumer items from railway fares to sugar, promising increase in production and increase in employment, albeit the aam aadmi might feel his pockets pinched in the near future. Moreover, to compare Modi’s policies with those of Abe is like comparing apples and oranges, because while the former needs an infrastructure reincarnation, elimination of red-tapism and greater centre-state relations to help clear large projects, the latter needs to accelerate its growth which seems to have braked and invest in health-care to improve its working class demographics. (Hornung 2014)
Slowly, but steadily, the targets are being achieved. The initially worked out figure of six hundred thousand jobs is nearing completion, the GDP of Japan was re-assessed at 3.8% this fall and inflation is beginning its upward journey towards the ear-marked 2%. All that is left to be seen is whether, as Greg Ip – Editor of The Economist puts it, ‘this gigantic experiment in monetary policy’ is sustained in the long run, paying Japan the dividends it has long deserved and desired.
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