Friday, May 28, 2010

>What lessons can be learnt from Japan’s lost decade?

The worldwide recession that followed the subprime crisis was unprecedented in many
ways, but not so unique that no lessons can be learnt from previous experiences. Japanese’s lost
decade comes probably closest. Both episodes were preceded by the bursting of speculative bubbles, with led to a prolonged banking crisis. In the case of Japan, it took the economy more than 10 years to recover. At the end of the period, GDP was around 20% below the level it would have achieved if capital spending growth had followed more normal patterns. Moreover, the slump in world’s second largest economy was not without repercussions for the country’s trading partners.

Even though this episode was followed by the longest boom in Japan’s post-war history, some
scars have remained, making the economy still very vulnerable to external shocks. Indeed, the country was among the most affected by the subprime crisis, even though its banking sector was not particular exposed to this market. The most obvious sign of weakness is that more than 20 years after its dramatic collapse, the Nikkei is still 75% below its peak reached by the end of 1989. In addition, the government accounts have seriously deteriorated.

Gross public sector debt amounts to almost 200% of GDP, and the government does not have a plan to reduce the debt to more manageable proportions. Finally, the economy is still confronted with substantial overcapacity, which has been weighing on prices. In November, the government declared that the economy went again into deflation. In the coming two years, GDP is expected to grow by around 2%, well above Japan’s potential growth rate, estimated at 0.8%. As a result, excess capacity will gradually dissipate. The Bank of Japan (BoJ) expects the economy to exit deflation in FY2011.

The lost decade
Japan’s lost decade was sparked by the bursting of bubbles in the stock and real estate markets in the early 1990 (cf. chart 1). Between December 1989 and December 1991, stock prices fell by 40%, returning them to their pre 1987 level. The property market started to falter in 1991. Between 1991 and 1993, land prices in the six major cities fell by 30%. These two asset categories might have destroyed JPY 1 500 000 billion in wealth, about three times the country’s GDP1.

In the following decade, the economy was characterised by slow growth, falling prices and
dysfunctional financial markets. Between 1992 and 2002, GDP growth averaged only 0.8%, compared with 4.5% in the preceding ten years. The OECD estimates that over this period, the potential output growth declined to 1.4% on average, down from around 4% before the bursting of the bubble.

To read the full report: JAPAN'S LOST DECADE