Japan's Economy in the 1990s and 2000s: Key Factors Explained

Introduction: Japan's Contradictory Economic Landscape

For roughly ten to twelve years, Japan was a study in contradictory economic forces. The country experienced little inflation, little economic growth, a deterioration in trade, higher government spending than in previous periods, and unreliable savings and investment on the part of both businesses and individuals. Compounding these pressures were an aging population requiring more services, volatile global oil prices, and unemployment rates higher than Japan had ever previously seen. Despite all of this, Japan was not apparently as economically destabilized as one might initially suspect.

Inflation and the Liquidity Trap

The reasons for that resilience become clearer through a brief examination of how the Japanese economy actually behaved from the late 1990s into the early 2000s.

In 1998, Japan was attempting to avert a deflationary spiral, and some economists argued for creating a modest bubble of inflation in order to jumpstart a sluggish economy. That would have been accomplished by increasing liquidity. They argued that the Bank of Japan (BOJ) needed to aggressively increase liquidity by printing money or by purchasing securities from the money market. In turn, this would push down interest rates, trigger demand for corporate capital investment, and encourage consumers to spend. Part of the reasoning was that Japan had fallen into a liquidity trap — money was not circulating as it should, and even extremely low interest rates were not encouraging companies to borrow for investment, because the expected return on that investment would be equally low. In fact, the opposite behavior was keeping inflation subdued: companies were holding large amounts of capital as a hedge against their expectation that the economy would worsen. This dynamic naturally affected consumers as well, who were also worried about a thinly stretched pension system and deteriorating job security. (Kobayashi, 5)

Before the events of September 11, 2001, Lynn Browne, Vice President and Director of Research for the Federal Reserve Bank of Boston, drew comparisons between Japan's inflationary period in the 1980s and that of the United States in the 1990s. Browne noted that rises in inflation in both countries had been driven in large part by the same factor: wide fluctuations in oil prices. In 1986, oil prices declined sharply, contributing to low inflation in Japan in 1986 and 1987. When oil prices rose again at the end of that decade, inflation in Japan increased correspondingly. Because of global oil price rises in 2004 and Japan's heavy dependence on foreign oil to fuel its manufacturing and daily life, it was possible that the need to engineer a mini-bubble of inflation would not arise again, as natural market forces tied to oil might address the deflationary pressure on their own. (Browne, 5+)

In the year 2000, for the first time, Japan's unemployment rate exceeded that of the United States. (Yamagami, 25+) Some economists cautioned, however, that the accuracy of this comparison depended heavily on how the figures had been calculated. Some believed the official unemployment rate was understated because Japan defined unemployment differently than U.S. economists did. On the other hand, some observers thought the reported figure was too high because it had been constructed using various measures of labor underutilization.

Unemployment Trends and Labor Market Inefficiencies

While the debate over the first concern was never fully resolved, most economists agreed with the second criticism and concluded that Japan's labor market was less efficient than the government suggested — though data collection itself was arguably more rigorous. (In Japan, the unemployment rate is reported monthly in the Labor Force Survey by the Statistics Bureau of the Ministry of Public Management, Home Affairs, Posts and Telecommunications.) The discrepancy was attributed to "slack in the labor pool," which consisted of workers pushed into forms of unemployment not captured by official counts — for example, discouraged job seekers who had stopped actively searching during recessions. (Yamagami, 25+)

Whatever the precise figures, there was broad agreement that Japan's economy had experienced an extended downturn during the 1990s. A modest resurgence between 1994 and 1997 was followed by another contraction from 1997 to 1999. By early 2001, the unemployment rate was approaching 5%, higher than the U.S. rate at the time. Similar forces appeared to be at work in both countries: corporate "restructuring" was pushing white-collar workers into unemployment at rising rates. Even some Japanese economists argued that the nation's much-celebrated "long-term employment system" could no longer be sustained, and that job security — as in many modern economies — had effectively become extinct. (Yamagami, 25+)

During the so-called Asian economic miracle, observers praised the region's high savings rate. Leightner argued, however, that "underconsumption" and "oversavings" explain the economic downturn in Asia generally and Japan specifically. He observed that the demand for investments — "whether in the form of intermediate goods or additional capital" — is ultimately derived from consumption. If no one purchases the additional goods produced through savings and subsequent investment, then the economy bears all the costs of that production while receiving none of its benefits. In such cases, prosperity suffers and GDP declines accordingly. (Leightner, 385)

The standard formula C + I + G functions, according to Leightner, only as long as Asian thrift and the resulting investment are balanced by spending elsewhere. Outside investment in Japan compounded the disparity further, making the economy appear even more savings-oriented — and thus even more investment-prone — than it actually was. Yet domestic consumption did not absorb the goods and services that investment produced.