Japan's Enduring Economic Doldrums


Feb 19, 2002

This commentary originally appeared in San Diego Union-Tribune on February 19, 2002.

For a decade now, Japan has been a black hole at the center of the global economy. Why Japan, the world's second-largest economy, cannot shake off the doldrums remains a puzzle.

But the answer, despite the pronouncements during this week's visit by President Bush, may be as simple as this: The economy is not yet bad enough to force needed reform. The country remains very rich; it has yet, for instance, to take less than half the global output of Louis Vuitton luxury luggage. Japan's economic plight may have to get worse yet before it can get better.

It is hard to believe that the world is less than two decades from "Japan as Number 1." Yet Japan's very success obscured the fact that while some of its companies were highly competitive internationally, others were not and depended on a highly protected domestic market. That fact became painfully plain with the bursting of the stock market and real estate bubbles beginning in the late 1980s.

Today, there is wide agreement that Japan's economy is in ever deepening trouble, but that has yet to create a crisis mentality that would induce the pain of real change to replace the broken economic development model known as "Japan Inc." That collusion between government and the private sector created a global titan of mass-production manufacturing, but has proven far less effective in nurturing entrepreneurialism and service industries that have been at the forefront of the U.S. economic resurgence.

What might produce a crisis that could bring dramatic change?

Everyone's favorite candidate is "non-performing loans" — Japan's own banking crisis that makes the one the United States experienced in the 1980s look pretty small. Bad loans totaled 36.8 trillion yen ($276 billion) at the end of September, an increase of about 10 percent in just a half year. Coupled with the declining value of banks' stock portfolios, major financial institutions could become visibly insolvent when books close on March 31, the end of the Japanese fiscal year.

So far, Japan's real interest rates have been near zero, and so it has been cheap to simply roll over existing loans, no matter how dubious they may be. But the cost of capital — that is, interest rates — can only go up. As that happens, rolling over the bad loans will no longer be free, and the shell game will end, forcing the banks to finally pull the plug on bad companies and sending unemployment, already at its highest levels since the 1940s, skyrocketing much further. It also might force the government to rob savings from average Japanese, including many retirees, to save the failing financial system.

From this pain some gains should quickly emerge. High-value labor previously trapped in low-value companies would be freed up to join new, more viable businesses. Excess capacity that drives down profitability would shrink as creaky companies go out of business. Rising unemployment also would trigger demands for a stronger social safety net, which in turn should help destroy the corporate aversion to cutting loose unnecessary employees.

That would just be a start. Japan also would have to confront labor shortages in certain industries that reflect a mismatch between the generalists that Japan's educational system produces and the white collar specialists its economy now requires — from nurses to engineers and lawyers. It is one thing, for instance, to have bankruptcy laws on the books, thus opening the way to an orderly exit for uncompetitive firms, but quite another to convert law into practice when there are, by one count, hardly more than a score of bankruptcy lawyers in the country.

The government plans a doubling of the number of lawyers in Japan and a loosening of restrictions on the operations of foreign lawyers, but such increases start from an astonishingly low base. Education reform in Japan has been in the works for decades, but with mostly cosmetic changes that fail to address the need for truly structural solutions.

Here, too, a crisis is needed to force the government, under pressure from voters finally reeling from the pain of a broken Japan Inc., to tackle these long-term issues of economic competitiveness. Perhaps March 31 will finally provide the bad news necessary to get the ball rolling.

Treverton is a senior fellow at the Pacific Council and director of its Japan Task Force. He is also a senior policy analyst at RAND.

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