20 Years of Leading Analysis

Japan's Past and the U.S. Future

Article
Summary
Changes in Japan's economic fundamentals, not its banking crisis, slowed the Japanese economy in the 1990s. No such deceleration existed in the United States before the crisis, suggesting that the U.S. economy will return to its pre-recession growth rate once the crisis passes.
Related Media and Tools
 

Japan suffered a massive banking and financial crisis starting in 1989, which was followed by a long period of slow growth and deflation. Even after the Japanese economy appeared to recover, growth remained low, prompting various observers to claim that the financial crisis had not only irretrievably reduced the level of Japanese output but also altered Japan’s long-term growth potential. Given the similarities between Japan’s crisis and that in the United States—a bursting housing bubble, a collapse in equity prices, and failing financial institutions—influential observers have speculated that growth in the U.S. economy will also remain depressed even after a sustained recovery is achieved, the so-called “new normal.”

An examination of the data calls into question the hypothesis that Japan’s crisis caused its secular growth deceleration, and also exposes the limitations of drawing a simple comparison between Japan and the United States. Well before the outbreak of its financial crisis, economic growth in Japan was slowing. A bubble that emerged around 1985 concealed this decline, and the crisis that followed exaggerated it, but the fundamentals of the Japanese economy predicted an era of much slower growth well before 1990. The data shows no such secular deceleration in the United States, suggesting that Japan’s experience gives little insight into long-term growth prospects in the United States.

Japan’s Lost Miracle?

Following World War II, Japan experienced a period of extraordinary growth—dubbed the “Japanese Miracle.” From 1955 to 1990, growth averaged 6.8 percent per year and GDP multiplied eight times. Growth fell below 3 percent only one year, during the first oil shock in 1974. In 1979, Harvard economist Ezra Vogel predicted that Japan would surpass the United States as the world’s leading economy, while others maintained this prediction as late as 1995.

At the end of 1990, however, Japan’s bubble economy imploded. Output growth slowed to 3.3 percent in 1991 and 0.8 percent in 1992. The financial crisis reached its most acute phase in 1997 when failing banks had to be merged. From 1991 to 2002, real GDP growth averaged 1 percent per year; GDP per capita grew by an average of 0.8 percent annually.

Had the bubble and crisis not occurred, Japan’s economy would be 10 percent larger than it is today, but it would be growing no faster.

Though hardly disastrous, this rate of growth was interpreted as a “Lost Decade” compared to Japan’s glory years. Furthermore, progress following the sustained recovery that began much later, in 2003, also appeared slow. Growth averaged “only” 2.1 percent per year (2 percent per capita) from 2003 through 2007.

But the claim that the credit crunch engendered by the crisis could depress demand for 20 years, even after Japan’s banking system was effectively reorganized and returned to health in 1999, is not plausible. The logarithmic trend line of GDP growth from 1960 to 1983 (approximately when the Nikkei 225 began to surge) illustrates that GDP growth in Japan was already trending down, well before the real estate bubble and subsequent banking crisis. Since the bubble and the crisis, Japan’s GDP level has fallen 10 percent below the trend line, reflecting the permanent output loss caused by the crisis. The GDP growth trend, however, predicts an average growth rate of 2.1 percent from 2003 to 2007—the actual growth rate over that period—suggesting that had the bubble and crisis not occurred, Japan’s economy would be 10 percent larger than it is today, but it would be growing no faster.

Changes in Japan's economic fundamentals, not its banking crisis, slowed the Japanese economy in the 1990s. No such deceleration existed in the United States before the crisis, suggesting that the U.S. economy will return to its pre-recession growth rate once the crisis passes.

What accounted for Japan’s growth slowdown, if not the banking crisis? A standard decomposition of Japan’s GDP growth suggests that three factors were at work: labor force growth falling, and investment and productivity growth rates converging to levels broadly consistent with those of other advanced economies.

From 1955 to 1970, Japan’s labor force grew at an average of 1.8 percent per year, nearly twice as fast as recent growth in the United States. By 1985, growth had fallen to nearly a third of this rate; by 1996, the labor force was shrinking.

Investment rates also peaked around 1970, at 35 percent of GDP—again, nearly twice the recent average in the United States. By 1985, investment had fallen to 27 percent.  After surging over 30 percent at the height of the real estate bubble, it continued its decline, dropping to 23 percent in 2007. 

Finally, Japanese total factor productivity (TFP) growth slowed from 6.5 percent per year (compared to a recent average of 1.3 percent in the United States) in the 1960s to 1.4 percent in the 1970s, long before the crisis began.1

Changes in Japan's economic fundamentals, not its banking crisis, slowed the Japanese economy in the 1990s. No such deceleration existed in the United States before the crisis, suggesting that the U.S. economy will return to its pre-recession growth rate once the crisis passes.

As the graph shows, the major drivers of economic growth were weakening by 1975, and GDP growth decelerated. Additionally, projecting the trends of these factors, rather than simply GDP growth itself, forward can provide a more articulated estimate of the long term growth potential of the Japanese economy. Based on this calculation, growth in Japan was driven significantly above potential during the bubble—and below it during the crisis—but it returned to a level in line with economic fundamentals once the recovery took hold.

Fully accounting for this slowdown in TFP and investment goes beyond the scope of this note, but the data is consistent with the idea that Japan had finished “catching up,” as economic fundamentals converged to those of other developed countries. In 1975, Japanese GDP per capita reached over 70 percent of that of the United States in purchasing power parity terms. Historically, advanced economies that have achieved this level of income relative to the United States have averaged annual productivity growth of 1.2 percent and an investment rate of 20 percent. From 1975 to 1980, Japanese productivity was growing at 1.4 percent annually, slowing from 4.5 percent annually during the previous decade. Investment remained high, averaging 31 percent per year from 1975 to 1980, and while it adjusted quickly following the crisis, it remained above the average of other advanced countries. Japan’s shrinking labor force completes the explanation.

The United States—Not on a Slowing Growth Path

Unlike Japan, the U.S. economy was on only a modestly slowing secular growth path before the crisis. The U.S. economy experienced five recessions between 1970 and 2007, but it has maintained a steady trend growth rate of 3 percent per year over that period, slowing to 2.7 percent in the years preceding the crisis. Unlike in Japan, labor force growth, investment rates, and productivity growth showed little sign of slowing.

Changes in Japan's economic fundamentals, not its banking crisis, slowed the Japanese economy in the 1990s. No such deceleration existed in the United States before the crisis, suggesting that the U.S. economy will return to its pre-recession growth rate once the crisis passes.

Thus, the most that can be said about the United States from Japan’s experience is that output lost during the crisis may be lost forever. Furthermore, once a sustained recovery has taken hold, the growth rate in the United States should return to its trend, as it did in Japan, implying average growth of around 2.5 to 3 percent per year.

Changes in Japan's economic fundamentals, not its banking crisis, slowed the Japanese economy in the 1990s. No such deceleration existed in the United States before the crisis, suggesting that the U.S. economy will return to its pre-recession growth rate once the crisis passes.
Sources: BEA, The World Order in 2050, author's calculation.

Though this is encouraging news for the United States, it also carries an important policy message: the severe and permanent loss of output during the Japanese crisis was clearly associated with the twelve-year duration of the crisis, reflecting in part the delay and modesty of Japan’s policy response, including the time taken to reorganize and repair the banks. Though the U.S. macroeconomic policy response has been more vigorous than Japan’s during its financial crisis, there is more work to be done. The quicker the United States completes restructuring its banks, insurance companies, and government-sponsored enterprises, the smaller the permanent output loss will be.

Bennett Stancil is a junior fellow in Carnegie’s International Economics Program.


1 This calculation, based on a simple Cobb-Douglas production function, is roughly in line with academic estimates.

End of document
Source http://carnegieendowment.org/ieb/2010/03/18/japan-s-past-and-u.s.-future/2dij

More from The Global Think Tank

Publication Resources

In Fact

 

45%

of the Chinese general public

believe their country should share a global leadership role.

30%

of Indian parliamentarians

have criminal cases pending against them.

140

charter schools in the United States

are linked to Turkey’s Gülen movement.

2.5–5

thousand tons of chemical weapons

are in North Korea’s possession.

92%

of import tariffs

among Chile, Colombia, Mexico, and Peru have been eliminated.

$2.34

trillion a year

is unaccounted for in official Chinese income statistics.

37%

of GDP in oil-exporting Arab countries

comes from the mining sector.

72%

of Europeans and Turks

are opposed to intervention in Syria.

90%

of Russian exports to China

are hydrocarbons; machinery accounts for less than 1%.

13%

of undiscovered oil

is in the Arctic.

17

U.S. government shutdowns

occurred between 1976 and 1996.

40%

of Ukrainians

want an “international economic union” with the EU.

120

million electric bicycles

are used in Chinese cities.

60–70%

of the world’s energy supply

is consumed by cities.

58%

of today’s oils

require unconventional extraction techniques.

67%

of the world's population

will reside in cities by 2050.

50%

of Syria’s population

is expected to be displaced by the end of 2013.

18%

of the U.S. economy

is consumed by healthcare.

81%

of Brazilian protesters

learned about a massive rally via Facebook or Twitter.

32

million cases pending

in India’s judicial system.

1 in 3

Syrians

now needs urgent assistance.

370

political parties

contested India’s last national elections.

70%

of Egypt's labor force

works in the private sector.

70%

of oil consumed in the United States

is for the transportation sector.

20%

of Chechnya’s pre-1994 population

has fled to different parts of the world.

58%

of oil consumed in China

was from foreign sources in 2012.

$536

billion in goods and services

traded between the United States and China in 2012.

$100

billion in foreign investment and oil revenue

have been lost by Iran because of its nuclear program.

4700%

increase in China’s GDP per capita

between 1972 and today.

$11

billion have been spent

to complete the Bushehr nuclear reactor in Iran.

2%

of Iran’s electricity needs

is all the Bushehr nuclear reactor provides.

78

journalists

were imprisoned in Turkey as of August 2012 according to the OSCE.

Stay In The Know

Enter your email address in the field below to receive the latest Carnegie analysis in your inbox!

Personal Information
 
 
Carnegie Moscow Center
 
16/2 Tverskaya Moscow, 125009 Russia
Phone: +7 495 935-8904 Fax: +7 495 935-8906
Please note...

You are leaving the Carnegie–Tsinghua Center for Global Policy's website and entering another Carnegie global site.

请注意...

你将离开清华—卡内基中心网站,进入卡内基其他全球中心的网站。