Part II: Japan’s Great Fall

Japan’s fall from grace in the mid-90s was part and parcel of extreme policy failure on multiple fronts.

First, Japanese labour supply eventually hit a wall and with it came rising wages and productivity stagnation.

Second, while the protection of domestic industry worked for large export-oriented firms, it also limited competition and innovation amongst firms operating in the domestic market.

None of this mattered, however, so long as the country’s trade surplus continued growing.

But this growth, and the 1985 Plaza Accords designed to devalue the US dollar, caused a significant appreciation of the Japanese Yen, and began a slow process of “hollowing out” the Japanese manufacturing economy. Exports, which were just about all Japan excelled at, suddenly hit turbulent waters. One million manufacturing jobs were lost between 1992 and 1996.

The rising value in the Yen, and near zero costs of capital, simultaneously sent stock and real estate markets soaring. This despite the decreasing profitability and exports of the companies listed. The bubble was primed to burst, and when it did, it took the luster and shine off of America’s next great threat. As Richard Katz noted in his book, Japan: The System that Soured, “The ideas and strategies that worked so brilliantly in the era of industrial takeoff had outlived their usefulness once Japan’s economy matured.”

Japanese policy makers were never able to navigate from a protectionist export strategy towards a more holistic productivity and innovation oriented economy. Some will point to the country’s leadership in mobile phones as a sign that the latter is untrue. However it must be noted that Japan’s mobile phone industry was one of the sole areas where open markets ruled. The competition from foreign entrants thus created a virtuous circle of innovation from domestic companies. Aside from mobile telephony, Japanese industry has struggled and has seen its neighbours in East Asia replace Japan as the most successful in high-tech components, computers, electronics and perhaps soon automobiles.

Thus after having been anointed the world’s next great economic power through the 1980’s, Japan hardly grew in the 1990’s and beyond. Today we see it largely as a rather benign competitor – a far cry from the hysteria of Japan’s coming that marked the 1980’s.


2 Comments on “Part II: Japan’s Great Fall”

  1. danxherman says:

    From Facebook….

    Jude Fiorillo, 28 January at 12:47

    Hey Dan, I enjoyed reading this and your other articles, you clearly put a lot of thought into them. I have a pretty deep interest in China, so here are a few thoughts on China as it continues to grow:

    I think the first daunting challenge that China will face in the near future is a collapse in its commercial and to a lesser extent, residential real-estate values. For a number of years there has been speculative and unsustainable growth in real-estate from apartments/condos, to office real estate, to massive luxury malls. Granted, much of the building is to accommodate the influx of migrants who continue to descend on the eastern sea board from the surrounding countryside/western China (the “greatest human migration ever seen on earth”), but many of these migrants are building the real-estate as workers, and are neither in a position to own, work, or spend within these new projects. This may be outdated, but I believe that 75% of the world’s construction cranes are currently in China (the large remainder being in Dubai and we know what is happening there), and much of this growth is fueled by easy money and a belief in an unbeatable China. I have heard about many new buildings in the business districts, as well as massive retail malls, sitting empty, and one has to question how sustainable this is. The malls themselves are massive and sit on nearly every other corner from my experience in Beijing. Here is a related post from a blogger who recently moved back from living in China for several years – i’ve read his posts on China for years and respect his opinions:

    In terms of cheap labour and the low valued RMB, I suspect that these two will continue for the forseeable future. There are still hundreds of millions of migrants who have yet to move to the cities, and they will continue to fuel cheap, low skilled labour. There will certainly be an increase in labour costs for skilled labour (although there continue to be an excess of university graduates who struggle to find gainful employment in their highly competitive fields), but for many basic export related products, i think that cheap labour in China will continue for a number of years before it shifts to the surrounding south-east asian countries (which to a certain extent has already started to take place). Increasingly China has developed highly sophisticated, world class, production facilities too, so it’s not just cheap products that will be coming from China in the future. … See more

    In terms of the currency, I also don’t think that the Chinese will relinquish control of their artificially low RMB. There is too much at stake, and for this to happen, the US would somehow have to apply leverage leading to severe economic consequences for China. In their current position, and increasingly in the future, they (and many individual nations) will lack such leverage from both an economic and political standpoint, as China is fiercely independent, and tends to treat any “interfering” by other nations (e.g. Tibet/Dali Lama, Taiwan, Ughars) with heavy handed repercussions of their own, both politically and economically.

    It will be interesting to see how things play out, there is still a great deal of growth and prosperity yet to be realized in China, but one thing I learned during my time there is that the volume of people and scale of their projects, dwarfs everything I had become accustomed to here in Canada. The rules of the game are dramatically different and because of that it can be difficult to foresee what exactly will happen.

  2. […] failures (Note: I briefly cover the impact of Japan’s rising Yen on its long-term economic growth here).  By 2000, the USD represented over 70 per cent of total reserve holdings versus just 19 per cent […]

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