The Development of the Global Economy (Japan)

Jin Yujia 11A14

JAPAN: Successes, Problems and Impact

Syllabus check Japans economic miracle: reasons for Japans economic success and its problems Overview Reasons for Japans Economic Success Role of USA e.g. US aid; USs military protection to Japan; USs spending in East Asia e.g. Korean War boom Role of government: promotion of industrial production and foreign trade; export-oriented industrialization; protectionist trade policies Socio-economic reasons e.g. work culture and frugality; employment system; high literacy rate Potential Essay Questions A-level The Japanese economic miracle was as much a consequence of favourable external circumstances as it was of domestic policies and practices. Discuss (Jun 2002) How far do you agree that Japans economic miracle was based almost entirely on special favours it received from the USA? (Nov 2005) Japans economic success was more to do with domestic policies than the changing nature of the international economy. How far do you agree with this view? (June 2007) How far was the Japanese economic miracle, from 1945, due to the aid and assistance of the United States? (Nov 2008)

General Assess the relative contributions of internal and external factors to the health of the Japanese economy in the period 1945 2000. Examine the causes and consequences of Japans economic success up to 1991 Is Japans religious and cultural tradition the cornerstone that provided the basis for Japanese economic miracle? Phases of Japans economic growth 1945-52: Allied Powers Occupation 1952-60: Economic take-off, transition from post-war economic recovery to unprecedented high-speed growth 1960-73: Stability and prosperity, economic miracle (GDP grew from $91 billion in 1965 to $1065 billion in 1980) 1973-85: Overcoming depression + emergence as economic superpower 1985-94: Challenges of globalisation and liberalisation

The Development of the Global Economy (Japan)

Jin Yujia 11A14

REASONS FOR JAPANS ECONOMIC SUCCESS

INTERNAL 1. ROLE OF JAPANESE GOVERNMENT 1.1 Ikedas Income Doubling Plan (1960) Prime Minister Ikeda Hayato provided Japan with a unified GNP first ideology which points at the ultimate goal that Japans income will double in 10 years. It was highly significant and successful due to its widespread positive psychological impact upon corporates and citizenry. Set out commitment to growth at all costs; wholehearted pursuit of single goal of economic expansion and industrial efficiency. His policies (e.g. emphasis on exports, tariffs on foreign goods, low interest rates and taxes) caused Japans GNP to grow at 10.4% per annum in the 1960s, a 4-fold increase from post-war conditions, overtaking all Western countries. 1.2 Promotion of Industrialisation Great emphasis was placed on the regeneration of the Japanese industry, culminating in the establishment of the Economic Stabilization Board and Reconstruction Bank in 1946 to stimulate economic recovery by coordinating production and capital. The Ministry of International Trade and Industry (MITI) was established in 1949 most important body in Japan that exercised a wide range of economic jurisdiction. Adopted interventionist role in basic industries by directing national resources to stimulate growth in specific sectors of the economy, and by practising protectionism for key industries. In 1951, MITI and the Ministry of Finance established the Japan Development Bank, a bank with access to the resources of the countrys postal savings system and which offered favourable loans to selected industries, resulting in rapid modernaisation and expansion of domestic industry. o By 1970, iron and steel were the leading exports from Japan, accounting for over 14.7% of total exports. Technical cooperation agreements with foreign firms (especially American ones) and actively sponsored formation of conglomerates like Mitsubishi and Mitsui, restoring them to full scale operation. Established a tripartite alliance (Iron Triangle) between big business, bureaucracy and politicians

Ability to adapt: focus on Export-oriented industrialisation Export-driven industrial growth formulated the overarching framework of the governments development policies. This was determined primarily by cheap raw material supplies and the access to foreign markets. Aim: to reduce reliance on external aid for food and raw materials by emphasising on exports. A broad range of economic incentives was developed: export price subsidies, formation of Japanese External Trade Organisation and tax incentives.

Export emphases were flexible shifted with changing conditions. Can be divided into 4 main phases:-

The Development of the Global Economy (Japan) (i) Labour intensive (1950-early 1960s)

Jin Yujia 11A14

Heavy industry was the main driver of economic growth due to the availability of a compliant labour force. Expansion of manufacturing led to 1958 consumer revolution, where consumer demand increased and high unemployment rates came to an end. Slogan: ju-ko-cho-dai (heavy, thick, long, big) (ii) Capital intensive (1960s onwards)

Shift to products requiring heavy capital investment and advanced technology (e.g. steel, petrochemicals and consumer goods like television, cameras, transistor radios, automobiles) due to competition from other East Asian nations. Slogan: kei-haku-tan-sho (light, thin, short, small), focused on quality and reliability.

(iii)

Technology intensive tertiary and knowledge-based industries (1970s-80s)

Fostered domestic research and development, production techniques technology, high-end consumer electronics due to ample supply of educated, skilled technicians/scientists + decline in primary-secondary industries like textiles and shipbuilding. This helped offset impact of oil crises, heightening resilience of economy as a result. (iv) Export restriction, direct foreign investment abroad (1980s-1990s)

The Japanese economic miracle was a product of an effective combination of its favourable trade relations and the Japanese governments appropriate intervention into the Japanese economy. However, the role of the state should not be overstated. Despite the establishment of a common goal and purpose, there remained conflicts between government and private enterprises o E.g. In an attempt to protect mature industries, MITI delayed Hondas entry in the car manufacturing sector Importance of Bretton Woods Consensus and Western econ growthsuccess of this exportoriented policy a result of BW Consensus, and European Recovery opened markets for Japanese goods.

1.3 Protectionist economic policies Bureaucratic/non-bureaucratic apparatuses made Japanese economy impenetrable from outside. Infant industry protection: The government introduced tax credits and subsidies to prevent strong multinationals like GM and Ford from killing weak, infant Japanese companies like Toyota and Nissan in the early years, allowing them to grow to maturity. This proved to be significant in laying the foundations for Japans eventual success in export-oriented industrialization. Strategies/methods: (i) Tariffs (ii) Non-tariff barriers in the form of: o Government procurement: cost procurement relationship between keiretsu and government serve to limit foreign penetration o Reducing licenses for foreign firms to limit their presence, restriction of types of foreign goods entering Japanese market (iii) Informal barriers o Retained formidable informal import barriers which created large obstacles for importers. o E.g. small car suppliers to the Japanese market not only faced stringent safety rules, but also had to pay for lengthy inspections of each individual car to make sure that it met peculiar and highly particular regulations of the Japanese market.

The Development of the Global Economy (Japan) 1.4 Role of the zaibatsu and keiretsu

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Zaibatsu were big conglomerates of major companies and banks often controlled by a shareholding company. Examples: Mitsubishi, Sumitomo, Mitsui, Yasuda. Dominated most industries, but dissoluted after the war (SEE: role of US). As such, huge new firms based on the zaibatsu model, the keiretsu, were formed. Examples: Hitachi, Toshiba, Toyota and Nissan These highly efficient groupings allocated resources effectively and became competitive globally with high profit-margins for domestic firms. They avoided duplication and destructive competition by marshaling resources to target a sector and destroy competition. As such, the economy benefited from economies of scale o Japans total world exports rose from 3.2% (1961) to 10% (1986)

2. CULTURAL AND SOCIAL FACTORS 2.1 Japanese values Japanese values created a unique strain of capitalism. Examples of these values include work ethic, honesty, frugality and an orientation towards collective goals. o On average, employees worked 46 hours a week in 1987. The shape and spirit of Japanese capitalism have also been molded by a second level of values that include emphasis on the group over the individual, stress on social harmony, mutual trust, simultaneous competition and cooperation, acceptance of a deep sense of obligation, respect for hierarchy and belief in long-term, binding business commitments. With these values, Japan was able to exploit the conditions favourable to her development, and develop resistance to potentially challenging situations (e.g. oil crises, Nixon tariff shock)

2.2 Nature of workforce Hardworking, efficient, driven to produce high quality products, cooperative Intensely competitive public education system o Produced highly-skilled and literate manpower, and this facilitated the dissemination of new technology + later on in research and development fields o Reinforces cultural values of teamwork, imbued into children from a young age. Meritocratic system also necessitated extremely hard work Employment system o Corporations reinforced the subordination of their workers by rewarding the cooperative worker and punishing the non-conformist. o Lifetime employment (job security): Strong psychological attachment to the firm; employees not only have greater incentives to stay on the firm, they also have greater motivation to work harder and contribute more to the firm. Knowing that core workers will remain with them for many years, employers are more willing to invest substantially in labour-skills training. productivity, flexible responses to market changes o Seniority (nenko) wage system: Salaries of employees increase with the amount of years they remain in the company. As such, young workers were paid relatively little, with the promise that their loyalty will eventually be rewarded with wages that exceed worker productivity. This was viable in post-war conditions, due to the enormous availability of new workers. cooperation between various levels of management, elimination of competition along age lines o Dual structure provided labour flexibility: this system allowed for the separation of excess labour in times of recession by subcontracting them to smaller companies. This gave SMEs the right to lay off workers, cut back overtime and trim bonuses in times of recession. these temporary workers function as shock absorbers that insulate the core workforce from vicissitudes of the business cycle

2.3 High savings rate

The Development of the Global Economy (Japan) Jin Yujia 11A14 Frugality of the people, inadequate state welfare system (to provide security in times of illness, unemployment and retirement), New Life campaigns, restoration of household assets and the lack of consumer credit were the main reasons for Japans high savings rate o Annual savings rate in Japan between 1960 and 1987 was 27%, as compared to USAs 39%. Also has 25% of disposable income, one of the highest in the world. These savings were the main source of capital supply for Japan, and became a powerful engine of economic growth. Banking system channelled these savings into corporate investments. 2.4 Stable labour-management relations Enterprise unions ensured a minimum level of labour turmoil o After the number of trade unions skyrocketed to 6.75m in 1948, SCAP restrained militant activity and weeded out activists. These new enterprise unions served as a forum for dialogue, compromise, information input that forged close bonds between workers and employers. As such, with labour disruptions among the lowest in industrialised countries, firms were strengthened with increased efficiency and strong labour-management ties. The cooperative spirit contributed to economic success.

3. CORPORATE STRATEGIES AND PRODUCTION PRACTICES 3.1 Focus on long-term growth rather than short-term profits Unlike Western companies who were preoccupied with short-term profits to keep shareholders happy through quarterly reports, Japanese firms recognised that rapid short-term increases in sales were insufficient to guarantee long-term corporate survival. Instead, commercial bank borrowing was a far more important source of capital for Japanese firms, which were directed towards growth rather than profits. As such, these firms were more willing to plough back profits as investment capital for R&D, contributing to continual economic growth

3.2 Efficient production practices Quality control: aimed at zero defects, and was soon associated with quality (e.g. in automobile industry. Japan soon displaced the US as a leading innovator in assembly line methods. o Advantages: (i) more consumer confidence, thus increasing sales (ii) money saved on recalls on manufacturing problems and (iii) higher prices can eventually be charged after reliability and superiority are established. Focused and flexible manufacturing: Firms focused their production on a limited number of product variations, thus lowering production costs. Also, moved away from mass production and catered their products to special needs and demands.

3.3 Intrinsic link between R&D and economy Japanese manufacturers ensured that R&D was well integrated with product design and productionscientists and engineers work in proximity with production line personnel Was exceptionally good at modifying borrowed ideas (mostly from USA, who was willing to facilitate technology transfer). A lot of money was spent buying up the rights to technology in the 50s and 60s. o

E.g. Sony copied American production methods of tape recorders and in 1953, it bought the patent of the transistor radio from the US o Companies like Honda and Toyota were imitating American production methods to supply the Japanese market. This facilitated Japans shift into a high-end, technological spectrum of manufacturing and development, the main driving force of economic growth in the later period.

The Development of the Global Economy (Japan) EXTERNAL 4. SIGNIFICANCE OF WWII

Jin Yujia 11A14

4.1 WWII provided Japan with greater scope, opportunity and incentive to implement a new technological approach (as compared to America) Due to the destruction of the war, post-war Japan has a blank slate, hence this provided Japan with the platform to introduce new technology that translates into new methods of production. o The war raised the level of technology and production capacity in heavy industry, notably in iron and steel, machinery, and chemicals, leaving in place a network of financial controls available to governments as instruments of reconstruction This new technological approach led to more efficient production methods and increased Japans production capacity in heavy industry, inevitably contributing to Japans economic growth 4.2 WWII altered the mindset of Japan Before the war: Japan, like Germany, was concerned with militaristic expansion. Such aggressive and expansionistic territorial goals proved to be disastrous for Japan in the aftermath of WWII. o Post-WWII saw a whole-sale rejection of militaristic vision and witnessed a shift in focus to industrial and economic growth This laid the foundation of Japans economic vision and direction in the later years. 4.3 Militarization of economy during WWII facilitated an easy conversion from war-time production to peaceful civilian economic production The war militarised the economy and made Japans industry much more productive that before. Companies could thus switch easily from war-time production to peaceful civilian economic production. o E.g. In the automobile industry, 10 out of 11 of the major manufactures came out during war years.

4.4 Inspiration from America Humiliation and absolute defeat suffered by the Japanese during the war led to the realization that America much better developed than them. This stimulated their desire to re-learn and their inherent inclination to emulate, not just copying blindly, but copying and adapting. o Japanese copied American know-how by reverse engineering, taking western models apart and learning to make them better o They also sent missions to visit Western lands and humbly learn by watching, asking, photographing and tape-recording.

This new-found desire to re-learn and progress economically as a result of the lessons learnt from WWII undoubtedly paved the way for greater economic growth in Japan.

4.5 Available pool of labour force The end of the war left 10 million people unemployed. This meant that a pool of skilled labour was ready to be directed towards new tasks

5. Role of the USA Effects of American occupation was more drastic in Japan than in Germany due to the infrastructural destruction brought about by WWII that rendered Japan to a clean slate. The complacency of US victory allowed Japan to grow unobstructed.

The Development of the Global Economy (Japan) 2.1 US aid

Jin Yujia 11A14

1945-47 Early Liberal years 1948-52 Reverse course Intention Intention Retributive: weaken the economy and Facilitate Japanese economic recovery, a impoverish the people, remove all vestiges of touchstone for the health of the US-Japan militarism and feudalism and establish strategic alliance. democracy and pluralism in its place to Use Japan as a CW ally in East Asia ensure Japan will not rise again following Chinas fall to the communists. Japans economic recovery and the integration of Japan into the Western block became major objectives for the USA. Reforms hindering growth Belief that policies pursued should benefit Supervised reparation payments, diffused them in the long-term wealth and power (purges of pro-military This intention was entrenched by the Korean business leaders) War DECENTRALISATION (Zaibatsu dissolution) these large industrial conglomerates were Reforms facilitating growth engines of Japanese economic growth, but Provision of $2 billion financial aid up to US deemed them responsible for Japans 1950, shipments of food and raw material militarism and introduced anti-monopoly under Dodge Plan legislation to eliminate this concentration of Cheap and convenient technological transfer economic power, and hasten the spread of (licensed Japan with imported technology) Peace clause: US decision to demilitarize democracy to Japan. Japan reduced military expenditure, capital Land reforms: Previously, huge areas of land channeled to outlets for national were owned by very rich individuals; basic development. Continued presence of this security umbrella: Japan-US Treaty of landholding structure was that of tenancy. Mutual Security, 1952 The US banned absentee ownership of agricultural land, limited a village landowner o Less than 1% of Japanese GNP only to a small area beyond what he himself spent on defense. RECENTRALISATION: Policy towards farmed, and sold landholdings to the peasants, creating a class of peasant zaibatsu was eventually relaxed. Led to the formation of Keiretsu (set of companies with proprietors, whose conservatism sustained right-winged governments. interlocking business relationships and Labour law: Trade Union Act + Labour shareholdings) which retained several Relations Act (1945) gave workers the right important features of the Zaibatsu that to strike but by the end of 1948, there were promoted efficiency and the economy of 34,000 unions and nearly 7 million workers. scale. Financial austerity measures (Dodge Line): deflationary policies, reduce government spending, encourage growth of export sector by giving it preferential access to raw materials and foreign currency earnings Stringent labour laws: Red Purge removed 22,000 left-wing workers from their jobs, weakened trade unions and limited right to strike. Secured a compliant labour force, and established a solid foundation for efficient economic growth.

2.2 USs efforts in resolving the reparations issue (early to mid-1950s) by brokering treaties between Japan and SEA countries Reparation treaties were concluded, by which Japan promised to furnish goods and services, which she had formerly occupied, rather than sacrificing her own industrial plants.

The Development of the Global Economy (Japan) Jin Yujia 11A14 o $200 million of aid was promised to Burma in 1954, $550 million to Philippines in 1956, $220 million to Indonesia in 1958. o Coupled with these were loans to the same three states totaling $700 million, by mid-1960s, over 30% of Japans overseas investment was in SEA The way the issue was resolved was of fundamental help to the growth of Japans economy. It was Japans means of entry into the SEA market and it proved to be beneficial for Japan as they gained a foothold in SEA which they built on effectively. 2.3 Korean War and Vietnam War The export boom that the Korean War brought about salvaged the fragile Japanese economy and brought immediate recovery from the Dodge recession. The Korean War in the 1950s also completed Japans post-war growth as her economy benefitted greatly from the US war effort. It resulted in high US military demand and triggered rapid reconstruction of the Japanese economy. o By 1952, Japan restored the real GDP level to a level comparable with that of 1935, and Japanese industries ranging from textiles to coal and paper went into full production with a ready market in the US military. It also triggered import growth in Japan. The Japanese-produced goods were paid for in dollars, with the result that annual foreign currency income increased to $800 million per year through 1953, enabling Japan to import goods worth $2 billion annually. This economic boom was further financed by Special Procurements which allowed MacArthur to purchase army supplies in Japan without having to go through the complex purchasing and tender system of the Pentagon, subsequently pumping $3.5 billion worth of funds into Japan o Japans manufacturing output leapt by 50% between 1950 and 1951 and standards of living returned to pre-war levels. o Japan established itself as the Asian powerhouse of the Cold War. Similarly, the Vietnam War in the 1960s served to drive the real boom years of the Japanese economy as it served as an industrial base for the USA. American procurements meant a further demand for Japanese goods to sustain the high growth in the 1960s. o Shipyards took on triple shifts to meet the USAs insatiable demand of cargo ships while Japanese electronics in US bases in Vietnam benefitted from GI spending. o Japan was able to reap considerable economic benefits from these surrogate hot wards conducted by the superpowers and their local allies 2.4 Impact of International Economic Environment led by American Leadership Japanese growth also benefitted from American economic leadership as evident in the Bretton Woods Institutions o The US, as the leading worlds economy, was eager to prevent a repetition of the events of the 1930s Great Depression, when countries had responded to the economic crisis by raising high tariff walls around their economies, a policy which only served to prolong and intensify the world depression. o Hence, through the Bretton Woods Institutions, USA promoted trade liberalization. o Furthermore BW also established monetary stability (low ER for Japan), providing an international economic environment that was advantageous to Japan, which benefitted greatly from export-led growth. Japanese exporters benefitted from the relatively low value of the yen. The exchange rate of 360 Yen to the US dollar, set in 1947, remained unchanged until 1971, though by the 1960s, this value was unrealistically low, making Japanese goods artificially cheap on world markets. 2.5 American Complacency (Not a virtue but a factor that aided Japans economic growth) Primary feelings that America had with Japan in early 40s to 60s was contempt based on the fact that Japanese lost the war and the assumption that Japan would never be an important economic competitor. Hence, American was highly complacent in terms of Japans protectionism as they did not recognize Japan as an economic threat. Allowed Japan to retain considerable protective barriers, such as tariffs and foreign exchange controls around its own economy, indirectly contributing to the growth of Japans domestic industries.

The Development of the Global Economy (Japan) Jin Yujia 11A14 Furthermore, such complacency towards Japan also caused America to increase technological transfer, trade with Japan (automobiles) present until quite late allowed Japanese to gain a foothold in American market. o In other words, due to American complacency, Japanese good were allowed relatively access to the markets of US and Western European nations, which greatly stimulated the recovery of the Japanese economy.

The Development of the Global Economy (Japan) PROBLEMS OF JAPANS ECONOMIC SUCCESS (1970s to 1990s) Overview 1. Problems of an export-oriented country Heavy reliance on imported raw materials Dependence on access to foreign markers Rise of Yen ; Erosion of competitiveness 2. 1980s Bursting of the Bubble Domestic speculative frenzy Over-valued asset prices Loan defaults and bankruptcy Prolonged recession 3. Structural Problems Rigidities of big conglomerates High costs of life-time employment Prolonged banking crisis Economic stagnation

Jin Yujia 11A14

Background Just as it was being hailed as a dynamic model for development, Japans economic miracle turned to malaise. The mid-1970s marked a turning point for the Japanese economy and for most industrialized economies as economic growth started to decline. Stagnation also gripped Japans labour market In the 1990s, the countrys unemployment rate rose by nearly 3%, whereas that of the US fell by 2%. Stark contrast to the late 1950s through the 1980s when Japanese unemployment typically ran to 3%-5% below the US rate. Miles basic argument *Good starting point for an essay Main problem for Japan was that by the 1970s, it was a mature economy, having already tapped into the dynamism of the domestic and overseas new frontiers. o Hence, growth rates were bound to slow Problems lay primarily in its failure to adapt its approach to its own changing circumstances o Important to recognize that the very strengths that has been highlighted as contributing to its early success became handicaps and weaknesses in these changed circumstances that caused the faltering of Japans later performance! KEY ARGUMENT However, of course, Japans later economic performance was also stymied by external developments e.g. oil crisis, AFC, rise of new competitors. Problems of an export-oriented country 1.1 Heavy reliance on imports of raw materials made Japan susceptible to recession and inflation caused by the oil crises in the 1970s Of all the industrialized economies, Japan was by far the most dependent on oil to sustain its economy. This was due to the expansion of heavy industries and the development of new industrial estates along the coastal fringe of Japan which made Japans resource-poor economy more dependent than ever on the imports of raw materials, e.g. iron ore, bauxite and crude oil. o Fully three-fourths of its national energy requirements were satisfied by oil imports. Hence, the 1973 OPEC oil crisis saw inflation soar well into the double digit range as a speculative panic took hold in the country. Furthermore, cut in the use of oil pushed the economy towards recession and a shortage in state tax revenue, which forced the state to abandon the welfare state. o Japans GDP in 1974 showed a decline for the first time after the war. In other words, heavy dependence on raw materials rendered Japan vulnerable to external pressures/crisis, such as the oil shock of 1973 that dealt a huge blow to the Jap economy.

The Development of the Global Economy (Japan) Jin Yujia 11A14 However, higher oil prices only lowered Japans growth by 0.2% a year during 1973-1984. Had oil shock been the only problem, growth would have recovered far more than it did. In other words, the quick response of the government to control inflation in light of the second oil crisis following the Iranian Revolution and the Iran-Iraq war in the late 1970s mitigated the negative effects of the oil crisis on Japans economy, hence undermining its influence. 1.2 Dependence on access to foreign markets (due to culture of thrift) rendered Japan vulnerable to external crises e.g. the AFC One problem in the Japanese economy by the beginning of the 1990s concerned the high rates of personal savings and consequently low levels of consumer demands (CULTURE OF THRIFT) o Sapped the core strength of the domestic economy -> Japan had to rely on access to foreign markets. o By 1983, the ratio of Japans exports to GNP had risen to just over 15% Hence the 1997 Asian Financial Crisis dealt a huge blow to Japan and was the major external factor responsible for Japans economic downturn. o It affected many markets of importance to Japan e.g. SK, HK, Thailand, Indonesia, Malaysia and Singapore and worsened the Japanese economy by reducing export demand. o Worse, in light of the recession, the government could not make the classic response of cutting taxes in order to stimulate demand. Led to collapse of 3 major Japanese banks which aggravated the decline of the Jap economy, which registered a 2.5% GDP decline in 1998. 1.3 Rapid appreciation of the Yen resulted in the erosion of Export Competitiveness Background: Initially, Japan was able to build up its economy in the late 1960s due to the pegging of the ER to exactly 360 yen to the dollar. This gave Japanese exporters a strong cost advantage in countries such as the US. In early years, weak yen had not been a serious threat to the US industries which were going through their own boom years. By the early 1970s, it was clear that the rapidly strengthening economies of Europe and Japan no longer justified an artificially strong dollar relative to their currencies. Hence, for a period in 1971, President Nixon imposed a 10% surcharge on imports and called on Europe and Japan to revalue their currencies. In the early 1980s, the yen did not rise significantly but in 1985, finance officers from major nations signed an agreement (The Plaza Accord) affirming that the dollar was overvalued, and therefore, the Yen was undervalued -> led to rapid rise in value of the yen. o E.g. from its average of 239 yen per dollar in 1985, the yen rose to a peak of 128 yen per dollar in 1988, virtually doubling its value. As such, with the yen off the linkage to the linkage to the dollar after the collapse of the Bretton Woods System, it appreciated quickly, leading to complexities of trade. The appreciation of the yen affected Japanese exports as Japanese goods became more expensive abroad, hurting their export competitiveness. Consequently, Japanese exports abroad fell. As such, Japan, being highly dependent on its exports for economic growth, witnessed a decline in its economy as a result. Furthermore, in an effort for slowing exports, the government pumped new money into the economy through spending programs and lower interests rates -> bout of inflation. 1980s: Bursting of the Bubble *Might be a potential essay on its own. Hence, I tried my best to elaborate on the reasons for its development and subsequent burst; else, we have to summarize it as a factor that posed as a MAJOR problem to Japans economic growth. Background Between 1986 and 1990, Japan experienced an economic bubble in which real estate and stock prices greatly inflated o Nikkei stock index hit its all-time high on December 29, 1989 which it reached an intra-day high of 38,957.44 before closing at 38,915.87. Additionally, banks granted increasingly risky loans -> property prices were highest in Tokyos Ginza district in 1989, with choice properties fetching over 100 million yen. Both stock and real estate prices plunged in 1990 and kept on heading down.

The Development of the Global Economy (Japan) Jin Yujia 11A14 o This is what is known as the bursting of the bubble and had devastating impacts on Japans economy, resulting in what is known as the lost decade By 2004, prime A property in Tokyos financial districts had slumped to less than 1 percent of its peak. Tens of trillions of dollars worth were wiped out with the combined collapse of the Tokyo stock and real estate markets. The bubble and its bursting is the major cause of Japans economic problems in the 1990s. 2.1 FACTORS LEADING TO THE CREATION OF A BUBBLE ECONOMY 2.1.1 Presence of excessive liquidity allowed surplus capital to be funneled into stocks and land, driving an appreciation in asset prices and wildly optimistic speculation - Japans current account surplus and government restrictions on overseas investment by individuals and institutions during late 1980s created huge pool of excess money sloshing around Japan. - Decision to allow steep appreciation of the yen in the Plaza Accords of 1985 also contributed to excess liquidity as it was accompanied by economic stimulus measures taken by the Bank of Japan and the government. - Hence, in absence of alternative investment vehicles and with extremely low interests rates on bank deposits and government bonds, -> surplus capital was pumped into stocks and land, driving an appreciation in asset prices - Price rise was further intensified by greed and herd mentality powerful group psychology that encouraged people to suspend their judgement and worry more about being left out of the boom. Continuing escalation in prices of stocks and real estate became a matter of faith and investors remained confident even as prices plummeted that there was still untapped momentum if they remained invested and patient. 2.1.2 Government interest rate policy also contributed to speculation by making it very cheap to borrow money, injecting huge sums of money into system already awash with capital. - The Japanese government was promoting expansion with cheap money -> managed to spur growth averaging 5% between 1986 and 1989 (at a time when other leading economies were languished in recession) - Further worsened by the LACK OF SOUND CORPORATE GOVERNANCE. o With such low interest rates, bankers had to loan more money to turn a profit -> aggressively expanded lending without careful credit assessment. o Neither did banks nor the government monitor how the money was used Seemed like green light from bankers and governments for companies to borrow vast sums of money to engage in Zaitech (financial technology asset speculation that boosted a companys balance sheets) - As a result, double trading borrowing money for speculation became a common practice Keiretsu banks also lent on basis of group solidarity rather than careful risk assessment o Hence firms could borrow at negative interest rates and without any effective market signals o Cost of capital for a while became effectively zero. - Mismanagement of economic policies by the Finance Ministry bureaucrats they failed to pursue policies that would effectively address the problems that had accumulated during the bubble era. - In other words, with government running a loose monetary policy and bankers eager to lend money, risks were thought to be minimal and megaprojects were launched without consideration of worstcase scenarios or returns. 2.1.3 The role of the Yakuza (less important) Yakuza stand accused of manipulating bankers and bureaucrats to secure huge loans for speculative and illegal activities -> many of the jusen (bank-related real estate lending institutions) had yakuza ties Caused many of the loan problems, suggesting that the bubble was a giant con game that enriched the mob at the public expense.

The Development of the Global Economy (Japan) Jin Yujia 11A14 All of which led to domestic speculative frenzy - What ensued was a dizzying cycle of spending and speculation - The construction boom inflated real estate values; because land is so scarce in Japan -> Higher real estate prices bloated the stock market because most major companies have huge land holdings -> soaring stock market helped companies raise capital to sustain investment spending. o Between 1985 and 1990, residential land values in major cities rose 167% o Stock market doubled in value two years before its peak. 2.2 REASONS FOR THE BURSTING OF THE BUBBLE/COLLAPSE OF THE BUBBLE ECONOMY 2.2.1 Central Banks effort to control inflation burst the bubble The Bank of Japans recognition that a runaway economy could spawn higher inflation and its subsequent policy of raising interest rates five times in 1989 to prevent asset inflation from spilling over into the rest of the economy burst the bubble o In late 1989, Yasushi Mieno, the banks new head, raised interest rates sharply. o Without easy credit, the speculative machine went into reverse, causing land prices, the stock market and corporate investment to slide, hence the economy slowed dramatically. In the Black August of 1990, the value of Japanese stock market fell by over 16% in a single month, a development precipitated by the Iraq invasion of Kuwait. o From then on, the bubble began to burst as share and asset prices fell and many newly acquired overseas companies and assets were sold off by their Japanese holders. As a result, Japan was mired in recession during the 1990s

2.3 IMPACT OF THE BUBBLE BURST 2.3.1 The bubble burst caused prolonged recession in Japan and led to depressed business conditions - All economic indicators showed signs of this recession -> money supply, housing, durable goods, inventory, employment, machinery orders, capital expenditures. o E.g. as of late 1997, industrial production barely higher than in 1990 o One million manufacturing jobs disappeared between 1992 and 1996 - Reduced domestic consumption 2.3.2 Massive loan defaults and bankruptcy The burst of the bubble which sent stock and land prices tumbling forced 10723 companies into bankruptcy owing a record $60 billion in debt. o When the bubble burst, the construction and real estate sectors failed to make a profit and quickly became unable to repay their debts. o With plunging real estate prices, the liquidation of real estate collateral proved insufficient to cover loans, hence non-performing loans quickly accumulated on a massive scale. Banking crisis in 1997-98 Bursting of the bubble in the early 1990s made highly indebted firms unable to repay loans due to the decline in collateral values, thus creating non-performing loans (NPLs) As a result, NPLs rapidly increased in the banking sector, and the banking system fell into a systemic crisis in 1997-98.

2.3.3 -

2.3.4 Collapse of major financial institutions, signifying the end of the convoy system - Corporate profits stagnated, coupled with the accumulation of non-performing loans and the plunge in the market values of equities, major financial institutions e.g. Hokkaido Takushoku Bank, Yamaichi Securities went bankrupt in 1997. It was the first time in history of post-WWII development of the Jap economy. 2.3.5 Bubble unleashed unprecedented criticism of Japans corporate culture and its values and as a result, corporate practices and structures began to change - Change in employment practices and abolishment of long-term employment practice: Unemployment rate rose from 1-2% in the early 1980s to 5% in 2000. Share of non-regular employees such as part-time workers, fixed-term workers, and temp workers sent out by temp agencies, had drastically increased.

The Development of the Global Economy (Japan) Jin Yujia 11A14 - Decline of the Keiretsu - Government moved to ban activities of the sokaiya (corporate extortionists connected with the Yakuza gangsters. 2.3.6 2.3.7 Persistent deflation The Japanese economy experienced persistent deflation starting in the middle of the 1990s. This, too, was a phenomenon never before experienced in the post-war development of Japan. Detrimental social consequences Families suffered rising divorce rate and children were yanked out of university because tuition had become an unaffordable expense 1999 number of suicide hit an all-time high of 33,000 and 20% of these deaths are attributed to debts or job loss (nearly double the corresponding figure of 1998) Growing cardboard-box communities of homeless men gathered in train station areas

In summary, the bursting of the bubble (i.e. collapse of stock prices and real estate prices) sent shockwaves throughout the country and brought the financial sector to its knees. It effectively crippled the Japanese economy, causing it to suffer serious stagnation. Hence, the decade after the bursting of the bubble is now called the lost decade in post-war Japanese developmental history. Structural Problems 3.1 Rigidities of Big Conglomerates i.e. Keiretsu More than 40% of companies shares are held by bank-related institutions, and members of the Keiretsu (business family) own 20 to 30% of the shares of their groups bank. Hence, banks lend mainly to entrenched companies with which they have a relationship rather than funding up-andcoming ventures. o This is not a system favourable to new or small companies and it stymied industrial progress and innovation. - In addition to the strong relationship between firms and banks, the Japanese economy is characterized by long term relationships between businesses in the form of keiretsu, or enterprise groups - However, the Keiretsu system does not seem to have served Japan well in the 1990s. The current frontier of technological innovation touches industries and companies that are not traditionally affiliated with Keiretsu. o The horizontal keiretsu (across different industries) are typically composed of large companies in the finance and manufacturing sectors. However, it is not these established firms that are likely to experience the next wave of expansion, but service industries, such as transportation, discount retailing and entertainment. o For their part, vertical keiretsu (between a manufacturer and its suppliers) are not generally suited to the organizational needs of the service sector. In manufacturing, further efficiency gains will depend on initiatives of large discount stores and other retailers to eliminate intermediaries or at least to reduce transportation costs and the profits margins of wholesalers, rather than on the keiretsu relationship. 3.2 Problems with the labour force Disappearance in labour surplus which had previously characterized the economy: By 1970, annual increase in population of working age had fallen to less than half of the middle 1950s. Reduction in former reserves of labour in rural areas. o Shortage of labour -> pushed up wages -> increased production costs -> rise in price of intensive-labour goods -> worsened inflation. The rise of an aging workforce was also a detriment to the Jap economy percentage of employees older than 45 jumped from 34.8% in 1976 to 48% in 1997. o Why? Partly because of the long work hours that kept husbands away from home. Japanese women increasingly delayed marriages until their late 1920s and reluctant to have more than one child.

The Development of the Global Economy (Japan) Jin Yujia 11A14 o Significance: saddled Japanese firms with rising proportion of well-paid, less productive senior employees (drawback of the seniority wage system and lifetime employment) - Growing shortage of unskilled and semi-skilled labour many bankruptcies of smaller firms came about because of their inability to recruit such workers. *Although this should be under problems of labour, we can use it as a separate point* 3.3 The seniority wage system and lifetime employment (the very strengths of the Japanese economy in the earlier period) now proved problematic as they incurred high costs. - Job creation and destruction are normal indeed, integral parts of economic revitalization. For an economy, flexibility in hiring and firing is essential to recycle labour from less valuable to more valuable sectors. o Hence, the lifetime employment system which gave workers strong psychological attachment to firm, led to very low labour mobility between firms and industries which was very damaging to the economy. - Despite its past advantages, there is mounting evidence that lifetime employment practices are a reason why the Jap economy now faces long-term problems such as stagnant productivity growth rates and high costs. (Katz) o Japanese firms that are burdened with employees that they cannot layoff are facing costs that cause great disadvantage in international competition. - Furthermore, to avoid massive layoffs, many companies initiated a policy of reducing salaries, wages, and bonuses to reduce the high costs of lifetime unemployment, thus lowering the living standards of many employees and decreasing spending, which, in turn, has prolonged the economic decline. - This is coupled with the seniority-based wage system which became an obstacle that chokes away companies growth potential o While encouraging loyalty and hard-work, the seniority wage system tends to discourage innovation and risk taking, the very qualities that are vitally needed in hi-tech and service industries. Studies of promotion in Japanese companies illustrate that those who dont fail at tasks tend to get promoted. o Kept labour costs down in 1950s and 60s but by late 1980s and 1990s, firms were topheavy with these more expensive workers just as the nation plunged into prolonged recession Backfiring of seniority wage system led to layoffs (to avoid workers collecting on their seniority) led to increased unemployment (faster growth unemployment has been among men aged 45-54) 3.1 Deficiencies of government policy also contributed to the downfall of the Japanese economy as the policies that worked in the early period were not necessarily appropriate for the changed circumstances of later decades. - Katz argues that the system that propelled Japan to economic success in the 1950s and 60s had soured policies, priorities, regulations, institutions, protectionism that generated economic miracle were appropriate for recovery and catch-up phase of development but proved less relevant and futile as the Jap economy matured. - In mature economy of the 70s, government should have loosened developmentalist policies but instead they intensified them e.g. when oil crisis of 1973 and 1979 hurt basic industries, protectionist measures for these industries increased. o Excessive government regulation on businesses and financial institutions tended to weaken their sense of risk or discouraged risk-taking behavior, dulled the threat of competition, and delayed their adjustment to changes in the business environment, hence fostering inefficiencies that was detrimental to the economy. o Hence, this also made regulated industries more susceptible to damages caused by a weakening of the external economic environment. - As a result, the aim of Japanese economic policies changed from picking winners (encouraging success in promising industries) to protecting losers (protecting sunset industries and postponing restructuring) o Overall thrust of Japans industrial policy switched from acceleration to preservationism, undeniably slowing down economic growth.

The Development of the Global Economy (Japan) Jin Yujia 11A14 - Regulation also brings about a high-cost structure leads to price differentials between Japanese and overseas markets. o In 1998, aggregate consumer prices were 41% higher in Tokyo than in New York City. o A high cost-structure imposes a cost burden on tradable sectors and weakens Japanese international competitiveness. o Japan, being a highly export-dependent economy, suffers heavy damages as a result. 3.6 Iron Triangle (between big business, bureaucracy, LDP politicians) a coalition of interest groups that worked together when common interests dictated) can claim credit for overseeing economic miracle but now considered responsible for the economic malaise. - Politicians and mandarins who stand to lose most from deregulation slowing pace/scope of change reform vested interests of the old paradigm skilfully defending their privileges - Flaws of old system exposed dramatically collusive, corrupt, and opaque practices intrinsic to this system have been identified as the culprits in what went wrong o Lack of accountability and transparency permitted incompetence and negligence on a grand scale - Made institutional change hard once companies and their labour forces have learnt to make money in a certain framework, they have a stake in keeping things as they are. Resistance to change meant greater inflexibility of the Jap economy which was an insurmountable obstacle in light of the economic depression that led to Japans economic malaise. 3.7 Rise of regional competitors/rivals e.g. Korea, Taiwan and Singapore - Regional rivals/NICs (e.g. South Korea, Taiwan, Singapore) had edge on labour costs (relatively low in these countries), were quickly climbing technological ladder, closing the gap with Japan - Rivals making inroads in worldwide steel, shipbuilding, black and white TV, automobile markets - Double whammy of high oil prices and rising yen permanently priced some Japanese industries out of the market e.g. aluminium, petrochemicals Summary Internal Factors Heavy dependence on raw materials e.g. oil made it susceptible to external economic shocks External Factors Oil Crises of 1973 (OPEC) and 1979, Asian Financial Crisis However, can argue that it was more of Japans internal weaknesses that mad e it highly susceptible to these external crises e.g. culture of thrift -> heavy dependence on access to foreign markets and overdependence on raw materials e.g. oil. Culture of thrift -> heavy reliance on access Rise of regional competitors to foreign markets -> susceptible to damages caused by weakening of external economic environment Bursting of the bubble due to corporate Rising yen due to external pressure from the mismanagement, role of governments policy USA and the collapse of the Bretton Woods -> low interest rates, restrictions on foreign system that resulted in erosion of export investments made by Jap individuals -> competitiveness presence of excess liquidity - Significance: Economic stagnation, collapse of major financial institutions, wide-spread bankruptcy and default of loans -> banking crisis. Structural problems - Rigidity of big conglomerates e.g. keiretsu - Problems of labour force: aging workforce -> low productivity but high costs -> lower cost competitiveness of firms, growing shortage of well-

The Development of the Global Economy (Japan) skilled, semi-skilled labour force. - Corruption/vested interests of government officials that were resistant to structural changes: Iron Triangle - Lifelong employment and senioritybased wage system - Deficiencies of government policies: high costs of protectionism, protectionist policies fostering inefficiencies

Jin Yujia 11A14