Japan’s Great Recession: Lessons for Today’s Global Crisis

Economic Policy November 14, 2016

Photo : © oleandra / Bigstockphoto

The Land of the Rising Sun emerged from the prolonged stagnation of the X by carrying out various initiatives such as deregulation, privatisation and fiscal consolidation; these methods remain relevant today for many developed and developing countries.

For some developed countries, the crisis that began in 2008 was far from being the first over the past quarter century. Japan is an example of this. After experiencing rapid post-war expansion and becoming the world's second largest economy in the mid-X, the Land of the Rising Sun entered a period of sluggish economic growth at the beginning of the X. If, from X to X, the average annual rate of growth of Japan's economy was X%, then from X to 2000, it amounted to only X%.

IndexBox analysts can confirm that one of the key features of the crisis was that it was accompanied by price deflation on both commodities and financial assets. From X to 2002, the total net worth of Japanese households fell by X%, to X trillion yen, while the overall value of land plots decreased by X%, to X billion yen. This land depreciation forced people to postpone their decisions regarding the acquisition of a home or property; this had a dampening effect on the construction sector, which had been the main driver of investment demand pre-crisis. Poor consumer activity was also reflected in the rates of growth of the GDP, and in the price trends and patterns for goods and services: from X to 2010, not a single year was recorded with a positive GDP deflator; X was the only exception to this, when inflation was marked at X%.

X Anti-Crisis Policy

Faced with deflation and low rates of growth, the Japanese government tried to stimulate the economy by introducing a range of fiscal measures. Between August X and December 2001, X sets of fiscal measures were brought into effect, designed to stimulate the budget; these measures totalled X trillion yen ($X trillion)[i]. From this funds injection, over two-thirds (X%) was pumped into construction, small businesses, farming and rural development; the decision to allocate the funds in this way was dictated by the fact that the electoral base of Japan's Liberal-Democratic Party was mainly concentrated in these sectors. The fiscal stimulation measures proved ineffective: from X to 2001, the economy expanded at an average annual rate of only X% (from X to X - X%); Japan's sovereign debt began to accrue rapidly, more than doubling from X to 2001 (from X% of the GDP to X% of the GDP).

The first attempt at fiscal consolidation in X was a direct result of these sharp increases in public debt: following the government's initiative, Parliament passed a law signalling the reform of the country's financial structure; this was designed to reduce the budget deficit to below X% of the GDP by 2003 (the deficit was X% of GDP in X), and to put an end to the issue of new government promisary securities that were funding the budget deficit. Moreover, the law aimed to reduce government spending in certain areas: in X, state investments were to be decreased by X% against the figure for X, and foreign financial aid was to be reduced by X%. Over a three-year period, state expenditure on defense, social security, education and agriculture was to be frozen.

The initiative to cut back on state expenditure consisted of a single set of measures, with an increase in taxes and insurance payments: consumption tax escalated by X percentage points (from X% to X%); company health insurance payments increased by X percentage points and personal tax exemptions were abolished. These measures succeeded in suspending any rise in the country's sovereign debt, which only increased by X% to X% of the GDP in X. The budget deficit also came down during this period, falling from X% of the GDP to X% of the GDP. The economy's rate of growth, however, slowed as well: if in X the GDP increased by X% in annual terms, in X this figure contracted by X%. The economic recession spurred an increase in bad debt incurred by the banks, which resulted in the bankruptcy of various financial institutions such as Yamaichi Securities, Sanyo Securities and Hokkaido Takushoku Bank.

The slowing economy forced the government to reject the fiscal consolidation measures and return to the policy of providing fiscal stimulation to businesses. By April X, the Cabinet of Ministers had introduced a new set of stimulatory measures equalling X trillion yen. These measures, however, failed to set the Japanese economy on a sustainable growth progression; the six further sets of economic stimulation measures initiated over the next three years also proved unsuccessful. In 2000, the Japanese GDP increased at a relatively high rate of X%, but the slump in the Japanese GDP in X (by X%) and its sluggish growth in 2001 (X%) strongly indicated that an economic recovery would be impossible without the support of fiscal measures. However, the large-scale government spending kept loss-making banks afflicted with bad debt afloat, and supported companies that would have had to withdraw from the market a long time ago.

Koizumi's Reforms

The need to implement far-reaching structural reform formed the basis of Junichiro Koizumi's reform programme; Koizumi assumed the premiership in 2001. The curtailment of the extra-budgetary financial investments and loans programme, which retained funds for the postal savings scheme, as well as private and state pension funds, proved one of Koizumi's key achievements. These resources were allocated to the Bureau of Trust Fund Management under the Ministry of Finance; a small percentage of these funds were then forwarded to various companies close to the state, which were involved in investment projects with regard to residential housing, transport infrastructure, science and education. This programme was, in fact, the second budget, the scope of which attained up to X% of the total budgetary expenditure.

Koizumi's advent to power changed the way the fiscal programme measures were conceived: government bonds floated on the open market, and were purchased mainly by those organisations that previously had to file their internal funds to the Ministry of Finance; these bonds would now become their main funding source. Although this initiative served to increase sovereign debt, IndexBox experts maintain that it made the process of creating the fiscal programme more market-orientated. The volume of sovereign debt, which registered at X trillion yen in X, had decreased to X trillion yen by 2001, and by 2006, it stood at X trillion yen. This sizeable reduction was achieved not least due to the reform of eight state financial corporations, which were involved in redistributing the programme's assets and resources: one of these organisations was abolished, two were privatised and the remaining five were merged into a single conglomerate.

Bringing down public spending was yet another important achievement made by Koizumi's government. From 2002 to 2006, the Japanese Cabinet of Ministers successfully cut back expenditure on education and defence, as well as on local authority grants and public works. In addition, the rate of social security spending growth was also considerably reduced: Japan's ageing population made this a complex issue in terms of introducing cuts, as it involved increased spending on healthcare provisions. The reduced public spending also slowed the sovereign debt's rate of growth: if from 2000 to 2003 it increased by X percentage points (from X% of the GDP to X% of the GDP), then from 2003 to 2006 it rose by X percentage points (from X% of the GDP to X% of the GDP).

Koizumi's Cabinet also introduced a range of important structural reforms, which contributed to both the complete and partial withdrawal of the state from a number of economic sectors. First of all, the reform of the postal savings system should be mentioned, as in the early X, it accounted for one-quarter of Japan's financial assets. At the cost of dissolving Parliment, which opposed the introduction of these reforms, Koizumi pushed through the decision to privatise the national post and divide it into four companies, which would then focus on postal deliveries and savings, insurance contributions and post office management, of which there were over X. The X post office staff members forfeited their status as civil servants and their right to guaranteed employment for life.

Closing and privatising X state and quasi-state companies is another one of Koizumi's achievements; this measure alone helped to save up to X trillion yen per year. Four road corporations were featured amongst the companies that went under the hammer, and were then transferred into private hands in October 2005; this decision was made complex by the fact that members of the LDP had been lobbying for these companies to be awarded public tenders, in a bid to secure additional votes with the electorate. Another important step Koizumi made was the transfer of a series of taxes from a national to a local level, in exchange for a reduction in state budget grants being afforded to the municipalities by X trillion yen from 2004 to 2006. Koizumi also made cuts to the poorly managed special accounts budget (from X to X), which functioned separately from its main account, accumulating X trillion yen.

The Reasons Behind the Koizumi Cabinet's Success

Koizumi's reforms led to a gradual reduction of the budget deficit: if from 2001 to 2003 the deficit's average annual volume amounted to X% of the GDP, then from 2004 to 2006 it was down to X% of the GDP, and then down to X% of the GDP from 2007 to 2009 (i.e., after Koizumi's resignation). The objective of reducing the budget deficit to under X% of the GDP, which was envisaged in the X Law on Financial Structural Reform, was achieved by the end of the X. Correspondingly, we should not forget the previously-mentioned reduction programme of financial investments and loans (from X trillion yen in 2001 to X trillion yen in 2006): this was a de facto development budget which existed separately from the state budget, affording civil servants ample opportunity to invest people's savings into infrastructure projects, regardless of their potential financial viability.

What was the reason for the Koizumi Cabinet's relative success in reducing public spending? First of all, there was the negative experience of the X, when one set of measures designed to stimulate the economy replaced another without any apparent effect on the economy's rate of growth. Not only society, but also civil servants and key members of the LDP were finally ready to change the direction of economic policy. Koizumi's political charisma was also an important factor: he was prepared to enter into political conflict with the LDP in an attempt to finish what had been started; the dissolution of the lower house in 2005, after MPs voted against the reform of the postal savings system, bears witness to this. The consequences of electoral and administrative reform initiated in the X were another crucial factor.

During the X electoral reforms, government subsidies to political parties were introduced. If, before the reforms took effect, the leaders of the various factions of the LDP were responsible for securing funding, now they would depend on the availability of funding from the government. When Koizumi assumed the premiership, he succeeded in securing an important tool for maintaining influence over those factions of the LDP which were opposed to his reforms. Electoral reform also brought in a mixed parallel system of elections to the Parliamet's lower house: X MPs were elected into single-seat constituencies and X into seats with proportional representation. The country was divided into X single-seat constituencies and X proportional representation-based seats, representing several prefectures.

Following the reforms, MP candidates were forced to appeal to a wider selection of voters; this meant that they had fewer opportunities to lobby the interests of a particular social or regional group. Improving the function of the ideological platforms of both the parties and the political leaders in the electoral process proved yet another consequence of the reforms. If, back in the X, the LDP presidential elections depended on the financial and administrative power of a particular party faction, then by 2001 (when Koizumi was fighting for the LDP presidency), the siginificance of the political position of all the candidates competing for the post had increased sharply. This, in turn, allowed the winner of the race (Koizumi, in this case) to introduce and implement various policies when in office, while being less focused on lobbying the factions' interests in his party.

A series of administrative reforms, developed in the X and taking effect in 2001, also helped Koizumi to push through additional reforms. The reforms enhanced the Prime Minister's influence: the drive to implement fiscal policy, in particular, passed directly from the Ministry of Finance to the Prime Minister. In addition, a Council for Economic and Fiscal Policy was established as a result of the reforms: reporting directly to the Prime Minister, it was a key body in the preparation of reform. The ministries and agencies that had previously retained a handle on shaping economic policy became secondary, which gave Koizumi free reign: he could introduce reforms while only keeping an eye on public opinion; the electorate, however, trusted him, as clearly shown in the 2005 elections for the lower house, which was expressed as a referendum of confidence in the Prime Minister.

Several other factors also contributed to Koizumi's success. First of all, he abolished the tradition according to which Cabinet members were appointed by the various factions of the LDP, leaving exclusively the Prime Minister to concur with their choice; when Koizumi came into power, the Prime Minister made this choice himself, preferring loyal candidates. Koizumi applied the same principle during the reelection campaign for the lower house: he determined the selection of candidates to the LDP himself; the factions of the LDP were not involved in this process as they had been previously. As a result, following reelection, Koizumi was able to push a draft law on the reform of the postal savings system through Parliament. He had finally dispensed with the practice of securing the approval of the LDP's Executive Board, before the implementation of any government initiative or set of measures. After the 2005 elections, this restriction ceased to exist[v].

Implications for Today

In general, the relative success of the fiscal consolidation measures from the first half of the X was predetermined by the fact that Koizumi possessed a number of qualities that distinguished him as a leading reformer of the X Century. Firstly, Koizumi had prepared a tangible plan of reform, based on the ideas of deregulation and privatisation, and on reducing the state burden on the economy. Secondly, he succeeded in winning the support of the parliamentary majority, even if this meant entering into conflict with several members of the LDP. Thirdly, he enjoyed the support of the electorate; this was evident during the 2005 elections, which turned into a referendum on confidence in the Prime Minister. Finally, Koizumu succeeded in investing his political capital into tangible reforms; the majority of this was accomplished in the last year of his premiership.

Without politicians who are strong, intelligent and unafraid to take risks, reform is impossible, no matter how painful and protracted the pre-crisis period actually was. This is, perhaps, the main lesson to be learned from the Great Japanese Recession.

Source: economonitor.com


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