Table Of ContentADB Institute Series on Development Economics
Naoyuki Yoshino
Farhad Taghizadeh-Hesary Editors
Japan’s
Lost Decade
Lessons for Asian Economies
ADB Institute Series on Development Economics
Serieseditor
NaoyukiYoshino,Tokyo,Japan
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Naoyuki Yoshino • Farhad Taghizadeh-Hesary
Editors
Japan’s Lost Decade
Lessons for Asian Economies
123
Editors
NaoyukiYoshino FarhadTaghizadeh-Hesary
AsianDevelopmentBankInstitute(ADBI) KeioUniversity
Tokyo,Japan Tokyo,Japan
KeioUniversity
Tokyo,Japan
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ADBInstituteSeriesonDevelopmentEconomics
ISBN978-981-10-5019-0 ISBN978-981-10-5021-3 (eBook)
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Thisworkisdedicatedtothegentlesoulof
SirAlanArthurWalters(17June1926-3
January2009), whowasmyPhDthesis
supervisoratJohnsHopkinsUniversity,USA
(1979).
NaoyukiYoshino
ThisworkisdedicatedtoProfessorNaoyuki
Yoshino,myPhDthesissupervisoratKeio
University,Tokyo,Japan(2015)whotaught
meJapaneseeconomicpolicyandtomy
parents,mywifeFarnaz,andmybrother
Farzad,fortheirsupportandimportantroles
inmylife.
FarhadTaghizadeh-Hesary
Summary
This book analyzes the causes of Japan’s long-term economic recession which
started following the real estate and stock market bubble burst of the 1990s and
providesremediesforthisrecessionthatcouldbeusefulforotherAsianeconomies.
Japanhassufferedfromsluggisheconomicgrowthandrecessionsincethe1990s,
a period dubbed Japan’s “Lost Decade.” The People’s Republic of China, the
Republic of Korea, Thailand, and many other Asian countries may face similar
problemsinthefutureandareconcernedbyJapan’slong-termrecession.
ThisbookaddresseswhyJapan’seconomyhasstagnatedsincetheburstingofits
economicbubble.Theempiricalanalysisofthisbookchallengesthebeliefsofsome
economists,suchasPaulKrugman(NobelPrizelaureateineconomicsciences),that
theJapaneseeconomyisinaliquiditytrap.
This book argues that Japan’s economic stagnation stems from a vertical
investment–saving curve rather than a liquidity trap and that monetary policy is
ineffective for escalating its economic growth. The impact of fiscal policy has
declineddrastically,andtheJapaneseeconomyfacesstructuralproblemsratherthan
atemporarydownturn.
Thesestructuralproblemshavemanycauses:anagingdemographic(afrequently
overlookedproblem),localgovernments’overrelianceontransfersfromthecentral
government, high costs of energy due to a nondiversified energy basket as a
result of the Fukushima nuclear disaster and nuclear plant shutdowns, and Basel
capital requirements that have made Japanese banks reluctant to lend money to
start-up businesses and small and medium-sized enterprises. This latter issue has
discouraged Japanese innovation and technological progress. This book addresses
all these issues empirically and theoretically and provides several remedies for
Japan’slong-lastingrecession,whichcanalsoprovideusefullessonsforotherAsian
economies.
vii
Preface and Introductory Remarks
In the early 1990s, Japan’s real estate and stock market bubble burst and the
economy went into a tailspin. Since then, Japan has suffered from sluggish
economic growth. During this period, referred to as Japan’s “Lost Decade,” the
country’s economic growth rate has been the lowest among the world ’s major
developedcountries.From1995to2002,forexample,Japan’sannualaveragereal
gross domestic product (GDP) growth rate was only 1.2%, lower than that of all
theotherG7countries(i.e.,Canadaat3.4%,theUnitedStatesat3.2%,theUnited
Kingdom at 2.7%, France at 2.3%, Italy at 1.8%, and Germany at 1.4%), lower
than the eurozone average (2.2%), less than half that of all of the other larger
OrganisationforEconomicCo-operationandDevelopment(OECD)countries(the
Republic of Korea at 5.3%, Australia at 3.8%, Spain at 3.3%, the Netherlands at
2.9%,andMexicoat2.6%),andlowerthantheOECD-wideaverage(2.7%).1
Studying the causes of and remedies for Japan’s long-lasting recession and
low growth is crucial for other Asian countries, to prevent similar situations from
occurring. Nobel laureate Paul Krugman has argued that the reason for Japan’s
recession is that the country is currently in a liquidity trap, a situation in which
monetary policy is ineffective in lowering interest rates. However, our empirical
results in Chaps. 1 and 8 of this book indicate that the problems in the Japanese
economystemfromothersources.Theoreticalandempiricalresultsinthisbookwill
show that stagnation of the Japanese economy comes from a vertical investment–
saving curve rather than a liquidity trap. This means problems are arising from
structuralchallengesratherthanfromatemporarydownturn.
There are several reasons for this long-term stagnation since the 1990s, which
will be discussed in this book. One of these is Japanese companies’ increased
investmentoverseasandreducedinvestmentinJapan.Becausetheagingpopulation
creates diminished future demand, companies have become wary of increasing
investment, despite very low interest rates. In addition, the aging population has
1HoriokaCY(2006),ThecausesofJapan’s“LostDecade”:Theroleofhouseholdconsumption.
NBERWorkingPaperSeriesNo12142.NationalBureauofEconomicResearch,Cambridge,MA
ix
x PrefaceandIntroductoryRemarks
increased social welfare expenses. Japan has the highest life expectancy in the
world,buttheretirementageisstillaround60yearsold,resultinginadiminishing
working population as the number of elderly and retired people rises and the
population of the younger generation shrinks. Typically, elderly people consume
less than younger generations, so this has added to the problem of reduced
domestic consumption. Other factors include the high level of transfers from the
central government to local governments, which reduced the productivity of local
governmentsbecauseoftheirrelianceoncentralgovernmentmoney,andtheBasel
capitalrequirements,whichmadeJapanesebanksreluctanttolendmoneytostart-
up businesses and small and medium-sized enterprises and discouraged Japanese
innovationandtechnologicalprogress.
ManyoftheseissuesarealsopredictableforthefutureofotherAsiancountries.
Hence, it is crucial for countries like the People’s Republic of China (PRC),
Indonesia, Thailand, and others to look at the causes of Japan’s long-lasting
economicrecessionandthepossibleremediesmentionedinthisbook.
Chapter 1 acts as a summary of this book. This chapter addresses, both
theoreticallyandempirically,whyJapan’seconomyhasstagnatedsincethebursting
of its economic bubble. It argues that Japan’s economic stagnation stems from a
vertical investment–saving curve rather than a liquidity trap. The impact of fiscal
policyhasdeclineddrastically,andtheJapaneseeconomyfacesstructuralproblems,
not a temporary downturn. The chapter provides both causes and remedies for
Japan’slong-lastingrecession,whichareexpandeduponinthesubsequentchapters.
Chapter 2 talks about the changes in economic effect of infrastructure and
financing methods in Japan. The marginal productivity of public capital was high
during the high-growth period (1955–1969) of Japan but declined from 1970
onward. It is likely that the misallocation of public capital also contributed to
a lower rate of return from private capital, since public investments did not
remove the “infrastructure bottlenecks” that lower the rate of return from private
investment.Thischapteranalyzestheeconomiceffectofinfrastructure,focusingon
the productivity effect of public investment, and discusses how to promote private
sectorinvestmentininfrastructurethroughenhancingtherateofreturntoinvestors
by utilizing part of spillover effects from the infrastructure. Private investors have
found it difficult to obtain adequate rates of return. This chapter proposes one
remedy: that the incremental tax revenues along the highway or railway should
contributeacertainfractionoftaxrevenues(say30%)toinvestorsininfrastructure.
Todoso,theincrementaltaxrevenuesalongtheinfrastructureinvestmentmustbe
computed. This chapter empirically estimates spillover effects by the use of both
macroeconomicandmicroeconomicdata.
Chapter 3 discusses Japan’s high level of government debt and the optimal
fiscal policy rule for achieving fiscal sustainability. Japan’s debt to GDP ratio
is the highest among OECD countries. This chapter firstly answers the question
of whether the Japanese government debt is sustainable. Next, while the Domar
condition and Bohn’s condition are often used in the literature to check whether
a government’s debt situation is in a dangerous zone, this chapter shows that the
Domarconditionisobtainedonlyfromthegovernmentbudgetconstraint(namely,
PrefaceandIntroductoryRemarks xi
the supply of government bonds) and does not take into account the demand for
government bonds. A simple comparison of the interest rate and the growth rate
of an economy using the Domar condition is not adequate to check the stability
of a government’s budget deficit. Both the interest rate and the growth rate of the
economy are determined endogenously in the model. Thirdly, this chapter shows
thatBohn’sconditionsatisfiesthestabilityofthegovernmentbudgetinthelongrun
by imposing constraints on the primary balance. However, Bohn’s condition does
notachieveeconomicstability—eveniftheconditionissatisfied,therecoveryofthe
economymaynotbeachieved.Thischapterproposesanewconditionthatsatisfies
both the stability of the government budget and the recovery of the economy. The
chapterwillshedlightontheseissuesboththeoreticallyandempirically.
Chapter4talksaboutmacroeconomicvolatilityunderthehighaccumulationof
government debt in Japan. This chapter applies Bayesian estimation to an open-
economydynamicstochasticgeneralequilibrium(DSGE)modelofJapantoassess
the effects of expanding government debt on interest rates, real exchange-rate
dynamics,andrealsectorperformance.Theauthorsfindthattheemergenceofeven
asmallriskpremiumongovernmentdebtwilltriggerconsiderableinstabilityinthe
realandnominalvariables.Thechaptershowsthataswitchtoanexchange-raterule
formonetarypolicywouldconsiderablymoderatetheinstabilityinducedbyarising
riskpremium.
Chapter 5 sheds light on Japan’s postwar monetary policies and discusses
whether they were developed according to Taylor rules or something else. This
chapter investigates postwar Japanese monetary policies through the lens of the
TaylorequationandtheassociatedTaylorrule.Authorsbreakfrompreviousstudies
inextendingtheinvestigationbacktotheearlypostwarperiodandbyexaminingthe
stabilityoftheTaylorspecificationinvarioussubperiods.Ingeneral,theyfindlittle
supportfortheTaylorequationintheJapancase.Apossibleexceptionistheperiod
from1980to1997,butthiswasduringthe“bubbleeconomy”andsubsequent“Lost
Decade.”
Chapter 6 discusses the energy sector, especially Japan’s oil consumption, by
an empirical analysis. After the earthquake and tsunami that hit Japan’s eastern
coastinMarch2011(oftenreferredtoastheGreatEastJapanEarthquake)caused
a nuclear disaster and shutdown of all the country’s nuclear power plants, energy,
especially oil and gas, became a more interesting topic as Japan substituted fossil
fuels for nuclear power. This chapter sheds light on the impact of crude oil price
volatilityontheresidential,transport,industrial,commercial,andnonenergysectors
in Japan, the world’s third-largest crude oil consumer. The chapter’s empirical
results indicate that some economic sectors, such as the residential sector, did
not have significant sensitivity to sharp oil price fluctuations, while others, like
the commercial, industrial, and transport sectors, were strongly sensitive to such
fluctuations.Moreover,thefindingsshowthatmostsectors’sensitivitytooilprice
volatilitydeclinedaftertheFukushimadisasterin2011,whichledtotheshutdown
ofnuclearpowerplantsinJapanandincreasedrelianceonoilimports.
Chapter 7 analyzes the three arrows of “Abenomics.” Abenomics refers to
the economic policies advocated by Prime Minister Shinzo Abe, who became
