Infometric's Gareth Kiernan warns our public policy managers that Japan's malaise is the result of doing 'whatever is necessary' to keep economic pain away from voters, and shying away from essential reforms in the face of an ageing population

Infometric's Gareth Kiernan warns our public policy managers that Japan's malaise is the result of doing 'whatever is necessary' to keep economic pain away from voters, and shying away from essential reforms in the face of an ageing population

Economic growth, inflation, and interest rates around the globe remain significantly lower than they were prior to the 2008 Global Financial Crisis.

The limited success of efforts to stimulate the economy over the last 12 years are reminiscent of the Japanese economy’s stagnation during the 1990s.

Are other developed economies, including New Zealand, at risk of suffering the same malaise as Japan over the medium-term?

There’s a little bit of Japan in all of us

It’s January 1990 in Tokyo. The Nikkei stock index has just completed its ninth straight year of real gains, having risen 369% over and above inflation since its close at the end of 1980. The rise in property prices has been sustained for even longer, although the 65% real increase in house prices over the previous 12 years pales in comparison against the share market’s performance. Economic growth since 1975 has averaged 4.5%pa, and unemployment is virtually non-existent, at 2.2%.

Of course, the stagnation of Japan’s previously high-growth economy is now legendary. Since 1990, the country’s economic growth has averaged just 1.0%pa. House prices are still down 38% from the peak they reached in early 1991, and the share market is also languishing at about 60% of its 1989 closing level.

It’s worthwhile recalling some of the contributing factors to Japan’s failure to recover from its economic downturn.

  • The Bank of Japan’s monetary policy response was ineffective, with the Bank initially raising, rather than cutting interest rates, in response to the crisis. Even when the Bank cut interest rates, the speed at which monetary conditions were eased was not enough to stop deflation setting in.
  • The government’s fiscal stimulus consisted of pork-barrel policies, handing out funds to vested interests and politically supportive businesses. Government debt ballooned but the moves failed to generate a pick-up in economic growth.
  • Population growth was slowing, and the aging population became increasingly worried about its retirement prospects given the loss of wealth in the property and share markets. These concerns were added to by soaring government debt leading to doubts about the government’s ability to pay superannuation, which intensified the drop-off in spending as households concentrated on saving instead.
  • Large parts of the business community were focused on survival rather than dynamic change and resource reallocation, thereby undermining growth in productivity and GDP.

Many of these factors have an air of familiarity about them when we consider the performance of other developed economies since the Global Financial Crisis (GFC). To be fair, nowhere has the response to the GFC been anywhere near as muddled or ineffective as Japan’s economic policies of the 1990s. But it’s still difficult to shake the nagging feeling that Japan’s long, slow demise could be a forerunner of what we’re currently seeing in other parts of the world.

The following set of charts compares the evolution of several variables in Japan between 1989 and 2001 against the same variables in other developed economies over the 12 years since the GFC. We also show where each of the indicators now sits for Japan, 30 years after its bubble burst.

Reduced scope for monetary policy assistance

Chart 1 shows the gulf between 90-day bill rates before the crisis and more than a decade later. For Japan, it’s important to note that the central bank continued to raise interest rates throughout 1990, despite the stock market’s crash, because house prices were still climbing and the Bank was concerned about inflation. It was more than five years after the downturn started before short-term interest rates in Japan got below 1%.

This flawed response from the Bank of Japan in the 1990s contrasts with the substantial interest rate cuts and quantitative easing measures implemented by central banks following the GFC of 2008. Nevertheless, 12 years later, interest rates remain at historically low levels, leaving limited leverage for central banks ahead of any future slowdowns in economic growth.

In simple terms, monetary policy has not been as successful at stimulating economic growth or inflation since the GFC as might have been hoped, preventing interest rates from returning to “normal” levels. Indeed, from Japan’s perspective, the GFC kneecapped promising signs of some recovery in its economy, and the Bank of Japan had very limited scope to ease monetary conditions to mitigate the downturn.

Inflation goes AWOL

The onset of deflation in Japan by 1995 meant that any recovery for the economy became that much harder to generate. Households were already firmly in a saving mindset given the loss of wealth from the stock and property market collapses, backed up by concerns that the government wouldn’t be able to provide for their retirement as its debt levels soared. Falling prices simply gave consumers another reason not to spend today, knowing that goods and services were likely to be cheaper tomorrow.

Chart 2 shows that other countries have been successful in avoiding deflation since the GFC. Nevertheless, price pressures have generally held below average, despite the monetary and fiscal stimulus that has taken place. This outcome seems to be largely due to downward pressure on prices caused by production efficiencies in China.

Certainly within New Zealand, businesses have been complaining about the squeeze on profits and inability to put prices up given competitive pressures. However, it is likely that stronger demand growth globally over the last decade would have put more upward pressure on prices than we have seen. In this respect, inflation remains uncomfortably weak, particularly given how low interest rates are.

And growth is a pale imitation

Chart 3 shows the drop-off in Japan’s GDP growth after 1989, but it also demonstrates that American and European economies have suffered a significant slowdown in average growth since the GFC. In comparison, New Zealand and Australia have got off reasonably lightly.

The inexorably aging population

The relative outperformance of New Zealand and Australia since the GFC appears to have been at least partly driven by population growth. High net migration has been a prominent feature of New Zealand’s economic growth in recent years, while Australia’s population growth remains relatively strong, at 1.6%pa (see Chart 4).

For Japan, the reluctance of households to spend has been exacerbated by its aging population and, over the last decade, the fact that the population has been shrinking. The dampening effects of a contracting population on business activity will be well understood by businesses located in New Zealand’s provincial areas that have struggled to maintain their population base over the last 35 years. Japan is experiencing that phenomenon on a nationwide scale.

Perhaps most critically for Japan, population growth peaked in 1972 and has been slowing ever since (see Chart 5). During the 1980s, this trend was at odds with the country’s housing boom and laid the foundation for the subsequent correction in property prices. At least, in New Zealand, the strength of population growth in recent years provides some justification for the surge in house prices.

Over the next 15-20 years, we note that population growth is expected to continue easing throughout the developed world. Unless there is an acceleration in per-capita growth rates, this trend implies that aggregate GDP growth will also slow over the medium term.

How much government debt is too much?

It’s important to note that, in the wake of the GFC, no government was as negligent in its spending as Japan’s government during the 1990s. American and European governments’ attempts to shore up the banking system or stimulate economic activity weren’t perfect, but they were generally sensible and not unduly driven by hopes of political gain.

Government debt in the US and Europe might not be as big as Japan’s was in 2001, but the levels are still high and cannot be glossed over. Much like monetary policy, there is arguably limited scope for fiscal stimulus in these countries to soften any future economic downturn. Indeed, given the current very high levels of debt around the globe, it is somewhat surprising that interest rates on government bonds are not at above-average levels, rather than at multi-decade lows.

The moral hazard of avoiding recessions at any cost

In our view, long-term interest rates are symptomatic of a broader problem that has developed with regard to monetary and fiscal policy over the last 10-20 years. Particularly since the GFC, central banks and governments have become so scared of recessions that they will do anything in their power to avoid one.

Yet the process of clearing out the dead wood during a recession, and the subsequent reallocation of resources towards more productive activities, is a fundamental part of a healthy, well-functioning, dynamic economy. One of Japan’s biggest problems during the 1990s was the propping up of “zombie” banks by the government. These banks were not forced to call in their non-performing loans from unprofitable companies, who in turn kept hold of labour and capital resources that potentially could have been used more gainfully elsewhere.

Currently in developed economies, cheap credit is being backed up by a belief that any significant slowdown in the economy will be pre-empted by monetary and/or fiscal stimulus. This environment has effectively created a “moral hazard” whereby, at an aggregate level, businesses implicitly expect they will be rescued by the government or central bank from more difficult economic conditions that would require hard decisions to be made. The “too big to fail” mantra, which pervaded the global banking system following the GFC, now almost seems to apply at an economy-wide level.

In New Zealand, the fine-tuning approach of monetary policy means that we now seem scared to allow, or we are unwilling to let, economic growth slip below 2%pa. In the short-term, this approach feels good – it is certainly preferable to the pain caused by business failures, redundancies, and unemployment. But it carries a risk that we build up more and more obstacles to achieving better growth outcomes over the medium-term.

New Zealand’s economic position is nowhere near as bad as Japan’s was 20 years ago. Our government debt is low, and our population is projected to continue increasing for many years. But there are warning signs flashing at present, and the prolonged surge in our housing and share markets raises some cause for concern. In this regard, we are not alone, with many other developed economies facing similar issues. The challenge for New Zealand is to heed the warning signs now, or we might find ourselves slowly slipping into economic irrelevancy, as Japan has done.


*Gareth Kiernan is chief forecaster at Infometrics. This article was first published here and is reposted with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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"House prices are still down 38% from the peak they reached in early 1991, and the share market is also
languishing at about 60% of its 1989 closing level."

asset prices were a massive bubble in late 80s Japan. You are complaining that the asset bubble has not returned in the last 20 years?

Stable affordable house prices for the last 20 years, sounds like something we should try and imitate, not something to avoid.

You also make the mistake of looking at absolute GDP - that's relevant if you are looking to invade a neighbour. If you are looking at the wellbeing of your citizens however, it's GDP per capita that counts, and Japan and NZ are pretty similar there for the last decade.

Stable affordable house prices for the last 20 years, sounds like something we should try and imitate, not something to avoid.

True. Actually, Japan has always had affordable housing, even during its epic bubble through its public housing framework. Many chose to live in public housing for that very reason.

You also make the mistake of looking at absolute GDP - that's relevant if you are looking to invade a neighbour. If you are looking at the wellbeing of your citizens however, it's GDP per capita that counts, and Japan and NZ are pretty similar there for the last decade.

Was going to point out exactly what you say about GDP per capita. Great and relevant point.

There's a big tradition there too of employers providing housing for workers.

Agree. What we have now is not capitalism (where is the creative destruction?) and it is likely the State will get blamed, again, for the next crisis as they incentivized the misallocation of capital through the mispricing of risk via interest rates.
I mean, how does the RBNZ ever think they can raise rates now that everyone has loaded up on debt at these emergency level rates? In the USA you can fix your mortgage for 30 years and this is the only way you could run this sort of policy in a way that allows rates to normalise.
Japan has everything we want, i.e. scale, an abundance of STEM workers, a highly innovative high-tech industry, a united population, etc., and they're struggling. It will only be worse for us and it's only a matter of time.

Good stuff Gareth. That's been my concern for 5-6 years now, since finally getting my head around what was really happening. We also see this type of thinking in our welfare policies in the west. It's not the survival of the fittest anymore, it's survival of the weakest, which I think is your point. All we're doing is keeping the deadwood alive so that nothing big & bad happens to us now. Well, I've got news for some of you, big & bad will always happen & we just have to guts it out & deal with it. Sure, it shakes everybody up & it's not very pleasant, but your point of which is the biggest baddie, now(?) or later(?) is still very valid. The problem we face today, is that it's now become so political & related to the political cycle, and with the left & the right so far apart these days, who's going to blink first? And with the western countries mostly on the same page as far as economic cycles go, who is going to brave enough to call it out? The answer so far seems to be nobody.

The biggest baddie later mate when those in power are going not on my watch and preferably not in my lifetime either. In the meantime everything possible will get thrown under the bus to stop the next crash from happening.

Good note, LJM. When the focus and priority is the 'survival of the weakest', everything weakens: politics, economies, cultures, societies, businesses, values, families, individuals... the lot.

Science, engineering & innovation also. Look at Boeing's problems as an example.

Creative Destruction theory?

https://www.investopedia.com/terms/c/creativedestruction.asp

It was initially conceived as a process of the manufacturing sector - whereas presently it gets referenced in relation to TBTF services sector entities (banks, insurance companies, operating systems, online platforms...). But I don't think it applies to asset bubbles - they are a different matter.

"Yet the process of clearing out the dead wood during a recession, and the subsequent reallocation of resources towards more productive activities, is a fundamental part of a healthy, well-functioning, dynamic economy. One of Japan’s biggest problems during the 1990s was the propping up of “zombie” banks by the government. These banks were not forced to call in their non-performing loans from unprofitable companies, who in turn kept hold of labour and capital resources that potentially could have been used more gainfully elsewhere."
Even as we speak the money printers are going faster and faster - “Bubbles, Bubbles everywhere, But not a drop to drink” ...

Some fundamental points about Japan not mentioned here that are very important:

-- Japan's public debt is largely owed to itself, quite unlike the public debt of the U.S.

-- Household debt to GDP in Japan has been decreasing since their bubble. Even during that bubble, it has never been as high as it is in NZ or Australia now.

-- The unemployment rate in Japan is lower than almost any other developed country. In fact, there is a shortage of workers in many sectors that are being filled by workers from countries such as Vietnam.

-- Japan is the world's leading creditor nation (net external assets are approx 1.3x those held by Germany).

-- Japan's public debt is huge but so is their industrial output. Furthermore, the public infrastructure is developed beyond whatever NZ or Australia could dream of.

Japanese have a very strong savings culture.

Terrific article. And here's something to ponder: "... capitalism is still standing. But... something is badly wrong and it lies at the heart of our troubles. Consider the following fact: in August of last year [2019], the global money markets had 17 trillion dollars invested in negative yield bonds." Yes, 17 trillion. (Source: https://unherd.com/2020/01/what-sajid-javid-should-say-at-davos-but-wont...)

Thank you Kiernan for an outstanding article with great, clear graphs exemplifying your points and very sensible commentary. 10 out of 10 from me

House prices down 38% - That's a good thing right? Share market down 60% but are the companies profitable?

Gareth might be a little too wedded to traditional economic attitudes and measures. Try considering unlimited growth in a finite system?

Resources might be finite but our resourcefulness is infinite

Technically we live in a closed system with where our Sun outputs approximately a billion times more energy than hits the Earth, we don't need to even be that resourceful.

House prices down 38% - That's a good thing right?

Japanese tend to look at housing as a consumption good, not as an investment. Therefore, the focus is on value for money. Actually, the best value-for-money properties in Japan are foreclosures by city governments. Usually these houses are sold for a pittance of their real value and are sold to cover unpaid taxes.

Share market down 60% but are the companies profitable?

Depends on the company. Nevertheless, Japanese publically listed companies don't pay high dividends. Shareholders often come 2nd to the employees of Japanese companies.

https://data.oecd.org/lprdty/multifactor-productivity.htm#indicator-chart

I can’t buy your “desirability of recessions” argument. Despite an aging population Japan has the third highest oecd multi factor productivity growth. As a result, it’s a better place to live than many of the countries you highlight as having better managed their crisis.

Essentially, recessions hit the less well off hardest, by lowering employment. Versus this, confidence in the economy long term leads to more employment, investment in skills and technology and hence productivity. Japan is an example to follow, versus the boom bust boom continuum you advocate.

The US Fed seem to have bought that, over the “raise rates till a recession and then have a jolly good cleanout” argument they were toying with this time last year. I can’t say I like Mr Trump, but I think he his actually delivering for the less well off.

And I don’t buy the “increasing wealth disparity” argument either. The less well off need wage increases, that requires productivity increases, and they are less likely to invest to generate wealth - which productivity gains require, unless you’re a Marxist. The Nz option of flooding low skilled employment with immigrant labour and no productivity gains is a much worse option than Japans approach.

And I don’t buy the “increasing wealth disparity” argument either. The less well off need wage increases, that requires productivity increases, and they are less likely to invest to generate wealth - which productivity gains require, unless you’re a Marxist. The Nz option of flooding low skilled employment with immigrant labour and no productivity gains is a much worse option than Japans approach.

Agree that the NZ approach of importing a flood of cheap labour is not helping folk engaged in productive work for a living.

On the productivity vs. wages issue, it's interesting to see that in the USA productivity has increased massively since 1973, but wages have not followed...this gain instead being mopped up by a very select few seemingly as laws have been adjusted in their favour. Not so much trickling down as was advertised, perhaps: https://www.epi.org/files/2013/ib388-figurea.jpg

Middle-wage workers’ hourly wage is up 6% since 1979, low-wage workers’ wages are down 5%, while those with very high wages saw a 41% increase

Source: https://www.epi.org/publication/charting-wage-stagnation/

A lot of the reason folk have been reacting against recent decades' politics has been that undermining of the middle class life.

Neglect the middle class at one's peril!
The established older than 50 middle class in NZ have done well, it's the middle class coming through in their 20s and 30s where there will be issues

Great piece gareth.
I agree, a real economy runs in boom/bust cycles.
Governments nowadays are so afraid of recessions that they do anything they can to avoid them.
Can kicking is all it is.
The impending disaster just grows bigger.
I believe the dgms would have been right about the burst bubble if not for political interference.

Yeah. And by doing everything to prevent the busts they also deny the booms.
Can kicking and mediocre economies from here on in...at best. An international shock and we are in trouble

Investors are correct to obsess over productivity in an environment where productivity has stagnated. The benefits of improving efficiency that you saw up to the 1980s have petered out. Without top-line growth companies are trying to squeeze blood from a stone, the denominator (headcounts, labor) can only get to zero but the numerator can be an infinitely large number. When you hear leaders talking about six sigma, lean, process reengineering, span and layers analysis etc. you should run a mile because they are talking about the world as it was an not understand the world as it will be. $1 of revenue is worth far more than $1 of cost.

Avoiding recession at any cost....

Is it possible ...like life and death ...up and down is part of economy cycle and only a fool Willi say that market feel never fall.....can delay with easy and cheap money but over a period of time zero percent interest will be the norm and than what....negative ....than....

I would rather have Japan's problems than our useless GDP per capita growth, low productivity, rapid population growth and its concomitant housing crisis and infrastructure deficit. NZ has taken the lazy man's way of getting out of Japan's current problems by mass immigration - but the piper will have to be paid eventually.

Have been saying we need to stop avoiding recession for years and accept it is simply part of the capitalist model we are so enamored with. Denying recessions means you also deny what comes after, clean-out and a period of high growth and more importantly a period of high INNOVATION.

The problem with the current idiocy is there is absolutely no incentive for anyone to innovate. Why try and make something new to get rich when central banks will just hand you more money?

Humans are often the best problem solvers/creators when we are in adversity. Without the struggle, we create very little new technology and amble along with easy lives. Seriously, what new tech has been created in the past 2 decades? Social media is the only thing that is really new in that time and some would argue it was inevitable. Compare that to the period of creation from 1980-2000 when we had real innovation, governments and corporations investing in R&D and creating things like the public internet, huge technology advances in space/computers and large international agreements signed like the Montreal protocol.

Today we have a bunch of dithering frightened plebs in charge who are so frightened of their own shadow they are steadily destroying the human capital advantage - that of innovation and adaptation. This country is no exception.

Lots to agree with above. No gain without pain used to be the old saying. Our current student govt will only learn this lesson the hard way, like every generation had to before that. We can delay it but we cannot prevent it. How do we really know the true value of wealth? Usually by knowing the value of having nothing.

Seems a common view of common taters is that Japan is doing just fine. And they don'tholdmuch with the growth mantra Gareth repeats.

Stable population. Stable house prices.
My view is those things are very desirable.