Written for the Reimagining Japan book in April 2011
The triple disasters of March 2011 – earthquake, tsunami, and nuclear contamination – offered a stark depiction of Japan’s strengths and weaknesses to the world and perhaps to the Japanese themselves.
On one side of the ledger, the solidarity, courage and extraordinary mental toughness of the victims and rescue workers. On the other, incestuous ties between industry, bureaucrats and politicians, blinkered strategic thinking and a disturbing vacuum of leadership.
Coming to terms with a trauma of this scale will take years, but human nature demands a message and a pattern. The Governor of Tokyo, Shintaro Ishihara talked of a tenbatsu, “a punishment from heaven.” He retracted the remark once the scale of the damage became clear. Yet a variety of my acquaintances – from elderly professors of history to young musicians – agreed with him. Not in the literal sense that the victims of the disaster were in any way responsible for what happened, but in the metaphorical sense that Japan had received a society-wide “wake-up call” that needed to be taken seriously.
In both Western and Eastern mythology, natural disasters have often been viewed as symbols of imminent change in the human world, so such an interpretation is not surprising. But change from what to what? Here the answers were much less clear. The common points were regret for a loss of “pride” and a conviction that the drift and apathy that had characterized the political scene in particular had got to stop.
It often seemed that the Japanese public has resigned itself to the inevitability of deflation. Not just as a financial phenomenon, but in a broader sense that comprehends a steady decline in the potential for a better life and the erosion of Japan’s global status and ability to control its own future. The responses to the Great Tohoku Earthquake suggest something different; that many people are dissatisfied with the status quo, that they want to see an end to the era of deflation and a return to growth; in the economy, in Japan’s role in the world and in relation to their own personal projects and mental horizons.
So what is the status quo, and what could be done to change it? The “two lost decades” soundbite conceals a more complex reality. After the collapse of the bubble economy, Japan’s economic performance did indeed suffer a rapid decline. This came as a shock to the world and to the Japanese themselves, but in retrospect was inevitable. In the 1980s Japan had become seriously inflated, in reputation and self-perception as much as in asset values; books were written predicting that Japan would displace the United States as the world’s leading economy by the turn of the century. Bureaucrats and business leaders crowed that Japan had nothing left to learn from the West.
Nemesis swiftly followed. As most of the world boomed through the 1990s, Japan slid into deflation and financial crisis. The response of bankers and policy makers was fumbling and incoherent, but with some justification; unlike the US in 2008-9, Japan didn’t have a “Japan” to learn from. As we now know from the aftermath of the global financial crisis, there are no easy fixes for the damage caused by the collapse of a large-scale bubble, and Japan’s 1980s bubble was one of the biggest in history. Notably when it came to dealing with Wall Street and GM, the US proved reluctant to take the harsh medicine it had recommended to Japan a decade earlier.
By the early years of this century, Japan’s post-bubble workout was largely complete and economic performance started to improve. In the 2003-2008 period growth in economic output was faster than in the United States on a per worker basis. Corporate profits boomed, and for a while it seemed as if the recovery was on a secure footing. Some observers even went as far as to claim that reforms instituted by then-Prime Minister Koizumi had “worked” and Japan was “back.”
Such confidence proved to be badly misplaced. The global financial crisis was a kind of tenbatsu for the entire developed world. The severity of the recession in Japan revealed that, far from embarking on a self-sustaining recovery, as the policy-makers had boasted, the economy had become even more dependent on overseas demand; that there had been no recovery in wages and household income; that nearly half the workforce was earning less than three million yen a year. Inequality rose significantly, and indices of well-being such as the suicide rate remained at worrying levels.
While there was some excuse for the gridlock of the 1990s, there was none for more recent failures, which seemed designed to reinforce the deflationary mentality. The Bank of Japan’s justifications for inertia became increasingly convoluted and self-contradictory, but politicians shied away from the task of mandating accountability. The Democratic Party of Japan, which won a landslide victory in the election of 2009, had one promising idea – a substantial increase in child allowances, which would have offered hope of countering Japan’s demographic shrinkage. Unfortunately the proposal was watered down and deficit hawks managed to turn the Greek debt crisis into a rallying call for fiscal austerity in Japan. Official opinion seemed obsessed by the possibility of a decline in bond prices while turning a blind eye to the message delivered by the Nikkei Index at a twenty five year low.
Politically it seemed as if a Japan had at last shucked off the post-1955 monopoly on power of the LDP (Liberal Democratic Party) and graduated to the long-desired two party system. This hope also turned out to be built on sand. Despite winning a healthy majority, the new DPJ administration proved incapable of making significant changes, indeed appeared confused about what changes it wanted to make. Prime ministers continued to come and go with the rapidity of new cellphone formats. Worryingly, there seemed to be a diminution in the quality of personnel in the very top echelons of power.
In terms of Japan’s global status, the deflationary trend never relented. Britain likes to boast that it punches above its weight. Japan was punching well below its weight; sometimes not even getting into the ring. While China was becoming increasingly aggressive, building economic bridgeheads in South East Asia, Africa, and South America, Japan became increasingly passive. China used its financial muscle to acquire upstream resource assets,. Japanese bureaucrats rejected the idea of establishing a sovereign wealth fund on the grounds that some investments might lose money. Instead they continued to keep the entirety of Japan’s foreign currency reserves in US Treasury bonds, mostly with short duration and very low yields.
Attempts to create free-trade agreements were stymied by domestic interest groups. There was talk about turning Tokyo into a global financial center, but the reality was increasing marginalization as intellectual and financial capital flowed to Hong Kong and Singapore instead. Japan’s voice was little heard in forums like the G20 and the BIS which were important in coordinating the response to the financial crisis.
The confrontation with China about the arrest of a fishing captain by Japanese customs officials offered a brutal display of the changing balance of power in the region. Japan’s response was feeble and incoherent; China’s harsh and compromising. Inevitably Japan blinked. Russia took note and immediately made the provocative move of announcing a visit by President Medvedev to the disputed Northern Islands. The question arises; if this is the reality of the relationship between Japan and its two neighbors now, what will it be like in a decade’s time?
Despite the great geopolitical changes in the world, high officials of the foreign ministry seemed concerned only with avoiding any friction in the security alliance with the US and putting a lid on any problems in Okinawa. Politicians who thought otherwise, or “didn’t listen” to the views of their officials, were deemed irresponsible. The idea that the alliance might fall apart one day and Japan would quickly – perhaps very quickly – need the means to defend itself was considered about as likely as a fifteen meter tsunami hitting the coast of Tohoku and disabling a nuclear power plant.
There was nothing inevitable about this story of all-encompassing deflation. It was the result of decisions made or, more often, not made by institutions and individuals. Lurking behind them all was a fatalistic habituation to gradual decline and complacency about the consequences.
The departure point for reflation should be confidence in Japan’s real and enduring strengths. Japan has the resources to fund a reconstruction program of enormous scale. In terms of financial fundamentals, there could not be two countries less alike that Greece and Japan. Greece is insolvent. Japan is one the largest creditor nations in the world, with a vast nest-egg of overseas assets built up through three decades of current account surpluses. Official opinion seems transfixed by the government’s deficits without considering the private sector surpluses that have been financing them – with enough left over to finance a considerable portion of the US’s deficits too.
If Sidney Homer’s classic “History of Interest Rates” is any guide, Japanese bond yields are at the lowest levels seen in recorded history. This gives the Japanese government a golden opportunity to issue bonds at longer maturities. Perhaps 100 years, like the Mexican bonds floated in 2010, or better still of no maturity at all, like the perpetuals floated by Britain to finance the war against Napoleon.
There is even more leeway in monetary policy. Japan is the only major country experiencing declining prices, and market expectations are for deflation to persist for the remainder of this decade. If the Bank of Japan were to mount a Bernanke-scale program of quantitative easing – as opposed to the small scale, sporadic and badly communicated program of 2001-3 – the risks of inflation rising to threatening levels are minimal. Significant purchases of government bonds by the central bank would force financial institutions to put their money elsewhere – which would have the welcome effect of weakening the yen and triggering a bull market in shares and probably other assets.
Japan’s crisis of confidence has been exacerbated by its geographical proximity to China. The rise of China and the emerging world as a whole means a loss of status not just for Japan, but for the small group of developed countries that have ruled the global roost since since the industrial revolution. This global rebalancing of power and relative wealth is inevitable and positive, though likely to generate some dangerous tensions along the way.
So the question is not whether Japan has poor prospects in comparison to the fast-growing emerging economies, but whether prospects are necessarily poor compared with other developed countries. In the 1990s the answer would probably have been yes. Now the picture is less clear. Given the financial turmoil of 2008/9, the sovereign debt crisis in the eurozone, the substantial depreciation of the dollar and the pound, the heated debate about mass immigration in the US and Europe, the truculent mood of the public almost everywhere, Japan’s structural problems suddenly seem less threatening. China itself is sure to face serious challenges too, not least from rising labor costs as urbanization peaks and the rapid aging of a still poor population.
Japan’s proximity to high-growth emerging economies is both an opportunity and a risk. There are new markets to be cultivated, deals to be struck and alliances to be created. Splendid isolation or a twentieth first century version of “sakoku” (the closing of the country) are not options. The mixing and melding of cultures and ideas is the defining feature of our times, and Japan cannot stand apart from it without risking more decline and, as a consequence, more vulnerability.
At the same time, the terms of Japan’s engagement with other Asian countries need to be managed carefully. Economic growth fuelled by mass immigration is the demographic equivalent of fool’s gold. If the immigrants integrate fully with the native population, then the birth rate will converge and the problems of an aging society will merely have been kicked down the road. If integration does not occur, there will be a loss of social cohesion and potential for conflict at times of economic stress. The problem is compounded by the fact that China has a history of using its vast population as an instrument to project power – as in Inner Mongolia and Tibet and to some extent in South East Asia.
Immigration is going to increase, whether Japan sanctions it or not. Much better to have systems in place to ensure that Japan avoids the mistakes that some Western countries have made and gets the people it needs on the terms it wants.
There are plenty of bright ideas around for the revitalization of Japan; many of them have been debated for ten years or more. The problem has been implementation. Nobody has cared enough; not the powers-that-be, who seemed content to “manage decline,” as Britain’s establishment were in the 1960s and 1970s; not the general public, who remained disengaged.
If the disasters of 2011 have accomplished anything, it will have been to break down this wall of complacency. The idea that weak leadership and unaccountable institutions have little impact on everyday life is no longer tenable. Tenbatsu or not, the psychological shift necessary for the reflation of Japan has started to gain momentum.