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The Bubble and the Lost Decade 269 BlackwellOxford,TWECThe0378-5920©March2631000OriginalTHEGARY 2003 World BUBBLE 2003R. BlackwellUKArticle SAXONHOUSEPublishing Economy AND Publishers THE TheLtd LOST AND Ltd DECADEROBERT (a Blackwell M. STERN Publishing Company) Bubble and the Lost Decade Gary R. Saxonhouse and Robert M. Stern Inthediscuss this evidence overview a number suggests of ofthe unconventional Symposium that looser fiscalpapers, and policybold we measures notewould that have thethat beenbubble the BOJineffective, that and occurred MOF monetary could in Japan’s pursue.policy asset measures It appears, markets might however, in the have late that worked. 1980s the political cameHowever at will a, the timeis absent BOJ when followed to the undertake conventional a relatively such1. indicators measures.tight monetary ofINTRODUCTION So Japan’s long policy as economic inthis 1991–93. is the performance case, In the the face effects were of the relativelyof theliquidity lost stable. decadetrap that Following will ensued continue the in collapsethe to actlast as ofof a thet hedrag 1990s,bubble, on the the neither economy. conventional the Bank tools of Japan of stabilisation (BOJ) nor thepolicy Ministry appeared of finance to be (MOF)of limited took use. timely To help and theeffective Japanese measures economy to deal to recovewith ther from recession the ‘lost that decade,’ followed. we While thus LITTLE more than a dozen years ago, in 1989, Japan was completing a decade Aof excellent economic performance. Its 3.9 per cent average annual rate of growth of gross domestic product, while slower than what it had achieved in any earlier decade since 1950, was still significantly better than the performance of the world’s other advanced industrialised economies. During this same decade, equity prices rose six-fold and land prices more than four-fold.1 Even as equity and land prices increased dramatically, in 1989, many econom- ists were prepared to argue that the new valuations were justified by Japan’s economic fundamentals.2 Japan’s distinctive, but superior system of economic management, both at the government level and within the firm, it was argued, justified more optimistic expectations of further exceptional economic growth even as Japan’s unusually high national savings rate kept real interest rates lower than those in other major industrialised economies. Indeed, its distinctive eco- nomic system was seen as working so well by comparison with those of other major economies that Japan was hailed by Chalmers Johnson (1989) as the only ‘Communist nation that works.’ In March 2002, when the Symposium was convened in Ann Arbor at which earlier versions of the papers were presented, Japan looked very different. Japan’s post-1989 GDP growth has averaged no more than 1.2 per cent annually, worse than that of any other major industrialised country. Japan’s equity markets, after reaching a peak at the end of 1989, have fallen by 75 per cent. Japanese land prices have fared still worse with prices falling by 80 per cent, so that in 2002, Japanese land prices are below levels prevailing 20 years ago. Thus, GARY R. SAXONHOUSE and ROBERT M. STERN are from the University of Michigan (Ann Arbor). The papers in this issue were prepared initially for a Symposium held on 22 March, 2002, at the University of Michigan. Support was provided by the Japan Foundation, Centre for Global Partnership. The latter stages of Saxonhouse’s work on this project were facilitated by a residency at the Rockefeller Foundations Bellagio Study and Conference Center. 1 See Figure 1 in Takatoshi Ito’s Symposium paper below. 2 Frankel (1991) reviews much of this literature. © Blackwell Publishing Ltd 2003, 9600 Garsington Road, Oxford, OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA 267 268 GARY R. SAXONHOUSE AND ROBERT M. STERN Chalmers Johnson who wrote in 1989 that ‘Japan is the only Communist nation that works’ more recently (1998) has written that ‘Japan truly fits the crony capitalism description that has complacently continued to protect its structurally corrupt and sometimes gangster-ridden firms.’ As Nishimura and Kawamoto show in their Symposium paper below, the very economic institutions, such as community banking and permanent employment (and they might have added close government-business relationships) that for four decades were seen as enhancing Japanese growth prospects are now seen as standing in the way of renewed superior economic performance. With hindsight, it is easy to criticise the failure of so many observers in the late 1980s to foresee the marked change that was about to occur in Japan’s economic fortunes. In light of the experience of the United States in the 1990s, however, it is clear that such failures are not unique to Japan. In both Japan in the late 1980s and in the United States in the late 1990s, prices of assets, such as equities and land, rose rapidly even while the prices of goods and services were relatively stable. In such an environment, it admittedly is difficult to deter- mine, until after the fact, whether the asset-price increases represent speculative excess or a secular change in the rate of growth of productivity. But, for our purposes, we will assume that a bubble did occur in Japan. With this in mind the Symposium that follows seeks to explore: (1) whether the bubble could have been prevented; (2) how much of the economic pain that Japan faced during the 1990s was the result of the bubble’s collapse; and (3) what can be done today to help resolve Japan’s continuing economic problems.3 2. COULD THE BUBBLE HAVE BEEN PREVENTED? Takatoshi Ito addresses the first of the issues raised above in his Symposium paper. Mindful that it is difficult to know that a bubble has occurred until after it is over, Ito suggests that the Bank of Japan (BOJ), at the time of the Louvre Accord in February 1987, should not have cut the discount rate from 3 to 2.5 per cent. Failing that, he argues that the BOJ discount rate could still have been raised in August 1988 when the Federal Reserve and the Bundesbank raised interest rates. According to Ito, earlier tightening of monetary policy might have nipped the bubble in the bud, but even in the summer of 1988 tightening credit conditions might still have prevented some of the worst problems that ultimately arose. By May 1989 when the discount rate was finally raised, according to Ito, it was too late. 3 These and other current issues pertinent to Japan are also explored in depth in the papers in Stern (2003). © Blackwell Publishing Ltd 2003 THE BUBBLE AND THE LOST DECADE 269 To underline how politically difficult it might have been for the BOJ to raise its discount rate, it should be remembered that, during the very years that Ito says that the BOJ should have reversed policy, many observers abroad were not only praising Japan’s economic institutions, they were also praising the quality of Japanese macroeconomic management for simultaneously keeping interest rates low and inflationary expectations damped. For example, David Hale, a highly influential US business economist, wrote in August 1989 that: During the second half of the decade, it was the Japanese MOF [Ministry of Finance] which used a mixture of direct intervention and moral suasion to protect the US financial system from sharply rising interest rates at a time when foreign private investors lost confidence in the US dollar. the MOF and the BOJ pursued a low interest rate policy to boost the US dollar during 1987– 88 and neutralized the potential inflationary consequences on credit growth through administrat- ive guidance (pp. 60–61). Likewise, in 1988, C. Fred Bergsten, the Director of the Institute for International Economics, praised Japanese policies: Since 1986, in perhaps its most impressive performance to date, Japan has adjusted to a near doubling in the dollar value of the yen by shifting with remarkable speed from the export-led growth of the early 1980s to a domestic-led expansion that has produced a burst of rapid growth despite the steady decline of its trade balance in real terms. Japan’s new Five-Year Plan (1988–92) projects GNP growth of 3.75 percent annually and growth in domestic demand of 4.25 percent annually. It . seems both desirable and feasible for Japan to exceed targets in the plan, perhaps maintaining domestic demand at about 6 percent annually. In fact, domestic demand growth reached an estimated 7.4 percent in 1988 (pp. 63 and 103). Quite apart from an earlier move to more restrictive macroeconomic policies, Ito suggests that stricter prudential policies, had they been adopted, could have had a significant impact on the magnitude of the bubble. Ito believes that Japanese authorities could have: (1) introduced a regulation (or guidance) on the loan/value ratio on real estate lending, citing the increased risk of real- estate-price volatility; and (2) issued a regulation (or guidelines) to limit lending to real-estate-related sectors, citing the risks of concentrating loans too heavily in a single sector. Many market participants in the late 1980s already recognised that these very steps, that Ito now recommends with hindsight, were required. Interestingly enough, they believed that the Japanese government was taking just such measures. Quoting again from Hale: The BOJ ordered the banks to reduce the growth rate of total lending and sharply curtailed the supply of funds available for property speculation. As a result, the growth rate of bank lending for real estate fell from 32% to 8% and there was a modest decline in Tokyo real estate prices during 1987 and 1988 despite a monetary policy which was highly accommodating in every © Blackwell Publishing Ltd 2003 270 GARY R.
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