Japan’s post-World War Two economy has always been described as one of the most robust and progressive of the modern era. However, recent political troubles, volatile economic circumstances, and natural disasters have forced a more critical examination of the future of Japan.

The great Mount Fuji overlooks the Skyscrapers of Shinjuku in the bustling Japanese capital city of Tokyo, but here, the threat of economic collapse also looms large. After the post-war economic miracle that lasted until the early 1990s, Japan’s economy stumbled into the new century marred by a recession, with financial decisions from both households and the Japanese government severely affecting future Japanese economic stability and growth. The effects of this near economic catastrophe still linger, and were exacerbated in the 2011 Tohōku earthquake and tsunami disaster that resulted in the meltdown of a key nuclear energy plant and closures of Japanese factories.

In the wake of Japan’s 2012 general elections, we need to reexamine the economic state of Japan using hindsight and current events, and determine whether the Japanese government is doing enough to address these persistent economic woes. The analysis will include an astute consideration of Japan’s “Lost Decade” of the 1990s, which underlies policy schisms between the government and banks, and the implications of the consequences through the 2008 recession and the Tohōku-Fukushima disasters.

While the Japanese government has focused on maximizing its comparative advantage in the automotive and technological development industries to fuel export-led economic growth, weak fiscal and monetary policies, and a lack of tax reforms have stunted the Japanese economy. However, there are indicators that Japan’s economy and its governance is not as bad as it seems and that the infrastructural foundation is present to weather any storm while maintaining its high economic potential. From these findings, the financial measures Japan can implement to recover its position at the top of Asia’s economic totem pole, now and in the near future, may be explored.

Economic Hindsight: Fractured Financial Institutions 1989 – 2010

Japan’s infamous “Lost Decade” can be attributed to a lack of a clear or consistent government policy implementation and inadequate coordination between entities that let to market failure. The unchecked liquidity trap that resulted from a high volume of household savings, which, coupled with a low interest rate, greatly increased land and stock market prices to the late 1980s. Due to Japan’s high personal savings rates (a conservative practice of older generations left unbalanced by Japan’s low birth rate) and average consumer spending, much money was left available for interested big buyers. This phenomenon had major implications on the money market; Japan’s supporting bank networks lent money without much concern for the history of the buyer or his ability to pay, a “policy” that was encouraged by a strong corporate-bank relationship and the assumed availability of bailout funds. The moral hazard issue was aggravated when more banks decided to quickly cash in and dole out traditional loans accompanied by reduced lending standards.

A booming economy with plenty of yen in bank coffers created an atmosphere in which Japanese firms largely ignored capital markets to acquire funds; capital markets would have better regulated the overall money supply in the Japanese economy and created spending opportunities without incurring bad debts. The massive asset bubble was finallydeemed unsustainable in late 1989 by the Bank of Japan, in coordination with the Finance Ministry, which dramatically increased interest rates to drive land and stock prices up, an act that eventually burst the bubble. The stock market crash and the subsequent bailout of debt-laden banks revealed poor monetary policy coordination between the government and its financial institutions.

The debt crisis that followed was particularly indicative of this lack of communication: Japanese banks kept injecting funds into so-called zombie firms under the guise that these companies were “too big to fail” despite harboring unprofitable assets and operations; they would be unsustainable even with the sizeable bail-out funds given the amount of bad debt. The government formed a $500 bn bank rescue plan in 1998 to encourage bank lending and borrowing, while also pouring more Yen into the economy in the hopes that inflation would help ease the burden of bad debts and increase public spending.

Though the Japanese economy recovered somewhat after the unsound lending practices were stopped, the damage had left a lasting mark on future Japanese economic progress; the national debt to GDP ratio rose to 100%, and a 2.4% budget surplus in 1991 reversed to a deficit of 4.3% in 1996 and 10% in 1998. The Japanese economy began to recover, posting a real growth rate of 2% in 2003, on the backs of imports from the US and China. But even this “bailout” was questionable. Renowned economist Paul Krugman suggested that the recovery was “provisional” and that there was still a risk of a return to a liquidity trap, given the saving patterns and tendencies of Japan’s households and firms. The full repercussions from indecisive government reaction, poor policy coordination, and irresponsible banking practices were given a reprieve in part due to Japan’s robust international trade networks.

The recession of 2008 saw Japan's economy contract at an annual rate of 1.8% in 2008, shrinking 0.8% through the fiscal year 2009. Levels of public debt remained extremely high through 2010, approaching 226% of GDP, a possible lingering effect from the “Lost Decades.” As consumers around the world decreased spending on expensive electronic goods and luxury goods, such as cars, produced and developed in Japan, overall trade income declined. The post-Lost Decade trade boom receded significantly, despite achieving a strong potential rate by growing 60% from 91.4 tr yen to 142.6 tr yen from 2001 to 2006. While the government put forth a generous stimulus package, the main area of concern remained largely unaddressed: Public spending.

To stem the economic backlash from the recession, an ideal move from the government would have been to increase consumer confidence and overall spending in the economy, while keeping inflation rates relatively low. Instead, domestic demand for local and foreign products remained very low as Japanese households opted to save and cut costs, operating under the principle of frugality encouraged by the media. The government’s $275 b stimulus package, which includes provisions to provide about $600 for each family of four, can be deemed inadequate for the task at hand, never mind the lingering doubts on the conditions for the benefits package. Given the propensity of household consumption, there would be a very small impact on overall GDP.

Thus, domestic spending as a primary economic driver was unable to compensate for the loss of overseas exports as international firms reduced contracts with major Japanese companies, which further increased the trade deficits.The problem does not lie within any financial plan, but with the overall responsiveness of the concerned Japanese Ministries to provide unique solutions to the potential liquidity trap that lingers unresolved to this day. Japan's economy as it stands will continually be testedwith low consumption rates, particularly with its many industries that rely on a strong participation in the international market.

The Natural Disaster of the Japanese Economy

Yet, consumer spending is not the only economic crisis in need of a resolution; just a year past the Fukushima catastrophe, Japan’s trade balance shows consistent deficits.

Such a situation injures the Japanese economy in terms of both exports and imports, which are reflected in Japan’s trade balance. The crippling of Japan’s nuclear power generating capacity has caused an increase in expensive oil and natural gas imports that further contribute to the negative trade balance. Conversely, Japanese exports have fallen not only because of the 2008 recession, but also because many major production and development centers for key exports have been shut down due to power shortages or damage; these goods include electronic parts and cars.

The energy squeeze is projected to slow down numerous sectors of Japan’s economy, and rolling blackouts will adversely curtail the production from factories, stores, and homes. With the aftermath of the recession still lingering and further set backs from this new disaster, households look increasingly to protect their assets at the cost of less luxurious lifestyles. Japan’s ability to produce goods for an extended period of time is in question as the bleak outlook resulted in a 6.2 % plunge in the Nikkei 225 stock index, following reports that major manufacturing and exporting companies like Sony and Toyota scaled back operations. Damage to suppliers and to the nation’s transport and infrastructure system has been a particularly grave problem; affecting logistical flexibility, with most manufacturers experiencing delays transporting products.

These long wait times coupled with closed ports have affected customers abroad, especially for multi-assembly or multi-part products. Companies with computer chips that are only halfway through the manufacturing process must either wait for power and production efficiency to return or risk losing multimillion-batch contracts. Alternatively, they could source suppliers outside of Japan, decreasing Japan’s total exports.

The Japanese economy also suffers from disruptions in export volumes for their specialized fuel-efficient cars like the Toyota Priusand the Honda Fit, which cuts into their market share in large EU and US markets. With the projected shutdown of automobile plants, Japanese manufacturers stand to become uncompetitive, or fail to capture a part of the demand for these cars created by gasoline prices—they may stand to lose customer loyalty due to inconvenient service and spare parts holdups. The Japanese economy is kept afloat by a strong export market that supplies the world with 40% of the data microchips in smartphones and is a leading producer of liquid crystal displays (LCD) used in consumer electronics products. A break in production could harm the investments of Japanese companies in many foreign export markets.

Consumable product exports have also suffered hits. Milk and milk-derived products as well as vegetables and fruits produced from Japanese prefectures have been detained or rejected from many countries. The economic impact of this natural disaster is clear—a trade deficit has developed and the Japanese economy is hard-pressed for assistance. Risk consultancy firms such as Equecat calculated that the economic and productivity losses from the earthquake could total more than $100bn over a weekend. Japan’s history of soft consumer spending together with weaker exports has hit Japan’s economy, which only grew by 1.4% annualized growth. Notably, private consumption only grew by 0.1% as spending on services fell.

In a similar vein, net exports decreased 0.1 percentage points due to shipping complications from manufacturers and high imports of fuel to replace lost energy. The 2012 Organization for Economic Cooperation and Development (OECD) Yearbook stated that Japan's debt “rose above 200% of GDP partly as a consequence of the tragic earthquake and its economic consequences.”

However, short-term public investment has to an extent, offset the deficiencies of certain Japanese sectors. Strong public investment in tsunami-stricken Tohōku has resulted in the high mobilization of needed resources from local industries around the area. Gross domestic product data showed that public investment was up 1.7 % due to this influx of spending, which was attributed as a primary driver of Japan’s growth between April and June. Local industries experienced rising sales as the demand for equipment and living necessities by Japanese households and companies increased during the rebuilding process of the crisis. It is apparent that while consumer confidence cannot be built overnight, short bursts of spending could help revitalize a stagnating Japanese economy. Government spending and investment patterns that promote local industries could potentially speed up reconstruction operations and boost Japan’s economy. Joint ministry work to build on this short-term domestic consumption can partly offset export losses to late 2012 until a longer-term stimulus plan can be made.

Another issue that must be addressed is the surging yen, which has hurt Japan’s profits since the 2008 recession via the currency carry trade. Continued turmoil in the world's financial markets drove investors from high-yielding currencies such as the euro, while lower-yielding currencies like the yen rose in value, since investors considered them a safe haven. A robust yen adversely impacts Japan’s export-led economy as profits for Japanese firms are reduced as sales from abroad get converted back into yen—as the yen climbs, Japan’s stock market performs worse. Foreign investment, which has helped Japan recover from previous recessions, has fallen due to currency appreciations that make the investment cost unprofitable as Japanese exports and product prices become more uncompetitive given that one dollar would be worth less yen than normal.

The views expressed in this article are the author's own and do not necessarily reflect Fair Observer’s editorial policy.