The Overview of the Economy
Japan is made up of several islands namely Honshu, Hokkaido, Kyushu, and Shikoku. The four make up 97% of the total land area. It is the 10th most populous country with a total population of 128 million people. The governance of the country is under a monarchy with the limited powers of the emperor and a powerful prime minister who is the head of the government. Currently, Emperor Akihito is in charge; he is the 125th emperor of Japan and ascended to power in1989.
The economic timeline of the country can be structured into five phases. The first phase is the Meiji restoration characterized with the arrival of the American black ship in 1868 (Allen 26). The Navy ships forced the opening of the island to the rest of the world through trade. Before the entry of the American military, the country was semi-feudal society, but with the restoration of the Meiji, the governance was centralized and under the control of an emperor. The changes, in this case, lead to the establishment of a robust political economy driven by the open policy and the introduction of technology. The second phase is the restoration of the World War II (Allen 120). Having developed a strong economy and military strength, Japan participated in the war significantly leading to the destruction of the economy. After the war, the government concentrated on restoration, where the phase occupied the period from 1945 to 1952, with the introduction of new technologies playing a central role. The efforts during the recovery led to the phase referred as “Japanese Miracle.” The era occupied the period from 1960 to 1980, which was characterized by high economic growth and enormous exportation. The fourth phase is characterized by the late 1980s, where the economic bubble state was experienced; the period ended in 1990 with the economic turn-down. Lastly, the economy showed some recovery in 2005, but it has not yet regained strong indicators as it was during the boom and growth period.
The Bubble Economy
The Japanese economic bubble started in the late 1980s and ended in 1991. The economic situation was characterized by the inflated prices in the real and stock market. The asset prices accelerated significantly with the overheated economic activities. The money supply was relatively uncontrolled and credit made available and affordable. Overconfidence and speculations regarding assets and stock led to inflation (Colombo 2012). Since the bubble was unsustainable, the economy slowed down in 1990 leading it to drastic fall in the Nikkei Stock Index, as shown in the graph below. In the analysis, the bubble period, the pre-bubble period, the causes of the bubble, the aftermath, and the lessons learned are incorporated.
The Events before the Bubble Economy Period
At the end of the Second World War, the Japanese economy was massively destroyed. Its major cities were destroyed and the economic system much obliterated compared to a state before the war. The efforts by the government and the people brought the economy into stabilization and slow recovery. The United States realized the role it played in the destruction of the country during the war and offered to support economic restoration, through the Marshal Plan. The plan aimed at assisting in rebuilding, the provision of capital, and military protection (Colombo 2012). The economy benefited with infrastructural development and capital to start up industries. The provision of military protection enabled the Japanese government to spend less on military and concentrate on economic development.
The efforts to restore the economy lead to the establishment of many factories. Individuals who used to be peasants became factory workers. The number of people securing white collar jobs increased, which led to the significant growth in the middle and upper class. The white-collar and factory workers were offered lifetime employment, a situation that encouraged them to remain loyal to their employers. Eventually, the factories and business became significantly stable, while the workers were in a position to save a large portion of their earnings.
Small and midsize companies merged to become large industrial and banking conglomerates called Zaibatsu (Colombo 2012). The conglomerates developed a strong competitive edge to compete in the world market. The companies were in a position to improve western products, which gained significant market in the western countries. Progressively, the conglomerates purchased each other’s shares leading to the development of extensive networks of cross-holdings. The strong ties among the companies made it possible for the businesses and industries to remain stable due to the synergy established.
The “economic miracle” was empowered by the improved performance in electronics and automobile industries. The economy dominated the world electronics market through the development of innovative and revolutionary products. Some of such products include pocket transistor radio and Sony Walkman. In addition, the Japanese manufacturers made significant strides in the computer hardware development. Products such as semiconductor chips, CPU Chip, and circuit boards dominated the market (Colombo 2012). Companies such as Sony and Hitachi gained a significant dominance in the world electronics industry and had their products demanded and used across the world, a situation that brought a lot of income through exports.
In the 1970s, the inflation in the United States and the oil crisis was a significant threat to the American economy and in particular to its automobile industry. Therefore, the American cars became expensive to the rest of the world, while the cost of running automobiles was relatively high. The Japanese car manufacturers, including Honda and Datsun took advantage of the situation to position their products in the world market (Colombo 2012). The two developed smaller and fuel-efficient car models, which were cheaper than the American cars. The automobile manufacturers started using robots in the assembly sections, reducing human errors and eventually improving the quality of the automobiles. The companies gained fortunes around the world just like the electrical manufacturers.
Causes of the Bubble
The expansion of the economy was not the real cause of the bubble. In fact, the economic management approaches and the conduct of the players in the economy played a central role in driving the economy into a bubble. The factors that are fundamentally considered to the bubble economic status include the monetary policy, the tax system, lack lease, and the behavior of the banks.
Governments use the monetary policy as a tool for managing the economic environment through the money supply. The money supply influences the level of economic activities because they are the main ingredient to the economic development and growth. The primary tool used in the monetary policy is the interest rates. At low economic activity level or when a government intends to spur economic growth, the interest rates are lowered to make the investment capital available to both the individuals and firms. Indeed, it is the duty of the Bank of Japan to control the interest rates. As from 1986, the bank dropped its official lending rate from 5.00% down to 2.5% in 1987.
The lowered interest rates led to the decrease in the demand of the Yen from foreign investors; hence, the exchange rates declined significantly. The low-interest rates were maintained due to the slide in the US dollar from about ¥237/US$ in September 1985 to ¥153/US$ in February 1987 (Bank of Japan 1). The interest rates remained constant as the government waited for the dollar to stabilize. The bank became concerned about the low-interest rates because it could lead to “economic overheating.” As a result, a closed door meeting with Germany resolved to raise the discount rates. Investor speculated that the rise in the interest rates would lead to increased rate of return; hence, they invested in assets and stock in the stock exchange. The increase in demand for assets such as land, led to demand pulled deflation triggering the bubble economy.
Real estate price index
The Tax System
Tax is a fiscal policy tool used by the governments to raise revenue and achieve the intended economic performance. The tax regime applied in the 1980s in Japan played a role in the combination of other factors in the development of the economy bubble. The inheritance tax in Japan was significantly high at around 70% of the market price in 1988 (Kennard and Hanne 65). The value of land for taxation purpose was about half of the market value, but this effective amount of inheritance tax paid was still significantly high. As a result, the wealthy people would resolve to raise funds through borrowing instead of inheriting land and pay the huge taxes. The individuals and firms found it cheaper to pay interest rates than to inherit land and pay the underlying tax when selling the property. The implication of the behavior is that the supply of land, particularly in the urban areas, remained low. The low supply of land and increased ability of the people to purchase such property contributed towards the price deflation.
In the early 1980s, the effective property tax was 0.1% of the market price. The local government, which was to determine the taxable value, did not adjust despite the rise in value in consecutive years. As a result, the effective property tax on land declined to about 0.06% in the late 1980s (Kennard and Hanne 65). The tax cost of owning land in the country was, therefore, negligible; hence, encouraging people to invest in land as an asset. The situation would be different in case it was costly to own a land; many people would seek to sell the land they held and invested in other ventures. Holding land as an asset and the interest of the people to invest in real estate led to higher demand for reducing suppliers, a situation that increased the prices.
Land lease law
The other prominent cause of the economic bubble was the lease law at the time. The land lease law was strengthened during the World War II with the aim to enhance the right of the lessee, while the freedom of contract as spelled in the Civil Code was bent. The need for the reform was realized during the war as many of the breadwinners had been called to undertake the military duty, leaving their families at risk of eviction (Kennard and Hanne 66). On the other hand, some of the families with properties under lease were in danger of losing income due to the failure of the tenants to honor the contracts. The situation could easily result in social instability.
Under the new provisions, land leases would be automatically renewed after the lapse of time. The landlords were given the opportunity to object the renewal with immediate effect giving reasonable grounds such as the personal need to utilize the property or by other reason that the court may interpret to be a just cause. Since the leases were normally up to thirty years, it implied that if a landlord fail to terminate the renewal he/she may be forced to wait for another thirty years to use the land for personal needs. Additionally, in case both the parties to an effective lease fail to agree on the rent amount, the law requires that the court should determine the fair and reasonable rent (Kennard and Hanne 66). The lessee continues to utilize the land upon depositing the amount deemed reasonable. Under the legislation, the landowners have limited negotiating opportunity leading to relatively low lease prices. As a result, individuals owning deserted land feared to lease it out; hence, reducing the supply of land in the economy.
The Behavior of the Banks
The banking sector in Japan played a central role in triggering the economic bubble. The reconstruction and economic development experienced since the end of the war led to a situation where the banks received many deposits from savers, particularly among the workers. The amounts in the deposits were issued as advancement/loans for investment purpose. The lifting of the ban to raise revenue in the stock exchange in 1980 brought on board an alternative source of funds to the Japanese companies. Since the issuance of shares and securities assisted firms in raising equity capital, many of the firms preferred selling securities market rather than bank loans. Therefore, the banks were at risk of performing poorly due to the reduced income from the interests on loans. The entities became aggressive and changed approaches to attract additional borrowers (Kennard and Hanne 66). Most of the banks introduced personal loans to target individuals as a way to expand their capital base. Ordinary people working in white-collar jobs could access a huge amount of loans to purchase property, which was used as collateral.
The move by the banks made it possible for those who would not afford to pay for the assets to access funds and purchase the property. The demand for the real estate assets increased drastically pushing the prices high. The banks also made funds available to individuals for the speculative purpose. Since the economy had been stable over the years and companies had their share prices performing attractively, speculators would borrow to buy stock in the stock exchange (Kennard and Hanne 66). Since the demand and supply determine the price of the stock, the increase in demand led to the drastic rise in the stock prices.
The End of the Bubble
The bubble economy was at its peak on December 29, 1989, with the Nikkei Stock Index at 38, 915; after which the index plunged by 202 points by 4 January 1990. The decline was the first sign that the bubble was to burst. The land prices in Tokyo started slowing down by the end of 1989, while in the metropolitan the prices took the similar direction. The two outcomes are considered to have triggered the bursting of the bubble economy. As from 1987, there was public demand for the government to undertake land price measures. However, the parties concerned, particularly the Ministry of Finance and Bank of Japan perceived quantitative restrictions to be ineffective. Despite the relaxation to undertake the relevant steps, the Bank of Japan introduced restrictions on real-estate related loans. The aim of the measure was to reduce the availability of funding and eventually reduce the demand for land. As a result, only the individuals and firms who would raise funds to purchase land were in a position to do so. With the reduced demand for land, the prices, which had been rising over the years, started recording a decline.
Additionally, when it was evident to the government that the bubble economy was not sustainable, it took measures through the monetary policy applied by the BoJ (Bank of Japan). The economic overheating and inflation were signs of a likely recession. Indeed, to address the problem, the interested rate had to be adjusted upwards. The rate rose by 0.75 in May 1989, to 3.25 percent. By August 1990, the interest rates had reached the peak at 6%, where at this point the cost of raising money by borrowing from the banks was high. As a result, individuals and firms could not borrow or purchase stock and other assets. Instead, some would end up selling their held assets and shares, increasing their supply as the demand declined leading to the reduction in their prices.
The Aftermath of the Bubble Burst
The massive rise in asset prices characterized the factors triggering the bubble economy, which eventually collapsed in 1990-1991 fiscal year. The aftermath of the burst to the asset prices is an aspect of significant importance. According to Kennard and Hanne by 1992, the national wide land prices declined by 1.7%, while in six key cities, the prices dropped to an average of 15.5% from the peak of the boom (65). The commercial, residential, and industrial classified land lost value by 15.2%, 17.9%, and 13.2% respectively (Kennard and Hanne 66). The decline in the price was a significant concern bearing in mind that land in the economy had been on the rise for decades. The property in the Tokyo’s financial districts used to be the most expensive across the world, but it dropped to less than 1% compared to the peak. Eventually, the value of the land in Moscow and other cities overtook Japan. Nevertheless, Kennard and Hanne (2015) state that by 2012, land in Tokyo had regained its value to be the most expensive in the world.
Impact on the Household
The bursting of the bubble affected the household in various ways. First, individuals from the households invested in real estate and securities; hence, the decline in their performance led to decrease in earnings. As a result, the ability to purchase goods and services by the household were undermined. Secondly, the confidence of the households on the assets and securities in the economy deteriorated, resulting in reduction in investment (Kennard and Hanne 67). Lastly, a large number of the households had borrowed money to invest in assets and securities. The rise in the interest rate as the BoJ raised the discount rate, which forced the borrowers to pay more interest expenses than anticipated.
Impact on the Corporate
The Japanese companies had gained financial strength enabling them to invest in research and development of innovative products. As a result, manufacturers in the economy were unable to continue producing innovative products making them less competitive in the foreign market (Kennard and Hanne 67). The revenue and profits from international operations deteriorated, affecting the performance of many companies as reported in their income statements. Additionally, the balance sheets of the companies were affected due to the decline in the value of assets and securities held by the organizations. In essence, the net worth of the companies weakened, making it difficult to convince investors to support investment and operations.
Financial and Banking Sector
The bursting of the bubble had a significant effect on the banking sector in Japan. One of the most significant effects is the increase in the nonperforming loans. The largest portion of the loans was tagged on land; therefore, the significant decline in the prices led to the deterioration of the quality of the loans. Borrowers were allowed to borrow up to 90% of the value of the land and other real estate related assets. The collateral value declined by about 50% between 1991 and 1998 leaving about 40% of the loans uncovered (Kennard and Hanne 67). Individuals and firms who had used land as the collateral would rather not pay the loans and instead have their property taken over by the banks because of the deteriorated prices. Therefore, the banks were frustrated because selling the collaterals would not assist them in recovering the loans.
Apart from the fall in the prices of land and related assets, the failure of the stock market to maintain the prices of securities as before the bubble economy intensified the amount of the non-performing loans. The banks had allowed the borrowers to access loans and repay from the proceeding of the capital gain and dividends earned. Many investors had a lot of confidence in the stock market and made use of the opportunity given by the commercial banks to acquire loan-funded shares. The bursting of the bubble sent a negative signal that the economy was heading into a decline. Stockholders rushed to sell their securities, which lead to the massive increase in supply while the demand decreased immensely (Kennard and Hanne 67). The situation triggered the decline in the stock prices in an alarming rate. Again, the banking sector was left in the mix of another category of the non-performing loans because the individuals holding stock-funded loans were unable to repay.
The bad debts experienced by the banks did not only affect the profit levels, but also led to the loss of money. The local environment was not conducive for the banks; some allowed the borrowers the loans to invest in other economies where earnings were better and stable. The move was also another risky venture since it was not guaranteed that the investment in other countries would perform as well.
The bad debts and weak earnings reported by the banks adversely affected the stability of the banking sector. Some of the banks that used to be strong and highly valued could not overcome the challenges leading to their collapsing. On November 1997, Hokkaido Takushoku Bank, and Yamaichi Securities Co failed to continue with the operations (Kennard and Hanne 67). The situation intensified with the collapse of Long-Term Credit Bank and Nippon Credit Bank in October and December 1998 respectively. However, the financial crisis intensified due to the reluctance of the government to take the necessary steps early enough to caution the troubled banks from collapsing.
Investment level is the other important economic indicator used in the evaluation of the performance of an economy. The investment level in Japan grew rapidly in the late 1980s due to growth in capital. The investors tried to gain from the rise in the rate of return in ventures, which used to be of low return and high risk. The financial sector (banks) had increased the supply of investment capital enabling individuals and firms to borrow and invest in their interested ventures (Iyoda 69). Apart from the local investment, foreign investors got interested in the economy increasing foreign direct investment. The situation lasted for a short time because with the burst of the bubble economy, the investment level decreased significantly. Investors, both local and foreign lost the confidence in the economy, while the banks reduced their funding due increased bad debts.
Lessons Learnt from the Japan’s Economy Bubble
The occurrence and bursting of the economic bubble affected the Japanese economy and the livelihood of its people, as well as the performance of business entities. It is important to learn from the situation to avoid making mistakes and the repeat of the mismanagement of the economy. First, it is clear that the adjustment of the exchange rates may not assist in ending an economic bubble, particularly during the consumer price index stable period. The Japanese government appreciated the Yen against the US$ to reduce productivity and lower the economical heating locally, which did not work during such a time when the CPI was stable. The other lesson is that it is important to deal with immediate economic prosperity to determine whether it is long-term and sustainable. The undertaking would have assisted the Japanese Government to take up necessary measures before the “heating of the economy,” which would lead to the bubble whose bursting affected the economy for decades.
The Japanese economy as one of the most stable globally has come a long way, particularly after the World War II. The economy was adversely affected by the destruction of its key cities and reduction in economic development and growth rates during the war. The commitment from the government and assistance from the United States assisted the economy to recover it prosperity trend. The Bank of Japan kept on lowering the interest rates to encourage local investment, exchange rates, and boost exports. The business entities, particularly the manufacturers of automobile and electronics industries dominated the world market, bringing in huge foreign income from foreign markets. The government through the Bank of Japan and the Ministry of Finance failed to manage the “economic heating” in the late 1980s leading to an economic bubble. The government concentrated on controlling the exchange rates, while retaining the low-interest rates, which did not slow the rising prices of assets and securities. Since the rise in the prices was triggered by speculations, the economy bubble collapsed, leading to a recession that took decades to manage.