FOR MOST of the second half of the twentieth century, Japan was a model of economic success – and the envy of the West. Economic growth was around 9 to 10 per cent in the 1950s and 1960s, and 4 to 5 per cent in the 1970s and 1980s. But the wheels came off following its financial crisis in the early 1990s. Since then, economic growth has averaged less than 1 per cent a year for over two decades.
In the wake of the global financial crisis, there have been fears that the major western economies are now “turning Japanese”. It’s a significant concern – and one that I explore in my new book Rediscovering Growth. After all, the headline growth numbers over the recovery so far have not been encouraging. UK economic growth in the first four years of recovery has averaged just over 1 per cent a year. The US has fared a bit better – at just over 2 per cent. But in the euro area it has been worse, just 0.6 per cent.
There are some western economies which clearly face major structural problems – particularly in southern Europe. In Italy, GDP per head of population has fallen by 7 per cent since the start of the twenty-first century. But for the US, UK and other economies in northern Europe, the outlook should be much brighter – if we stick to the right economic policies.
One reason that Japan’s economic growth has been weak is that its population has not been growing. So comparisons with countries with stronger population growth like the UK and the US can be misleading. But that is only part of the story.
There are three other important differences between the Japanese experience in the 1990s and the position of the western economies since our financial crisis. First, Japan was slow to face up to its financial problems. It took the Japanese authorities the best part of a decade to deal with the problem of non-performing loans and lack of capital in the banking system. In the UK and the US, these issues were addressed much more quickly, though progress in the euro area has been slower.
Second, Japan was slow to relax monetary policy. Interest rates were pushed up to 8 per cent in 1991 and only gradually reduced. It was not until the mid-90s that Japan moved to a near-zero interest rate policy. Quantitative easing was deployed even later – in 2001, a full decade after the onset of the financial crisis. In the major western economies, monetary policy was relaxed much more dramatically and quickly in 2008-9, and we saw the benefits of this when economic growth resumed in the second half of 2009.
Third, Japan was slow to undertake supply-side reform to make its labour markets more flexible and boost productivity in services. Historically, the Japanese economy has been highly dependent on an efficient and productive manufacturing industry, but the services sector has under-performed in terms of growth and productivity. This is linked to relatively low rates of participation of women in the workforce, which limits the supply of labour available to support the growth of a services-oriented economy.
Because of these policy mistakes, Japan has found it difficult to wean itself off a diet of very cheap money, high deficits and rising government debt. The UK, US and other European economies are better placed because we responded more quickly to our financial crisis. And having flexible labour markets and an efficient services sector – like the UK, US and other northern European economies – should be an advantage in a post-crisis world.
There is an alternative to the experience of Japan. In the early 1980s, when Turning Japanese by The Vapors was rising up the UK singles charts, the major western economies started to recover from the growth doldrums of the 1970s. That growth phase lasted from the early 1980s until 2007, with the brief interruption of the early 1990s recession. In Britain, we experienced 25 years of growth averaging over 3 per cent from 1982 to 2007 – rivalling the “golden age” of the 1950s and 1960s.
The lesson from this transformation in the early 1980s is that supply-side reform and prudent monetary and fiscal policies can support a return to sustained economic growth. Vested interests and political inertia have held back reforms in Japan, so its economy has continued to be dependent on an unhealthy dose of monetary and fiscal stimulus. We can – and should – avoid that fate here in the UK, and hopefully other western economies will follow the same path.
Andrew Sentance is senior economic adviser at PwC and the author of Rediscovering Growth: After the crisis, published by London Publishing Partnership. He is also a former member of the Bank of England Monetary Policy Committee.