On the financial front, all of the rescue plans were justified by the belief that asset prices would eventually recover their previous value, which never happened because they were inflated by speculation to begin with. Near-zero interest rates throughout the 1990s and early 2000s enabled banks and corporations to take out new loans to cover the bad ones, creating a legion of “zombies” that otherwise would have been insolvent. Meanwhile, fiscal stimulus focused heavily on public-works projects meant to benefit politically-connected companies and regions and to soak up extra labor to prevent social instability. All this resulted in perpetuating inefficiencies in the system and allocating massive resources toward investments that would see no returns. Moreover, when each new stimulus wore off, this growth driven by public demand proved unsustainable. Japan underwent several recessions (bottoming out in 1992, 1997 and 2000), with each broken up only by brief and intermittent periods of slight growth that never amounted to a true recovery.
Another factor that made Japan’s recession particularly malignant was the onset of price deflation. Deflation is a general, sustained decrease in price levels. It becomes self-reinforcing when consumers increase their savings and delay purchases in anticipation of ever lower prices, creating a nearly inescapable swirl of decreasing consumption, business profits and investment. (This was seen as a major factor in the disastrous effect of the Great Depression in the United States in the 1930s.) In Japan, deflation has been blamed on the Bank of Japan (for tightening monetary policy briefly from 1989 to 1991 in response to the bubble), on heavy deficit spending that left little room for a recovery of private investment that could have spurred prices, and on fiscal stimulus policies that artificially propped up manufacturers at a time when demand remained low, creating a surplus of goods that drove prices down further.
Whatever the case, consumers could not be prodded into spending enough to drive prices back up to where they had been. Japan’s consumer price index went negative several times from 1994 to 1996 and most tenaciously from 1998 to 2006 (with prices falling their fastest in December 1999 at -1.3 percent and in February 2002 at -1.9 percent). It happened again in the spring and summer 2007 after several years of GDP growth. The persistence of deflation in Japan further snarled the economy, worsening recessions and dampening periods of growth.
The net effect of Tokyo’s fiscal policies and financial rescues during the lost decade was to dramatically speed up the accumulation of public budget deficits and, ultimately, government debt. Expenditures soared and revenues plummeted, leaving Japan with national account deficits worth over 30 trillion yen (about 6-7 percent of GDP) every year from 1998 to 2006, all of which was covered by issuing bonds. Total government debt grew twice as fast in the 1990s as it did in the 1980s, and from 1993 to 2005 it rose by 209 percent, after growing at yearly rates of above 10 percent in 1994 and from 1996 to 1998. By 2005, Japan had amassed 827.5 trillion yen in debt (153 percent of GDP), the highest in the world.
Koizumi Era
Financial turmoil quickly translated into political turmoil throughout the 1990s. In the summer of 1993, a coalition of opposition parties defeated the Liberal Democratic Party (LDP) in parliamentary elections, shattering its 38-year political dominance. Though the LDP returned to power in less than a year, it was deprived of its full majority and forced to form coalitions with smaller partners to stay in power. Meanwhile, battles were raging between various government entities with different agendas, most notably the Ministry of Finance (which controlled fiscal planning) and the Bank of Japan (which controlled monetary policy). The combination of financial and economic disaster and political chaos created a volatile situation in the upper echelons of the LDP, and prime ministers and cabinets were shuffled through even more rapidly than usual for Japan, thus depriving the country of a unified leadership in the crisis. This meant uncertainties and mistakes in policy, such as the overly optimistic plan to impose fiscal discipline in 1997, which slowed the economy, causing a drop in tax revenues and a huge increase in deficits.
Finally, Japan emerged from this extended period of financial and economic distress — though only for a brief time — during the premiership of Junichiro Koizumi (2001-2006), a reformer who attempted to privatize government agencies, cut wasteful programs, rein in Japan’s budgets and map out a plan for reducing the country’s bloated national debt. With the U.S. and global economy booming from 2003 to 2007, Koizumi’s Japan saw consecutive years of growth for the first time since 1997 (though at an unimpressive rate of around 1 percent). Koizumi’s reforms were a start, but in comparison to the size of the country’s problems they were humble. He did little more than slow Japan’s descent. Though he shrank budget deficits during his term, he did not manage to bring them back down even to 1995-1996 levels, and national debt continued to grow (though at a much reduced rate).
The Koizumi era appeared to mark Japan’s recovery from the lost decade — but the financial system was never restructured, repeatedly high public deficits crowded out private investment, and the rising number of retirees drawing on pensions and health care promised to consume more and more of the country’s private wealth. Japan was not likely to rebound easily from its economic and fiscal woes even if the economy had not begun to decelerate again in 2007, following a U.S. slowdown. The year 2008 saw the onset of recession at home, massively amplified by financial turmoil in the United States’ that triggered a global recession.
