Hamish McRae: Can we avoid the years of stagnation suffered by Japan?

There has been virtually no increase in Japanese living standards for 20 years

Wednesday, 29 October 2008

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If London markets have been rocked by share prices hitting a five-year low, think what it feels like here in Tokyo, where prices on Monday hit a 26-year low. Japan has been down this path before. At the end of the 1980s it confronted a situation similar in many ways to that which faces the US and Europe today. It had experienced a huge speculative property bubble, built on borrowed money.

At one time the land of the Imperial Palace in the centre of Tokyo was valued at the same as the whole of California. People had to take out 50-year mortgages to buy a modest flat: children inherited parents' mortgages along with the property. Then the boom collapsed. The banks were propped up but were in effect bust. One large securities house was let go into bankruptcy and many medium-sized companies folded. Gradually, through the 1990s property prices slid back, but even though they have come up a bit in the past three or four years, they are still well below the late 1980s peak.

The aftermath of that bubble has been a millstone round the neck of the Japanese economy. True it is still the second largest in the world and true, Tokyo is still the sprawling, clean, efficient, safe and shiny city it was 20 years ago. The great Japanese companies such as Toyota, Sony and Honda still prosper. But the bottom line is that there has been virtually no overall increase in Japanese living standards for 20 years and that inequality has risen sharply.

You don't see it in central Tokyo, where the smart salary workers of the giant companies commute every day, but I am told by Japanese friends that there is real hidden poverty in a way that they find shocking. Homelessness has increased, one third of jobs are part-time, and the thing they found most shocking is that quite a lot of people have no health insurance because they cannot pay the low social security charges to maintain their cover.

Why can't the Japanese government do anything about this? Because it hasn't got the money. The country has the highest proportion of old people in the world, a shrinking workforce, and the largest national debt of any developed country, equivalent to about 160 per cent of GDP. (In the UK it is still only between 40 per cent and 50 per cent, though it will rise further.) That national debt is the result of massive borrowing in the 1990s, indirectly to support the banking system, and zero growth. Japan botched its rescue of the economy after its bubble, and the result was stagnation. It tried to borrow its way out of trouble and it failed.

If there seem to be alarming parallels with our own situation in Britain, or indeed with that of most EU members and the US, there are solid reasons why our prospects look better than those of Japan in 1990. More of those in a moment. First what can we learn from Japan's experience? The first is that cutting interest rates and boosting public spending will not of themselves solve the problem. Japan did both, with near zero interest rates for 20 years and the huge public borrowing noted above. The government spent on supposed "pump-priming" schemes, building new bridges, roads and rail links, but while this pumped things up for a bit, it failed to establish sustained growth.

During the early 1990s the country escaped recession, unlike for example the UK, but the economy was flat and when the recession did come, in 1997, it was a biggie. Then until a couple of years ago it was back to stagnation. So while cheap money will help, and some increase in government borrowing is inevitable, they will not on their own fix things. Wasting money on ill-conceived public spending (which Japan did) is damaging in the medium-term.

A further mistake of the Japanese authorities was that they tried to prop up depreciating asset prices, including the stock market. They had a plan called the price keeping operation or PKO, which used public money to buy shares on the market and so stabilise the price. The joke at time was that it should not be called the PKO but the PLO, or price lifting operation.

The other major failure of Japan was to sort out its banking system. The banks were so full of bad debts, in many cases concealed, that they were unable to lend to new and more creditworthy customers. Banks have to be realistic about their bad debts and then, having opened the books, they have to get new capital so they can get back into business. The UK model of optional partial nationalisation looks a better bet than the US plan to take the bad debts off the banks into a publicly-funded pot.

So from a British perspective, we are on the right track in forcing the banks to disclose their rubbish loans and then replace their capital, if necessary by getting it from the state. But we are in danger of making the same mistake as Japan if we boost public spending to try to pump-prime the economy with a big spending programme.

The deficit will rise anyway as a result of falling tax receipts; the government has to be careful about increasing it yet further. These stories that the Prime Minister wants to try and borrow its way out of recession have a nasty ring to them, given Japanese experience.

Mercifully there are some reasons to suspect that the UK and European situation may be more manageable than that of Japan 20 years ago. Our property bubbles have been smaller, relative to GDP, than Japan experienced, and asset prices are being allowed to fall rather than being artificially supported by the government. Our banks are now no longer concealing the extent of their losses, as did the Japanese, and as I am afraid they themselves have done in the first part of this year.

There are two further reasons to be cautiously optimistic about UK prospects now vis-à-vis those of Japan 20 years ago. One is that we have made structural reforms to increase the efficiency of our economy, for example, liberalising trading hours and work practices. There have been some reverses, with restrictive legislation, often originating in Europe. But the theory of the enterprise culture, if not always its application, is well understood by this government and one hopes the next one.

The other is simply that the UK does have some underlying population growth. The UK total fertility rate (the number of babies a woman will have during her lifetime) has risen almost to 1.9 babies per mother, not far short of replacement rate of 2.1 babies; in Japan the fertility rate is still falling and is now just over 1.2 babies.

And while the British debate about inward migration continues to rage, some further immigration seems inevitable. Accordingly the UK working population will rise over the next 20 years, while the Japanese will continue to shrink.

So it seems unlikely that the UK will be condemned to a Japan-style decade or decades of economic stagnation. If that is right it will be a relief, because I don't think we would cope socially with such an outcome with the decency, tolerance and order that the Japanese have sustained. Coping so well with what has been and still is a very difficult situation, is hugely to their credit – even if in an ideal world they should not have got themselves there in the first place.

h.mcrae@independent.co.uk