Japan's Economy: Recession, Effect on U.S. and World

7 Characteristics of Japan's Economy

Japan Earthquake destruction
The 2011 earthquake threw Japan into recession. Photo: Getty Images

Japan is the world's fifth largest economy after China, the European Union, the United States, and India. Its economic output was $4.658 trillion in 2015, as measured by purchasing power parity. That was 0.1% less than its Gross Domestic Product in 2014. 

Abenomics

In 2012, Shinzo Abe returned as Japan's Prime Minister. He promised economic reform to shake the country out of its decades-long slump. "Abenomics" has three principal components.

 

First, the Bank of Japan (BOJ) initiated expansive monetary policies, including Quantitative Easing. That successfully lowered the value of the yen from $.013 to $.0083. That is typically expressed in reverse, so the value of the dollar rose from 76.88 yen to 120.18 yen. Central bank spending equals 18% of the country's GDP and accounts for nearly all of government borrowing. (Source: Holman Jenkins, "Japan at the Brink," WSJ, November 19, 2014.)

Typically, this devaluation boosts exports, since their prices drop in dollar terms and makes them more competitively priced. However, Japanese companies haven't increased exports as expected. Many Japanese companies have already outsourced factories to lower-cost areas, or to be closer to their markets (such as Toyota in the United States). Even more disturbing is that Japanese consumer electronics aren't as competitive as they used to be. (Source: Mitsuru Obe, Japan's Export Volume Falls Despite Weak YenWall Street Journal, December 17, 2014)

Second, Abe launched expansive fiscal policy, primarily through increased infrastructure spending. He promised to offset the rise in Japan's 225% debt-to-GDP ratio with a 10% consumer tax in 2014. The consumer tax backfired,  throwing the economy back into recession.

Third, Abe promised to modernize Japan's agriculture industry by reducing tariffs and expanding plot sizes.

That probably won't work, because the rice lobby is too powerful in national politics. (Source: Daniel Stelter, How Japan's Economy Put Itself Out to Pasture, Japan Times, December 25, 2014).

7 Characteristics of Japan's Economy

The following seven factors have become a hindrance to Japan's growth. 

Keiretsu is the structured interdependent relationships between manufacturers, suppliers, and distributors.

Guaranteed lifetime employment has traditionally been for a substantial portion of the urban labor force. However, the recession has changed that. More Japanese workers have lost that benefit. 

World’s largest net food importer is because Japan has just one-third as much arable land per person as China.  

An aging population means the country must pay out more retirement benefits than it receives in income taxes from the working population. It hires temporary workers from nearby South Asian countries but does not welcome immigrants. 

Yen carry trade is a result of Japan's low interest rates. Investors borrow money in low-cost yen and invest it in higher-paying currencies, such as the U.S. dollar. It's one reason the dollar's value soared 15% in 2014. A lower yen normally increases the price of imported commodities, triggering inflation.

However, plummeting oil prices in 2014 meant the BOJ didn't have to worry about inflation, and could keep rates low.

Japan briefly became the largest holder of U.S. debt in 2015. Japan does this to keep the yen low and the dollar strong to improve its exports.

Japan's massive debt-to-GDP ratio means Japan owes more than twice as much as it produces annually. The biggest owner of its debt is the Bank of Japan. That allows the country to keep spending without worrying about higher interest rates demanded by skittish lenders. 

Earthquake, Tsunami and Fukushima Disaster Impact

Before Japan's 2011 earthquake and nuclear power plant disaster, its economy was emerging from the deepest recession since the 1970s. It rebounded in 2010 when GDP increased by a healthy 3% -- the fastest growth in 20 years.

It fell off briefly during the last quarter of 2010 but was expected to pick up again with stronger exports to fast-growing neighbors in Asia.

However, Japan lost much of its electricity generation when it shut down nearly all its nuclear power plants after the earthquake. The economy shrank .5% in 2011 as manufacturing slowed due to the crisis.

Japan's Lost Decade

In January 1990, Japan's stock market crashed. Japan's economy had only recently recovered from the deflation that hobbled it in the 1990s.

In 2007, Japan's economy started to improve. It was up 2.1% in 2007, and 3.2% in Q1 2008, leading many to believe it had finally grown out of its decade-long recession.

That all changed in Q4 2008 when GDP growth plummeted 12.9% from the prior year, the worst decline since the 1974 recession. Japan's economic collapse was a shock, since Q3 growth was only down .1%, following a decrease of 2.4% in Q2 2008. The severe downturn was a result of slumping exports in consumer electronics and auto sales, 16% of Japan's economy and a driving force behinds the country's economic revival from 2002-2008.

Why Japan's Economy Is Important to the United States

The Bank of Japan had been the largest holder of U.S. Treasuries until China replaced it in 2008. Both Japan and China does this to keep the value of their currencies low relative to the dollar. That keeps their exports competitively priced. However, this strategy drove Japan's debt to 182% of total GDP output even before Abenomics. (Source: CIA World Factbook)

A low yen made Japan's auto industry very competitive. That was one reason that Toyota became the number #1 auto maker in the world in 2007. However, if the BOJ decides that a low yen isn't boosting growth, and oil prices rise, then it may let the yen strengthen to reduce inflation. It would purchase fewer Treasury bonds, which would allow yields to rise, and boost U.S. interest rates as a result.