Japan's Phoenix Economy

Richard Katz

From Foreign Affairs, January/February 2003

Article preview: first 500 of 5,925 words total.

Summary:  It is hard to be optimistic about Japan's economy, given that Tokyo has already frittered away a decade. But a corner has been turned. The Japanese people increasingly realize that without reform the situation will only get worse. This new awareness was the force behind Prime Minister Junichiro Koizumi's election in 2001. The bad news is that it may take another decade to get the economy back on track.

Richard Katz is Senior Editor of The Oriental Economist Report, a monthly newsletter on Japan. This article is adapted from his recent book, Japanese Phoenix: The Long Road to Economic Revival.

TEN YEARS TO RECOVERY

A half-century ago, Japan picked itself up from the ashes of war and, within a few years, stunned the world with its economic achievements. In all likelihood, it will do the same again. True, some analysts see muddling through and stagnation as Japan's future. Others even fear the financial system is headed for outright meltdown. But the most likely outcome is that Japan will reform and revive. And if it does so, bringing its host of inefficient sectors up to world benchmarks, it can achieve sustained growth of three percent a year, perhaps more.

Japan has already frittered away one decade, skeptics retort. Why should the next one be any different? Because no society puts itself through wrenching transformation until it has exhausted all other alternatives. And for years many of the best and brightest economists claimed that such alternatives existed: just spend more or print more money. As recently as the brief upturn of 1999-2000, many claimed these nostrums were already working; Japan's politicians and people preferred these consoling illusions. Only now have events persuaded the Japanese people that without reform the situation can only get worse. This new awareness was the force behind Prime Minister Junichiro Koizumi's election in 2001. The first step in solving a problem is admitting you have one.

Japan does not have the feel of a failed state. On the contrary, this is still the same nation that created the economic miracle of the 1950s and 1960s. The problem is that the institutions and practices forged to create that miracle still rule Japan -- and those obsolete institutions have turned into a political and economic straitjacket. Nonetheless, Japan abounds with bright, ambitious businesspeople, academics, and even bureaucrats who yearn to break out of those bindings. They are capable of leading the new Japan. What they lack is a clear economic program, critical mass, and an institution around which to coalesce. The good news is that with time, those too will come. The bad news is that it will probably take ten more years to reach this promised land. And the road from here to there will be very bumpy.

Why ten years? Japan's dysfunctions are so deep-seated that even if it did everything right today, it would take five years to achieve truly vibrant growth. But Japan will not do everything right today. Opposition to reform is equally deep-seated. A myriad of special interests and millions of jobs are at stake.

Japan's dilemma is that the obstacles to growth are woven into the very fabric of the nation's political economy. Decades of corporate collusion and protective regulations have steadily eaten away at productivity, limiting potential economic growth to around one percent a year, even at full capacity. Worse yet, Japan cannot even come close to full capacity despite enormous budget deficits and zero interest rates, because high prices suppress real household income and therefore consumer purchasing power.

Until the 1990s, "peaceful coexistence" between growth and Japan's structural flaws was ...

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