By Laura Catterson, Hottinger Investment Management
A term of economic plight, ‘Japanification’ is characterised by a sustained period of anaemic growth, very low interest rates, negative inflation and high government indebtedness. This is a cycle Japan has found itself in for almost three decades, with its aging population making it difficult to escape[i]. Stymied by a lack of policy flexibility, Europe continues to experience similar economic conditions, prompting many market watchers to consider whether it will succumb to a similar fate or whether notable differences between the two economies will favour the Eurozone in the future.
Following WWII, reconstruction narrowed Japan’s focus onto industrialisation and by 1978 it became the second largest economy in the world. However, weak yen policy addressed at the 1985 Plaza Accord led to significant appreciation ‘bringing exports to a standstill and abruptly halting growth’[i]. A horde of stimuli followed. Financial deregulation and loose monetary policy led to a fall in bond yields and significant easing of credit conditions. Outstanding loans rose to more than 210% of nominal GDP in 1990, up from around 140% at the beginning of the 1980s[ii]. Additionally, the acquisition of financial market securities and real estate prompted a surge in prices and by the beginning of the 1990s the market capitalisation of listed companies in Japan had increased fourfold, reaching approximately 140% of GDP[ii]. This explosive growth, coupled with speculative hysteria, caused the economy to significantly overheat. In response, the Bank of Japan raised rates in the early 90s (and held them at this rate until the mid-90s), causing a spectacular asset bubble burst. An immediate – yet short lived – spike in inflation caused by the crash preceded deflation due to the withdrawal of credit supply, which led to further depressed economic conditions and an unprecedented amount of quantitative easing.
The Eurozone currently finds itself in a similarly feeble economic environment which, at first glance, bears a striking resemblance to Japan’s ‘lost decade’ of the 90s. However, there are notable distinctions to be made so as to avoid bold comparisons.
Over the last 10 years, GDP growth year-on-year for both regions is close to parallel, remaining in a narrow range between 2% and negative 1%, however, significant national differences are masked by aggregate figures with southern Europe, namely Italy and Spain, being hit harder by the 2012 debt crisis and two consecutive recessions than the rest of the bloc. Europe is still running ahead of Japan in terms of growth and there is hope that this will continue with additional stimulus from the ECB.
Inflation is another area where similarities, yet also notable distinctions, can be drawn. Figure 2 clearly shows where policy rates have come into force(rates have been negative for both since the 2008 recession). Both regions have been unable to generate any effective inflation, suggesting that their economies are still running very slowly. Nevertheless, whilst the Eurozone is yet to reach its target level of 2% inflation, it has avoided deflationary years. By contrast, negative inflation has occurred 12 times in Japan since 1991, with the first deflationary month occurring after just three years[iii].
The Eurozone has managed to get its banks lending again following the financial crisis faster than Japan did after its credit boom collapse. If central bankers can continue to deliver accommodative monetary policy, ‘money supply should continue to grow above the rate of inflation and lending should remain positive too’[iv]. Coupled with the appreciation of real assets, Figure 3 suggests the Eurozone’s current situation stands in stark contrast to Japan’s enduring deflationary bust of the 1990s [iii].
Another negative trend in Japan and a significant contributor to long-term stagnation has been the decline of its working age population. In a bid to tackle this issue, Japan has drawn a lot of women and young people into the labour force, pushing employment to 60.9%[v], however that rate is unsustainable if the size of the population does not increase. Adding to this challenge is Japan’s inadequate pension system, which results in an over-reliance on younger generations. The public pension, which serves as the main source of income in retirement, is limited and thus burdens the youth with taking on additional risk in order to have any hope of supporting their latter years[vi]. Although a concern for the Eurozone, breathing room comes in the form of its structural advantages over Japan, which it will need to capitalise on in order to accumulate capital. These advantages include a relatively liberal approach to immigration, the global exposure and reach of European companies and the expansion of industries with the potential for strong growth. One such industry is renewables, where Europe currently leads the world. Additionally, Europe will have to make significant advancements in robotics and automation if it is to maintain its GDP per capita at the current high levels whilst the population continues to age.
Japan’s inability to recover completely from the asset bubble burst of the 90s can be attributed to a slow and timid response by the central bank, coupled with significant mismanagement. With a government bailout only forthcoming at the end of the 90s, zombie firms, propped up by banks to prevent mass unemployment, staggered on, draining growth and being ‘unable to service their debts’[i]. For the Eurozone to avoid a similar fate, boosting potential growth and maintaining resilience against significant economic headwinds is key. It is still debatable whether quantitative easing can provide meaningful short-term growth without supressing growth metrics in the long-term[vii]. The Eurozone may need to look to fiscal policy to fully escape its current lull. For this to manifest, swift – albeit likely unpopular – structural and stimulus decisions are vital.
[i] https://www.worldfinance.com/wealth-management/europes-growing-risk-of-japanification
[ii] https://economic-research.bnpparibas.com/Views/DisplayPublication.aspx?type=document&IdPdf=38519
[iii] According to Bloomberg Japan CPI Year on Year at -.3% July 1994
[iv] https://www.rathbones.com/sites/default/files/imce/22_rathbones_investment_insights_q4_2019_v8.pdf
[v] https://tradingeconomics.com/japan/employment-rate
[vi] https://www.japantimes.co.jp/news/2019/06/04/business/financial-markets/japans-pension-system-inadequate-aging-society-council-warns/#.Xib3Fsj7S70
[vii] https://www.ft.com/content/031b49ec-c415-11e4-9019-00144feab7de
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