Case Analysis: Japan's Economic Malaise

Topics: Public finance, Government debt, Recession Pages: 5 (1756 words) Published: November 7, 2013

CLOSING CASE for week two
Case Analysis: Japan's Economic Malaise
Review the Japan's Economic Malaise Case Study at the end of Chapter 3 of the Hill text. Answer the five Case Discussion questions in a Word document and submit your responses to the Week 2 Course Dropbox. You will find at the end of chapter 3 starting on p.95 in our electronic e-Book in the classroom. Japan’s Economic Malaise

In 1989 Japan was widely viewed as an economic super-power. After three decades of robust economic growth it had risen to become the world’s second-largest economy. Japanese companies seemed to be obliterating entire American industries, from automobiles and semiconductors to earthmoving equipment and consumer electronics. Japanese companies were buying assets in the United States, including movie studios (Universal Studios and Columbia Pictures), golf courses (Pebble Beach), and real estate (the Rockefeller Center in New York). The stock market was booming, the Nikkei index hitting an all-time high of 38,957 in December 1989, an increase of more than 600 percent since 1980. Property prices had risen so much that one square mile of Tokyo was said to be worth more than the entire United States. Books were written about the Japanese threat to American dominance. Management theorists praised Japanese companies for their strategic savvy and management excellence. Economists were predicting that Japan would overtake America to become the world’s largest economy by 2010. It didn’t happen. In quick succession the stock market collapsed and property prices rapidly followed it down. Japanese banks, which had financed much of the boom in asset prices with easy money, now found their balance sheets loaded with bad debt, and they sharply contracted lending. As the stock market plunged and property prices imploded, individuals saw their net worth shrink. Japanese consumers responded by sharply reducing spending, depressing domestic demand and sending the economy into a recession. And there it stayed—for most of the next two decades. Today the Japanese economy is barely larger in real terms than it was in 1989. In 2010, China passed Japan to become the world’s second-largest economy. The average price of a home in Japan is the same as it was in 1983, way below the 1989 peak. The Nikkei stock market index stood at 9,600 in early 2011, 75 percent below its 1989 high. And worst of all, Japan has been gripped by deflation for the best part of two decades. Deflation is a situation where prices are falling. When consumers and businesses expect prices to be lower tomorrow than they are today, they react by putting off spending, by hoarding cash, since that cash will buy more tomorrow than it will today. Such behavior can result in a negative cycle. Expectations that prices will fall can lead to reduced demand. Businesses respond by cutting prices further to try to get consumers to spend. Seeing this, consumers react by waiting to buy in expectation that prices will again fall in the future, and so demand continues to decline, which results in additional price cuts to try to stimulate demand, and so on. As businesses see their revenues and margins fall, they reduce employment and cut wages and salaries. This further reduces spending power and adds to the deflationary cycle. To make matters worse, in a deflationary environment the real cost of debt goes up over time. While prices and wages fall, people still have to make fixed payments on their mortgages and car loans. Over time, this takes up an ever-greater proportion of their income, further limiting their ability to spend more on other goods and services. All of this has happened in Japan over the past 20 years. For its part, after initially being slow to respond to falling asset prices, during the past 15 years the Japanese government has repeatedly tried to stimulate the economy and reignite consumer spending. Interest rates have been cut to zero and major investments have been made in public...
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