7 September 2020

Can Europe learn from Japanification? It may be too late

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As Prime Minister Shinzo Abe fades into retirement, does the Japanese economy and the deflationary threat of “Japanification” provide insights into what’s in store for Europe and the US? A number of analysts have recently described Japan as a warning from history. It’s an interesting perspective but, I suspect,  a flawed one. Japan has problems – but Europe’s are likely to prove much worse.

The perception is that Japan’s decades of lost growth and stagnation since 1991 – despite negative real interest rates and the longest sustained period of monetary experimentation in the form of QE – highlights that artificially low rates and too much debt will severely repress economic growth.

It’s a fair observation, but needs refinement. Every nation has issues to resolve. Japan’s unique problems include its ageing population, but also rigid social structures, including a fixation on above-the-surface consensus and social barriers that still discourage women from joining the workforce. Its arcane political system, described as a “flawed democracy” by The Economist, is effectively a one-party state (despite a brief period where the opposition got in) run by insiders on a patronage basis. It does not encourage talent or dramatic policy responses. Japan remains suspicious of and aloof from the outside world – the recent problems of Carlos Ghosn show it is not a place for foreign devils to succeed in business.

On the other hand, Japan is not some decaying backwater. In many way’s its culture, social cohesion and economic stability remain the envy of other nations. The fixation on not being a proud nail has discouraged the worst aspects of inequality across its society. The Japanese may even have stumbled on the secrets of a long-term comfortable slow-economy – low growth, social stability and an effective stakeholder rather than stock-owner economic basis.

But first, some history… Back in the 1980s, aided by dollar appreciation, the Japanese economy completed its evolution from cheapest-to-deliver low-cost manufacturer into a leading global technology-led economy on the back of cheap and readily available credit. Bubbles erupted as the stock market rose to record levels. The land the Imperial Palace was built on in Tokyo was said to be worth more than the whole of California. Japanese companies were top global brands leading by design; Toyotas were hip, and everyone wanted a Sony Walkman. There was easy money to be made in Japanese equity warrants and a stock market that was only going higher.

But, as always happens to stock bubbles, in the early 90’s the market popped. It left Japan’s debt-addled companies as “Zombies” struggling aimlessly as economic growth stuttered, despite the central bank slashing interest rates. Its industrial design lead was overtaken, while productivity crashed and household industrial names became largely irrelevant in the global markets.

Over the next 30 years “Japanification” – deflationary stagnation – became a bedtime story to scare the kids.

Yet, 30 years later Japan does not look like an economy in deep trouble. There is low unemployment, but the economy isn’t close to full capacity. The stock market has gone up and down, while the once vibrant JGB government bond market is largely held by the Bank of Japan (50%), which has also been buying EFTs to try and boost the deflating economy. Effectively Japan’s economy hit stall-speed in 1990, and has never truly recovered the pace of the 1980s. There were moments when growth took hold and the markets showed promise, but each recovery quickly faded.

Then along comes Shinzo Abe – an able and capable politician (compared to the usual faceless LDP party-men) promising economic renewal. His “three arrows”: i) liquidity creation via essentially unlimited monetary policy, ii) fiscal stimulus to rebuild infrastructure and prestige projects, and iii) a dash for growth, all sounded like genuine grown-up growth policy. But that’s all the the three arrows ever were – policies that failed to seriously address the rigidities at the heart of Japan.

To be fair, it didn’t help that natural disasters and the Fukushima nuclear accident compromised growth, and now the pandemic has stifled what little green shoots were visible. Nor did it help that Abe made the mistake of allowing bureaucrats to impose consumption taxes on the economy to pay for his monetary creation and fiscal handouts. Taxing consumption in an economy notorious for thrift and saving was right up there with European austerity in the pantheon of economic blunders. The reality is that Abenomics promised much but achieved little.

The failure to ratify TPP – the trade agreement with the US – combined with Trump’s stomping on traditional alliances, raises the prospect of Japan being pushed outside the Western hegemony. And though Japan wants to do deals, there are serious doubts on how whomever succeeds Abe can continue to drive the economy. Promising political leadership is in short supply. Bureaucrats were constrained under Abe, but will likely resume their “overly comfortable” command and control of the economy now he’s gone. Japan could yet surprise the world in all the wrong ways.

Is Europe better off?

Does that gallop through the treacle that is Japan’s complex political economy trigger any alarm bells re: Europe? Zombie, debt-ridden companies? Negative real interest rates? A lack of leadership? Trade wars?

The shocking truth is Europe may actually be in much worse shape than Japan ever was:

First: Europe faces an employment crisis for young people that Japan did not. Ten per cent youth employment seems to have become an acceptable number for Brussels. That’s a social time bomb in cities with large, unhappy and disenfranchised immigrant populations, and in decaying rural backwaters – witness the Gilet Jaunes in France, the rise of the right and unrest elsewhere.

Second: Japan is a single homogenous culture with a shared common sense of destiny, while Europe is constructed polity of many tribes with multiple historical grievances (even within the individual nation states).

Third: Japan has the advantage of its own currency and control of its bond market. It matters nothing that Japan’s debt stands at 240% of GDP and it is spending $2 trillion on stimulus measures. It’s very different in Europe. Italy’s debt stands at 159% of GDP but is borrowing in a currency it doesn’t control, without the power to turn on the printing presses. Japan could notionally write off the 50% of JGBs owned by the Bank of Japan while borrowing as much as it requires by pressing the print go-button. If necessary Japan can print and target helicopter money to drive domestic consumption – with the added advantage of devaluing the yen.

In contrast, Italy has to go cap-in-hand begging more from Brussels as its economy collapses after the pandemic zero-tourist season. All the while the Euro soars higher, further blighting recovery.

Fourth: Japan had Abenomics. It might not have worked, but it was a clearly stated policy. What have we got from the Eurocracy? Vague promises to spend €750bn of richer countries’ money on the poorer regions? Agreement on Brussels controlling disbursements? The difference is Japan had unified national government. Europe functions on compromise between the Commission and domestic capitals – democratic oversight isn’t clear or transparent which is fuelling anti-EU sentiment across the continent.

Fifth: Japan’s industry might have lost ground over the last 30 years, but it’s still a dominant force in area such as nuclear power and autos. It has an education system capable of producing the skilled workers that will be required for a new tech-based fourth industrial revolution driven by robotics, 3-D and logistics. It already has effective health care and governance. Some Northern European nations understand the importance of industrial planning and resources – but the struggling south never adapted or reformed their economies prior to the Euro, and are now paying future taxes away today to keep their heads above water.

Then there is the debt crisis.

Japan’s 1980’s financial asset bubble created a Zombie economy requiring massive banking bailouts. That was possible for Japan – but it’s proving insurmountably difficult for Europe to agree a common bank resolution format, aside from repeating the “do-what-ever-it-takes” mantra. The Americans (and to a lesser extent the Brits) quickly realised banks were the issue and resolved them. The Europeans have failed to take difficult decisions.

Despite resolving the banks, it’s taken 30-years for Japan’s corporates to wean themselves off debt and start to try to re-establish themselves as global lean and mean leaders.

What does the Japanese corporate experience mean for the rest of the West?

US and European firms are still at the start of the Zombie debt crisis – although you could argue it started 10 years ago with ZIPR and QE. It’s going to take years for effects of corporate indebtedness to cycle through the economy in terms of investment and growth opportunities missed.

Meanwhile, a broader debate between the merits of classical monetarist theory that corporations only exist to make returns for their owners, versus the Neo-Keynesian concept of a stakeholder based economy where companies exist to create wealth across owners, employees and customers, is likely to widen as the failures of the last 30 years become increasingly apparent.

Boeing is a great example of the failure of the stock-owner economy – for the last 30 years it reaped profits as a duopolist in passenger aircraft. It made billions, but rather than invest in new green efficient aircraft it scrimped, upgrading the 50-year-old B-737 jet until in its final iteration, the B-737 Max, it had become an unbalanced death-trap – killing 346 passengers and crew as software designed to fly the unstable plane failed. The company borrowed billions from the bond market and used that money and profits not to design better planes, but to buy back its own stock. It pushed the stock price higher, allowing executives to reward themselves with massive bonuses, even as worker were sacked or saw their wages fall. Today, the stock price has collapsed, and the company is a debt-laden zombie. It can’t afford to develop the new green aircraft global travel will require. But because of its importance to the US economy and military it will probably earn a bailout.

The realisation of just how badly the stock-owner economy skewed all the rewards onto owners while shifting risks to the workers and consumers is impacting society in terms of how we vote. It may already be too late to learn from the threat of Japanification, bureaucracy and zombie corporate failure. The effects are already upon us.

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Bill Blain is market strategist and head of alternative assets at Shard Capital.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.