Is Japan the Future? (part 1)

1. From Clogs To Clogs In Three Generations

Economy is the basis of society. When the economy is stable, society develops. The ideal economy combines the spiritual and the material, and the best commodities to trade in are sincerity and love.

-Morihei Ueshiba, founder of Aikido

Japan is the global imagination's default setting for the future."
-William Gibson

The word you most often hear to describe Japan is "futuristic." That image, fostered by Japanimation movies like Akira and high-tech companies like Sony and Mitsubishi, conjures visions of gleaming steel and glass skyscrapers filled with thousands of inhabitants, speeding bullet trains packed with commuters browsing the latest Manga comics heading off to work in spotless offices, uniformed students filing obediently into schools, advanced infrastructure, and the push-button robotized convenience of everything from food dispensing to automatic toilets. It is the landscape of Blade Runner. To the tourists wandering it’s neon-lit streets crammed with wall-to-wall towers and festooned with video screens, Japan always seemed like it was at least twenty years ahead of the rest of the world. I think that once again Japan has leaped into the future at least twenty years ahead of the rest of us, but probably not in the way we typically imagine.

Japan was a closed, feudal agrarian society until 1853, when American coal-powered steamships under Commodore Matthew Perry arrived and forced the Japanese to sign the treaty of Kanagawa, opening up Japan to trade. During the period between 1853 and 1867, Japan entered a period of civil conflict known as Bakumatsu, where various factions jostled for power, some wanting to keep Japan isolated while others wanting to open up to the outside world. During this conflict, the Tokugawa shogunate collapsed, and the Meiji government came to power, restoring the emperor in a drive to gain political power and establish order. Subsequently Japan industrialized faster than almost any economy in history. Japan imported experts from Europe in every field to teach them Western methods of science, business, education, engineering, manufacturing, law, government, military tactics, etc. Because the innovations had already been developed in Western economies, the Japanese merely had to appropriate them wholesale to transform their society, achieving in a decades what had taken centuries in Europe, aided by a uniform culture and strong central authority. They also built a strong military and a massive, powerful navy. So great was it’s progress that this formerly feudal agrarian society was able to defeat Russia’s navy in a territorial dispute by 1905, signaling the beginning of a increasing militarism and territorial expansion.

The Meiji government invaded and occupied Manchuria in northern China in 1931 after the Mukden incident, eventually occupying nearly the entire country. Throughout this period, Japan continued to expand militarily, allying itself with Germany and Italy and occupying Indochina, Indonesia, the Philippines and numerous Pacific Islands. While the ultimate causes are complex, it is believed that oil and raw material shortages played a major factor in the Japanese sneak attack on the United States in December, 1941. The resulting brutal four year war in the Pacific culminated in the dropping of two atomic bombs on Japan in 1945, ending the war in a crushing defeat for Japan.

After the war, Japanese society and infrastructure lay in ruins. It was totally rebuilt from the ground up as a democratic constitutional monarchy, mainly by the United States, which occupied the country for several decades and still maintains military bases there. Because their infrastructure and manufacturing base were destroyed, Japan was able to implement the latest technology as it rebuilt, giving it an edge in international competition. It also adopted highly effective manufacturing techniques initially developed in America but rejected by American manufacturers. Because of this, Japanese products went from being poor-quality knockoffs of American brands to the best quality in the world. Japanese businesses invested heavily in electronics and heavy industry, and Japan quickly became one of the world’s leading exporters. Japan eventually became the world’s second largest economy after the United States (it was surpassed by China in 2010). It was known as the post-war economic "miracle."

Japanese electronics makers like Sony, Hitachi and Toshiba dominated the global production of electronic goods. Japanese automakers like Toyota and Honda beat American automakers in head-to-head competition, nearly putting domestic auto manufacturers out of business. The Japanese bought up American properties and real estate all over the east and west coasts, including the iconic Rockefeller Center in New York City, a move that was seen as symbolic of the Japanese "takeover" of America. Japanese companies expanded rapidly, starting factories in the U.S. and hiring American workers. American film and television depicted Japan as a juggernaut that would out-compete the U.S. on every level. The Japanese became notorious for their endless hours at the office, their fanatical devotion to their employers, and a hard-drinking, hard-partying culture in their scant off hours. Workaholic Japanese men were held up as a model for "soft" and "lazy" Americans - they were beating us because they worked harder, often sleeping in their offices and barely seeing their families. It is worth noting that the Japanese have a word - Karoshi – specifically meaning death from overwork. By the 1980’s, the Japanese economy was booming. In Japan, land values tripled within the decade, with spaces in Tokyo selling in the neighborhood of $150,000 a square foot.

The real estate asset bubble burst at the beginning of the 1990's, and Japan went from boom to bust. From it's 1989 peak of 38919, the Nikkei fell by 68% during the 1990's, and real estate prices slumped. The Nikkei stock index is still 70% off its 1989 peak, and property prices are still at around 40% of their 1990 values. Japan's share of global GDP declined by half throughout the first decade of the twenty-first century. According to Wikipedia:

The strong economic growth of the 1980s ended abruptly at the start of the 1990s. In the late 1980s, abnormalities within the Japanese economic system had fueled a massive wave of speculation by Japanese companies, banks and securities companies. A combination of exceptionally high land values and exceptionally low interest rates briefly led to a position in which credit was both easily available and extremely cheap. This led to massive borrowing, the proceeds of which were invested mostly in domestic and foreign stocks and securities.

Recognizing that this bubble was unsustainable, the Finance Ministry sharply raised interest rates in late 1989. This abruptly terminated the bubble, leading to a massive crash in the stock market. It also led to a debt crisis; a large proportion of the debts that had been run up turned bad, which in turn led to a crisis in the banking sector, with many banks being bailed out by the government.

As the decade wore on the Japanese government grew increasingly alarmed at the state of the economy. Japanese banks started writing off their bad debts in the mid-1990’s, and the Japanese government engaged in their own version of a bail-out, forming the Resolution and Collection Corporation to handle the disposal of bad loans. After the banks were free to lend again, much of the money was spent keeping unprofitable firms afloat and extending credit to pay old debts in order to "save face." The Japanese government took increasingly extreme measures, injecting literally trillions of yen as "stimulus" into the economy. The Bank of Japan lowered interest rates to essentially zero. Their measures were almost identical to what is being tried now, including "quantitative easing" policies and spending on large public works projects. Yet all this massive borrowing and spending did little. Consumers lost faith in the economy, and held onto their savings. Businesses were reluctant to take on additional debt. Real estate prices are still depressed. Consumer confidence remains weak, and consumers are reluctant to spend. The Japanese economy has experienced an "undulating plateau" of essentially zero growth ever since.

Sound familiar? It should, because it's exactly what happened later to the rest of the industrialized world, circa 2008. While the term “lost decade” was initially coined to refer the decade between 1990 and 2000, growth did not return during the next decade either, effectively enshrining two lost decades (a lost score?). Just as Japan's transformation from an isolated feudal society to an industrial powerhouse was astonishingly rapid, its fall seems have taken the same lightning-fast trajectory. The last twenty years of Japan’s history are best understood by the four D's: downturn, deflation and demography and debt.

2. The Lost Decade

1. Downturn

Japanese people born in 1975 graduated from university and became full-fledged members of society in 1997, the year that Yamaichi Securities went under. Yamaichi Securities was one of Japan’s top four brokerages, and it’s failure became a symbol of the “lost decade”, very similar to what happened to Lehman Brothers in the U.S. In the late 1990’s people began to speak of an “employment ice age” in Japan. The generation entering the workforce at the time was dubbed a “lost generation,” and that lost generation is currently in the peak consuming years of 35-44 years old. This recent history has had a profound effect on the social values of this generation. The fanatical overwork and overconsumption so symbolic of the Japanese “salaryman” culture began to fade. A widely cited 2010 article in the New York Times entitled "Japan Goes From Dynamic To Disheartened" vividly described the cultural shift that two decades of zero growth has had on Japan:

The downsizing of Japan’s ambitions can be seen on the streets of Tokyo, where concrete “microhouses” have become popular among younger Japanese who cannot afford even the famously cramped housing of their parents, or lack the job security to take out a traditional multidecade loan.

These matchbox-size homes stand on plots of land barely large enough to park a sport utility vehicle, yet have three stories of closet-size bedrooms, suitcase-size closets and a tiny kitchen that properly belongs on a submarine.

“This is how to own a house even when you are uneasy about the future,” said Kimiyo Kondo, general manager at Zaus, a Tokyo-based company that builds microhouses.

As living standards in this still wealthy nation slowly erode, a new frugality is apparent among a generation of young Japanese, who have known nothing but economic stagnation and deflation. They refuse to buy big-ticket items like cars or televisions, and fewer choose to study abroad in America.

Japan’s loss of gumption is most visible among its young men, who are widely derided as “herbivores” for lacking their elders’ willingness to toil for endless hours at the office, or even to succeed in romance, which many here blame, only half jokingly, for their country’s shrinking birthrate. “The Japanese used to be called economic animals,” said Mitsuo Ohashi, former chief executive officer of the chemicals giant Showa Denko. “But somewhere along the way, Japan lost its animal spirits.”

Yukari Higaki, 24, said the only economic conditions she had ever known were ones in which prices and salaries seemed to be in permanent decline. She saves as much money as she can by buying her clothes at discount stores, making her own lunches and forgoing travel abroad. She said that while her generation still lived comfortably, she and her peers were always in a defensive crouch, ready for the worst.

“We are the survival generation,” said Ms. Higaki, who works part time at a furniture store.

Hisakazu Matsuda, president of Japan Consumer Marketing Research Institute, who has written several books on Japanese consumers, has a different name for Japanese in their 20s; he calls them the consumption-haters. He estimates that by the time this generation hits their 60s, their habits of frugality will have cost the Japanese economy $420 billion in lost consumption.

“There is no other generation like this in the world,” Mr. Matsuda said. “These guys think it’s stupid to spend.”

[all emphasis mine]

It’s no wonder they think it’s stupid to spend – employment in Japan changed from jobs with lifetime security to temporary and contract jobs with no job security and fewer benefits. Such employees now constitute a third of Japan’s labor force. Wikipedia again:

Despite the economic recovery in the 2000s, most of the conspicuous consumption of the 1980s, such as spending on whiskey and cars, had not returned. This was due to the traditional Japanese emphasis on frugality and saving, and also because Japanese firms that had dominated the 1980s, such as Sony and Toyota, were fending off heavy competition from rival companies based in South Korea and Taiwan.

One cannot help but wonder at the subtext here, which is "why are these stupid kids not spending all their waking lives at the office and overconsuming, like their parents did?" Of course, they were fully able to see what it got their parents - heart attacks from overwork, isolation, loneliness, broken families, etc. and the economy crashed anyway. To someone less materially minded than the businessmen and economists interviewed for the article, it might seem like the Japanese had regained their sanity. They lost faith in a system that has badly betrayed them, and didn't see fit to consume "heroically" for the good of the nation by spending money they didn't have.  Don't believe the bright neon lights, the "consumer economy" has shallow roots in Japan.

2. Deflation

Japan has endured steadily falling prices for most of the last decade (that is, consumer prices, minus food and energy). This phenomena, known as deflation, means that money in the future is worth more than it is today, due to the products and services that one buys with that money costing less. Since money goes farther in the future, it makes sense to hold onto it rather than spend it immediately or speculate. Putting it under one's mattress is a s good as putting it in a bank, hence banks offer essentially no interest on deposits. Because currency gains value in the future, it is actually bad for debtors, since they are paying the loans back in increasingly valuable dollars (or yen), increasing their actual debt burden. Every incentive for businesses is to pay down debt rather than risk commercial expansion. The reluctance to spend, described above, puts constant pressure on companies to reduce prices so they do not build up the cash reserves to fund investment. All this leads to a so-called deflationary spiral, as Paul Krugman explains: "the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed." As the New York Times article described:

The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the rational way to act when prices are falling is to hold onto cash, which gains in value. But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people instinctively reluctant to spend or invest, driving down demand — and prices — even further.

While the effects are felt across Japan’s economy, they are more apparent in regions like Osaka, the third-largest city, than in relatively prosperous Tokyo. In this proudly commercial city, merchants have gone to extremes to coax shell-shocked shoppers into spending again. But this often takes the shape of price wars that end up only feeding Japan’s deflationary spiral.

There are vending machines that sell canned drinks for 10 yen, or 12 cents; restaurants with 50-yen beer; apartments with the first month’s rent of just 100 yen, about $1.22. Even marriage ceremonies are on sale, with discount wedding halls offering weddings for $600 — less than a tenth of what ceremonies typically cost here just a decade ago. [all emphasis mine]

The conventional response to deflation is to flood the market with new money, which theoretically causes inflation. This "money creation" by central banks is termed "Quantitative Easing," and it consists of selling government bonds in order to issue new currency (all modern currencies are based on debt, that is, they are IOU's). The Japanese government began this policy in 2000, along with the construction of public works to stimulate the economy. The central bank also lowered Interest rates to essentially zero to stimulate borrowing (new money is created when a loan is taken out in a fractional reserve system). None of this had any effect at getting businesses to go further into debt, or getting workers who had only known a declining economy to go on more spending binges. Japanese firms, still highly indebted and facing stiff competition from China, Taiwan and South Korea held onto the money rather than expand. Despite Japan's economic troubles, the Yen remains a strong currency, keeping Japanese exports relatively expensive. The end result of all this was that the Japanese government became highly indebted, with government debt now standing at 200 percent of economic output ( by contrast, in the U.S., the U.K. and Germany, who are in a supposed debt "crisis", debt is under 100 percent of GDP).

3. Debt

There is a unique feature, however, to Japan's debt - it owes it largely to itself. The Japanese people have always been a frugal nation of savers rather than hedonistic spendthrifts. Even during the boom period, saving rates were high, that is, people did not spend more than they earned, unlike in the United States where during the housing boom the savings rate was actually negative (people spent more than they earned). Despite all the glitzy advertising one sees on the streets of Tokyo and the TV ads starring American celebrities, the easy-credit "buy now pay later" culture never quite took hold as it did in the United States. As the BBC reports:

Traditionally the Japanese government has had no trouble selling its debt to domestic investors. Risk-averse small savers, pension funds and institutions are content to hold Japanese government bonds (known as JGBs). About 90% of the outstanding stock of debt is held by these local investors. So the government has not had to worry about foreign market perceptions of the mountainous debt burden.

Again contrast this with the United States, which has had to sell its debt to foreigners on the open market because its saving rates are so low. In fact, the major buyer of U.S. government debt has historically been Japan, which holds a large portion of the U.S. foreign debt. In recent years, however, they have been surpassed by China. Together, Japan and China hold the majority of U.S. debt. This debt was purchased mainly by Asian central banks to shore up the U.S. economy, which Japan and China both depend on for export markets (consumer spending is 70 percent of the U.S. economy, and the U.S. maintains a negative balance of trade, that is, we consume other people's products rather than exporting our own). It should be noted that due to the Quantitative Easing policies undertaken in the United States in the past several years, the Federal reserve has surpassed Japan and China as the leading holder of U.S. debt. It should also be noted that one reason savings are as low as they are in the U.S. is no doubt due to declining wages and increasing expenses for the average worker over the past thirty years.

Japan’s public debt is the second-highest in the world after Zimbabwe. However, Japanese government bonds have some of the world’s lowest interest rates, reflecting overall confidence in the Japanese economy and the government’s ability to repay its debts. There is some concern, however, that as the population ages, the elderly will need to begin spending the money they have saved up to support themselves, leading to lower savings rates. The concern is that the younger generation will not be able to purchase JGBs in the same quantity as their parents were able to, and without this reliable source of domestic saving, the debt will be more of a concern in the future than it has been in the past. This is ultimately due to Japan's demographic situation. There is additional concern that Japan will no longer be able to finance U.S. debt, and will need to convert it’s currency holdings to pay for reconstruction after the earthquake and tsunami of March 10, 2011. This could have a ripple effect throughout the global economy.

4. Demographics

What is most incredible about Japan is that in an overcrowded world, their population is actually shrinking. The national birthrate in 2008 was 1.37 children per woman -- up from a record low of 1.26 in 2005, but still nowhere near what the country needs to replenish its population. Tokyo had the nation's lowest birthrate at 1.09 children per woman. If current trends continue, and there is every reason to believe they will, Japan's population will fall to 95-100 million by 2050, from about 127 million now. Elementary schools are being shuttered and playgrounds are quiet in many cities. In 2010, Japan's population shrank by a record amount, with 1.19 million deaths and 1.07 million births, for an overall change of negative 123,000 people. It was the fourth consecutive year of population decline.

The Japanese government is doing what it can to encourage the birthrates, giving cash allowances of more than $3,000 a year per child to families, with monthly payments for children under high-school age to help defray the costs of child-rearing. Despite this, costs of having children continue to rise even as incomes fall, causing marriage and childbirth to be put off or curtailed. Records show that there were 706,000 marriages in 2010, the fewest since 1954. One blogger writes:

An individual family can decide to have more children, but their efforts will be a drop in the ocean in a country of 120 million people. With the number of women of child-bearing age getting progressively smaller, it would require an unimaginable societal shift in preference towards large families. Marriage and family formation are in an unprecedented decline. Despite the fact that the population is falling, the number of households is actually rising, to 30% of total households from 20% a decade ago. Young and early middle-aged Japanese have made it very clear that they are not prepared to accept the responsibility of child rearing.

Japan’s also has one of the world’s oldest populations. Immediately after the end of the second World War, Japan had a baby boom like many other countries. This boom generation is now entering their retirement years. Japan had the world's highest life expectancy at birth for men and women in 2008, at 86.05 years for women and 79.29 years for men. By 2030 the share of population over age 60 will be 37 percent, from 30 percent in 2010. The concern is that there will not be enough working-age people to support the burgeoning retired elderly population. Currently the ratio of working age people to retirees stands at only 55 percent (slightly more workers than retirees).

Continue to Part 2