Why Japan Had a Lost Decade—and Why the US Won't

Fisher Investments |

With much of the world experiencing slower economic growth over the past year, I've seen a surge in the number of editorials forecasting a Japan-style “lost decade” in some nations. Based on a quick Internet search, the US, UK, Ireland and South Korea are just some of those purportedly at risk—sure, historically they've been resilient, but this time it's different.

Problem is, none of this analysis has an accurate understanding of what caused Japan's lost decade—two-plus decades, now—of deflation and slow growth. Common wisdom says Japanese businesses and consumers were overleveraged during the economic boom of the 1980s, and when they were hurt by the bursting property bubble, the central bank was too slow to act, and monetary policy remains too tight today despite near-zero rates and nearly perpetual quantitative easing.

Common wisdom, however, is missing some key, critical ingredients. Monetary policy's largely the scapegoat for the past 20-plus years, and though no doubt a contributor to slow growth, it's not necessarily the principal culprit. Japan's long-running economic difficulties stem from deep structural problems—problems today's alleged lost-decade candidates don't share. Among them: weak demographics, waning productivity and narrow labor markets (due to cultural barriers impacting women's labor force participation), all of which make output growth difficult. Japan Post, the state-run banking albatross, uses government guarantees to lure savers at very low rates—and then uses those deposits to purchase Japanese sovereign debt, helping support public spending—likely creating market distortions.

High trade barriers also hurt. Japanese trade policy has long included strong protections against agricultural imports in order to support local rice farmers (like 777.7% rice tariffs). Signing broad free trade agreements would require Japan to drop agricultural import restrictions and tariffs—a politically contentious action. Even if politicians overcame this hurdle, new trade agreements may also require them to privatize Japan Post—a reform passed by former Prime Minister Junichiro Koizumi but dialed back by the six governments since and, given the bank's convenience as a fiscal stimulus machine, unlikely to happen soon. As a result, external barriers to Japanese trade remain high, hurting domestic exporters—the lifeblood of Japan's economy.

But here's another big, often overlooked reason: Since Japan's industrialization began during the 19th century Meiji era, huge conglomerates have dominated Japanese industry, stifling competition. The original iterations, known as zaibatsu, operated like today's chaebol conglomerates in South Korea—the founding families maintained full control of the central holding company and all its subsidiaries and affiliates, allowing them to award contracts within the group almost automatically, limiting competition. When the US occupied Japan after World War II and tried to guide economic reconstruction, US officials deemed the zaibatsu undemocratic and tried to dismantle them. However, realizing how much Japan's recovery depended on these firms, they softened—instead of forcing all zaibatsu to break up, they dismantled only some and forced the rest to restructure, eliminating family control. Under the new structure, known as keiretsu, shareholders replaced family members at the top, and the holding companies replaced full ownership of subsidiaries and affiliates with cross-shareholdings.

Yet a glaring problem remains to this day: The six major horizontal keiretsu are organized around banks. These banks have cross-shareholdings in all the affiliates and subsidiaries—and vice versa. This makes corporate financing easy, but it prevents unprofitable affiliates from failing—because of the cross-shareholdings, the banks have a vested interest in keeping related firms afloat. Hence, Japan has many unprofitable firms, propped up by banks, which crowd out would-be competitors. Competitors, who, given the chance, could be the engine of Japanese economic growth. And bank balance sheets are riddled with unrealized losses, constraining new lending—regardless of how much yen the BOJ prints. Money doesn't move, and deflation persists.

Among major economies, this phenomenon is unique to Japan. Chaebol may rule Korea, but there's a Chinese wall between chaebol and banks—cross-shareholdings are illegal. And no major banks in the Western world own industrial affiliates—there's no Wells Fargo Steel, Citi Chemical, Barclay's Construction or Anglo-Irish Electronics. Instead, firms must earn financing on their own merit, whether from banks or investors. Unprofitable firms fail, making way for new competitors. Even in Korea, several chaebol fell during the late-90s financial crisis—and the 2000s were far from a lost decade there.

As long as a nation has a diverse, competitive economy, the risk of a lost-decade is exceedingly low. No matter how deep financial-sector or economic woes may seem in the throes of crisis, there's a foundation for recovery and future growth. This is true in today's lost-decade candidates—they may have some headwinds, but all have strong foundations. Hence why the US has grown since 2009, the UK economy has fought hard against regulatory headwinds, Ireland's emerging from its 2010 crisis and South Korea's growing. Provided their regulatory systems enable banks, businesses and entrepreneurs to operate freely and compete, investors likely needn't fret a lost decade.

This article constitutes the views, opinions, analyses and commentary of the author as of January 2013 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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