Article co-written with Sebastian Palacios from Clarette Consulting.

Japan will have to change. We must build a country where innovation occurs naturally, causing new industries to flourish that allow us to lead the world.

Shinzo Abe

Shinzo Abe, who held the record as Japan’s longest serving prime minister since 1945, was assassinated on July 8, 2022 while speaking at a political rally in Nara prefecture, in the western part of the country. The motives for the murder are still unclear, but the perpetrator is known to be a Japanese citizen who served in the Navy. This type of violence in Japanese public spaces is very rare; Japan has one of the strictest gun laws in the world and recorded just one death from gun violence in 2021. The US, for example, saw 20,726 gun murders in the same year.

After World War II, the US-imposed constitution led Japan to develop a free-market economy that allowed the country to grow at very high rates and become the second largest economy in the world, a position held from 1968 to 2010, year in which China took that place. The Japanese economy suffered a significant slowdown after the bursting of its asset bubble in 1991, due to a monetary easing policy that was excessive and increased the money supply in times of market liberalization, coupled with overly rigid corporate structures and corruption problems. The complicity between banks and companies lowered lending standards, as there was an implicit guarantee that the government would always bail out large corporations.

This resulted in financial institutions having a large number of non-performing assets, the so-called “zombie banks”, which had lent money to heavily indebted, loss making companies. After the 1991 crisis, Japan entered an era called “The Lost Decade”, with GDP growth of less than 1% per year, inflation close to 0% (including many years of deflation), key interest rates below 0.5%, decrease in real wages, increase in the number of part-time contract workers and a very strong decrease in population. In 1989, 32 of the 50 largest companies in the world were Japanese; by 2018, only one company, Toyota, remained on that list. Clear reflection of what happened to the Japanese economy in those years.

Demographics, along with the long-term effects of the credit crunch, have been cited as the main explanation for Japan’s stagnant GDP growth. Additionally, the decrease in the population can also be explained by economic and cultural factors that reinforce this dynamic, so that the economic environment directly affects demographics, which in turn is slowing down consumption and having long-term effects on the population growth of Japan.

Japan’s population decline is due to very low fertility rates and a large increase in life expectancy. If the trend continues, in 2060 those over 65 years of age will represent 40% of the population. The number of pensioners will be almost equal to that of people of working age and the total population will go from the current 126 million to 87 million. No country in the world has experienced a demographic decline of that magnitude.

Currently, the percentage of people between 18 and 39 years old who have not had a sexual experience is 25%, an increase of 20% in relation to 1992; low-income men are 15 times less likely than average to have sexual experience; men who work part-time have a virginity rate four times higher than those with full-time contracts, while women from low-income backgrounds have in general more sexual relations than women with higher incomes.

Despite generous child support programs, every year Japan closes around 400 schools to convert them into care centers for the elderly; these social services represented only 6% of Japan’s GDP in 1970, compared to 30% in 2019. Since real wages have fallen since 1991 due to structural problems in the Japanese economy, and residential units have become smaller and more expensive, many young Japanese prefer to secure a good future before embarking on the adventure of raising a family. Individual economic insecurity is related to the fact that 40% of workers in Japan have a non-permanent job, which makes it difficult to build a family in a highly modernized and individualistic society.

Various governments have tried to jump start the economy by fighting deflation. The problem with deflation is that it stifles demand, because it makes consumers expect goods and services to be cheaper in the future, which discourages spending today and makes it harder for businesses to make a profit, which in turn hurts the economy, employment and the growth of real wages. On top of that, the Japanese state has been raising VAT for the last 20 years to reduce fiscal deficits, hurting an already very sensitive aggregate demand on consumer goods.

It was under these circumstances that Shinzo Abe, a conservative-nationalist leader of the powerful Liberal Democratic Party, which has ruled Japan for most of the post-war years, was elected Prime Minister in 2012, for the second time after a short term stint in 2006 -2007 that was interrupted by health problems. Abe launched a highly unorthodox economic strategy, known as “Abenomics,” with the goal of ending deflation and boosting economic growth. Key points of the Abenomics policy included:

  • Printing additional yen currency to make Japanese exports more attractive and setting interest rates low to generate modest inflation and pay off the national debt, which must always be denominated in yen.
  • Increase government spending through infrastructure and social service programs to stimulate aggregate demand and give business tax breaks to boost supply.
  • Structural reforms to make companies more competitive, facilitating the dismissal and hiring of national and foreign workers.

The inflation rate in OECD countries reached 9% in mid-2022, as a result of the war in Ukraine, the prolonged effects of the pandemic that impacted global supply chains, and loose monetary policy that includes massive money printing and low interest rates. However, in the same context, Japan has achieved an inflation of only 2% in this period. Abe’s policies were truly unique in that they went against many generally uncontested macroeconomic principles, which state that a country cannot sustain low inflation, low interest rates, low unemployment, and high government spending for a long period of time.

Japan’s gross debt currently stands at 270% of its GDP, the second highest in the world after Venezuela, but the reason Japan is not at risk of default and inflation remains very low could be because the largest part of its debt is in its national currency (yen), a statement that is disputed by some economists, but strongly defended by the promoters of the so-called Modern Monetary Theory (MMT). In fact, 92% of Japan’s public debt is held by Japanese yen creditors, mainly the Bank of Japan (45%), insurance and public funds (30%) and domestic banks (15%).

MMT economists and advisers to the Japanese government think that a country can stay afloat if it is in control of its fiat currency and has its debt denominated in fiat currency. This is because that country will always be able to print more money to pay off that debt, and that debt won’t create big inflation if it’s just used to pay government spending. There is currently an intense debate in academic circles about this unconventional perspective on debt and money printing, and Japan is the prime real-world example where these premises are being tested.

However, results from Abenomics policy have been mixed. Under Abe (2012-2020), real GDP growth averaged just 0.9% and inflation did not rise above 0%. On the other hand, the Bank of Japan’s quantitative easing (large purchases of financial assets by the central bank to lower an economy’s interest rates) managed to keep Japanese interest rates close to 0% and thus stimulate private borrowing. This policy made the yen cheaper on international markets and, along with reducing corporate taxes by up to 23%, allowed many companies to make more profits, as Japan is an export-oriented economy.

Furthermore, the unemployment rate at the end of Abe’s term fell to just 2.4%, the third lowest in the list of G20 countries after Singapore (2%) and Switzerland (2.2%). To counter the mounting debt, the Abe government increased VAT-type taxes from 8% to 10%, arguing that this rate is much lower than in the European Union and OECD countries, which average more than 20%, and it is still less than China’s 17%.

A final observation about Abe’s economic legacy is that crony capitalism and rigid corporate structures have not abated. The corruption scandals surrounding the staging of the Tokyo Olympics and the revelation that the Abe government overstated building order data for many years to inflate GDP growth figures are examples of this. But perhaps the most structurally challenging situation for Japan could be the decrease in its population, because there is no possibility that the welfare system for the elderly can be sustainable in the long term if there is no renewal of the base of its demographic pyramid, and perhaps this pessimism is the reason why the Japanese economy cannot enter an upward spiral again, despite trying unorthodox recipes like Abenomics.

Japan’s experience provides several lessons for Mexico and should make us think about what kind of structural reforms we should make to avoid falling into a similar dynamic in the country. Mexico has been a country of mediocre economic growth for two decades. In the past six-year term, several structural reforms were attempted that unfortunately did not have continuity. Our demographic bonus is being consumed, we have not been able to provide educational and technological tools to an important part of our population, and we are wasting the great historical opportunity created by the global trend towards “nearshoring”. Despite all its economic openness and its experimentation with political models of all kinds, Mexico continues to be a country that has not been able to banish the capitalism of “compadres”, its public and private monopolies, the great de facto powers infiltrated in government and unions, and that now faces the tremendous ghost of the narco-state. As a society, we must remember that samurai proverb that says: “There is a door through which good or bad fortune can enter, and only you have the key to decide who enters.”

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