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What went wrong: Aggregate demand, structural reform, and the politics of 1990s Japan

Madsen, Robert A.

This paper argues that the cause of Japan's stagnation in the 1990s was not inefficient corporations, a failure to implement adequate reforms, or bad macroeconomic policy. The problem was more fundamental: a structural inadequacy of aggregate demand. By the middle 1980s Japan was approaching economic maturity, and its savings rate should have fallen as consumption replaced private non-residential investment as a source of new demand. Demographic factors, however, prevented this adjustment from taking place. Much of the population was now entering middle age, the stage of life in which people everywhere increase their savings in order to prepare for the exigencies of retirement. The behavior of these older people kept the savings rate elevated long past the point where such elevation was helpful; and the country consequently suffered from a surfeit of capital which, if not absorbed by some sector of the economy, might well have pushed it into a prolonged recession or even a depression. The most obvious way to resolve this imbalance would have been to ship the excess funds abroad through a much larger current account surplus. The government, however, could not weaken the yen in order to produce this effect because Japan's trading partners were complaining that it was already exporting too much and, perhaps paradoxically, because important domestic interest groups were also opposed to a policy of aggressive depreciation. Political considerations likewise prevented the government from enacting structural reforms that might have lowered the savings rate, as is evident in this paper's review of conditions both in the overall economy and in the automobile, retail, banking, and construction industries. By default, then, Japan was forced to rely on a combination of excessive corporate investment and ever larger government budget deficits as a means of employing capital and forestalling recession. This strategy cannot be adjudged a complete failure, for it bolstered demand and enabled the country to achieve GDP growth of some 1% per annum. But it was certainly suboptimal, leaving the economy highly inefficient and causing the national debt to increase dramatically. Japan would therefore have fewer resources with which to remedy its profound structural distortions when it finally attempted to do so in the 2000s and 2010s.

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Academic Units
Center on Japanese Economy and Business
Publisher
Center on Japanese Economy and Business, Graduate School of Business, Columbia University
Series
Center on Japanese Economy and Business Working Papers, 227
Published Here
February 14, 2011
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