Thursday, August 21, 2008

Japan's Slowdown Holds Lessons For Asia

Source : The Business Times, August 21, 2008

IT may be going too far to describe the economic recovery that Japan enjoyed from 2002 until earlier this year as a 'fraud', and yet the speed with which it is falling apart now that other major economies are slowing down certainly suggests that the recovery was more illusion than reality. Meanwhile, the jury is still out on how genuine have been the economic 'success stories' seen in other parts of Asia in recent times.

To argue this is not to deny that Asian economies have made spectacular progress in their development, or that they appear to have compressed into decades what it took centuries to achieve in Europe and America. But there is a real issue as to whether these economies have been piggy-backing too much on demand from the so-called advanced economies - demand that was based upon profligate expansion of credit rather than genuine growth.

Japan is itself an advanced economy in the sense that it is the world's second largest, and its transition to modernity dates back to the start of the Meiji era in 1868. But its export-led development, which persists even to this day and which has provided a model for much of the rest of Asia, classifies Japan more comfortably among its emerging market neighbours than among the economies of Europe and North America.

This is of critical interest to the rest of Asia precisely because of the leadership role that Japan has played in development. Where goes Japan, so goes the rest of the region (East Asia at least) - and there are disquieting signs that Japan is going virtually nowhere. It is like an electric light bulb that glows brightly when infused with the power of external demand but dims to the point of being extinguished once that demand is removed.

Japan's most recent economic recovery - which lasted from 2002 until earlier this year and was the longest in Japan's post-war history - amply illustrates this point. The recovery was attributed to many things, not least being the economic 'reforms' ushered in during the era of superstar former prime minister Junichiro Koizumi.

Corporate restructuring and banking reform under Mr Koizumi were said to be behind the 'success story'. Yet, behind all the talk of a 'new Japan', and despite the way in which Mr Koizumi managed to convince the public that postal system privatisation was the answer to all of Japan's post bubble-economy economic woes, lay a hidden reality.

This was that it was in fact China that came to Japan's rescue. From the early 2000s, China's economy boomed in the same way (some might say an equally suspect way) that Japan's had in the 1960s and 1970s and pulled Japan along with it. The China boom was in turn driven by credit-gorged US demand.

Just about all the products upon which Japan had built its post-war export success in North America and Europe - from steel and cement to shipbuilding to heavy machinery - were in heavy demand from a fast-industrialising China. For Japan's traditional industries that were groaning under a heavy burden of excess capacity and excess debt, this was a godsend. US demand, meanwhile, provided the backdrop for a boom in Japanese motor and electronics industries.

Mr Koizumi enabled Japanese industry to shake off its third burden - excess labour - by making corporate restructuring socially acceptable. Meanwhile, the greatly enhanced cash flows generated by this surge in industrial activity, based upon demand from China and the US (and to a lesser extent Europe), enabled corporate Japan to repay its debts. The country's banking crisis then duly disappeared.

All very impressive - albeit highly vulnerable to changes in external demand. Which brings us to the present day. The US financial bubble has finally burst and this time, unlike in previous decades, it cannot be re-floated with a massive injection of financial liquidity, because the system that intermediates credit is bust.

Europe has slowed in sympathy while Japan is on the brink of economic recession. If Japan has not been able to build domestic demand that can survive a US slowdown after a century and a half of economic development, what hope is there that China and others in Asia have had more success?

My personal prediction is that, in the global recession that will spread in ever-wider ripples from the vortex of imploding US demand, Asia will have to rethink its economic model and also the idea that it is possible to concertina development into a few decades and to sustain growth rates that have been the envy of the rest of the world.

Domestic demand has a lot of catching up to do with the output capacity that Japan and its Asian neighbours have built up in pursuit of a now-shattered American Dream of unending growth.

No comments: