Some experts have observed that the current global financial crisis resembles the collapse of Japan’s bubble economy in the early 1990s. Indeed, the U.S. and European governments have responded now much as Japan’s did then (although at a faster pace). Authorities are reforming mortgage-related agencies, consolidating major financial-services companies, and injecting public capital into a few big banks. In Japan, these measures halted the collapse, but they did not lead to general economic recovery for a decade. What can today’s policymakers and global companies learn from Japan’s collapse?
At first glance, there might seem to be a fundamental difference between the world today and Japan in the early 1990s. During the Japanese bubble, commercial banks drove up stock and real estate prices with the capital from their deposits. In the U.S. and the European Union, the securitization market was the source of capital. But the underlying behavior was the same: Financial institutions, looking for fast returns, provided financing without enough restraint. This capital in turn fueled sectors of the real economy, such as durable consumer goods and housing, and caused them to overdevelop, as players in each industry competed for customers.
If the dynamics of the recent global bubble are the same, then the path to recovery may be clear. Before Japan could return to prosperity, its business community had to learn three critical lessons: the dangers of excess supply, the value of customers as scarce resources, and the need to embrace consolidation. Today’s global business community, by heeding those lessons, may be able to recover more rapidly than Japan did.
The Dangers of Excess Supply
From the 1950s through the 1970s, the Japanese economy grew largely through exports. Japanese leaders took advantage of their country’s low labor costs to develop the overseas market. They promoted exports because they understood that, with a population of 120 million and little growth, their own country’s consumer base was limited.
The origins of Japan’s bubble economy began after 1986, when there was a steep rise in the value of the yen. Japanese policymakers regarded this as a drag on Japan’s export-driven economic growth. Thus, they increased deregulation and added more government supports to business, all aimed at stimulating domestic demand. The relaxation of some constraints on financial activity spurred investment; the manufacturing sectors interpreted this activity as real growth in consumer demand and accelerated investment in production capacity. The financial sector took this expansion as an opportunity to rush into real estate lending; they had too much deposit capacity relative to other lending opportunities. After a few years, as the bubble grew, the price of commercial real estate skyrocketed.
As long as real estate prices continued to rise, the Japanese banks did not have to worry about the risk of defaults, because the value of their collateral kept growing. Industrial companies, as well as real estate developers, expanded their businesses by relying on their increased ability to borrow. This business growth in turn drove up the Nikkei stock index. Along with rising stock prices, there was an extraordinary boom in convertible bond financing. Banks’ corporate lending business needed to compete with market financing and went into stiff price competition in lending rates.
Only after the bubble collapsed in 1991 did the underlying problem with this growth strategy become evident: The consumer market in Japan was limited and the perception of high demand was fictitious. But many companies had invested in anticipation of future demand, and now the country had too much supply capacity and too much debt. The financial sector was criticized for over-banking, while nonfinancial sectors were criticized for over-borrowing. Many borrowers ended up with huge debts that exceeded the value of their collateral assets.