Demystifying Japan's Economic Recovery: A Tale of Its Structural Reform

By Kurihara, Jun | Business Economics, July 2007 | Go to article overview

Demystifying Japan's Economic Recovery: A Tale of Its Structural Reform


Kurihara, Jun, Business Economics


After having undergone protracted economic doldrums, Japan has begun to attract the world's attention. Prime Minister Shintaro Abe, taking office in September 2006, pledged to continue his predecessors reforms while looking to closer economic ties with Japan's neighboring countries. This paper examines the challenges the Abe administration must address, the reforms the administration still needs to tackle, and the problems that lie ahead. It starts with an evaluation of Japans economic condition from a long-term perspective, especially the drastic change in its labor market and its rapidly aging society. It then discusses the unfinished reforms the government is facing--restored fiscal balances, a less-regulated economy both at home and abroad, and a new innovation-driven growth path. In sharp contrast to his single-minded and charismatic predecessor, Prime Minister Abe has taken a less spectacular and more nuanced stance toward reforms. A more market-principled Japan will create increased competitive conditions for economic players in both the private and public sectors. Japan's economy will face a precarious state--swinging between an economy armed with market-based principles (but suffering from a "growth pain") and an "ugly Japan" that divides the haves and the have-nots.

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Since 2003, Japan's economy has demonstrated its long-awaited robust growth, though still being overshadowed by the spectacular growth of its neighboring economy, China. After turbulent gyrations in macroeconomic policy in the late 1990s, the Japanese government has restored its confidence both in macroeconomic and structural policies, especially under the charismatic leadership of former Primer Minister Junichiro Koizumi between April 2001 and September 2006. Coupling a stringent fiscal policy with a flexible monetary policy, the Koizumi administration and the Bank of Japan led by Governor Toshihiko Fukui have successfully set a new course for a revitalized Japan.

The recent economic recovery has been achieved by an undauntedly aggressive expansion of non-residential investment backed by rising profits and a continued increase in exports supported by a favorable world economic environment. Despite persistent uncertainty, especially with respect to higher oil prices, fluctuating exchange rates, and domestic deflationary pressure, Japan's economy appears to have achieved sustainable growth. Therefore, the current Prime Minister, Shintaro Abe, seems to be in an enviable position to define his new economic policy. The Japanese government indeed can enjoy some breathing space for its macroeconomic policy. However, for the structural features of the economy, there is still a long way to go. (1)

Adam Posen aptly describes the post-bubble doldrums by stating, "Japan's Great Recession of the 1990s was the result of fiscal, financial, and monetary policy mistakes cutting off the economy's natural recovery." (2) Ironically, this disastrous situation did force a vast majority of the Japanese people to reexamine the old structural issues, many of which had remained untouched and even unnoticed during the 1970s and 1980s when Japan enjoyed its buoyant growth. Toward the end of the 1980s, Japan's bubble created a tight labor market leading to a higher rate of female labor force participation and a growing number of two-income families, which resulted in a relative decline of households supported by the husband's income alone, as shown in Figure 1. The 1992 collapse of the bubble that resulted in recession (often called the Heisei Recession) combined with a weaker labor market to change these trends. The two-income families continued to increase, but at a much slower pace, with a growing number of part-lime female workers whose incomes were extremely disadvantaged compared with those of their full-time counterparts. Accordingly, the Heisei Recession trapped an overwhelming majority of the population in a cul-de-sac and let them cogitate on the economic malaise in the mid-1990s. …

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