The Japanese Bubble Economy

Business cycles and bubbles differ from one another, but the technical similarities between the Japanese and U.S. bubbles are striking. The Japanese bubble began in the early 1970s, the U.S. bubble started in the early 1980s. Both stock markets grew rapidly for thirteen years and then went parabolic to form bubbles, which peaked in Japan at the end of 1989, and in the U.S. during early 2000. Both stock markets lost about a third of their value eighteen months after their peaks. The Nikkei Stock Index has since lost as much as three quarters of its peak value, while the Dow Jones Industrial Average has been down forty percent and the NASDAQ Index seventy five percent of its peak value. The real estate bubble continued in Japan for some time after the stock market began its meltdown and, likewise, real estate – particularly housing – has remained in a bubble since the initial breakdown of the U.S. stock market in 2000.

The surprising thing is that in the U.S. the lessons of the Japanese bubble seem to have gone almost unnoticed.  Japan has experienced fourteen years of economic stagnation since its bubble popped. The U.S. is now in the fourth year of economic malaise. Most troubling, the U.S. not only failed to heed the warnings of the Japanese bubble, they have thus far mimicked Japan’s failed attempts to stimulate its economy with extremely low interest rates and large government budget deficits. Both countries have opted for a slow, agonizing “recovery,” rather than a sharp correction of past errors that would quickly reallocate resources. Experts tell us that the Japanese and their economy are very different from the U.S., and that their bubble and policy response to its crash were likewise different, but while there certainly are many important differences between the U.S. and Japan, the technical features and new-age thinking are strikingly similar in both bubbles.

For example, there is no doubt that technology and new-era thinking played a major role in the Japanese bubble. During the bubble, Japan took over leadership of high technology in the areas of consumer electronics, the automobile industry, manufacturing, and even robotics, and was perceived as a major threat to dominate all technological development around the globe – just as the U.S. is today. The threat posed by Japan’s growing technological prowess can be seen in the titles of books published during the bubble era: Japan’s High Technology Industries (1986), The Technopolis strategy: Japan, high technology, and the control of the twenty-first century (1986), A High Technology Gap?: Europe, America, and Japan (1987), The Science and Technology Resources of Japan: a Comparison with the United States (1988), United States-Japan Economic Dilemma: a Look Into Automobile Industry (1989), Created in Japan: From Imitators to World-Class Innovators (1990), Japan as a Scientific and Technological Superpower (1990), Japanese Technology Policy: What's the Secret? (1991), Japan’s Growing Technological Capability: Implications for the U.S. Economy (1992).

Writing near the pinnacle of the bubble in the stock market, Kodama explained that the Japanese takeover of technological progress was a result of a new Japanese paradigm that was ushering in a new era:

He found that in Japan the innovation of high technology “seems to be different from that for conventional technologies” and therefore that studies focused on Europe and the U.S. would not lead to a “new scientific framework for analyzing innovation of high technologies.” He suggested that we break away from the inadequate linear model of the past to the more unlimited model experienced under the unique “social and cultural context” of Japan. [2] He even ended his book with the suggestion that it was the Japanese cassette tape recorder, VCR, and fax machine that made the Iranian revolution, Philippine revolution and the Tiananmen uprising possible. [3] This is classic new-era-bubble thinking.

Another component of modern new-era thinking is the belief that the so-called scientific management of the economy creates perpetual prosperity. Here the Japanese experience epitomizes this phenomenon because the Japanese economy was said to represent a new “third way” positioned between the free-market economy and that of the centrally planned economy. In Japan, government and corporations are said to act cooperatively to achieve both their self-interest and the general interest of the nation. Bureaucracies help plan and coordinate the economy. They provide incentives, such as financing and tax breaks, in order to channel investment in profitable directions. Corporations, in turn, participate in joint research programs with their competitors, but share the results among participating firms, with each choosing what technological advances to employ in their firms. Production planning is facilitated by an overlap of ownership between final good producers and their input suppliers. Japanese management, especially during the bubble, was said to spur innovation, enhance product quality and reliability, and to create large market shares in export markets for Japanese industries. Alas, none of this could prevent a meltdown of the Japanese stock market and well more than a decade of stagnation in the Japanese economy.

New-era thinking about the scientific management of the economy was never more prominent and bold than during the Japanese bubble of the 1980s. It was often said that the Japanese system would lead to economic dominance and threaten the preeminence of the U.S. economy. Laura D’Andrea Tyson, who would later become Chairman of President Clinton’s Council of Economic Advisors, outlined (at the apex of the bubble) the “threat” of Japan’s technological superiority:

In Japan, the government channeled research and development efforts, directed financing, and protected markets for business. This new third way of government management of the economy was thought to be Japan’s source of economic strength and would inevitably place it in a position of economic preeminence. As Tyson confidently asserted:

Tyson and her coauthors questioned the validity of traditional economic thought, as all new-era thinkers must. They justified Japan’s “often flagrant and self-aware violations of the nostrums of traditional economic thinking” because when “technological change is a key determinant of market outcomes, standard economic models that treat such change as exogenous are a poor guide to understanding the dynamics of market competition and the effects of policy on such competition.” They argued that the “nostrum” of economic efficiency should be abandoned in favor of the less constraining and poorly defined notions of growth efficiency and technological efficiency. [6]

Leaving the anchor of economic efficiency and traditional economic thinking behind, Tyson was able to justify a variety of non-economic policies such as “beggar thy neighbor” protectionism. She heralded the concept of growth efficiency, which is essentially a Keynesian idea that rests on the assumption “that there are always unutilized resources that can be mobilized to meet growing demand…It is exactly this kind of thinking that led the Japanese to target industries whose products were perceived to have high income elasticities as a foundation for rapid economic growth.” [7] Ignoring the economic condition of scarcity and grasping the concept of an economy of perpetual unutilized resources is a precondition for new-era thinking, as well as a quintessential mistake of freshman college students taking their first course in economics. If resources are perpetually available then an unlimited amount of all goods and services can be produced and there are no economic problems to solve. This would seem the most basic of economic errors and a particularly grievous one to make in analyzing resource-poor and land-poor Japan.

Naturally she must also offer a rationale for why markets do not work, and she concluded that entrepreneurs will pass up more profitable long-run investments in order to pursue short-run profits under certain conditions. She even admitted that her argument was simply a variation of the long-discredited infant-industry argument for protectionism:

From this perspective, modern-day entrepreneurs might invest in the production of jute, mechanical typewriters, and black and white television sets without the prodding and oversight of government bureaucrats.

In their justification of Japan’s new-era thinking, Tyson et al. view technology from the historical rather than economic perspective. In an age of information and communication technology, their “path-dependent” and “sticky” processes of technological development seem odd and not entirely appropriate for new-age thinkers who often view technology as “spontaneous,” perfectly flexible, and ever-present. Nevertheless, they clearly are new-era philosophers of the Japanese bubble and its new technological paradigm:

In retrospect, the new-era thinkers of the Japanese bubble economy seem conceited and hopelessly naïve, but that is the power of bubbles to deceive. One of the few observers to correctly identify and characterize the bubble was Christopher Wood, who wrote that Japan “became so arrogant in the late 1980s because it really believed it was immune from the natural laws of the marketplace. This really was one of the most astonishing acts of mass delusion ever, and future historians…will marvel at it.” [10] The Japanese people might be particularly susceptible to the delusions of a stock market bubble because their culture has so long emphasized honesty and respect for authority, and the government has carefully maintained the isolation of its people, all of which could contribute to herd-like behavior and makes them ripe for what Charles Mackay famously called the “madness of crowds.” The Japanese also have characteristics in their social psychology as well as their well-known emphasis on precision and details, which might make them more impervious to new-era delusions. The truth is that all these psychological characteristics are unimportant in terms of the cause of bubbles.

In the wake of the bubble and bust, Japan experienced a long series of corruption scandals, a procession of failed prime ministers, the ousting of financial ministers, the conviction of bureaucrats for corruption, and the breakup of their one-party system. However, the Japanese have failed to truly recognize the cause of their bubble and to liquidate their economic mistakes. Instead they embarked on a post-bubble course of easy credit, public works, and deficit spending that has only served to condemn the Japanese economy to continuing economic doldrums.