Studies on Japan's Prolonged Recession and Policy Countermeasures
Published April, 2016
The Japanese economy entered a long, deflationary recession characterized by low growth, low prices, and low employment rate after the early 1990s when the bubble of the late 1980s finally burst. The Japanese financial authorities failed to take appropriate actions prior to the bursting of the bubble and took a passive approach to monetary easing in response to the economic depression after the bursting of the bubble, which only made the recession much more prolonged. The Japanese government maintained expansionary fiscal policy in an effort to stimulate economy, but this resulted in no more than a short-lived economic recovery. The Japanese government did not aggressively pursue structural reforms to improve productivity and instead focused primarily on fighting deflation by pumping up aggregate demand through conventional economic stimulus measures such as reducing policy rates and increasing government spending. This caused the Japanese government to incur huge national debts, which consequently reduced the available fiscal space for restructuring.
The Abe administration, inaugurated in December 2012, announced an economic stimulus package of bold monetary policy (first arrow) and flexible fiscal policy (second arrow). Acknowledging that pump-priming without structural reforms or increasing aggregate demand without improving the supply side would only have limited, temporary effect, the Japanese government introduced a new growth strategy called the Japan revitalization strategy (third arrow). In light of chronic budget deficits stemming from the long-term economic recession, decreasing tax revenues, and repeated bouts of government spending to stimulate the economy, the Abe administration announced fiscal reform plans on June 30, 2015 for (1) exit from deflation and revival of the Japanese economy, (2) expenditure reform, and (3) revenue reform. However, these reform plans are less likely to achieve the aim of a fiscal surplus by 2020.
There are several lessons and implications that Korea should glean from Japan's long recession and failures of the Japanese government's economic policies. First, the monetary authorities must precisely understand the economy and inflation, take appropriate countermeasures, and guard against the entrenchment of economic agents' expectations of lower inflation. Second, in light of fiscal policy, the Korean government needs to continue its efforts to secure mid- and long-term fiscal soundness in consideration of the nation's aging demographic profile and the increase in social welfare spending instead of increasing discretionary spending for short-term economic stimulus. Third, the Korean government should continuously strive to address the bifurcation of the labor market between non-regular and regular workers, which is the centerpiece of labor market reform, bridge the gap between them, and improve employment flexibility. Fourth, the Korean government needs to refer to key points of the Abe administration's new growth strategy involving the designation of national strategic special zones and the improvement of the manufacturing sector's competitiveness, which are specific action plans to achieve mid- and long-term sustainable growth through structural reforms. Fifth, with respect to foreign trade, the Korean government needs to comprehensively analyze the impact of Japan's signing the TPP agreement on the Korean economy and take on an aggressive action to be one of members of the TPP in order to maximize the national interest. Finally, with the Japanese government making efforts to raise corporate competitiveness through extensive business restructuring within and between industries, the Korean government needs to pursue industrial restructuring more quickly and aggressively.