Will West repeat Japan's lost decade?:: Standard Chartered Research/ Business Line,

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For the West, the main message is to avoid deflation and boost demand. 

Japan's economic bubble burst 20 years ago. Since then the country suffered weak growth and what became known as “the lost decade”. In recent weeks, a dominant question has been whether the US and European economies are to suffer the same fate? If anything, the immediate challenges in the West now are worse than they were in Japan when its bubble burst. The West faces little growth and low interest rates for the next few years. But then the West can rebound as, unlike Japan, it is more likely to face up to the need for supply-side reforms aimed at boosting productivity. For the West, the main message is to avoid deflation and boost demand.

An ominous lesson for the West is that when bubbles burst economic pain cannot be avoided. Whereas the West had its economic and financial crisis at the same time, Japan's was spread over eight years. Japan's bubble burst at the end of 1989. Yet from 1990 to 1997, employment rose, as firms expected growth to rebound and they were reluctant to lose skilled staff. Then, Japan had its financial crisis in the autumn of 1998 when Yamaichi Securities collapsed, then the biggest corporate failure in history.

Japan was the world's second-largest economy and enjoyed high living standards. That lessened the sense of urgency for Japan to take radical action. Japan's lack of political debate didn't help. Socially it could handle slow growth, as income disparities were not huge, in contrast to the US and some parts of Europe now.

Japan's debt problem was different from the West. Japan ran current-account surpluses and was able to fund its debt easily at home. The US or the periphery of Europe does not have that luxury, and they have had to face up to problems sooner than Japan ever did. Japanese people were large savers when its bubble burst. In contrast, the troubled countries in the West have high personal debt.

Deflation was Japan's biggest problem. Its stock market is still a fraction of its 1989 peak. Land prices peaked in 1991 and took until 2006 to stop falling, and this added to collateral and bad-loan problems for Japan's banks. As consumer prices fell, people delayed spending. Japan's industry “hollowed out”, moving production to lower-cost centres elsewhere, feeding downward pressure on costs and margins at home. The same is happening in the West now. This reinforces the need for growth, to avoid a self-feeding downward spiral and encouraging firms to invest. The deregulation issue is one big difference. Japan could never come to terms fully with the need for supply-side reform and structural change. Parts of the periphery of Europe show similarities now. Although the West cannot avoid weak demand in coming years, there is reason to think the US industry will bounce back.

POLICY URGENCY IS KEY

Japan faced demand- and supply-side problems. It focused largely on the demand side, but not well enough, and ignored for a long time supply-side solutions. In monetary policy, the lessons from Japan are acting aggressively and in a shorter period than the Bank of Japan.

The fiscal lesson from Japan is more complex. Most worrying for the West now is that just ahead of its financial collapse Japan had embarked upon tough fiscal tightening in 1997. From the bursting of the bubble in December 1989 to 1997, Japan had fiscal boosts. All worked. But 1997 marked a turning point. Fiscal policy was tightened. The consumption tax was hiked and public spending squeezed. The economy suffered, and the financial sector imploded. One lesson was that premature fiscal tightening is not good in an economy that needs demand.

The other lesson has been seen over the subsequent twenty years: avoid weak growth, as it has continued to push the Japanese government debt up to worrying levels now. In the West now, there is much talk of inflating debt away. That proved hard in Japan. Its population was ageing and had savings so there was no mandate to inflate. Also for Japan, the yen proved resilient and this reinforced deflationary pressures. A lesson for the West now is that a strong currency policy does not help and that inflating debt away is a hard policy to implement.

The West is set to face a long hard slog. Thus, the lesson for the West from Japan is the need for more quantitative easing, no premature fiscal tightening and further economic deregulation to encourage investment and growth. The main message is to avoid deflation at all costs.

(The author is Chief Economist and Group Head of Global Research at Standard Chartered Bank.)