Chapter 22

Discovering Japan’s Economic Dilemma

1. A Chronic Lack of Domestic Demand

2. The Unbalanced Post-1973 Economy

3. Exports, Oil Shocks and Mini-Bubbles

4. Origins of the Bubble Economy (1989-91)

5. Post-Bubble

My impudent belief that I should tell Japan how to solve its economic problems began with my being asked to join a small committee organized by Hosomi Takashi back in the mid nineties.

Hosomi was an economist-consultant with Nippon Life Insurance, and had a long career in the bureaucracy behind him. We had previously been together on the Finance Ministry committee for trade problems I mentioned earlier.

He had a commission from the Cabinet office to organize a group to discuss economic policies - in particular, how to revive the economy from its post-Bubble collapse. 

For several years we would meet at intervals, with our views reported back to people who mattered, or so we presumed.


For much of that time the economy was suffering from the restrictive fiscal policies of the Hashimoto administration (1997-99) - policies urged on the administration by US supply-side economists, Japanese big business (mainly Keidanren), the media and the commentators.

They all claimed strong concern over the high levels of public debt.

But the cuts in government spending they had urged had thrown the economy into a tailspin. The Hashimoto regime was to lose popularity and bow out, ungracefully.

Richard Koo, myself and one or two others on the committee pushed the line that the weakness of post-Bubble demand meant government still had to rely on spending to fill the demand gap – the Keynesian solution.

Hosomi seemed to agree.

As for the public debt problem, that still was not out of hand. Besides, government spending into a depressed economy can often generate enough tax revenue to balance the spending.

Cutting government spending can easily cut total tax revenues as much if not more than total spending cuts.

Our advice may just possibly have contributed to the mild recovery under the expansionist economic policies of the Obuchi and Mori administrations in the late nineties.

1. A Chronic Lack of Domestic Demand

Even more than the others in the committee I was worried about the weakness of consumer demand.

At the time the Anglo economies (the US, UK, Australia and New Zealand) were all enjoying strong growth rates, around four percent.

The Europeans were muddling along with two-three percent growth rates.

Only Japan seemed to be in serious trouble, and not just because of Bubble collapse.

Continued deflation, continued close to zero growth rates, even with close to zero interest rates, was abnormal.

Something seemed wrong with the economy.

This comparison of growth rates had led many to assume that the economic reforms, including government spending cuts, then being urged by supply-side economic theorists were the key to the strength of the Anglo economies, and therefore the answer to Japan’s problems too.

But there was, I thought, another and very different possibility, namely that weak consumer demand, rather than lack of economic reform, was the key to Japan’s economic growth problems.

This seemed to be shown clearly when comparing household savings rates in the advanced economies, where savings rates could well indicate weak household consumption.

We Anglos had by far the lowest savings levels – one or two percent and even zero or negative at times – and the strongest growth rates.

The Europeans had much higher savings rates - around eight percent or more – and weaker growth rates.

Japan at around 12 percent had by far the highest savings rates, and the weakest growth rates.

In other words, might not high savings rates be bad for an advanced economy?

At the time the conventional wisdom still said that high savings were good for an economy, any economy.

Indeed, the then editor of the London Economist, Bill Emmott, had put out a book warning of future growth problems for Japan since the aging of the population could lead to a fall in Japan’s high savings levels.

But while high savings were important for a developing country, in an advanced economy there was a little-realised Catch 22 dilemma.

High savings were only useful if they were returned to the economy in the form of increased investment.

In a developing economy this is no problem.

People save to buy the basic consumer goods and services they need.

Confident of future demand, investors borrow those savings to produce those goods and services.

The economy operates on a beneficent cycle.

But if high savings were a result of weak consumer demand – consumers preferring to save rather than spend - investors would rightly be reluctant to invest.

No one wants to put money into a project that cannot sell its output due to weak demand.

The economy could well be knocked into a downward spiral – lack of consumption leading to lack of investment leading to further cuts in consumption…

(Supply-siders like the Economist seem to work on the assumption that there are always consumer demands that need to be satisfied, in any economy.

(The idea that in an advanced economy like Japan’s many consumers might be quite happy with what they have and prefer saving rather than spending seems hard for many - us Anglos in particular - to grasp.)

In any case, there seemed to be a clear reverse correlation between savings levels and growth rates in the main advanced economies.

From this it followed that Japan needed policies that focused heavily on encouraging people to spend. Failing that, government had to do the spending.

If there really was a public debt problem (something that could be disputed as I came to realize later), then Japan needed tax policies that increased tax revenues without harming consumption.

This was the gist of the article for Nikkei article I mentioned in the previous chapter.

And while my efforts to persuade Nikkei and some others were not very successful, in the process of making my arguments I began to realize that this problem of high savings and therefore inadequate demand was not just a post-Bubble problem.

In fact it had been around long before the Bubble years – ever since the early seventies to be precise.

The lack of domestic demand was chronic. It was the key reason for Japan’s unbalanced economy, and the problems that had occurred over the years.

2. The Unbalanced Post-1973 Economy

I had long felt that since the early seventies there had been something fundamentally unstable about the Japanese economy.

The boom that had carried Japan into the early seventies was, as in China today, sustained by demand for basic goods and services – housing, white goods, TVs, transport, etc.

High savings by individuals, as in China today, provided the funds needed by the firms making the goods and services. Individuals then used those savings to buy those goods.

In the case of China, and to some extent Japan, foreigners had also been very willing to buy some of those goods.

The Japanese had called it their kodo seicho jidai – the high growth period. Annual growth rates of seven-eight percent were common.

It ended around 1973 – the date of the first oil shock, which is seen as the reason for the ending.


In fact, not just the oil shock was involved.

For what happens to an economy when demand for basic essentials is fulfilled?

Replacement demand is hardly enough to keep the economy turning over. Like it or not, new demands have to be created.

As already mentioned, in the Western economies - the Anglo economies such as the US, the UK, Australia and New Zealand especially - that has been no problem.

Demands for leisure, lifestyle and status-symbol goods/ services did much, or even more, to fill any demand gap.

Indeed, as we now see, they did too much. They led many consumers into serious debt.

But in Japan similar demands were very slow to emerge. Most Japanese were very happy with their very modest middle-class lifestyle.

They did not need expensive cars, yachts, second-houses, swimming pools or luxury tours abroad to keep them happy.

They had little need to spend heavily. They continued to save heavily, despite very low returns on savings. * (see footnote one).

The psychology that led them to think small and safe in their way of living had also led them to think small and safe in their savings attitudes.

They kept much of their savings in cash and deposits, which did little to stimulate demand in the economy even if it did make them feel safe.

If they sent their savings abroad, as the less risk adverse did, there was even less stimulation.

I had always liked the Hicks theory I had learned back in university days when post-Great Depression memories were still fresh in the collective memory.

This said that an economy is like a bicycle, with the two pedals, demand and supply, working in tandem to keep balance.

But if one pedal outpaces the other – in this case, if demand does not match supply - the bicycle can easily topple over.

If your identity is decided mainly by the ‘locational’ work group - the Nakane ‘ba’ factor - you may be willing to spend heavily on the education and other trappings needed to gain entry to that group.

But from then on your identity and prestige depend almost entirely on your willingness to cooperate and fit in with that group.

To do that you do not need expensive cars, houses etc.. On the contrary, ostentatious spending could even harm your status within the work group.

Ostentatious leisure would almost certainly be a negative.

Most of us non-Japanese tended to see identity and status more in terms of the Nakane ‘attribute’ factor.

Among those attributes were conspicuous spending and possessions. They helped tell us, and others, who we were.

We were willing to spend heavily to gain both.

With the exception of the Canadians for some reason, we Anglos were the worst offenders, possibly because of the weaknesses in our cultural identities.

(The example I liked to use were the retired couples living in the hills around Los Angeles.

(We discovered them after each bush/scrub fire in the area.

(Each had an enormous house, often flanked by a pool or tennis court and with several well-furnished and equipped bedrooms. All that, just for the pair of them.

(With each bushfire several hundred of them would be flushed out before the TV cameras, leaving me if not others to wonder how and why the needed to live like that.

(The answer, one presumed, was that it was there to satisfy egos, organize home parties and impress friends.)

In Continental Europe people could rely more on the attributes of class, religious, education, professional rank or family for status and identity - areas where spending demands were more limited.

In north Europe, Germany especially, there was also the Protestant ethic frugality factor at work, pushing savings levels even closer to the Japanese level – yet another Japanese-German similarity.

Meanwhile Japan was conspicuous for its lack of big-ticket conspicuous life-style spending.

True there was no shortage of spending fever at times, manly on fashion goods and mainly by young women who lacked other forms of identity, corporate identity especially.

But none of this small-ticket spending even began to add up to the demand stimulating effects of building expensive country houses, yachts etc.

True also, boom periods would often see yet another rush to develop country besso –weekend house – resorts. But most would soon be left to gather weeds and rubbish until the next boom came along.

And by that time few would be much interested in former failed developments anyway.

(Conspicuous yacht owning in this allegedly maritime nation is close to zero.)

A Bicycle Economy?

But that raised another problem.

For if the lack of demand problem had been around since the early seventies, why in that case did we have to wait till the mid-nineties for the Japanese bicycle to begin to topple?

What was holding it up in the intervening two decades?

The short answer: exports, oil shocks, and mini-bubbles

3. Exports, Oil Shocks and Mini-Bubbles

As domestic demand relative to supply began to fall off in the early seventies, makers began even more to turn to overseas markets, to dispose of surplus production and find sales avenues for new production.

The result, naturally enough, was growing export surpluses, trade frictions and upward pressure on the yen.

The trade frictions issue could be handled in part by hiring lobbyists and by insisting that the rest of the world had to observe the principles of free trade while Japan itself was denying those principles, rightly, to develop its own car, computer and chip industries (though eventually it was to lead the US to threaten special import surcharges on Japanese goods, which is how I had met Hosomi originally, on the 1982 Finance Ministry committee to discuss the surcharge issue.)

But upward pressure on the yen was less avoidable. Intervention in foreign exchange markets to try to keep the yen cheap could only do so much.

With the 1972 Nixon shock forcing the yen to upvalue from 360 to the US dollar to around 240, exporters, and the economy overall, seemed headed for trouble.

Oil Shocks to the Rescue

But help was soon to come from another and very unexpected direction – the 1973 oil shock.

Expensive oil imports cheapened the yen greatly. The cheaper yen allowed export industries to continue to survive and thrive.

True, expensive oil harmed some other industries. It also led to wild inflation.

But since the export rather than import industries were lead industries for the economy, the harm was greatly lessened. (Lead industries are important since they usually stimulate more investment in ancillary industries.)

As well, the oil shocks stimulated new investment in energy saving devices.

The net effect on the overall economy from the oil shock was almost certainly positive.

Even the wild inflation of those days could have had a stimulation effect – some people wanting to spend or invest their money before it lost more value.

More Oil Shock

But this quick economy recovery in turn meant that the trade surpluses would to continue their rise.

And as before, the more you exported the more the yen appreciated. But the more the yen appreciated, the harder it was to export.

As the Japanese used to say, you strangled yourself with your own necktie.

Fortunately another rescuer was to emerge, this time in the shape of the second oil shock of the late seventies, when Iraq attacked Iran.

Once again the yen cheapened. Like desert flowers in bloom after a sudden downburst, the exporters gained yet another new lease of life.

(Later, on the lecture circuit, I used to enjoy telling audiences that the two oil shocks probably did Japan more good than harm.

(Most of my listeners had gone along with the conventional wisdom that said the shocks were bad for the economy.)

Asset Bubbles/Booms Also To the Rescue

But exports could only do so much to solve the demand problem.

In effect foreign demand was substituting for lack of domestic demand, and there were limits to how far this could go.

Another rescuer was needed, and this time it came in the shape of the continuous land and share bubbles/ booms running right through to the grand-daddy of them all – the Bubble of the late eighties.

This time domestic demand was stimulated greatly.

But in the worst possible way.

The Tanaka Boom

The Tanaka Kakuei land boom of 1972-73 started it all. It was triggered by Tanaka’s ambitious plans for heavy spending on highways and bullet trains.

The vision of vast land-works and construction spending, with remote areas being opened to road and rail communication, was more than enough to inflame speculative nostrils.

(The land alongside my Boso kiwi farm – see chapter on the amateur land developer – had been a typical product of the Tanaka boom.

(An unattractive hillside, it had been bulldozed into tiny lots with bad access and then sold off at high prices to a variety of urban middle-class types fearful that the boom would leave them behind, landless.

(Few of them had any liking for rural living.

(In the thirty years since they have let their land return to jungle, or disfigured it with soon-to-be-abandoned shacks.)

(Today we use their land to find logs for burning, bamboo poles for kiwi trellis construction, or bamboo shoots for eating.

(Thank you, Mr Tanaka.)

True, that ‘Tanaka’ land boom was soon to be chopped short by oil shock-induced inflation and high interest rates.

But Japan’s quick recovery from the oil shock seemed to convince the speculators that the economy, and asset prices, would rise forever.

And with only very occasional mild setbacks asset prices did continue to rise, right through until well into the eighties.

At the time people like myself who simply wanted to own the house over their heads felt they were on a price rack whose screws were being continuously tightened.

To get off the rack we had to sacrifice all. But at least we were spared the pain for seeing prices rise even further.

Miracle Economy?

Few, both inside Japan and outside, seemed to realise how this constant asset price boom mentality helped to keep the Japanese economy turning over.

Most seemed to think that Japan had found some magic formula – educational superiority and enterprise management techniques especially - for eternal progress.

The idea of Japan as a miracle economy, as Number One, as a model for us all etc, gradually took root among the pundits and academics.

And it is true, there were aspects of the economy that clearly were superior, as I tried to point out in my writings at the time.

Familial management techniques, for example, were a plus.

But they were the result of feudal era values, not some brilliant, new, modernistic genius on the part of Japan’s enterprise managers (see my review of Robert Ozaki’s book, on website).

Another was Japan’s strength in manufacturing – the result of a feudal tradition of monozukuri (making things) and attention to detail.

But in those days few wanted to believe that Japan’s feudal traditions could be a positive factor.

Most, like Robert Ozaki, wanted to see Japan as paving a brave new route to the society of the future.

Mercantilist Japan?

But others, outraged by Japan’s constant export surpluses and the damage they were doing to other advanced economies, had a different view.

These were the so-called revisionists, people such as Chalmers Johnson or James Fallows, who saw both the economic progress and the surpluses as proof positive of some plot by Japan Inc. seeking to take over the world economy.

(These people were called revisionists since they were supposed to ‘revise’ the concept of Japan as a normal economy and society keen to take its place in the world community.)

References to the 18-19th century European mercantilism – nations deliberately promoting exports to strengthen their global position – abounded.

Japan’s frequently voiced obsession over how its lack of domestic resources meant it had constantly to increase its exports in order to pay for its imports reinforced their angry views.

(Few seemed to notice Japan’s later about-turn in the face of continued export surpluses, trade frictions and yen appreciation wiping out many traditional industries.

( From promoting exports it began to devote large official resources into promoting imports, hardly the mark of a mercantilist nation.)


This confused image –Japan as Number One miracle economy and Japan as Number One marauding economy – managed to dominate much Western commentary on Japan for a very long time.

Few seemed to realize that Japan was Number Neither, that it was simply blundering along trying best to cope with buffeting forces..

4. Origins of the Bubble Economy

As we moved into the eighties, the export surpluses, trade frictions and anti-Japan accusations began to reach crescendo level.

One result was the US threat to impose surcharges on imports from Japan, cars especially, (which led to my being on the 1982 Finance Ministry committee to discuss the question).

Another more serious was the Plaza Accords of 1985 forcing further yen upvaluation (it was briefly to reach 80 yen to the US dollar soon after).

Endaka - The ‘Expensive Yen’ Solution

Many assumed that endaka (the inflated value of the yen) would finally put an end to Japan’s export surpluses.

But it didn’t.

One reason was the J-curve effect.

For example if the yen becomes more expensive against the dollar, this should increase the volume of imports (as they become cheaper in yen terms) and therefore the total dollar value of imports.

This should then work to cut the trade surplus as expressed in dollars.

But in the case of Japan, imports were mainly raw materials needed for processing, so the volume imported tended to remain fairly fixed.

So on the import side, the trade surplus reduction effect was limited.

On the export side, in theory there should also have been a decline in export volume, further reducing the trade surplus expressed in dollars.

But if exporters initially increase the dollar prices of their exports to match the appreciation, which often they can do when their goods are in strong foreign demand (as in the case of Japan), the net result can be an increase in the total dollar value of exports, rather than a decrease

This in turn then leads to an increase rather than decrease in the trade surplus as expressed in dollars, even if the surpluses expressed in yen are falling.

(For a while the curve and its explanation were front page news items in Japan.)

Another reason for continued trade surpluses was the do or die mentality of the exporters. If higher dollar prices of their exports hurt sales, they would cut yen prices and costs to the bone in order to survive.

Even if the yen value of their exports fell there was no fall in the dollar value.


The failure of export surpluses expressed in US dollars to fall despite heavy yen appreciation was soon seen by the ‘revisionists’ as yet another proof of Japanese infamy.

Meanwhile the expensive yen had created another problem – hungry Japanese investors armed with cheap dollars keen to buy up everything from South Seas resorts to California golf courses and Manhattan real estate.

For the ‘revisionists’ this was even more proof of Japan’s infamous efforts to take over the world.

In fact it said more about the lack of attractive investment possibilities in parsimonious Japan.

Forcing Japan to Expand Domestic Demand

Gradually US policy makers began to realize, correctly, that weak domestic demand, not infamy, was the key problem.

Encouraging consumers to buy more on credit, as in the US, was seen as one answer

(However some critics still managed to think that this lack of buying on credit was also a Japanese plot - that Tokyo had cunningly devised policies such as restrictions on credit cards to cut consumer demand so its exports could continue to take over world markets.)

Tokyo was even urged to remove restrictions on opening large stores in Japan – anything to stimulate the consumer demand that was supposed to exist and, as in the US, was just waiting to be unchained.

Few seemed to realize that the amount of demand waiting to be unchained was limited – that in this very important respect Japan was not like the US, or any other advanced economy.

Bubble Origins

Finally Washington realized that the only real answer was to pressure Tokyo to expand domestic demand though loose money policies and low interest rates.

The Keynesian-minded and pro-US Finance Minister, Miyazawa Kiichi, agreed to go along.

At the time I admit I thought that the harm from the extreme yen appreciation we had seen (endaka higai – damage from the expensive yen) would keep the economy down for some time, that loose money policies would do some good.

I was wrong. I failed to realize fully the never-ending bullishness of Japan’s speculators.

I suspect Miyazawa made the same mistake.

For suddenly, almost from out of the blue, we began to see around us the beginnings of an extraordinary increase in land and share prices triggered by that loose money policy.

Combined with the emotional irrationality factor I outlined earlier, it was to create the monster of all booms - what is now known as The Bubble economy of the very late eighties and early nineties (see previous chapter for details).

5. Post-Bubble

As Japan struggled out of Bubble collapse it had sensibly relied heavily on expanded government spending to stimulate the economy.

That after all was the policy that rescued the US economy after the Great Depression of the 1930’s, and laid the basis for Keynesian thinking.

Consumers shocked by Bubble collapse were continuing to squirrel away savings.

Firms too were naturally reluctant to borrow and invest. Many wanted to repay former bank borrowings quickly before they were declared loan delinquents.

Someone had to be spending if the economy was to recover, and that someone had to be government.

Certainly that is what I thought. And I know that many bankers and businessmen thought the same.

I met a lot of them on the lecture circuit at the time.

Some people in high places agreed too. The Keynesian-minded Miyazawa had become prime minister and was happy to see fiscal stimulation.

(I mentioned earlier how his Keynesian views had been influenced by my father’s books, not to mention the prevailing economic wisdom in Japan in the postwar years.)

And the Keynesian policies worked.

By 1996 Japan at four percent had the highest annual growth rate of any OECD country.

The Anti-Keynesians

But there was another group I did not know much about, and soon they would control the economy.

They were the anti-Keynesian, US-influenced supply-siders dogmatically opposed to any increase in government spending, regardless of need or circumstances.

Backed up by Japan’s conservative, elderly Keidanren business chiefs for whom deficit financing to increase government spending was the equivalent of selling the farm to the money-lenders, they were a powerful force.

Superimposed was what I can only describe as a return to the Hooverite thinking that caused the US Great Depression of the 1930’s – the naïve belief that purging the financial system through forced bankruptcies would somehow see Japan emerge purified and whole.

It was an ungodly combination – anti-Keynesian ideologues, peasant-minded conservatives and Hooverites.

Disaster could not be far behind, I felt

And this time I was right, very right.

* footnote one
Later I was to realize that the differences in household savings levels could be explained neatly by my ‘tribal’ theory.
(Next – The Lost Decade) 
Please join the Online Forum for Discussion about this Chapter.