Will Japan's Economy Ever Recover?

Japan’s economy hasn’t really been doing  well over the past two decades. Here’s a graph of Japan’s gross domestic product  (GDP) from the World Bank. As you can see, Japan’s GDP has grown tremendously fast from  the 1960 to the mid 1990s.

It was during this time that Japan had experienced its own  economic miracle. What’s even more surprising about Japan’s economy at that time is that it  was nearly going to catch the United States. In 1995, Japan had a GDP of over $5.

55 trillion,  whereas, the US had $7. 64 trillion. This gap caused many economists and politicians back  in the United States to talk about the rise of Japan.

They thought that Japan was going to  eventually surpass the United States. However, if we go back to the graph, and extend  it over the coming decades – we see this. Japan’s GDP had stagnated, and didn’t really  grow at all.

In the latest year of 2023, Japan’s GDP had shrunk by a mere small sum  of just $4. 21 trillion. While the U.

S. had surged tremendously to over $27. 36  trillion.

In the same way how the U. S. left the Japanese economy,  many countries have caught up.

Here’s a comparison of China’s GDP to Japan’s GDP.  China was lagging behind Japan for nearly all of the half century since 1960. Yet in 2010,  China’s GDP had surpassed Japan.

In 2023, the two countries’ differences are  now incredibly large. Recently, even Germany has surpassed Japan. Just Like China,  Germany had a smaller economy compared to Japan back in the 1990s, as you can see here in the  graph.

Germany’s GDP was just $2. 59 trillion, less than half of what Japan was in 1995. But in  2023, Germany had caught up.

This fall now makes Japan the world’s fourth largest economy  – which is below where it once was. Soon, it is likely that India will overtake Japan,  and erode Japan’s role as a global leader. The fall of Japan was, of course, due to the  so-called “lost decade”.

It occurred because of an economic bubble burst, where asset  prices in real estate and stock markets plummeted. Japan’s economic growth in  the mid to late 20th century was driven by aggressive lending and investments,  leading to this bubble that had bursted. But that’s not what we want to talk about  – what we want to know today is whether Japan can still make a comeback. 

Can Japan’s economy ever come back? Or, rather, will their economy even stay  afloat or will it continue to drop and fall behind compared to the rest of the world?  Well, there are a few key indicators that actually showcase how Japan is slowly,  but surely trying to fix its economy.

One of the biggest problems Japan had faced over  the past few decades was deflation. Deflation happens when the general price level of goods  and services decreases over time. For example, if the price of an apple was 100 yen  last year but falls to 95 yen this year, deflation occurs.

This might sound like  a good deal right? You get to buy cheaper apples. But prolonged deflation can lead to a  vicious cycle where consumers and businesses expect prices to continue falling, so  they delay spending and investment in hopes of lower future prices.

This lack  of demand ultimately hurts businesses, which then cut back on production, wages, and  hiring. As a result, economic growth stagnates. That is one of the big problems Japan has had  since the 1990s.

Here’s a graph of Japan’s inflation rate as published by the World Bank. As  you can clearly see here, Japan had experienced deflation from 1999 to 2005, and again from  2009 to 2012. There were other select years that deflation had occurred as well.

While there  were years of inflation, these were minimal, very minimal. It was very rare for Japan’s inflation  to increase to more than 1 percent. But as we add the data in the past two years, we see this.

In  2022 and 2023, Japan’s inflation had increased to 2. 5 and 3. 3 percent, respectively.

This rate  has never been seen since the early 1990s. This is a good sign because it reflects a  healthier economy where consumer spending is rising, potentially breaking the cycle of  deflation that has hampered growth for so long. A moderate level of inflation encourages consumers  and businesses to spend rather than hoard cash, knowing that prices will likely rise in the  future.

This spending cycle can stimulate business investment, drive job creation, and  ultimately lead to more sustained economic growth. One of the reasons why inflation has risen is  because of the Bank of Japan (BOJ). The BOJ and the Japanese government had been implementing  aggressive monetary and fiscal policies.

The BOJ’s monetary policy includes its yield curve control  and negative interest rate strategy. What this means can best be explained in a graph. Here’s a  graph of Japan’s 10-year government bond yield.

As you can see, it’s been very low, less than  2 percent since the start of the 21st century, but even less since around 2015 to 2022 at  just 0. 1 percent. The goal of the BOJ is to keep this yield at lower rates, at best around 0  percent.

Doing this will make borrowing cheaper for businesses and consumers, encouraging them  to spend and invest more freely. But recently, inflationary pressures and shifts in global  monetary policy have put strain on the BOJ’s yield curve control strategy. As inflation  rose, markets began to anticipate a potential tightening of Japan’s monetary policy, leading  to upward pressure on government bond yields.

The second tool that the BOJ implemented  are interest rates. Here’s a graph of Japan’s interest rates. Again, for most  of the past few decades – It was very low, at 0% and even -0.

1%. By keeping interest  rates low, the BOJ aims to stimulate economic growth by making borrowing cheaper. It is  quite similar to the yield curve control, but the difference is that the  interest rate directly affects the cost of borrowing across all durations,  not just for long-term government bonds.

But as inflation had risen as we just saw from  the previous inflation rate graph, the BOJ had now increased interest rates to ensure that inflation  remains stable and doesn't spiral out of control. Another reason for Japan’s inflation rate to rise  is because of fiscal policies. Fiscal policies can be best explained as government actions around  spending and taxation.

Over the past few years, Japan has pursued aggressive fiscal policies  to stimulate its economy and support recovery from both the pandemic and its prolonged  deflationary period. This can be seen in Japan’s infrastructure programs to  public services and even subsidies. Here’s a graph published by the International  Monetary Fund about government spending.

Here we can see government spending as a share of GDP.  It is an indicator that shows how much a country relies on public expenditure to fuel its economy.  As you can see, it has continuously risen over the past few years.

Comparatively, Japan’s government  spending is one of the highest around Asia. Just compare this to China, South Korea and Hong Kong.  The difference between Japan and the rest of these major economies shows just how involved  the Japanese government is in the country’s economy.

Why this matters to inflation is because  government spending, particularly at high levels, tends to increase demand within an economy.  When the government spends more—whether on infrastructure, subsidies, or direct financial  support to citizens—it injects money into various sectors, creating a ripple effect that  boosts overall demand for goods and services. One of the politicians that has actively pursued  inflation was former Prime Minister Fumio Kushida who served from 2021 to October of 2024.

Kushida  had introduced an agenda called “New Capitalism”, it was to address Japan’s structural  issues, including income inequality, stagnant wage growth, and insufficient  innovation. One of those – wage growth is essential in raising Japan’s overall economy  and inflation. Here’s a graph of Japan’s average annual wages in US dollars according to the  OECD.

Unfortunately, as this clearly shows, Japan’s average wages – just like its economy  hasn’t grown at all. Kishida’s new capitalism had introduced several measures such as  targeted subsidies and tax incentives for companies that increase employee  wages, and boosting Japan’s minimum wage. In 2024, the so-called Shunto Negotiations, which  is a critical event in Japan’s labor landscape, saw the largest wage hikes in decades. 

"Shunto," or spring labor negotiations, is an annual period when Japan’s major companies  and labor unions negotiate wage adjustments. Finally, one of the most interesting data that  came out to show that Japan is really back is its stock market. Japan’s stock market was  historically a powerhouse, especially during the 1980s when the Nikkei 225 reached record  highs.

As you can see here in the graph, Japan’s Nikkei 225 has rapidly increased from the  early 1980s to the late 1980s. Yet, since then, the Nikkei 225 has been stagnant. But as the  graph shows, the Nikkei 225 is recovering big and fast.

In the early months of 2024, Japan’s  Nikkei 225 even broke records that was last seen in 1989. What this means is that Japan is  now once again an attractive place for both domestic and foreign investments, which  is vital for sustained economic growth. This is partly because of the weak yen, which  made Japanese stocks to become attractive to foreign investors, as well as significant  reforms to encourage a more dynamic stock market.

The stock market, however, isn’t  really seen as an “economic engine”. Yet, if a country’s stock market were to rise,  its effects are felt far beyond the trading floors, influencing consumer confidence,  corporate behavior, and national wealth. For instance, if stocks perform well,  consumer confidence tends to rise, creating a “wealth effect” that encourages  spending.

For a country like Japan, which has long struggled with low consumer spending and  a high savings rate, a thriving stock market can promote a sense of financial security among  households, making them more willing to spend. Lastly, before we end the video – one of  the reasons why Japan’s GDP has dropped is simply because of the weak yen. Don’t get me  wrong here, it’s just one of the reasons out there – of course, Japan’s economic structure has  loads of problems like its aging demographics, and rising import costs.

But the yen’s  fall is actually an important piece of the puzzle. When the Yen falls, Japan's GDP,  at least as shown in official statistics, appears lower when converted to other  major currencies like the U. S.

dollar. This effect is largely due to currency  conversion: while Japan's economy might be growing modestly in yen terms, the  depreciation of the yen against stronger currencies like the dollar or euro creates  a perception that Japan's GDP is shrinking. If we go back to the data where it showed Japan’s  GDP in 2023, we see that the country had fallen behind Germany.

But one of the reasons here is  because of the Yen appreciating a lot. In 2020, the exchange rate from USD to Yen was about 1  US dollar to around 105 yen. In 2023, however, it rose to over 140 to 150 yen to a dollar. 

If the yen never depreciated this much, then Japan’s GDP would likely appear much higher when  converted into U. S. dollars, possibly retaining its spot ahead of Germany.

But anyway, do let  us know what you think. Thanks for watching!