From a post-war economic miracle to a global leader in technology, Japan has consistently defied expectations. From the bullet train to the pocket calculator, the nation’s innovations have consistently shaped consumer culture and advanced industries worldwide.
As we sit here today, Japan emerges from its economic challenges, reaching new market highs, but the question remains: Can Japan reclaim its position as the global innovation powerhouse it once was?
Japan underwent rapid expansion post-Second World War, driven by a focus on industrialisation through factory modernisation and market reforms. This period saw Japan emerge as the world's second largest economy in 1968, propelled by robust domestic demand, increased corporate investment, and a shift from primary activities like agriculture, manufacturing, and mining to processing, telecommunications and computing.
Stringent post-war tariff policies encouraged domestic savings, facilitating access to credit. This, coupled with a substantial trade surplus, led to Yen appreciation, further boosting the economy. During this time, Japanese companies allocated capital in overseas markets, reducing domestic prices and expanding the trade surplus. This, in turn, intensified Yen appreciation and fuelled speculation in the 1980s, as Japan outpaced economic rivals like the United States.
Simon Kuznets, the Nobel laureate famous for his work on standardising the measurement of gross national product, used to group economies into four categories: 'undeveloped, developed, Argentina and Japan'. He cited these two countries because their economies made them impossible to categorise neatly as either developed or undeveloped, with Japan’s unique classification stemming from its status as the first non-Western country to successfully accomplish industrialisation.
However, in the late 80s the Bank of Japan's decision to tighten monetary policy by raising interest rates to curb speculation in equity markets triggered the bursting of the equity bubble in 1989, resulting in a significant decline in equity prices.
The lost decade
In the early 1990s, the Bank of Japan continued to implement a series of interest rate hikes to curb rising real estate prices. However, this prolonged period of restrictive monetary policy inadvertently set the stage for a liquidity trap (when very low interest rates fail to stimulate demand) and a subsequent credit crunch. As a result, real estate values plummeted, beginning in the early 1990s and extending into the mid-2000s. Japan became an outlier again, as the only advanced economy in the world where inflation, interest rates and wage growth all remained zero.
As Japan is behind the curve compared to other developed economies on policy rate hikes, the Yen has been strengthening against the Dollar.
The sleeping giant
Since 1993, Japan had essentially experienced zero economic growth. There have been brief periods of expansion such as in the mid-2000s, but the Global Financial Crisis of 2008-09 plunged Japan back into economic uncertainty. There was much hope that the election of Shinzo Abe as Prime Minister in 2012 would herald a new era of prosperity. His “Abenomics” strategy, a three-pronged approach of monetary easing, fiscal stimulus, and structural reforms aimed to revitalise the stagnant economy. Similarly to prior Japanese economic policy, it yielded success at points, whilst stalling at others. While ‘Abenomics’ offered a temporary reprieve, Japan’s long-term economic health remained tied to addressing deep-rooted structural issues, whilst fostering sustainable economic growth.
The Sakura Blooms again
Numerous attempts to revitalise the economy through quantitative easing, negative interest rates and yield curve control, all had limited impact. However, recent developments suggest a potential turning point. In March 2024, Japan ended six years of negative interest rates, shifting its monetary policy stance to normalisation with the gradual raising of interest rates, and simultaneously easing its monthly bond-buying program. These moves, coupled with the appointment of a new prime minister, have sparked optimism and helped Japan’s Nikkei 225 Index hit all-time highs.
As Japan is behind the curve compared to other developed economies on policy rate hikes, the Yen has been strengthening against the Dollar. This divergence in monetary policy has led to bouts of financial market volatility when the Yen has rallied sharply. In this environment, investors who had borrowed in Yen (where the cost of borrowing is still very low) to fund purchases of international equities have been forced buyers of Yen and sellers of equities. Whilst being optimistic on equity markets in the round, as we look ahead into 2025 it is nonetheless reasonable to expect further Yen strength to cause periodic market volatility.
Japan’s interest rate rises have been driven by the exogenous shocks of the Covid pandemic and the Ukraine war, providing a catalyst for economic growth. Imported inflation, driven by rising commodity and energy prices have seeped into wages, marking the first significant wage growth in over two years. This newfound spending power among consumers is now driving domestic demand.
Japan can aspire to reclaim its position as a global economic powerhouse.
Beyond monetary policy, Japan is undergoing significant structural changes. The Tokyo Stock Exchange has implemented reforms to corporate governance structures, encouraging greater alignment of interests between shareholders and management. Elsewhere, corporates are reducing cross-shareholding (where publicly traded companies own shares in other publicly traded firms), a positive step towards efficient capital allocation in the minds of investors. Moreover, increased government spending on defence and technology, along with a more favourable investment climate is attracting foreign direct investment, further stimulating domestic demand.
As the land of the rising sun navigates the complexities of a rapidly changing global landscape, the future rests on its ability to achieve sustainable economic growth. By addressing structural and demographic issues, whilst fostering a more dynamic business environment, and embracing technological advancements, Japan can aspire to reclaim its position as a global economic powerhouse. Only time will tell whether the sleeping giant will awaken and once again shape the course of global economic history.
