Japan's Financial Problems

Abstract

Japan's Financial Problems THE JAPANESE ECONOMY has faced difficult times in the 1990s, and the overall economic situation has grown worse in 1998. One core aspect has been the emergence of an enormous amount of bad debt, now officially estimated to be roughly 25 percent of GDP. Resolution of this problem has proceeded slowly and, as of the summer of 1998, doubts remain concerning the ability or willingness of the Japanese government to deal adequately with it. This paper considers how the problem emerged, evaluates existing policies, and offers some thoughts on probable outcomes. The Postwar System From the early 1950s through the 1980s, the Japanese economy operated with a financial system quite different from that of the United States, though probably somewhat similar to those of other countries that deliberately pursued industrialization. To grasp what has happened in the 1990s, it is useful to establish how the postwar system was structured. The basic shape of that earlier economic system emerged out of government controls imposed during the Second World War, although a number of changes were made in the late 1940s and early 1950s. I The hand of government was heavy, inspired by the explicit goal of guiding the economy and a strong mistrust of markets. Core elements of this system included conservative fiscal policies, strong control of financial 1. For the basis in government controls, see Noguchi (1995). 347 348 Brookings Papers on Economic Activity, 2:1998 markets, corporate governance emphasizing managerial control, encouragement of company-based unions and so-called lifetime employment (in large firms), encouragement of cartels and other forms of cooperative industrial behavior, enforcement of very strong protectionist barriers on both trade and investment, and the creation of vertical and hierarchical keiretsu (enterprise group) relationships. While they did not emerge from any overarching theoretical concept, in retrospect the various pieces of the structure appear to have been mutually consistent or reinforcing. In the financial sector, the hand of government was particularly heavy for reasons that reflected the desire to guide the economy. Normally, a financial system is composed of a variety of direct and indirect methods of connecting savers to those engaged in real investmentbanking, stock markets, bond markets, and various other forms of corporate financial paper. Because of the variations in risk and expected return, there are reasons for a robust system to comprise a mixture of all of these financing methods. However, financial markets can be a problem for a government that desires to guide industrialization. In bond and stock markets, private institutions make judgments on creditworthiness in deciding to underwrite bond or stock issues, and a myriad individual actors then determine the price of those instruments in the market. The large number of such investors, and their demand for credible assessments from investment banks and rating agencies, make it difficult for a government to manipulat...

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