Is the eurozone turning Japanese?
Such has been Japan’s economic malaise since the early nineties that the term “Japanification” has entered the investment lexicon. It’s used to describe economies that appear to be heading down the same path Japan did. It’s a path that no country wants to follow.
Since its asset price bubble burst in 1990, Japan’s economy has faced decades of stagnation. Its only respite was a brief boom that preceded the global financial crisis
Recently, many observers have compared Europe to Japan. They point to the region’s lack of growth, its flirtation with deflation and negative interest rates as evidence that the Japanification of Europe is inevitable.
But is this fair?
To find out, we explored the root causes and subsequent experiences of Japan in the 1990s. We then compared them to the current situation in the four largest eurozone member states: Germany, France, Spain and Italy.
Here are some of the similarities and differences we see between Japan and Europe.
- The growth drivers.
There are large differences in the composition of growth in Japan following the bursting of the 1991 bubble and Europe following the global financial and EU sovereign debt crises.
Japan suffered a far larger fall in business investment, which in turn had a long-term negative impact on productivity. In Europe, capital investment only fell by about half the amount, and has since recovered.
- Labour markets.
The demographics of both Japan and Europe are poor. And working hours in Europe have been falling.
However, there is scope for improvement in Europe in areas such as the elderly and female participation rates, where they have lagged behind global standards.
Unemployment rates are also higher in Europe than they were in Japan, which suggests there is a source of additional demand if more jobs can be created.
One area that contrasts vastly is migration, or in Japan’s case, the lack of it. Europe has been able to partly replenish its working age population with inward migration, helping to alleviate the burden of an ageing population. This offers further hope for the coming decades.
Both have low inflation. In considering the reasons why, we found that in Japan before and after the Asia crisis, wage growth was affected by unemployment rates. The labour market simply became unresponsive to the swings in GDP growth. Despite the deep recession in Japan, unemployment barely rose. As a result, wages did not fall, and productivity remained low for many years.
In Europe, the inverse relationship between unemployment and wage growth has weakened at a country level, but still holds at an EU level.
In contrast with Japan, EU employment did respond to changes in GDP/demand, increasing the chances of a recovery in wages.
The main exception is Germany which has a notably more rigid market, thanks to government support to keep workers employed during a downturn.
The balance of payments and reliance on the external economy is another similarity. While both have prominent export industries and are exporters of capital, Japan is far more reliant on net exports for growth than Europe. Europe can still generate growth through domestic demand.
- Fiscal policy.
Both have seen large increases in debt, but unlike Japan which has been freely spending over recent decades, Europe has shown that its budgetary rules are far stricter, and that austerity was brought in to reduce government deficits.
- Monetary policy.
This is an area where there are extensive similarities. Arguably, the European Central Bank (ECB) has been more aggressive than the Bank of Japan, but the need for more aggressive policy can be put down to the limitations of the monetary union and the lack of risk sharing.
Overall, the similarities in monetary policy are large and it is clearly an area where policy makers share and copy ideas.
A further key difference was the ECB’s success in depreciating its currency, compared to the sharp appreciation in the Japanese yen following the bursting of its asset price bubble. This was a key contributor to the Japanification experience which the eurozone has escaped.
- Social order.
Lastly, whereas protests are commonly seen across Europe in response to various issues from austerity to migration, such behaviour in Japan is almost unheard of.
Solidarity and social order are at the core of Japanese culture, which helps explain the developments in the labour market following the bursting of its asset price bubble.
The results of which was decades of underemployment, poor productivity, low wage growth and deflation. In Europe, recent history shows that the public will support populist parties to force change when necessary.
This makes poor macroeconomic outcomes less likely to be sustainable as the population would vote for change.
Overall, there are clearly lots of similarities between Europe today and the Japanese experience since the Asia crisis.
Europe undoubtedly faces major challenges ahead, particularly in coping with its demographics and its ageing population.
However, there are significant macroeconomic and political differences that suggest Europe is unlikely to endure the same tribulations as the Japanese economy.
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