How Not To Get Lost In Translation

It's not overtaking Japan's GDP that's instructive for India. We should learn from the Asian powerhouse's bitter and long experience of trying to cover up underlying economic weaknesses

- SATYAJIT DAS

Global policymakers looking to resuscitate economic activity and combat falling asset prices would do well to critically examine Japan's trajectory, which illustrates the problems of traditional approaches—especially their risks.

Japanese post-war success was based on low costs, manufacturing competence and an undervalued currency. When the 1985 Plaza Accord forced a revaluation of the yen and adversely affected exports and growth, the authorities cut interest rates, fuelling a debt-funded real estate and stock price boom. The bubble economy collapsed in 1990 and triggered a balance-sheet recession, as heavily indebted households and businesses cut back on consumption and investment to reduce debt.

Over two decades, Japanese policymakers repeatedly lowered interest rates, injected liquidity and unleashed waves of government spending to resuscitate the economy. The policies alleviated the slowdown, but did not restore the growth levels or create the inflation needed to boost nominal asset prices and reduce real debt levels.

Japan's potential growth rates fell, reflecting misallocation of capital that reduced returns on investment. Excessive manufacturing capacity and low domestic demand increased reliance on exports and balance of payments surpluses to align production and demand. Government-financed infrastructure investment only provided a short-term boost in economic activity.

Low interest rates and abundant liquidity allowed excessively high debt levels. Weak businesses survived in a zombie-like state, operating only to pay loan interest. Banks avoided writing off loan assets, tying up capital and reducing credit availability for productive enterprises, especially small and medium enterprises. Low returns reduced income for savers, decreasing consumption and encouraging additional savings for retirement.