June 12, 2006
Michael Hutchison coedits book about the
lessons of Japan's economic downturn
By Jennifer McNulty
The stagnation that plagued the Japanese economy throughout
the 1990s lasted twice as long as it should have, according
to UCSC economist Michael Hutchison, coeditor of a new book
that says Japan was hobbled by weak monetary policy and its
own dysfunctional financial institutions.
Hutchison, a leading authority on international finance and
the Japanese economy, coedited Japan's Great Stagnation:
Financial and Monetary Policy Lessons for Advanced Economies
(Cambridge, MA: MIT Press, 2006) with Frank Westermann. Hutchison
is a professor of economics and interim dean of the Division
of Social Sciences at UC Santa Cruz. Westermann is chair of
international economic policy in the Department of Economics
and Business Administration at the University of Osnabrueck,
The abrupt plunge of the Japanese economy, considered during
the 1980s the "new economic powerhouse" of the global
economy, provides a critical case study for other advanced industrialized
nations, said Hutchison.
"In the 1980s, Tokyo was the center of the world, and
there was no end in sight for growth," said Hutchison.
"The industrial and economic power of Japan was considered
The book presents an in-depth discussion of the causes and
effects of Japan's prolonged downturn by leading experts on
the Japanese economy, including UCSC economics professor Kenneth
Kletzer. The introduction by Hutchison and Westermann sets the
stage for the chapters that follow.
They write that the stunning drop in the Japanese stock market
on the last day of trading in 1989 signaled the beginning of
a downturn that ushered in conditions as close to those of the
Great Depression as any industrialized economy has faced since
the 1930s. "No one saw it coming," said Hutchison.
No specific news triggered the stock market collapse -- assets
plunged more than 50 percent by 1992 -- but the drop, coupled
with declining land prices and increasing unemployment, pushed
the banking system to the brink of collapse. One precipitating
factor was an unusual level of cooperation among government,
banks, and industry in Japan known as the "iron triangle."
"The banking system was failing in every regard, and what
was needed was a total overhaul of the regulatory structure,"
Hutchison said of a period marked by bank failures and the coining
of the term "zombie banks" for institutions that were
allowed to remain open despite shortages of capital. "Japanese
bank regulators didn't have all the information they could have,
and they hid or understated the information they did have, hoping
the problem would go away."
Japanese policy makers reduced interest rates to zero, but
the economy refused to budge: Banks were unable to make loans,
investors lacked confidence, and the exchange rate plummeted.
Faced with weak demand inside Japan, manufacturers turned to
the United States, where a booming economy fueled the American
appetite for Japanese exports, and China, where they sold goods
and built factories.
Not until late 1997 did the Japanese government begin to make
fundamental changes, stripping the Ministry of Finance of responsibility
and establishing a separate regulatory agency, the Financial
Services Agency. "They should have done that five years
earlier," said Hutchison.
By contrast, the U.S. banking industry is heavily regulated
and monitored. "Our own savings and loan crisis in the
1980s was resolved quickly because we took aggressive action,
closed down bad banks, and paid off their loans," said
Hutchison. Sweden's banking crisis in 1989 was resolved within
18 months by selling assets, mergers, and nationalizing some
"What happened in Japan underscores how critical the financial
system is to the workings of an advanced industrialized economy,"
said Hutchison. "The recession lasted twice as long as
it would have because of the broken-down banking system."
"What had worked so well in Japan -- decision making by
consensus -- became a problem because they couldn't reach consensus
regarding how to handle the banking crisis," said Hutchison.
"It had worked for years as a postwar development strategy
that made Japan one of the richest countries in the world. But
that policy impasse led to continued economic malaise and what
we call the Great Stagnation."
Although monetary policy was sound -- reducing interest rates
was the right thing to do, noted Hutchison -- the credibility
of the policies was undermined by statements of officials, who
failed to inspire confidence in the effectiveness of their own
actions, said Hutchison. "They were very uncomfortable
having rates so low, and they talked about it as a temporary
measure," he said. "They should've acted decisively
and with confidence to keep interest rates low."
The Japanese economy didn't emerge from the Great Stagnation
until late 2005, noted Hutchison. "In modern societies,
the banking system is critical to the smooth functioning of
the economy," he said. "We take that for granted because
it usually works so smoothly. But when it doesn't, the economic
costs can be enormous."