The Japan Syndrome

By Michael Schuman Sunday, Oct. 30, 2011
    • illustration by Richard Mia for TIME

    If you are in the U.S. or western Europe, amid the economic misery and political paralysis, remember: it could be worse. You could be in Japan.

    Japan has been experiencing the West's current woes for the past 20 years, ever since an asset bubble burst in the early 1990s. There is no end in sight. Yoshihiko Noda of the Democratic Party of Japan is its third Prime Minister since the party came to power just two years ago. China usurped Japan's No. 2 ranking in the world economy last year. Japan sank back into recession after the devastating earthquake and tsunami that slammed into the island nation in March. The situation is so dire that Japan is now a dirty word in economics, a synonym for never ending malaise and decay.

    As the West too suffers through a protracted downturn while its politicians bicker and dawdle, more voices are asking if the U.S. and Europe are facing a Japanese future. Such a fate isn't inevitable. Japan has important lessons for the West on how to avoid economic decline.

    The first is that the past need not rule the future. One of Japan's biggest problems is its refusal to admit its economic system has failed. By the 1990s, Japan's model — government-led, export-dependent and manufacturing-focused — fell out of touch with a changing global economy as other Asian countries started catching up and challenging Japanese dominance in core industries. Yet policymakers in Tokyo still cling to this model today. The West risks similar inflexibility. The Europeans are attached to their welfare-state system even though it is burying them in debt. The U.S. is so devoted to its own version of the free market that Washington cannot build much-needed infrastructure because of a public aversion to state intervention. Recognizing that new realities demand new ideas is a significant step toward dodging Japanese-style stagnation.

    Getting to that point requires the West to take another lesson from Japan: economic problems can be structural, not just cyclical. Tokyo's bureaucrats have hoped that a bit more cash or fiscal spending would finally return Japan to the good old days. The reason this never succeeded is that the government hasn't admitted, let alone addressed, the country's serious structural obstacles to growth. Excessive regulation has stymied entrepreneurship and competition, and policymakers have never done enough to encourage Japanese consumers, perennial savers, to spend. All Japan has ended up with is a dangerous level of national debt, even higher than Greece's.

    The U.S. and Europe could be looking at the same. The Federal Reserve's Operation Twist to stimulate the economy will have limited impact unless the underlying problems are tackled. That means a smarter restructuring of mortgages to repair the housing market and extensive job retraining for the unemployed. The euro zone, meanwhile, must undertake reform to break down remaining national barriers to form a true, Europe-wide common market to spur growth.

    Both the U.S. and Europe also have to realize that globalization is key to their recovery — something that Japan hasn't acknowledged. While the rest of Asia has become more integrated, Japan has remained generally resistant to foreign influence or greater market liberalization due to fears that special interest groups, like farmers, could get hurt. Japan thus suffers from the downside of globalization — a "hollowing out" of industry to low-cost neighbors — without enjoying the benefits — lower prices to boost consumer spending. The U.S., with its antitrade mentality, could tumble into a similar trap. That's why it's good news that the U.S. Congress approved free-trade agreements with South Korea, Colombia and Panama in early October after years of politically motivated indecision.

    Indeed, leadership is crucial. The most important lesson from Japan is the perils of procrastination. As Japan's politicians surrender opportunity after opportunity to change the country's course, its problems have gotten worse while the options for policymakers to solve them narrow. The political gridlock gripping the U.S. and Europe could also delay the tough decisions that must be made, making the cost of reform more painful and restricting the flexibility that governments have to implement it.

    As the recent debt-ceiling fiasco in the U.S. and the continued haggling in the euro zone over the Greek crisis show, the West is, like Japan, kicking the can down the road. Europe has been in denial about the weakness of its banking sector. That was also a major mistake committed by Japan after its 1990s financial crisis; by the time the banks were fixed, the damage was done. What Japan teaches us is the importance of political will. Without it, the West might turn Japanese.