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Will there be a ‘Japanification’ of Europe?

November 27, 2019

With many European economies stuck in a low growth, low inflation and low interest rate environment, it is difficult not to start drawing comparisons with Japan’s economic performance over the last few decades – a process some economists have dubbed ‘Japanification’.

 

To make such a claim about Europe may seem surprising: Japan has by far the highest debt to GDP ratio of any country, and has struggled with low inflation and growth for the past 25 years. The economy never really recovered from the asset bubble collapse of the 1990s, and efforts to revitalise the economy have been hampered by a succession of crises. Is this really comparable with Europe?

 

For some economists, it is. Particularly when comparing loosening monetary policy, an aging population, and rising government debt, Europe seems to show some of the symptoms of 1990s Japan. Inga Fechner, an economist at ING, believes that we are ‘already in the middle of a Japanese scenario in the Eurozone’. Indeed, most notably, the Eurozone’s demographic profile seems on track to resemble Japan’s. The Japanese working age population (15-64) has been in decline since the mid-1990s, with the population as a whole declining since 2011. Similarly, Europe’s working age population has fallen since 2009, and Eurostat (the official EU statistical office) predicts that working age as a proportion of total population will fall by 10 percentage points by 2080.

 

Bank of Japan board member Kiyohiko Nishimura has also weighed in on this argument, asserting that the problem of an aging population ‘is not unique, it’s universal. In some sense this is kind of inevitable and we have to face it’. The former deputy governor has argued that Japan’s slide into a low inflation and growth environment was ultimately down to an inability to accept Japan’s demographic future, and similar trends are emerging in other countries as well.

However, there will always be differences between Japan and the Eurozone. To begin with, a significant part of Japan’s ‘lost decade’ of the 1990s stemmed from the country’s own actions. The Bank of Japan waited too long to take decisive action against low growth and inflation, and even drastically raised rates from 2.5% to 6% in 1989 over concerns about asset price increases. This was followed by a delay in rate cuts, which reached zero in 1999, nearly a decade after the initial bubble collapse. While there were external factors, poor policy decisions exacerbated the effects of a depression. The ECB seems to have taken Japan’s lessons on board. Outgoing President Mario Draghi emphasised the lessons learnt from 2008, calling for proactive responses to the current low inflation environment. The ECB’s rate cut to 0% and a restart of its bond buying programme in October shows a commitment to this approach. Although this has been met with some criticism, there is a recognition of the need to stimulate the Eurozone economy before serious contractions occur, and this was not present in 1990s Japan.

 

Another key difference is the global economic backdrop. During the 1990s, Japan was very much an outlier of poor growth, averaging 1.8% GDP growth between 1990-2000 compared to the developed economies’ average of 3.2%, according to the IMF. Strong growth in the rest of the world at least offered high investment returns, and provided a buffer to Japan’s slowing growth, providing opportunities to export capital. The global economic environment the Eurozone finds itself in today is very different. The US/China trade war and Brexit continue to produce uncertainty and weak demand for exports, deterring many businesses from investing in capital projects. As a result, it will likely be much harder for Europe to produce strong export revenue today.

 

To conclude, Europe does share some structural issues with Japan – if Nishimura is right, a growing aging population will continue to be a challenge for future economic growth. The ‘lost decade’ of Japan does however teach a valuable lesson: the next crisis could be just around the corner, which may leave European central banks without enough monetary policy ammunition to get the Eurozone out of the low-growth rut. The Eurozone needs recognise and learn from the mistakes of the 1990s, but also recognise its differences, if ‘Japanification’ is to be avoided.

 

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