Japan had a vibrant economy. Then it fell into a slump for 30 years. : Planet Money Last month, Japan's central bank raised interest rates for the first time in 17 years. That is a really big deal, because it means that one of the spookiest stories in modern economics might finally have an ending.

Back in the 1980s, Japan performed something of an economic miracle. It transformed itself into the number two economy in the world. From Walkmans to Toyotas, the U.S. was awash in Japanese imports. And Japanese companies went on a spending spree. Sony bought up Columbia Pictures. Mitsubishi became the new majority owners of Rockefeller Center.

But in the early 1990s, it all came to a sudden halt. Japan went from being one of the fastest growing countries in the world to one of the slowest. And this economic stagnation went on and on and on. For decades.

On this episode, the unnerving story of Japan's Lost Decades: How did one of the most advanced economies in the world just fall down one day — and not be able to get up? Japan's predicament changed our understanding of what can go wrong in a modern economy. And gave us some new tools to try and deal with it.

This episode was hosted by Jeff Guo. It was produced by Emma Peaslee and engineered by Cena Loffredo. It was edited by Molly Messick. Alex Goldmark is Planet Money's executive producer.

Help support Planet Money and get bonus episodes by subscribing to Planet Money+
in Apple Podcasts or at plus.npr.org/planetmoney.

Japan had a vibrant economy. Then it fell into a slump for 30 years.

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There was a time back in the 1980s when the future looked like it belonged to Japan. Japanese imports were everywhere. Japanese steel, Japanese cars.


UNIDENTIFIED ACTOR #1: (As character) How can Corolla give you so much for so little?

UNIDENTIFIED ACTOR #2: (As character) It's just a Toyota tradition.

UNIDENTIFIED ACTOR #3: (As character) We believe. We believe. We believe.

GUO: Japanese electronics.


UNIDENTIFIED PERSON #1: Put on a Walkman and see the world in a whole new light.

UNIDENTIFIED SINGERS: (Singing) Sony Walkman.

GUO: Japan had performed an economic miracle. It had transformed itself into the No. 2 economy in the world, second only to the U.S. And it's hard to imagine now, but back then, people in the U.S. were genuinely anxious. There were, like, these big Hollywood movies that had Japan taking over the global economy, like this one from 1989 called "Black Rain."


KEN TAKAKURA: (As Matsumoto Masahiro) We make the machines. We build the future. Now music and movies are all America is good for.

GUO: There's also a lot of Japan-bashing. Like, literally, people would get together and smash Japanese cars.


UNIDENTIFIED PERSON #2: We've got Tim Donovan here taking his frustrations out on this '78 Toyota.

GUO: Japan seemed unstoppable. All that money that Japanese companies were making - they were using it to go on this international shopping spree. Sony bought up Columbia Pictures, the studio that made "Ghostbusters" and "Karate Kid." In 1989, Mitsubishi became the new majority owner of Rockefeller Center.


UNIDENTIFIED PERSON #3: Japan is now the world's strongest exporter and leading creditor.

GUO: But just a couple years later, it all came crashing down. Japan's economy hit a slump - and not just any slump. Japan went from one of the fastest-growing countries in the world to one of the slowest. If you lived in Japan, the future suddenly looked bleak. And this problem of slow growth - it went on and on and on and on for 30 years. Some people call this the lost decades. And now those lost decades - they might finally be coming to a close.


GUO: Hello, and welcome to PLANET MONEY. I'm Jeff Guo. Last month, Japan's central bank raised interest rates for the first time in 17 years. And that is a really big deal. It means that the economy is picking up and that one of the spookiest stories in modern economics might finally have an ending. Today on the show, how can one of the most advanced economies in the world just fall down one day and not be able to get up? Japan's predicament changed our understanding of what can go wrong in a modern economy, and gave us some new tools to try and deal with it.


GUO: When you talk to economists about Japan, they sometimes get this haunted look in their eyes because here was this vibrant, modern economy that one day just stopped dead in its tracks, basically stopped growing. And what's spooky about it is that it all kind of started innocuously. What triggered Japan's lost decades was a pretty normal recession, the economic equivalent of a common cold. And to tell us that story, we went to Takeo Hoshi. He's a professor of economics at the University of Tokyo. He literally wrote the textbook on the Japanese economy.

TAKEO HOSHI: Yes, it's literally called "The Japanese Economy," second edition from MIT Press.

GUO: Takeo was in grad school in the 1980s, during that moment when Japan still seemed unstoppable. But he says, even as Japanese manufacturing was the envy of the world, parts of the economy seemed to be growing too fast.

HOSHI: We sensed something strange or something spectacular going on in the Japanese economy. And looking back, that was the start of the bubble.

GUO: That bubble in the late '80s was centered on stocks and real estate. Housing prices doubled in the span of two years. Commercial land prices quadrupled. Someone calculated that just the land underneath the emperor's imperial palace - that's, like, a couple hundred acres in the middle of Tokyo - that was worth as much as all the land in California.

HOSHI: We know from the history that bubbles cannot last forever. The crash is inevitable.

GUO: In the early '90s, that bubble finally popped. The stock market crashed. Real estate prices plummeted back to earth. People lost a lot of money, and they stopped spending. And that sent Japan's economy into a recession. There wasn't anything exceptional about this recession. Recessions often happen after a bubble pops. And Japan responded in a totally textbook way.

Was there just a sense of, like, as economists, we know what to do? We know the solution to this?

HOSHI: Yes, the solution was an aggressive macroeconomic policy.

GUO: Aggressive macroeconomic policy would stimulate demand. You see, Japan's problem was that people and companies weren't spending money. They were saving instead of, like, buying a new refrigerator or building a new factory. And Japan needed that to change. And it had two ways that it could boost spending. The government could spend more money itself, you know, by funding public works, building more bridges, be the demand you want to see in the world. But the big one is that the central bank could lower interest rates. It could make it cheaper for people to borrow money. And this is to encourage people and companies to start spending again. Takeo says Japan did both of those things and, in his opinion, pretty aggressively. After a few years, it started to seem like this very normal recession was coming to an end. But pretty soon, another problem comes along - a banking crisis. This starts in 1997.

HOSHI: One big bank called Hokkaido Takushoku - they failed suddenly. It was the first time a major bank in Japan failed. So that was a big shock.

GUO: And the problem, weirdly, was that Japan's banks had been too nice, too lenient with their customers. You see, a few years earlier when the bubble popped, a lot of companies couldn't pay back their bank loans. But instead of cracking down on those deadbeat companies and making them go bankrupt, the banks actually cut them a break.

HOSHI: They reduced their interest payment, sometimes to zero. Or they can forgive a portion of the loans.

GUO: What? I've never heard of banks being so nice.

HOSHI: Yeah, probably not for small customers. But we can imagine for big customers, if big customers fail, the bank may fail at the same time.

GUO: Now, everyone knew that the banks were doing this. It was like an open secret. And eventually they nicknamed these loans zombie loans. And the reason the government hadn't cracked down on these zombie loans right away is there were so many of them, hundreds of billions of dollars' worth. Cleaning them up might require a really expensive, taxpayer-funded plan to rescue the banks.

HOSHI: Many people argued that the public money shouldn't be used to save the financial industry, which should sound very familiar.

GUO: And so the government just kind of let those bad loans fester until that first big bank failed. But even then, the government didn't clean things up right away. Six more years actually passed before the Japanese government finally forced all the banks to get their zombie loans off the books. And yeah, it was painful and expensive. One big bank failed. Another one had to be taken over by the government. But the banking crisis was finally over.

But that wasn't the end of Japan's troubles because letting those bad loans fester had done some real damage to the economy, and deeper things were going wrong. First, the demand problem that Japan started experiencing in the early '90s, you know, when people and companies started to pull back on spending - that took a turn for the worse. In 1998, Japan started to experience sustained deflation. In other words, people and businesses were spending so little that prices actually started to fall all across the economy.

HOSHI: That's when the people started to think, this is unprecedented, and we may be in a recession for a long time.

GUO: Yeah, it's around this time that this phrase starts to pop up in the Japanese vocabulary, the lost decade, because since the early '90s, Japan's economy had barely grown at all. And then Japan started to see something truly strange. You see, to get people spending, the central bank is supposed to lower interest rates, make it cheaper to borrow money by just printing a lot more of it, right? This is the main tool that any country has for managing its economy. But Japan had already been printing more money for years, and by 1998, they printed so much money that interest rates were already close to zero. Borrowing was basically free, and still the economy was slowing down. Prices were still falling.

HOSHI: We didn't believe that could happen, but that was happening. Everyone understood that was a theoretical possibility, but we never saw that in our lifetime.

GUO: And, you know, up until this moment, Japan's economic predicament - it was bad, but it wasn't, like, bad, bad. Japan had faced this garden-variety recession that had turned into a banking crisis. But now Japan had become kind of a spooky economic mystery because one of the most powerful economic tools that exists had just stopped working. This is when Japan started to attract the attention of economists around the world, including a future winner of the Nobel in economics, a guy named Paul Krugman.

PAUL KRUGMAN: The fact that Japan was, in fact, printing a lot of money and had cut interest rates to zero and the economy was still depressed was - you know, that was disturbing.

GUO: A lot of economists thought, surely, Japan was doing something wrong here. And Paul was one of them, actually. But then he sat down, and he really worked through this problem. And he realized that Japan actually might be going through something that the world hadn't seen since the 1930s, a liquidity trap. This is a situation where people are so unwilling to buy stuff that printing money doesn't change the behavior one bit.

KRUGMAN: If you try to print a lot of money under those circumstances, then it just piles up. It piles up in bank reserves. It piles up in money under the mattress. But it doesn't actually filter through to the economy.

GUO: At the time Japan was experiencing this, many economists thought that liquidity traps didn't happen anymore.

KRUGMAN: So there was a general notion that the liquidity trap was something that people might have believed in in the immediate aftermath of the Great Depression, and anyway, nothing like that was ever going to happen again.

GUO: Yeah, liquidity traps were supposed to be this boogeyman myth from the dark ages of economic history. But what Paul realized is that even with our modern economies and our modern economic models, a liquidity trap is possible. In fact, it's a threat that every economy still needs to worry about. Paul wrote up this argument. He put it up on the internet, and the whole thing went kind of viral or at least, you know, viral for an economics paper in the age of dial-up modems. Now, plenty of people were skeptical, but there were a bunch of economists who shared his concerns.

KRUGMAN: We had a little sort of Japan worrier club of people who did look at Japan, and instead of saying, well, they messed up, they said, well, maybe this can happen to the rest of us.

GUO: And you know who was one of the other members of this Japan worrying club?

KRUGMAN: Guy named - what's his name? Ben Bernanke. Don't know what happened to him.

GUO: (Laughter). Ben Bernanke, as in, you know, the guy who steered the U.S. economy through the global financial crisis - also a Nobel winner. Now, pretty soon, the Japan worrier club got to work trying to figure out how Japan could get out of this liquidity trap. And they developed a kind of off-the-wall recommendation to get people to spend money again. Paul's idea was that Japan's central bank needed to kind of play, like, a Jedi mind trick on the economy. It needed to convince people that serious inflation was on the horizon.

KRUGMAN: I probably didn't help my case by being an academic having some fun. I said that the Bank of Japan needs to credibly promise to be irresponsible.

GUO: Yeah. So the Bank of Japan did not go so far as to promise irresponsible levels of inflation, but it did start to make real promises to the public. There's a practice called forward guidance, which back then was a really unusual thing for a central bank to do. In this case, the Bank of Japan promised to just keep interest rates at zero until the economy got better. On top of that, Japan also became the first modern economy to try something called quantitative easing.

The idea is to inject money deeper into the economy. And I think the best way to explain this is, you know how sometimes you're driving around and you see a sign that says we pay cash for cars? That's kind of what quantitative easing is like. The government goes around to the big banks and says, hey, you have a lot of money tied up in bonds and stuff. How about we pay you cash and take all that stuff off your hands? The hope is that, you know, with all this cash in hand, the banks are going to lend more and, you know, spread that money around the economy.

And by 2006, it seems like these exotic tricks might actually be working, which becomes very relevant just a couple years later. Because what happened in the United States starting in 2007, it was eerily similar to what happened in Japan. There was a real estate bubble that led to a banking crisis that eventually landed the U.S. in something that looked a lot like a liquidity trap, where people could borrow for next to nothing, but the economy still wasn't picking up. Takeo says that as all of the chaos in the U.S. started to unfold, his expertise was suddenly in very high demand. He got calls from people at the Fed asking for his advice.

HOSHI: So I'm not sure if these meetings are considered to be confidential or not.

GUO: Oh.

HOSHI: So I'm not sure if I can talk exactly about what happened.

GUO: OK. So it was super secret or whatever. But Takeo was comfortable saying that his general advice was that the U.S. should learn from what Japan had gone through.

HOSHI: I mentioned these are what happened in Japan. So we need to resolve the problems very quickly.

GUO: In fact, that's exactly what the U.S. did. It took quicker and stronger actions than Japan had done. In 2008, Congress passed a $700 billion bailout for the banks. The Fed moved quickly to cut interest rates, and when those interest rates hit zero, and it looked like the U.S. was in its own kind of liquidity trap, the Fed leaned on those exotic practices that Japan had pioneered just a few years earlier, stuff like forward guidance and quantitative easing. And sure, it helped that Ben Bernanke, one of the founding members of the Japan worriers club, was in charge of the Fed at the time. But I don't know. It also seems like maybe Takeo deserves some credit. It really does sound like maybe you saved America.

HOSHI: I don't think so.

GUO: (Laughter) Helped save America a little bit. OK. OK. So saved might be overstating it because the U.S., like many other countries, had this long and slow recovery from the recession. For years, actually, there was a lot of worrying about whether the U.S. was having its own lost decade and stagnating just like Japan. But without the example of Japan, it all could have been much worse. Paul Krugman says what Japan went through was kind of like a dress rehearsal for the global financial crisis. But in Japan, the economic problems were not over. Coming up after the break, how Japan finally, at last, maybe, after 30 years, might be turning a corner.


GUO: Ever since Japan's economic troubles began in the 1990s, it had been dealing with a problem of demand, people and companies not spending enough money, not buying enough stuff. But by the mid-2010s, Japan had kind of thrown the book at that demand problem. They'd printed so much money that interest rates were at zero. They'd spent so much on government stimulus programs that they had more debt than any other developed country. They also used all these exotic tricks like forward guidance and quantitative easing, and they pretty much fixed the deflation problem. But still, Japan's economy was barely growing. And around this time, a different theory of Japan's economic troubles took center stage. Because an economy has two sides to it - right? - supply and demand. So for an economy to grow, you need people to want to buy things. That's demand. But you also need companies to make those things. That's supply. More and more people started to think that maybe Japan has a supply problem, a problem with making stuff.

HOSHI: That's, I think, the story of the Japanese economic stagnation. Both demand side and supply side, the both of those stagnated.

GUO: Takeo says, if you look at the supply side of Japan's economy, there are clear problems, like a lack of workers. Japan is the first industrialized economy to have a shrinking population.

HOSHI: If the population declines, it certainly is not good for growth.

GUO: And this is just simple math, right? It's harder to make more stuff every year if your workforce is getting smaller. You have to do more with less. You have to be more productive. But that brings us to another big problem with the supply side of Japan's economy, productivity - rather, the lack of productivity. The Japanese labor market is famously rigid. It's really hard to hire or fire people.

HOSHI: One thing you can see is people who are employed in big companies but don't seem to do any work. There is a Japanese called madogiwazoku, literally translating the people who sit by the windows without working, without doing anything and just watching the people go by.

GUO: Takeo says a lot of companies themselves in Japan are also kind of just watching the world go by. They aren't terribly productive or innovative, but they also don't get replaced by younger, more innovative companies. They just linger around.

HOSHI: Japan is characterized the lack of dynamism, corporate dynamism compared with other countries.

GUO: Takeo says these are some deep-seated problems in Japan's economy that make it hard to innovate, which may be sounds kind of strange when you're talking about a country that has created companies like Toyota, which are known for their efficiency. But Takeo says, even during Japan's boom times, a lot of what Japan was doing was playing catch up, copying what other countries were making, just doing it better.

HOSHI: But eventually, Japan comes to the phase that catching up strategy doesn't work anymore. So you have to come up with your own innovation for the future.

GUO: And all these supply side problems, problems like a lack of innovation or lack of workers, they're just much tougher to solve, unfortunately. Macroeconomics doesn't really have a playbook for any of this, but Japan has been trying. It launched this major plan in 2013. You may have heard of it. It's called Abenomics. Abenomics involved a lot of really aggressive moves to boost demand, but it also tried to fix the problems on the supply side. For instance, they tried to grow the labor force by encouraging more women to start working, called this effort Womenomics. They also changed the rules for how public companies operate, to try to get them to be, you know, a little bit more cutthroat.

Which brings us to last month's big news. The Bank of Japan raised interest rates for the first time in 17 years. They did that because people and companies are finally spending money again, and that's causing prices to go up. Japan all of a sudden has inflation. Takeo gives some credit to Abenomics for that. And also, he says, the shock of COVID, it kind of shook something loose in Japan's economy.

HOSHI: So at least I think Japan has solved the demand side problem. Now the Japan can focus on the structural reform even more.

GUO: Right. The problem is that the Japanese economy, it's still suffering from sluggish growth. There's still big questions about Japan's future. But now those questions are mostly focused on the supply side, questions like, can Japan be more productive, more innovative? Can it grow its economy even as its population is shrinking? These days, those are questions that a lot of modern economies are facing. So at least Japan isn't alone in trying to figure it all out.


GUO: This episode was produced by Emma Peaslee and engineered by Cena Loffredo. Is edited by Molly Messick. Alex Goldmark is our executive producer. I'm Jeff Guo. This is NPR. Thanks for listening.


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