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Will USA make Japan's errors?

June 5, 2002

In 1989, Japan enjoyed remarkable 5% growth, spurred by large investments and fabled management practices in high-technology industries. Policymakers were forecasting rapid growth for the next 50 years and a best seller, Trading Places, argued that Japan was replacing America as the world's leading economy.

But Japan's best of times were followed by the worst of times: a decade of stagnation so far, with no end in sight. Japanese stocks fell Tuesday to a new 16-year low, bankruptcy debt has reached new records, and the government now admits Japan's economy, the world's second largest, is in a state of deflation.

Japan's economic descent offers sobering lessons for the United States, as economic conditions weaken here. There are troubling parallels - and telling differences - between today's U.S. economy and the early stages of the collapse of Japan's "bubble economy." In both countries, downturns follow a decade of exuberant expansion and rising asset prices.

On 1989's last trading day, the Nikkei stock average hit its historic high. Worried about inflation, the Bank of Japan tightened the money supply, pricking the bubble. Within a year, the Nikkei fell by nearly 50%. The economy slowed to a crawl; growth in the 1990s barely averaged 1%.

During this same decade, the United States became the economic superstar, led by surprising productivity gains and vigorous investment in the Internet and other technologies. Our stock markets climbed, with the Nasdaq reaching its all-time high a year ago. Confident consumers went on a buying spree, cutting savings from 9% of income in the 1980s to below zero in 2000.

Here it was the Federal Reserve, concerned about overheating, that stopped the party by raising interest rates. As in Japan, the markets fell sharply. Investment is slowing. Consumer confidence is down.

Key differences

But the differences between Japan in 1989 and America in 2001 are more telling than the similarities. Japan's boom, unlike ours, was fueled by cheap loans, a product of easy money and prodigious domestic savings. By the end of the 1980s, Japan had invested in everything from manufacturing capacity to speculative marble palaces and U.S. golf courses. The result was bad debt that crippled the banking sector and has yet to be cleaned up.

Some U.S. investments - say, the frenzied Internet ads of the 2000 Super Bowl - look just as foolish now. But these investments, largely financed by equity rather than loans, won't leave a banking crisis behind.

Japan's inflexible labor markets and stock-ownership patterns, also quite different from ours, locked it into 1980s era industrial structures that kept Japan from capitalizing on many of the 1990s' opportunities, despite its technological prowess. And its consumers, always ready to save more than Americans, reacted to economic trouble by cutting spending still further.

More ammunition

But the key difference is that the United States today has a full deck of cards to play against recession:Our budget surplus creates chances to cut taxes, raise spending or put money back into play by repaying federal debt.Still-high interest rates here can be cut further.

In contrast to Japan's surplus in 1989, our trade deficit is a large 4% of the gross domestic product. With a lower dollar the likely byproduct of easier monetary policy, the United States can create more sales for domestic businesses.

The United States must avoid the complacency that paralyzed Japanese decisions early in its slowdown. Japan reacted too slowly and too gradually; for example, its problems were magnified by large banking losses and a spiral of declining wealth and spending. Today, Japan still needs aggressive monetary and fiscal stimuli and structural reform - and still lacks the political leadership to deliver it. We can learn from Japan's experience. If we quickly write off bad investments and address our economic weakness before the problems multiply, we can avoid its economic catastrophe.

Peter A. Petri is dean of and Carl J. Shapiro Professor in International Finance in Brandeis University's Graduate School of International Economics and Finance.

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