Re-examining the Historical Process of Japan's Emergence from Deflation

ABSTRACT

This Study establishes the patterns and factors underlying the deflation periods of the past and examines the lessons that can be learned from this for the deflation Japan is now facing. The examples analyzed here are the British deflation in the late 19th century and Japan in the 1920s - 1930s. England experienced a prolonged period of economic slump known as the Great Depression. During this period, prices continued to fall. In the late 18th century, England took a lead in spearheading the Industrial Revolution and becoming the world's greatest industrial nation. By the late 19th century, however, it lost its competitiveness and subsided into a long recession as the United States and Germany rose as new industrial powers. The present decline of Japan's competitive edge while China is in the ascendancy is an exact replica of the British situation in the late 19th century. In the 1920s and 1930s Japan fell into the grips of a chronic depression after the burst of the bubble in the years after the First World War. The nation was visited by a severe deflation in the Great Showa Depression. There is a striking similarity between the situation of that time and the present-day situation of Japan.

The factors responsible for England's deflation can be traced to a pattern of economic development in the wake of a decline in Britain's industrial competitiveness that is characterized by a high-cost structure of the economy and a downturn in the return on investments. The fundamental cause of the downward spiral of prices on aggregate was that investment returns continued to be lower than market interest rates amidst stagnating demand. After this, Britain experienced a protracted decline as the nation was unable to recover its competitiveness. In contrast, Japan's deflation in the 1920s-1930s was due to a high-yen on the currency market amidst with the economy spinning toward a high-cost structure as Japan fell behind in her attempts to make the necessary structural adjustments to her economy. The deflation of this period did give rise to corrective adjustments of the high-cost structure. Amidst the onslaught of the Great Showa Depression, however, the deflation intensified and the crisis was eventually overcome after a major depreciation of the yen and through a package of fiscal and monetary stimulating measures.

These English and Japanese examples have in common that they were both attendant upon a drift towards a high-cost structure and a decline in investment returns amidst a belated response to a structural change of the economy. The deflation Japan is now experiencing has the same underlying factors. The difference in the fate that awaited England and Japan as the two countries ultimately came to terms with their deflation can be understood in terms of the difference in the size of the two nations' accumulated wealth. Because Britain at that time was a creditor nation the situation did not immediately lead to an economic crisis despite her dwindling economic competitiveness. Instead, Britain went through a protracted period of decline. In contrast, Japan had little in the way of accumulated wealth although it had become a creditor nation in the period after the First World War. As a result, the crisis factors typical of an emerging economy appeared, ushering in a process that took a major depreciation of the yen to break away from the deflation. The present pattern of Japan's decline resembles rather the example of England in the late 19th century.

Introduction

Conclusion