September 12, 2011
- Japan's growth rate since 1990 has averaged 0.9 percent per year.
- The U.S. has grown 0.5 percent annually since 2006.
- Housing as a share of GDP has shrunk to 2.5 percent from 6.25 percent.
One of the many worries creeping into investors’ minds is the long-term future of the U.S. economy. Households have enormous debts to deal with. Persistent unemployment is pushing people out of the workforce. The federal government faces a looming fiscal crisis, and trading partners in Europe have their own burdens. New recession worries in the U.S. make it clear that recovering from the major financial crisis set off by the bursting of the housing bubble is going to be difficult. Americans are increasingly looking to Japan’s “lost decade” after its asset bubble burst in the early 1990s and worrying about a similar fate for the U.S.
The similarities between the U.S. now and Japan then are ominous. Both had suffered from a collapse in real estate values and stock prices, and both faced uncertain futures, which in Japan’s case turned into a dismal period of economic growth averaging 0.9 percent per year that has lasted 20 years. In the five years since the bust in home prices began in 2006, the U.S. has grown at a paltry 0.5 percent pace, with growing concern about the next few years.
Is the U.S. facing its own lost decade? “If it is, we think it will be for reasons other than the challenges that have faced Japan,” economists Michael Gavin and Piero Ghezzi at Barclays Capital say in a study that highlights the differences between the U.S. and Japan and offers hope that the U.S. can avoid such long-term stagnation. In a nutshell, they say there are three reasons that describe those differences.
- The U.S. does not face the same growth-inhibiting demographics that were a major contributor to Japan’s stagnation.
- Both Japan and the U.S. suffered from overinvestment, but Japan’s adjustment depressed a much bigger share of its economy compared with the U.S., where the overinvestment was confined to housing.
- The U.S. so far has avoided the policy mistakes that held back Japan’s recovery.
U.S. and Japanese demographics are strikingly different. The growth rate of the working-age population in the U.S. is slowing as baby boomers retire, but it’s still growing. That’s important because an economy’s ability to grow is determined by the growth of its labor force plus gains in productivity and technology. The number of working-age Japanese actually began to shrink in the early-1990s, and the rate of contraction is accelerating. This sharp turn in Japan’s demographics coincided with the bursting of its bubble economy, the Barclays study shows, greatly amplifying downward pressures on growth. In the coming decade, the working-age population is projected to grow 1 percent in the U.S. and shrink 0.6 percent in Japan.
The Japanese bubble largely reflected over-investment by businesses, while the U.S. bubble was mainly over-investment in housing. Thus, Japan’s adjustment was concentrated in the business sector, while the U.S. rebalancing is in the household sector. Fueled partly by cheap capital from soaring stock prices, Japanese business investment in equipment, land, and construction soared to 35 percent of GDP at the peak of the boom, only to slump to about 20 percent currently. The late-1980s boom and subsequent bust accounted for some that slump, but Gavin and Ghezzi say the demographic impact on overall economic growth has been the more important long-run depressant on business investment.
The U.S. adjustments in housing and by households, so far, have been much smaller than the impact of the massive shrinkage in business investment in Japan, say the Barclays analysts. U.S. consumers went into the housing bust with very low savings, which they have greatly rebuilt in recent years. Many households have cut their debt loads to manageable levels that allow more borrowing, as seen in the recent upturn in non-mortgage consumer loans. So far this year, monthly financial obligations of households have fallen to 16.4 percent of household income, the lowest since 1994.
Housing investment has more than adjusted. Residential construction in the U.S. has fallen from a peak of 6.25 percent of GDP in late 2005 to only 2.5 percent currently. That is far below the historically normal share of about 4.25 percent, suggesting significant under-investment in housing that could drive a strong housing rebound, once the constraints on mortgage finance have been removed.
But there’s the rub. Gavin and Ghezzi say the most important barometer of the household sector’s adjustment should be the resolution of problem mortgages, not how much overall debt levels should be reduced. That will take time and smart policy. The real problem, they say, is the devaluation of much of the housing collateral that stands behind household debt, reflected in the drop in home prices. With so many underwater mortgages that can’t be refinanced, a traditional channel through which lower interest rates have typically reinvigorated housing, household spending has been blocked.
Perhaps the most important difference between the U.S. and Japan is that, so far, the U.S. has not made the policy mistakes that many analysts say hurt Japan’s recovery process. Unlike Japanese banks in the 1990s, U.S. banks are quickly writing off bad loans to households and businesses. Policymakers in Japan encouraged banks to keep lending to essentially bankrupt companies, creating so-called zombie corporations, a policy that only postponed the pain of the necessary adjustments.
Unlike the slow reaction of Japan’s central bank, U.S. monetary policy reacted much faster to the possibility that an extended period of weak demand could set off a debilitating round of deflation like that which has haunted Japan’s economy for two decades. Plus, U.S. fiscal policy was quickly directed at supplanting lost consumer demand and supporting viable businesses, instead of propping up nonviable companies.
Still, a U.S. lost decade or worse could happen. Most economists, including those at Barclays Capital, believe the adjustments needed in mortgage markets and in the balance sheets of households and banks will take time. The longer it takes, the greater the chances of a policy blunder or a new financial shock that could create even more problems. “Although we think it unlikely that the U.S. will face a multi-decade slump,” say Gavin and Ghezzi, “it may be hard to tell the difference for a while to come.”