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Japan: Real Reason for ‘Turning Japanese’• Putting off needed structural reforms for lackof political (and popular) will to tolerate shorttermpain for the sake of long-term gain is arecipe for continued crises.• As in Europe today, after its bubble burstJapan relied for a long time on (1) forbearancepolicies to grow out of its balance-sheet woesand (2) aggressive fiscal spending to maintainthe spending structure and to shore up slumpinggrowth, but the result has been prolonged subpargrowth and biggest public debt of anydeveloped nation.• Japanese policymakers had thoughtproblems could be solved by economic growth,but trend growth cannot recover as long asbalance-sheet troubles are left unresolved. Thisrequires strict asset assessments, adequateloan-loss reserves and public fund bailouts.4.54.03.53.02.52.01.51.00.50.0Chart 1: Japan’s Per Capita Trend Growth Rate(= natural rate of interest, %)Potential grow th rate per w orker(five-year moving average)-0.585 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11Source: Cabinet office, MIC, BNP ParibasChart 2: Eurozone’s Per Capita Trend Growth Rate(= natural rate of interest, %)3.0• It seems that the sovereign debt crisis inEurope today is being aggravated becausepolicymakers are doing the same thing Japandid earlier.2.52.01.5Potential grow th rate per labor force(five-year moving average)• While Japan was the frontrunner in problemslike balance-sheet woes, banking crises, longtermeconomic stagnation, public debt anddeflation, the eurozone has surpassed Japan insovereign debt issues destabilising the financialsystem. But if Japan continues to put off fiscalreforms, it could end up like the ailing nations ofsouthern Europe today, but without a Germanyto bail it out.1.00.50.0-0.598 99 00 01 02 03 04 05 06 07 08 09 10 11Source: Eurostat, BNP ParibasThere are numerous reasons why the sovereign debtwoes in the eurozone have been aggravated. Onereason is the adoption of forbearance policies, whichJapan also did after the bursting of its real estatebubble of the 1980s. Rather than quickly moving toresolve the balance-sheet troubles afflictingEuropean banks, something that requires stricterasset assessments, adequate loan-loss reserves,and then plugging any capital shortfalls with publicmoney (if funds cannot be procured from the market),policymakers in the eurozone have opted forforbearance policies in the hope that revivedeconomic activity will enable their economies to growout of these problems. Unfortunately, as Japandiscovered, the failure to resolve balance-sheettroubles actually weighs on economic activity. Thetrend growth rate (i.e., potential growth rate) declinesbecause both real and human capital accumulation,is thwarted by impaired financial intermediation andfalling growth expectations.But as in Japan in the 1990s, various pressures workagainst the imposition of strict asset assessments.For one thing, banks themselves are wary becauseof the inevitable damage to earnings. Second,instead of cracking down on banks to ensure thatassets are stringently evaluated, authorities tend toallow lax assessments out of concern that banksmight cut back on credit to the detriment of themacroeconomy. Third, since strict assetassessments usually necessitate the injection oftaxpayer money to shore up undercapitalised banks,the authorities prefer to avoid doing this becausesuch bailouts are not only unpopular but they alsoRyutaro Kono 20 October 2011Market Mover16www.GlobalMarkets.bnpparibas.com