Home Economic Trends Bubble-Bust in Japan – Mark Thornton

Bubble-Bust in Japan – Mark Thornton

Adapted from The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century.

During the 1980s Japan was feared as an economic and technological powerhouse. Most observers attributed their stock market bubble and high growth rates to easy monetary policy, management style, and government managed technological development. Since 1990, the Japanese government has been fighting price deflation with monetary inflation and trying to increase growth by government deficit spending. By all accounts it has not worked. Their economy remains mired in low growth, they have by far the highest ratio of government debt to GDP in the world, and they face a dramatic demographic crisis as their population continues to age. This chapter is the lesson of what NOT to do and who not to listen to for advice.

Business cycles and bubbles differ from one another, but the technical similarities between the Japanese and US bubbles are striking. The Japanese bubble began in the early 1970s, the US bubble started in the early 1980s. Both stock markets grew rapidly for thirteen years and then went parabolic to form bubbles, which peaked in Japan at the end of 1989 and in the United States during early 2000. Both stock markets lost about a third of their value eighteen months after their peaks. The Nikkei Stock Index has since lost as much as three-quarters of its peak value, while the Dow Jones Industrial Average has been down 40 percent and the NASDAQ Composite down by 75 percent of its peak value. The real estate bubble continued in Japan for some time after the stock market began its meltdown, and likewise, real estate — particularly housing — experienced (two) bubbles since the initial breakdown of the US stock market in 2000.

The surprising thing is that in the United States the lessons of the Japanese bubble seem to have almost gone unnoticed. Japan experienced fourteen years (now more than twenty-five years) of economic stagnation since its bubble popped. Most troubling, the United States not only failed to heed the warnings of the Japanese bubble, it has thus far mimicked Japan’s failed attempts to stimulate its economy with extremely low interest rates and large government budget deficits. Both countries have opted for a slow, agonizing “recovery,” rather than a sharp correction of past errors that would quickly reallocate resources and return the economy to sustainable growth. Experts tell us that the Japanese and their economy are very different from the Americans and their economy and that the Japanese bubble and Japan’s policy response to its crash were likewise different, but while there certainly are many important differences between the US and Japanese bubbles, the technical features and new-age thinking are strikingly similar in both bubbles.

For example, there is no doubt that technology and new-era thinking played a major role in the Japanese bubble. During the bubble, Japan took over leadership of high technology in the areas of consumer electronics, the automobile industry, manufacturing, and even robotics, and was perceived as a major threat to dominate all technological development around the globe — just as the United States is today. The threat posed by Japan’s growing technological prowess can be seen in the titles of books published during the bubble era: Japan’s High Technology Industries, edited by Hugh Patrick and Larry Meissner (1986); The Technopolis Strategy: Japan, High Technology, and the Control of the Twenty-First Century, by Sheridan Tatsuno (1986); A High Technology Gap?: Europe, America, and Japan, edited by Andrew J. Pierre (1987); The Science and Technology Resources of Japan: A Comparison with the United States, by Maria Papadakis (1988); Created in Japan: From Imitators to World-Class Innovators, by Sheridan M. Tatsuno (1990); Japan as a Scientific and Technological Superpower, by Justin L. Bloom (1990); Japanese Technology Policy: What’s the Secret? by David W. Cheney and William W. Grimes (1991); and Japan’s Growing Technological Capability: Implications for the U.S. Economy, edited by Thomas S. Arrison et al. (1992).

Writing near the pinnacle of the bubble in the stock market, Fumio Kodama1 explained that the Japanese takeover of technological progress was a result of a new Japanese paradigm that was ushering in a new era:

Japan is becoming one of the frontrunners in industrial technology, which means that prominent science and technology policy researchers all over the world now pay more attention to Japan. Considering this change more deeply, one can understand the reason for the researcher’s academic interest: the paradigm of technological innovation is shifting.

Kodama2 found that in Japan the innovation of high technology “seems to be different from that for conventional technologies,” and therefore studies focused on Europe and the United States would not lead to a “new scientific framework for analyzing innovation of high technologies.” He suggested that we break away from the inadequate linear model of the past to the unlimited model experienced under the unique “social and cultural context” of Japan. Kodama3 even ended his book with the suggestion that it was the Japanese cassette-tape recorder, VCR, and fax machine that made the Iranian revolution, Philippine revolution, and Tiananmen uprising possible. This is classic new-era bubble thinking.

Another component of modern new-era thinking is the belief that the so-called scientific management of the economy creates perpetual prosperity. Here the Japanese experience epitomizes this phenomenon because the Japanese economy was said to represent a new “third way,” positioned between the free market economy and that of the centrally planned economy. In Japan, government and corporations act cooperatively in both their self-interest and the general interest of the nation. Bureaucracies help plan and coordinate the economy. They provide incentives, such as financing and tax breaks, in order to channel investment in profitable directions. Corporations, in turn, participate in joint research programs with their competitors, but share the results among participating firms, with each choosing what technological advances to employ in their firms. Production planning is facilitated by an overlap of ownership between final-good producers and their input suppliers. Japanese management, especially during the bubble, was said to spur innovation, enhance product quality and reliability, and create large market shares in export markets for Japanese industries. Alas, none of this could prevent a meltdown of the Japanese stock market and well more than a decade (now more than a quarter century) of stagnation in the Japanese economy.

New-era thinking about the scientific management of the economy was never more prominent and bold than during the Japanese bubble of the 1980s. It was often said that the Japanese system would lead to economic dominance and threaten the preeminence of the US economy. Laura D’Andrea Tyson, who would later become chairman of President Clinton’s Council of Economic Advisors, outlined (at the apex of the bubble) the “threat” of Japan’s technological superiority:

Certainly Japan continues to obtain technology wherever it is available and to translate it into commercial advance, as the United States itself did for so long. However, now talk has begun of a new, “technoeconomic” paradigm emerging in Japan, a new trajectory of technological development. That trajectory emerged from a pattern of industrial catch-up shaped by policies of import substitution and export promotion. As Japan reaches industrial maturity in a broad range of industries, its government is exerting substantial efforts to build a Japanese position in advancing technologies. Agencies such as the Ministry of Trade and Industries (MITI), which have become familiar names in policy discussions in the United States, are involved.4

In Japan, the government channeled research and development efforts, directed financing, and protected markets for business. This new, third way of government management of the economy was thought to be Japan’s source of economic strength and was to inevitably place it in a position of economic preeminence. As Tyson and Zysman5 confidently asserted:

A generation from now, Japan will almost certainly have created its own mechanism for advancing the technological frontiers in a range of domains. Now the continuing pace of productivity increase suggests that Japan may indeed be on a growth trajectory different from that of the United States. As Japan ascends, America frets about its decline.

Tyson and her coauthors, Dosi and Zysman,6 questioned the validity of traditional economic thought, as all new-era thinkers must. They justified Japan’s “often flagrant and self-aware violations of the nostrums of traditional economic thinking” because when “technological change is a key determinant of market outcomes, standard economic models that treat such change as exogenous are a poor guide to understanding the dynamics of market competition and the effects of policy on such competition.” They argued that the “nostrum” of economic efficiency should be abandoned in favor of the less constraining and poorly defined notions of growth efficiency and technological efficiency.

Leaving the anchor of economic efficiency and traditional economic thinking behind, Tyson, Zysman, and Dosi7 were able to justify a variety of noneconomic policies such as “beggar thy neighbor” protectionism. She heralded the concept of growth efficiency, which is essentially a Keynesian idea that rests on the assumption “that there are always unutilized resources that can be mobilized to meet growing demand. … It is exactly this kind of thinking that led the Japanese to target industries whose products were perceived to have high income elasticities as a foundation for rapid economic growth.” Ignoring the economic condition of scarcity and grasping at the concept of an economy of perpetually unutilized resources is a precondition for new-era thinking, as well as a quintessential mistake of freshman college students taking their first course in economics. If resources are perpetually available then an unlimited amount of all goods and services can be produced and there are no economic problems to solve. This would seem to be the most basic of economic errors and a particularly grievous one to make in analyzing resource- and land-poor Japan.

Naturally Tyson also had to offer a rationale for why markets do not work, and she concluded that entrepreneurs will pass up more profitable long-run investments in order to pursue short-run profits under certain conditions. Tyson, Zysman, and Dosi8 even admitted that their argument was simply a variation of the long-discredited infant-industry argument for protectionism:

Under conditions of nondecreasing returns there is simply no way that markets can relate the varying future growth efficiencies of various industries to relative profitability signals facing individual producers. Basically, this argument is a variant of the infant-industry argument. Because of increasing returns, current market signals can be misleading indicators of future profitability. Consequently, government policies to promote a domestic industry with high future growth potential can improve economic welfare in the long run.

It would seem from the perspective of Tyson, Zysman, and Dosi that modern-day entrepreneurs might invest in the production of black-and-white television sets or mechanical typewriters made out of jute if not for the prodding and oversight of government bureaucrats.

In their justification of Japan’s new-era thinking, Tyson, Zysman, and Dosi viewed technology from the historical rather than economic perspective. In an age of information and communication technology, their “path dependent” and “sticky” processes of technological development seem odd and not entirely appropriate for new-age theorists, who often view technology as “spontaneous,” perfectly flexible, and ever present. Nevertheless, they clearly are new-era philosophers of the Japanese bubble and its new technological paradigm:

The expression technological paradigm … involves a new set of best practice rules and customs, new approaches to how to relate technology to market problems, new solutions to established problems. The notion of a major industrial transition, of a second industrial divide, of a shift from “Fordist to flexible” manufacturing that has become a fad in some debates points to just such a shift in technological paradigm.9

In retrospect, the new-era thinkers of the Japanese bubble economy seem conceited and hopelessly naïve, but that is the power of bubbles to deceive. One of the few observers to correctly identify and characterize the bubble was Christopher Wood,10 who wrote that Japan “became so arrogant in the late 1980s because it really believed it was immune from the natural laws of the marketplace. This really was one of the most astonishing acts of mass delusion ever, and future historians … will marvel at it.” The Japanese people might be particularly susceptible to the delusions of a stock market bubble because their culture has so long emphasized honesty and respect for authority, and the government has carefully maintained the isolation of its people, both of which could contribute to herd-like behavior and which make them ripe for what Charles Mackay famously called “the madness of crowds.” The Japanese also have characteristics in their social psychology, as well as their well-known emphasis on precision and details, that might make them more susceptible to new-era delusions. The truth is that all these psychological characteristics are unimportant in terms of the cause of bubbles.

In the wake of the bubble and bust, Japan experienced a long series of corruption scandals, a procession of failed prime ministers, the ousting of financial ministers, the conviction of bureaucrats for corruption, and the breakup of its one-party system. However, the Japanese have failed to truly recognize the cause of their bubble and to liquidate their economic mistakes. Instead they embarked on a post-bubble course of easy credit, public works, and deficit spending that has only served to condemn the Japanese economy to continuing economic doldrums.


The success of Japan after WWII was due entirely to the free market economy, small government, low taxes, an appreciating currency, and a very high personal savings rate. That all changed when the bubble was born in the late 1980s because of overly stimulating monetary policy. A quarter century after the stock market meltdown Japan is still mired in an economic slump. At the prodding of mainstream economists, such as Paul Krugman, Japan has embarked on massive amounts of public works projects, enormous amounts of government borrowing, and extreme levels of monetary stimulus and quantitative easing. None of this has worked. It has left the country with the largest national debt relative to GDP in the world. It has also diverted the attention of the Japanese people and thus prevented the country from addressing its demographic crisis. In fact, it might have made the demographic crisis worse. After all, why get married and have children when the children will have to bear the enormous burden of the national debt?

  • 1. Fumio Kodama, Analyzing Japanese High Technologies: The Techno-Paradigm Shift (London: Pinter Publisher, 1991), p. 171.
  • 2. Ibid., p. 172.
  • 3. Ibid., pp. 173–74.
  • 4. Laura D’Andrea Tyson, John Zysman, and Giovanni Dosi, “Trade, Technologies, and Development: A Framework for Discussing Japan,” in Politics and Productivity: The Real Story of Why Japan Works, edited by Chalmers Johnson, Laura D’Andrea Tyson, and John Zysman (Cambridge, MA: Ballinger Publishing, 1989), p. xiv.
  • 5. Laura D’Andrea Tyson, and John Zysman, “Preface: The Argument Refined,” in ibid., p. xiv.
  • 6. Ibid., pp. 4–5.
  • 7. Ibid., pp. 14–15.
  • 8. Ibid., p. 17.
  • 9. Ibid., p. 31.
  • 10. Christopher Wood, The Bubble Economy: Japan’s Extraordinary Speculative Boom of the ’80s and the Dramatic Bust of the ’90s (New York: Atlantic Monthly Press, 1992), p. 255.