Understanding the economic dynamics of China or the socio-economic history of Detroit can be a fruitful exercise for determining what the future might hold, both in that region and globally. High-growth countries receive more press coverage than low-growth regions because a tremendous amount of emphasis is placed on a country’s maturing economy as it becomes a bigger player on the world stage. China and India are recent examples. An equal amount of press is given to the collapse of nations’ financial systems, like the Greek debt crisis a few years ago or the current disaster in Venezuela. Volatility makes for sexy headlines. Sometimes, though, a confluence of events and fiscal decisions lead a country down the path to boring Nowheresville, but while little is written about these situations, the lessons and ramifications can be equally significant to investors.
Japan rebuilt its economy in incredibly rapid fashion after World War II. By 1970 it was the sixth most populous country and had the second highest Gross Domestic Product (GDP) in the world – another way of saying that it was behind only the United States in global economic output. For the next 25 years the world believed Japan was taking over the global economy. The anything-goes 1980s were filled with examples. Toyota and Honda were dominating the Big 3 in sales growth and quality. Sony and Panasonic were the only electronics most people would even consider. Nintendo was the driving force behind the explosion of the personal gaming market. Movies such as Die Hard and Blade Runner showed us a present and future dominated by Japanese influence.
And with high profile Japanese purchases of iconic real estate assets like the Pebble Beach Golf Club and Rockefeller Center in New York, even real estate in the United States seemed to be turning Japanese.
This all came to a screeching halt in the early 1990s as Japan entered into what later became known as its Lost Decade. By 1989 the Bank of Japan (think of it as the equivalent to our Federal Reserve) was raising interest rates in an attempt to tame rapid appreciation in asset prices, and the Japanese economy collapsed in 1990 as a global recession took hold. Unlike the economies of the United States and Europe however, which eventually came out of the recession and began growing again in the mid-90s, the popping of Japan’s economic bubble had far more lasting consequences. Many banks became insolvent as real estate debt created in the 1980s defaulted. The Bank of Japan has held the country’s target interest rate near zero since the mid-1990s in an unsuccessful attempt to jumpstart Japanese consumer spending and economic growth that has never returned. The lost decade turned into the lost quarter century.
Even as the Japanese asset bubble was deflating in the early 1990s, the country’s global corporate success of the 1980s began showing cracks. Companies in lesser Asian economies learned to copy the efficient production methodologies and precision manufacturing techniques of their Japanese counterparts, in some cases overtaking Japanese dominance in a process that continues to this day.
Hyundai and Samsung (both Korean companies) have epitomized this trend. As consumer electronics and autos were front and center in the 1980s economy, personal computers and mobile phones dominated the 1990s. Japan missed out on this growth explosion and companies such as Nokia, Motorola, Microsoft and Apple became to global consumers what Sony had been during the previous decade.
Japan still holds 3rd place in the global GDP rankings (passed only by China in recent years), but those GDP figures are no longer growing. The backbone of new economy industries like internet, smart phones/mobile, financial/payments technology, online shopping, and others are all formed by software. These software advancements have been the primary driver of global growth since the 1990s, and Japanese companies have been completely absent from this explosion. Much blame lies with a lack of innovation inside Japanese business. Many Chinese companies are as large or larger than American counterparts and long ago raced past anything occurring within Japan. This is largely attributable to the fact that Japanese businesses are set up with clear hierarchies that do not respond well to disruption. They are perfect for building processes, and efficiencies within those processes, but coming up with new ideas is challenging.
In the United States and China, one way that large companies mitigate the innovation problem is by buying up smaller competitors that have come up with good ideas. Examples include Google’s purchase of home automation company Nest and Wal-Mart’s purchase of online delivery business jet.com. In Japan this type of M&A activity is virtually unheard of due to the strict corporate hierarchy that Japanese companies still generally adhere to, where promotions are based more on age than merit. Thus, they don’t want young multi-millionaires working next to older people who are making less money. Japan’s culture of corporate secrecy also has inhibited platform innovation that occurs freely in the United States and China. A startup business in Austin can create an app that connects seamlessly to the software of other companies, creating value for potential customers efficiently and without significant startup capital. That concept has never existed in Japan until very recently.
Japan also faces a problem much more difficult to solve than its lack of corporate innovation: its lack of babies. While the country’s global GDP ranking has only dropped from two to three, the population ranking has gone from sixth to eleventh since 1970. If current trends hold for another decade, Japan will be out of the top 15 by 2030. Population growth in the developed world has trended lower for several decades, but Japan isn’t just trending lower – it’s in crisis mode.
In the early 2000s it was the first notable economy to actually shift from population growth to decline. Japan is now the oldest major country in the world with an average age of 47 and almost a quarter of its people being at least 65 years old.
What the Japanese demographic problem means for the Japanese people in the medium term is one question that remains unanswered. The country has effectively been in a recessionary economic environment for over 20 years, and yet no serious political or societal upheavals have occurred. The quality of life of its people remains among that of the wealthiest countries on earth. And life expectancies are long and growing longer. Bearish commentators on Japan quickly point out that the country has the highest ratio of government debt to GDP. If history is our guide, this situation only ends in a catastrophic debt default or with the country growing its GDP to a point where the ratio becomes manageable. Unfortunately for Japanese policy makers, growth does not appear to be in the cards because it is almost impossible to imagine economic growth given the backdrop of population decline.
Some investors have positioned their portfolios for a debt crisis by shorting Japanese government bonds (JGBs), but the timing of when an actual event might occur is unknown.
This particular trade is well-known in financial circles as “the widowmaker” because the fundamentals that should create a debt crisis have remained in place for decades now (unsustainably high absolute debt levels, no growth). Yet Japan keeps muddling through, paying its interest and providing monetary stimulus in various ways in an attempt to at least keep its economy from shrinking, if not actually growing. Unlike minor countries such as Greece and Venezuela, first-world economies that are able to print money and borrow in their own currency have many levers to pull in order to stave off the grim reaper of default. After spending $55 billion annually buying the stocks of Japanese companies since 2016, the BOJ is a top-10 investor in half of all public Japanese companies, up from 40 percent just a year ago*. How and when these holdings can ever be sold without sending Japanese markets into a tailspin is one of many questions that remain unanswered for the country’s leadership.
Japan will be the world’s test case when it comes to answering the question of how an aging population affects its citizens in the 21st century. As retirees ultimately overtake members of the workforce, what unknown societal problems arise? Can automation and robots really take up enough labor slack? How will a country with Japan’s demographics even compete regionally in Asia, much less globally? Will Japan be forced to encourage immigrants inside its borders, a practice long-avoided by the country? These questions and many others will be answered between now and 2050. Developed countries around the globe best be paying close attention because Europe, China and even the United States will face similar challenges in the coming decades.