Why has the Japanese economy experienced stagnation for over thirty years?

Ikeda Nobuo’s book, “The Lost Two Decades—The Real Reasons Behind Japan’s Long-Term Economic Stagnation,” discusses the period of Japan’s lost two decades, which refers to the roughly 1989-2009 period when Japan’s economic growth remained stagnant. In fact, this stagnation continued until around 2019 and is often called “The Lost Three Decades.” This article is a reading note on the book, summarizing the main reasons for Japan’s economic stagnation discussed in the text. Studying Japan’s economic and financial policy successes and failures can also provide references for our policy-making.

The chart above shows Japan’s annual GDP from 1955 to June 2025. It can be seen that during “The Lost Three Decades,” the curve was flat, with almost no growth and even some decline. After 2020, due to large-scale stimulus policies and increased external demand from China, the US, and others, the economy showed significant improvement. Meanwhile, Japan’s real estate market also surged sharply starting in 2020. The main reasons for Japan’s 30-year economic stagnation can be summarized as follows:

1. Plaza Accord and Financial Liberalization Led to Capital Market and Real Estate Bubbles

The direct cause of Japan’s bubble economy was the Plaza Accord of September 1985. After the accord, the yen appreciated sharply, rising from 240 yen per dollar to 150 yen per dollar. To hedge against “appreciation depression,” Japan drastically lowered its statutory interest rates to historic lows. Almost simultaneously, Japan promoted financial liberalization, allowing banks and securities firms to operate jointly, leading to a large influx of funds into the stock market. The real estate market, where land prices only rose in the 1980s due to the so-called “land myth,” also saw continuous credit inflows. The bubbles in Japanese stocks and real estate markets were thus inflated.

To prevent the bubble economy, the Bank of Japan attempted to raise interest rates, but this was politically blocked. After the bubble burst in the 1990s, bad debts accumulated in the banking system, credit contracted, corporate investment waned, and deflation persisted long-term, eventually evolving into “The Lost Three Decades.”

2. Continued Tight Monetary Policy After Bubble Burst Worsened the Economy

The trigger for the bubble burst was when the Bank of Japan raised the statutory interest rate in May 1989, and the Ministry of Finance (equivalent to China’s Ministry of Finance, People’s Bank, Financial Regulatory Authority, and Taxation Bureau) implemented total volume controls on real estate financing in March 1990. Stock prices began to plummet in January 1990. After the crash, the Ministry of Finance and the Bank of Japan continued to pursue bubble suppression policies, tightening monetary policy, which worsened the economic downturn until interest rates were finally lowered in July 1991.

3. Injecting Capital into Zombie Banks Without Clear Asset Quality Led to Waste

In the 1990s, the Japanese government injected 800 billion yen of public funds into long-term credit banks and Japan Bond Credit Bank without fully understanding the risk assets of the troubled banks or thoroughly investigating their asset quality. Both banks went bankrupt within eight to nine months, wasting public funds. This rough rescue policy led to excessive bad assets in banks, which chose not to expose risks or pursue liquidation, ultimately being temporarily nationalized. These banks, known as “zombie banks,” hampered the efficiency of the entire financial system.

The end of Japan’s financial crisis was largely due to zero interest rates, which transferred deposit interest to banks, and the interest generated from loans revived the “zombie banks” with already heavy debts, thus filling the losses from the bubble economy.

According to statistics, from 1992 to 2005, Japanese households lost 2830 trillion yen in deposit interest, which can be said to be “zero interest rates restored Japan’s economy,” but at the cost to ordinary people.

4. Limited Effect of Fiscal Stimulus and Massive Increase in Government Debt Leading to Long-term Economic Stagnation

Many empirical studies show that the relationship between fiscal policy and GDP growth is not obvious. Fiscal expenditure mainly focused on fixed asset investment, which could not effectively stimulate consumption or significantly increase tax revenue. Japan carried out several large-scale infrastructure projects in the 1990s, which temporarily boosted GDP significantly but did not have lasting effects. Some even believe that large-scale infrastructure projects fixed the labor force in regions with low growth rates, hindering economic recovery.

In fact, Japan proposed a “balanced development” national comprehensive development plan in the 1970s, requiring even distribution of fiscal allocations. Under the economic policies of the 1990s, the government allocated over 100 trillion yen to local governments for large-scale infrastructure, leading to the first population reverse flow after WWII, with people moving from cities to rural areas.

This overall inefficient fiscal investment led to continuous increases in government debt, trapping the economy in a long-term slump. The author suggests that fiscal investments should be more focused on urban infrastructure to enhance urban carrying capacity, thereby improving investment efficiency and returns.

5. Bureaucratic System and Japan’s Traditional Contracting Model Led to Loss of Competitiveness in the ICT Industry During the Next Industrial Revolution

Industry policies formulated by bureaucrats are limited by vested interest groups and cannot achieve technological leadership. For example, the Ministry of Economy, Trade and Industry’s “Information Superhighway Project” in 2007 aimed to develop next-generation search and analysis technologies, initially intending to create a Japanese engine surpassing Google. However, it ended up as a project doing everything but nothing specific. The project was supported by a group of government-approved scientists who also served as legislators, competing for budgets and research funds, ultimately assigning tasks to their students, forming a contractor organization.

Similarly, NTT, a giant privatized state-owned enterprise, still suffers interference from bureaucratic agencies like the Ministry of Internal Affairs and Communications. Technological innovation is constrained by administrative directives, and market competition mechanisms are difficult to function. This government-enterprise nexus causes resource misallocation, preventing private innovative companies from competing fairly, leading to a rigid ICT industry ecosystem, low R&D efficiency, and missing the critical window for mobile internet development.

Japan’s traditional contracting structure also caused the ICT industry to lose competitiveness. Japanese companies like Toyota typically adopt a Japanese-style contracting model, where the core company bears operational risks and maintains long-term relationships with suppliers. According to statistics, Japanese automakers have fewer than 300 suppliers, all long-term partners, with contracts as short as four years. In contrast, American automakers usually have over 2,000 suppliers, with mostly one-year contracts. While the Japanese model fosters good cooperation, it is unsuitable for IT-related software development and component manufacturing, which require modular development and production.

6. Lifetime Employment and Seniority System Led to Lack of Motivation for Progress

Lifetime employment and the seniority system form the core of the “Japanese employment model,” ensuring wages increase with age and experience, providing job security for employees and their families. Under the seniority system, employees progress from staff to section chief, department head, and possibly to higher positions. This system created Japan’s “Showa Myth”—lifting Japan from ruins to become the world’s second-largest economy in just over 30 years. However, as Japan’s economy and society evolved, and industries transformed, significant problems emerged:

1. Lifetime employment hindered talent mobility, increasing the number of non-regular employees

In this system, the high costs of training and dismissing employees mean that, unless employees leave voluntarily, companies find it difficult to dismiss them. While this maintains workforce stability, it also causes rigidity in talent mobility. Companies cannot quickly adjust their human resources to market changes, reducing overall economic flexibility.

To control costs, companies increasingly hire non-regular employees. Since the 1980s, Japan has introduced non-permanent employment forms. By 2019, according to the Statistics Bureau, non-regular workers (dispatch and outsourcing) numbered 21.65 million, accounting for 38.3% of all workers. Non-regular employees often face wage disparities compared to regular employees, with fewer opportunities for promotion and raises.

2. This employment model also causes inefficiency and intergenerational conflict

Under lifetime employment, some regular employees become complacent because they are difficult to dismiss. Many slack off, loafing at work or wasting time, leading to phenomena like the “marginal workers” who, after reaching a certain age (possibly under 50), are assigned to window seats to idle away time until retirement. Meanwhile, young people find it hard to access high-quality jobs, creating intergenerational inequality.

3. Affects Japanese people’s risk-taking and innovation consciousness

The employment system shapes Japan’s unique work values, with most Japanese believing that working in government agencies and large corporations offers greater security. This further suppresses risk-taking and innovation. Japanese tend to save to prevent risks, and few are willing to start their own businesses. Since interest rates are a reflection of risk, Japan’s long-term zero interest rates discourage risk investment, and venture capital opportunities are scarce.

Currently, with the labor market supply and demand reversing, Japan’s traditional workplace culture is breaking down. As of April 2024, over 30% of new graduates leave their first job within three years. **$VIRTUAL **$IR