Vijay Kumar Gaba

The tremendous economic growth achieved by Japan in the post-WWII era is popularly known as “The Japanese Economic Miracle”. It was in fact nothing less than a miracle – a country totally devastated by war rose from ashes to become one of the largest economies in the world. Japan recorded a high rate of economic growth during 1950-1975. The growth was primarily led by strong capital accumulation, strategic initiatives to expand trade share in global markets, concentration on technology development & innovation, and development of a strong high-quality ethical workforce.

Supported by benign monetary policy, easy credit, and profligate fiscal policies, by the end of the 1970s, Japan had become a powerhouse of technology and finance. The 1980s however witnessed unprecedented heating of the Japanese economy. Asset prices ballooned to unsustainable levels. The Bank of Japan, in its wisdom, decided not to tighten the monetary policy to control the surging asset prices. Low rates and a stronger JPY, led to a prolonged phase of low growth and low inflation. Worsening demography, due to a variety of reasons, further exacerbated the deflationary pressures in the economy. 1990-2020 witnessed Japan struggling with low inflation and low growth. The Global Financial Crisis and Covid-19 pandemic made things only worse.

The present state of the Japanese economy has become a generic reference for economies struggling with low growth, low inflation, low rates, and high debt for a prolonged period; and is referred to as “The Japanification of Economy” in the popular economic lexicon.

Post the Global Financial Crisis (GFC) in 2008-09, the fears of Japanification of several global economies increased. Unprecedented monetary easing in the wake of Covid-19 further enhanced the risk of a prolonged phase of low growth in several developed and developing countries.

In the past couple of years, we have witnessed a strong spike in inflationary pressures across the globe. Initially, it was believed that this episode of inflation is mostly a consequence of supply-chain issues, which broke down badly due to the pandemic; hence it would be transitory. However, later it emerged that it may be more structural than transitory.

The quantitative easing in the wake of the GFC did not cause consumer inflation, because money printed during 2009-2011 was mostly given to banks, which did not lend much of it to consumers. The velocity of money remained very poor; thus the actual money supply did not increase materially. But during Covid-19, a large chunk of new money flowed into the hands of consumers increasing demand at a time when supply was seriously constrained. High inflation was a natural consequence. Erratic weather conditions globally and a war between Russia and Ukraine (major suppliers of energy and food to Europe in particular) added further to the food and energy inflation.

In the past fifteen months, the central bankers globally have tightened the money supply and efforts have been made to add production capacities to meet incremental demand. It seems for now inflation has been controlled; though the inflationary expectations remain high as it is commonly believed that slower growth and financial crisis (that looks imminent) would force central bankers to open the liquidity taps again – sooner than later.

Nonetheless, for now, Japanification of the US and Europe has not happened as inflation remains high, rates have been hiked and recession has been avoided.

On the other hand, the conditions in China eerily resemble the conditions in Japan during the early 1990s. After two decades of massive growth led by huge investments in technology, infrastructure, and manufacturing capacities, the Chinese economy is feeling the fatigue. The population is aging and employment conditions are worsening. The growth rate is consistently declining. The real estate market is in a bubble-like situation, with several defaults and a huge inventory. China is the only major economy, besides Japan, that has not cut rates in the past decade. Inflation continues to remain low. The financial institutions are weakening and fiscal support to consumers and the financial system remains high.

The risk of the Japanification of the Chinese Economy is real and material. Considering that China has been a major driver of global growth in the past couple of decades, a Japanified China cannot be good news for the world as a whole. However, on the positive side, it may be an excellent opportunity for India that may get favorable conditions for growth – what Japan got in two decades post WWII and China got after its admission into WTO.

 In a recent research report, Goldman Sachs estimated that “energy bills will peak early next year at c.€500/month for a typical European family, implying a c.200% increase vs. 2021. For Europe as a whole, this implies a c.€2 tn surge in bills, or c.15% of GDP.” The bank believes that repercussions of this “will be even deeper than the 1970s oil crisis.” Obviously, a problem of the magnitude would require an impactful policy intervention that could have wider and deeper implications for decades to come.

The policy interventions could involve partial suspension of free market mechanism; rationing of energy consumption; fiscal subsidies; deferment of climate goals and increased use of coal and/or accelerated shift to renewable sources of energy etc. Besides, there could be serious geopolitical implications also.

In another interesting paper, McKinsey & Co, outlines how inflation may be flipping the global economic script. In the paper McKinsey’s experts have examined many of the strategic implications of inflation. The key points highlighted in the paper could be summarized as follows:

·         In the past six months, inflation has far exceeded December 2021 expectations. In many countries, actual rates have doubled projections. European countries are particularly affected. Asia is seeing a less severe change: Indian inflation is about 7 percent, only a bit above projections; and South Korea is at 5 percent. In China and Japan, inflation remains muted.

·         In response to inflation’s alarming rise, central banks worldwide are raising their core bank lending rates. So far, however, rate raises in most countries have not matched the pace of inflation. The rising rates are expected to ease demand and lower prices for two critical components of headline inflation: housing and commodities such as energy and metals.

·         The lift-off in fertilizer prices, supply chain snags, drought, along with other fallout from the war in Ukraine, has pushed prices for basic foods much higher. Since 2021, food prices have risen to their highest level since the United Nations’ Food & Agriculture Office began its index. Prices today are considerably higher than in past surges in 2008 and 2011.

·         As economies stabilized and reflated post Covid, real wages began to creep higher again. But rampant inflation checked that growth, rising so fast that it has diminished the purchasing power of people’s take-home pay. For example, workers in the United Kingdom today have seen their real compensation fall by roughly 8 percent year-on-year.

·         As prices soar, and show few signs of abating, the risk is that inflation becomes entrenched and central banks will have to raise rates more assertively to slow demand. The growth may slow down much more than previously estimated.

The global economy is therefore entering a prolonged phase of correction and realignment. For many these corrections may be extremely painful, while for some it could provide an opportunity to enhance their position in the global order. India, being one of the least impacted countries in this global turmoil, hopefully would fall in the latter group. Amen!