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Nomura Research Institute's Richard Koo says that what the world is experiencing right now, a "balance sheet recession," is different from traditional recessions. However, Japan recently experienced a similar type of recession, and Koo says we can learn a lot from that country's experiences. Interviewed by Daniel Erasmus at King's College, April 2010.

c'est la thérorie de Pangloss, Japonisation. (tu me dirais ce n'est pas la pire des solutions)

As I see it, Japan’s problem was that during the 1980s it was so addicted to investment-led growth and artificially cheap financing that it misallocated capital on a massive scale and failed to include the resulting implicit losses in its GDP calculations. Especially after the Plaza Accord, Japan went on an investment binge that left it with a huge amount of wasted capital. Because of this overinvestment Japan grossly overstated its true GDP during much of the 1980s. Japan’s share of global GDP, after all, nearly doubled in that decade, which is almost too extraordinary to be true, in my opinion.

If it had correctly valued the true economic losses on the various investments, or if it had liberalized interest rates and “de-socialized” credit, and so correctly valued the subsequent rise in non-performing loans, Japan’s reported GDP growth rate in the 1980s would have been much lower. Japan’s true GDP, in other words, was never as high as its reported GDP – and the margin between the two was substantial.

So what happened in the past two decades, when Japan’s share of global GDP declined by over 50% (from 17% in 1991 to 9% last year – another number too extraordinary to be true, in my opinion)? I would argue that in real terms Japan didn’t actually suffer from zero growth. It kept growing, but because it had to write down all of that false GDP during this period, real growth was sharply understated in the official GDP numbers. Of course the fact that Japanese banks and corporations did not even begin to write down the losses for a very long time meant that capital continued to be misallocated, albeit at a slower pace than before.

This is not the problem that that the US or Europe is suffering from. They suffer from a typical debt-fueled overconsumption boom, whereas Japan suffered from a typical debt-fueled over-investment boom, and Japan’s period of over-investment was much, much more extreme (centralized investment booms can last much longer and go much further than decentralized consumption booms). This is why I think the Japanese experience tells us almost nothing about what Europe and the US will go through.

But the key point is not the broad generalization. It is that Japan had a massive overinvestment problem that was at the heart of its economic malaise. The Japanese crisis was not “caused” by the collapse in the stock or real estate markets any more than the Great Depression was caused by the 1929 stock market crash. They were simply symptoms of overinvestment, which is what caused the crash, the surge in debt, and the subsequent economic stagnation.

This is not the problem from which the US and Europe have suffered in the past decade. There is no reason, I would argue, to assume that their adjustments should at all be similar.