Abstract

This paper examines Japan's ongoing economic challenges, particularly its prolonged deflation since the early 1990s asset bubble burst, the effects of low interest rates, and the recent shift to raise the benchmark interest rate. While the economy is experiencing increased foreign investment, concerns about takeovers of important companies should alert the government. In this paper, I will argue that Japan must carefully balance promoting foreign investment with protecting strategically important industries to recover from stagnation.

The Prolonged Lost Decade 

Describing Japan's deflation as a decade-long issue is misleading, as the economic crash from the early 1990s remains unresolved, hindering Japan’s competitiveness in attracting investment in a growing global economy. After World War II, Japan emerged as a global manufacturing hub, leading to a booming property market fueled by a slump in private non-residential investments (Horioka, 2006). By the mid-1980s, Japan entered its "Baburu Jidai," or bubble era, during which property and stock prices soared seemingly without limit, transforming the country into a model of efficiency and remarkable economic growth. However, in the early 1990s, the bubble burst, causing productivity growth to decline and stagnate at low levels for more than two decades (Hayashi and Prescott, 2002). The enduring impacts of this bubble burst include persistent deflation and high public debt, which have exceeded 200% of gross domestic product (GDP) for many years. Compounding these challenges are Japan's struggles with an aging population and the rise of China as a dominant force in global manufacturing, both of which continue to raise questions about the Japanese economy’s future. 

Japan’s Monetary Experiment 

The Bank of Japan's unconventional recovery measures are undermined by a lack of trust in the domestic market, making sustainable economic recovery challenging. Of the central banks that adopted a more assertive stance, the Bank of Japan (BoJ) was a pioneer in implementing “forward guidance.” This strategy involved maintaining interest rates at zero (ZIRP), as noted by BoJ Governor Hayami, “until deflationary conditions subside.” (Montgomery, 2019). Japan's prolonged period of Zero Interest Rate Policy (ZIRP) and subsequent negative interest rates policy (NIRP) aimed to stimulate economic growth by reducing borrowing costs, hence encouraging businesses to invest and consumers to spend. However, despite these measures, the desired outcomes have been hit-or-miss, largely due to persistent economic uncertainty and cultural tendencies towards saving rather than spending. Domestic businesses remain cautious in their investments, hindered by a lack of confidence in future demand. Achieving the ideal scenario of robust investment and consumer activity in a chronically low interest rate environment has proven challenging in Japan's unique economic landscape.

The End of Low Interest Rate 

Decades of stagnant growth in wages have put pressure on the BoJ to finally end its more-than-25-year monetary experimentation in early 2024. As reported in a press release from the BoJ conference, the average base wage in the annual ‘shunto’ spring negotiations has grown by 3.7%, up from 2.3% in the spring of last year, and has exceeded the current inflation rate. The BoJ has raised its benchmark interest rate from minus 0.1% to the range of 0 to 0.1% hoping to reach a 2% stable inflation rate, a mark that would finally signify escaping deflation. The current interest rate, though still low, demonstrates Japan’s further commitment to reach a healthy economic state. 

Challenges

Japan has witnessed an increase in foreign takeover bids, driven by a consistently weak yen, a result of the BoJ's monetary policies which have made major Japanese firms more accessible and appealing for acquisition. According to Tanabe et al. (2023), the number of mergers involving Japanese companies reached an all-time high of 4,304 in 2022. Not only was there an increase in the number of deals, but the total deal value also rose by 23%, according to a Bain & Company report on Japan M&A by Ohara (2024), reaching approximately $123 billion in 2023 despite a global downturn. A notable case that has the potential to shape the future M&A scene involves Seven & i Holdings, the parent company of the well-known convenience store chain 7-Eleven, which is currently being targeted by the Canadian giant Alimentation Couche-Tard, renowned for its Circle K brand (Lewis and Keohane, 2024). Despite the need for foreign investment, Japan finds itself in a challenging position, as 7-Eleven is a brand of considerable significance. This has led to Seven & i Holdings Co. being classified as a “core” company, which would subject Alimentation Couche-Tard to stricter regulations similar to those applied to acquisitions of defense contractors or energy firms, as reported by Yoshida and Umekawa (2024). The Japanese government now navigates a delicate balance between promoting foreign investment through mergers and acquisitions and retaining control over its 'core' industries, which hold significant political, cultural, and economic importance for the Japanese public.