A number of hypotheses have been presented to explain Japan's continuing economic failure since the beginning of the ninetees: inadequate fiscal policy, the liquidity trap, depressed investment due to over-investment during the "bubble" period of the late 1980s and early 1990s, a broken banking system due to a combination of the former, outdated labour market and work practices, growing competition from China, and (my own strong hypothesis, of course) demographic processes. While we have many hypotheses, we have, as yet, no coherent and compelling account. The Hayashi and Prescott paper examines the history of the "lost decade" using a standard neoclassical growth model. It identifies finds two developments which seem to be important for understanding the Japanese economy in the 1990s. First and most important: there was a fall in the growth rate of total factor productivity (TFP). This, argue the authors, had the consequence of reducing the slope of the steady-state growth path and increasing the steady-state capital-output ratio. Their most important finding: that the drop in the rate of productivity growth alone cannot account for the near-zero output growth in the 1990s.
Japan a Lost Decade: Fumio Hayashi and Edward Prescott
This paper examines the Japanese economy in the 1990s, a decade of economic stagnation. We find that the problem is not a breakdown of the financial system, as corporations large and small were able to find financing for investments. There is no evidence of profitable investment opportunities not being exploited due to lack of access to capital markets. The problem then and still today, is a low productivity growth rate. Growth theory, treating TFP as exogenous, accounts well for the Japanese lost decade of growth. We think that research effort should be focused on what policy change will allow productivity to again grow rapidly.