The Parallels Between the Crises in Japan and the Eurozone

As the economic situation in the Eurozone remains difficult, there are justified concerns that the Eurozone’s economic future will look much like the situation that the Japanese economy has faced for the past two decades.  In fact, many of the same terms used to describe Japan’s economic struggles, such as “deflation”, “high debt levels” and “depressed domestic demand”, are all being used when describing the challenges facing the Eurozone economy today.  So, does this mean that the Eurozone faces long-term economic decline and a reduced standing in terms of global economic power and influence?

Before looking at the similarities between the Eurozone and Japan, it is important to note that there are some vital differences between the two economies.  For example, the Eurozone has a population that is nearly three times as large as Japan’s, and one that is far less homogenous than that of Japan.  This allows economic decision making to be highly centralized in Japan, whereas in the Eurozone, decision-making has proven to be a long, drawn-out process.  Another important distinction is that Japan was the world’s wealthiest large economy in the early 1990s, whereas the Eurozone’s per capita GDP levels today are nearly 40% below those of the United States.  Finally, Japan’s research and development spending as a percentage of GDP was far higher than that of the Eurozone today. A key factor is sustaining long-term economic growth.

While it is clear that there are major differences between the economic situation that Japan faced in the 1990s and the situation facing the Eurozone today, there are also a number of clear similarities.  First and foremost, both economies faced severe demographic declines that were the leading catalyst for the downturns in domestic demand that left both economies dependent upon export markets for their growth.  Second, both economies had currencies that were highly overvalued at a time when weaker currencies were needed in order to boost their export competitiveness.  Together, these demographic declines and overvalued currencies resulted in deflationary pressures that persisted in Japan for 20 years and are now threatening to derail the extremely fragile economic recovery in the Eurozone.

It is also important to look at the relative economic performances in Japan and the Eurozone before, during and after their respective crises.  In the decade before Japan’s economic crisis, its economy expanded by an average of 4.6% per year, an extremely impressive rate of growth for such a wealthy economy.  In contrast, the Eurozone economy expanded by exactly half that rate (2.3% per year) in the decade before 2008’s financial crisis.  In the seven years since the economic crisis in the Eurozone, its economy has actually shrunk, falling by 0.1% per year since 2008.  In the first seven years of Japan’s deflationary crisis, its economy actually expanded by 0.9% per year thanks to continued export growth.  In fact, Japan’s economy continued to expand by slightly less than 1% per year throughout its two-decade battle with deflation. 

For the Eurozone, it appears that its economic future looks something much like the last two decades have in Japan, with overall economic growth rates of around 1% per year.  On the positive side, the Eurozone’s demographic decline is not a pronounced as Japan’s, and the Eurozone has a greater capacity for increasing immigration, if it can attract highly skilled immigrants.  This will also prevent the Eurozone’s domestic market from declining as quickly as Japan’s did.  On the negative side, the Eurozone remains much too diverse to function as a unified economy and this situation will not change in the coming years.  Moreover, the Eurozone’s strength in high-quality manufactured exports will be challenged by competition from Asia and elsewhere.  As a result, the Eurozone is headed for a long period of low-growth and a persistent threat from deflation and this could impact the Eurozone’s unity over the long-term.