Lost Decades

Based on Wikipedia: Lost Decades

In 1989, if you wanted to buy all the real estate in Tokyo, you would have needed more money than existed in the entire United States. The Imperial Palace grounds alone—a patch of land smaller than Central Park—were theoretically worth more than all the real estate in California. Japanese companies dominated global rankings. Thirty-two of the world's fifty largest corporations by market value were Japanese. The country seemed unstoppable, a economic miracle that had transformed a war-devastated nation into the world's second-largest economy in just four decades.

Then it all collapsed.

What followed wasn't a recession in any normal sense. It was something economists had never quite seen before: a wealthy, technologically advanced nation entering a state of suspended animation that would last not years, but decades. The Japanese call it "Ushinawareta Jūnen"—the Lost Decade. But that name became outdated. The Lost Decade became the Lost Twenty Years. Then the Lost Thirty Years. As of 2025, Japan's nominal Gross Domestic Product—the total value of all goods and services the country produces—is actually lower than it was in 1995. Not lower in growth rate. Lower in absolute terms.

How does a wealthy nation simply stop growing for an entire generation?

The Bubble That Ate Japan

To understand the Lost Decades, you have to understand what came before: a bubble of almost cartoonish proportions.

Throughout the 1980s, the Bank of Japan—the country's central bank, equivalent to the Federal Reserve in the United States—had been quietly encouraging banks to lend more money. They did this through something called "window guidance," essentially telling banks how much they should be lending. The banks complied, and money flooded into the economy.

But here's the thing about floods of easy money: they have to go somewhere. In Japan, that somewhere was real estate and stocks. Land prices tripled. Stock prices tripled. Everyone was getting rich on paper. Banks kept lending because the collateral—land and stocks—kept appreciating. Companies kept borrowing because assets kept rising. It was a self-reinforcing cycle of euphoria.

The economist Paul Krugman later observed that Japanese banks "lent more, with less regard for quality of the borrower, than anyone else's." They weren't asking whether borrowers could repay from their business earnings. They were looking at collateral values and assuming those values would keep climbing forever.

They didn't.

The Day the Music Stopped

In late 1989, the Bank of Japan finally got nervous about the speculation it had helped create. Officials sharply raised interbank lending rates—the interest rate at which banks lend to each other overnight. This made borrowing suddenly expensive after years of being cheap.

The stock market crashed. Land prices began a long, grinding descent. Within a few years, these assets had fallen to just 40 percent of their peak values.

This wasn't just a financial problem. It was an existential crisis for Japan's entire banking system.

Japanese banks had lent enormous sums using land and stocks as collateral. Now that collateral was worth a fraction of the loans it secured. The banks were technically insolvent—they owed more than they owned. The same was true for countless companies that had borrowed to buy assets at bubble prices.

What came next created a phenomenon that economists would study for decades: the zombie economy.

The Walking Dead of Corporate Japan

Here's where Japan made a fateful choice. The government could have let failing banks and companies go bankrupt, accepting short-term pain for long-term healing. Instead, it chose to keep them alive through a combination of capital injections, cheap central bank loans, and creative accounting that allowed banks to hide their losses.

These became known as "zombie banks." They weren't dead, but they weren't really alive either. They stumbled along, technically solvent but functionally paralyzed.

The zombies created more zombies. Banks that should have cut their losses instead kept lending to failing companies—what some called "zombie firms." Why? Partly because admitting those loans were bad would force the banks to recognize their own insolvency. Partly because these companies were seen as "too big to fail." Partly because of the close, almost familial relationships between Japanese banks and their corporate clients.

These zombie firms weren't investing in new products or technologies. They weren't hiring aggressively. They were just... existing. Consuming capital that could have gone to dynamic new companies. Employing workers who could have been more productive elsewhere. Taking up space in markets that healthier competitors might have filled.

By the time the government finally allowed a wave of bank consolidation in the early 2000s—reducing dozens of major banks to just four national institutions—an entire decade had been lost.

The Strange World of Deflation

Most people in most countries worry about inflation—prices going up. Japan developed the opposite problem.

Deflation is when the general price level falls over time. That might sound pleasant. Who doesn't want things to cost less? But deflation creates a perverse economic psychology.

If you expect prices to be lower next year, why buy today? If you're a business, why invest now when the same equipment will be cheaper in twelve months? If you're an employer, why give raises when the cost of living is falling?

More fundamentally, deflation increases the real value of debt. If you borrowed 100 million yen and prices fall 10 percent, you now owe the equivalent of 110 million yen in purchasing power. Every debtor in the country—and remember, Japan was drowning in debt from the bubble years—found their burdens getting heavier each year.

This created what economists call a "balance sheet recession," a term coined by economist Richard Koo to describe Japan's predicament. Normally, when interest rates fall, companies borrow more and invest. That's how monetary policy is supposed to stimulate the economy. But Japanese companies weren't trying to grow. They were trying to survive. Every spare yen went toward paying down the massive debts they'd accumulated during the bubble.

From 1990 to 2003, corporate investment—normally a major driver of economic growth—fell by an amount equal to 22 percent of Japan's entire Gross Domestic Product. Companies that should have been borrowing and building were instead saving and shrinking.

Pushing on a String

The Bank of Japan tried everything it could think of to restart growth.

It cut interest rates. By 1994, the benchmark rate was below 1 percent. By the early 2000s, it was essentially zero. But here they hit a wall that macroeconomists call the "zero lower bound." You can't push interest rates much below zero because people would simply hold cash instead of keeping money in accounts that charge them for the privilege.

Think of it this way: if a bank account costs you money, you'd rather stuff yen under your mattress. This puts a floor on how low rates can go.

So the Bank of Japan invented new tools. In 2013, it launched "Quantitative and Qualitative Monetary Easing"—a program where the central bank essentially printed money to buy government bonds and other assets, trying to force more cash into the economy. In 2016, it actually pushed interest rates slightly negative, to minus 0.1 percent, essentially charging banks for holding reserves.

These unconventional policies achieved unconventional results: mild inflation of around zero to one percent. Not the robust growth anyone hoped for, but at least the economy had stopped actively deflating.

The Human Cost

Statistics can obscure suffering. Here's what the Lost Decades meant for actual Japanese people.

Real wages—what workers could actually buy with their paychecks—fell roughly 13 percent from their 1997 peak to 2013. This was unprecedented among developed nations. In most wealthy countries, wages might stagnate during bad years, but they don't fall for sixteen years straight.

The nature of work itself changed. Japanese companies had been famous for lifetime employment, a social contract where workers gave loyalty and companies provided security. That contract shattered. By 2009, more than a third of Japanese workers were "non-regular"—temporary, part-time, or contract workers with lower pay, fewer benefits, and no job security.

Household income in 2010 had fallen to 1987 levels. People weren't just failing to get ahead; they were sliding backward through time.

The conspicuous consumption of the 1980s—when Japanese tourists were famous worldwide for their spending—never returned. A generation grew up learning frugality, expecting stagnation, skeptical that tomorrow would be better than today.

The Competition Catches Up

While Japan stumbled, its neighbors sprinted.

In the 1990s, Japanese companies like Sony, Panasonic, Toyota, Sharp, and Toshiba dominated their industries. They were synonymous with quality and innovation. Japanese consumer electronics were what everyone wanted.

By the 2010s, Samsung, LG, and Hyundai from South Korea had become global giants. Chinese companies like Huawei, Lenovo, and BYD emerged as major players. These competitors didn't just catch up—in many industries, they surged ahead.

That statistic about corporate rankings bears repeating because it's so stark: in 1989, thirty-two of the world's fifty largest companies by market value were Japanese. By 2018, only one remained in the top fifty: Toyota.

Japan's labor productivity—how much economic output each worker produces—also fell behind. In 1990, Japan ranked sixth among the G7 nations, the club of the world's largest developed economies. By 2021, it ranked last, 29th among the 38 members of the Organisation for Economic Co-operation and Development.

The Mountain of Debt

Throughout the Lost Decades, the Japanese government tried to stimulate growth through fiscal policy—government spending. When consumers won't spend and businesses won't invest, the theory goes, government can step in to keep the economy moving.

Japan stepped in again and again and again.

The result is the highest public debt of any developed nation: roughly 240 percent of Gross Domestic Product as of 2013, and it's only grown since. To put that in perspective, a debt-to-GDP ratio above 90 percent is considered worrying for most countries. Japan is nearly three times that level.

Some economists argue this saved Japan from an even worse fate—a depression like the one that devastated the United States in the 1930s, when GDP fell 46 percent. Richard Koo believes the massive government spending filled the hole left by collapsing private investment, keeping the economy from complete collapse.

Others, like economist Scott Sumner, argue that Japan's monetary policy was simply too tight throughout this period, and that bolder central bank action could have ended the deflation years earlier.

Japan's situation is unusual in that most of its government debt is held domestically—by Japanese banks, insurance companies, and the Bank of Japan itself, rather than by foreign investors. This makes a sudden debt crisis less likely than in countries dependent on foreign creditors. But it doesn't eliminate the burden of servicing that debt or the constraints it places on future policy options.

The Curious Case of Abenomics

In December 2012, Shinzō Abe became Prime Minister of Japan with an ambitious reform agenda that would bear his name: Abenomics.

The program had "three arrows"—a metaphor from a Japanese folk tale about three arrows being stronger than one. The first arrow was aggressive monetary policy: the Bank of Japan would flood the economy with money until inflation reached 2 percent. The second arrow was flexible fiscal policy: government spending to stimulate demand. The third arrow was structural reforms: changes to make the economy more competitive and productive.

The initial response was electric. The stock market, which had languished around 9,000 in 2008, rallied to 20,000 by May 2015. Investors were betting that this time, finally, Japan had found the formula to escape its trap.

Reality was more complicated.

A survey in January 2014 found that 73 percent of Japanese people hadn't personally noticed any effects from Abenomics. Only 28 percent expected to get a raise. Nearly 70 percent were planning to cut spending because of a sales tax increase—the opposite of what the program intended.

The structural reforms, the crucial "third arrow" that was supposed to boost productivity and competitiveness, proved politically difficult to implement. Changing labor laws, opening protected industries to competition, empowering women in the workforce—all faced entrenched opposition from interest groups who benefited from the status quo.

The Yen's Strange Journey

One consequence of Japan's ultra-low interest rates has been a dramatic weakening of the yen.

Currency values are influenced by interest rate differences between countries. If Japan offers near-zero returns while the United States offers 5 percent, investors will sell yen to buy dollars, pushing the yen's value down. By July 2024, the yen had fallen to 161 per dollar—a 37.5-year low.

Even more striking is the "real effective exchange rate," which adjusts for inflation differences and trade patterns. By June 2024, this measure hit its lowest level since statistics began in 1970. The yen had become extraordinarily cheap by historical standards.

A weak currency is a double-edged sword. It makes exports more competitive—Japanese cars and electronics become bargains for foreign buyers. But it makes imports more expensive, squeezing consumers who buy foreign goods. It also makes the country poorer in international comparisons.

This currency depreciation contributed to a symbolic blow: in 2024, Germany overtook Japan to become the world's third-largest economy in nominal dollar terms. Germany's economy had been roughly half Japan's size just a decade earlier. Japan hadn't actually shrunk dramatically; the yen had simply become worth so much less in dollar terms that Germany's smaller economy now translated to a larger dollar figure.

A Trap Made of Decisions

Political scientist Ian Lustick and economist Jennifer Amyx have offered a fascinating lens for understanding Japan's predicament: the concept of a "local maximum."

Imagine climbing a mountain in dense fog. You climb upward whenever you can, and eventually you reach a point where every direction leads down. You've found a peak. But is it the highest peak? You can't tell—the fog prevents you from seeing that a much higher summit exists nearby. To reach it, you'd have to climb down first, into the valley, before climbing up to the greater height.

Japan, in this metaphor, reached a local maximum in the 1980s. Its institutions, its relationships between banks and companies, its employment practices, its regulatory systems—all were optimized for the economic landscape of that era. They had climbed as high as those structures could take them.

But the landscape changed. Globalization, the internet, the rise of China and South Korea, new industries like software where Japan had no inherent advantage—all these shifts meant the rules were different. Japan's institutions were optimized for the wrong game.

The tragedy is that Japanese experts often knew what needed to change. But getting there would require first getting worse. Banks would have to acknowledge losses. Zombie companies would have to fail. Protected industries would face competition. Workers would lose jobs before new ones appeared. Politicians who implemented such reforms would bear the blame for the short-term pain while their successors might reap the credit for long-term gain.

So Japan stayed on its local maximum, year after year, decade after decade.

Signs of Dawn?

Then something unexpected happened: global inflation.

The COVID-19 pandemic scrambled supply chains worldwide. Russia's invasion of Ukraine disrupted energy markets. Central banks that had printed money during the pandemic saw that money chasing too few goods. Inflation surged across the developed world in 2021-2023, hitting levels not seen in decades.

For most countries, this was a problem to be solved through painful interest rate increases. For Japan, it was almost a gift.

After trying for over twenty years to create inflation, Japan finally had it—imported from abroad, but inflation nonetheless. By 2023, Japan's inflation rate exceeded 2 percent, the target the Bank of Japan had been chasing since the early 2000s.

In February 2024, the Nikkei 225 stock index reached 39,098.68—higher than it had ever been during the bubble era, finally surpassing records set in 1989 after thirty-five years.

Some declared victory. Japan had escaped the Lost Decades at last.

Others remained skeptical. The Nikkei's rise reflected corporate reforms and global investor interest as much as domestic economic health. Japanese companies had become more shareholder-friendly, more willing to return cash to investors, more efficiently managed. But GDP growth remained anemic. Consumer spending was tepid. The demographic crisis—an aging, shrinking population—hadn't gone away. The mountain of debt remained.

As of 2025, Japan's nominal GDP and GDP per capita both remain lower than they were in 1995. In 1995, Japan's economy represented 17.8 percent of global GDP; by 2025, that share had fallen to 3.6 percent. These aren't signs of a nation that has escaped anything. They're signs of a nation that has been standing still while the rest of the world sprinted past.

What Japan's Story Means

The Lost Decades aren't just a Japanese phenomenon. They're a warning and a puzzle for economists worldwide.

The warning is about asset bubbles and their aftermath. When land and stock prices detach from reality, the eventual correction can create damage that takes decades to repair. The temptation to paper over problems—to keep zombie institutions stumbling along rather than allowing creative destruction—can extend the pain indefinitely.

The puzzle is about what to do when conventional tools stop working. When interest rates are already zero, what lever does a central bank have left? When consumers and businesses refuse to spend regardless of incentives, how do you restart an economy? When an aging population naturally spends less and saves more, how do you generate growth?

Japan tried nearly everything: zero interest rates, negative interest rates, quantitative easing, fiscal stimulus, structural reform programs. Some economists argue the policies worked better than they're credited for—that without them, Japan would have experienced something far worse than stagnation. Others argue the policies were too timid, too late, too constrained by political considerations.

Perhaps the deepest lesson is about institutional flexibility. The same structures that helped Japan succeed spectacularly in the postwar decades became anchors in a changed world. Success can create its own trap, optimizing for a landscape that no longer exists.

Japan remains one of the world's wealthiest nations. Its infrastructure is impeccable. Its society is safe and orderly. Its technology, while no longer dominant, is still sophisticated. Its culture has global influence. In many ways, Japan is a pleasant place to live.

But for a generation of Japanese, the Lost Decades represent something profound: the death of the assumption that tomorrow will be better than today. That each generation will surpass the last. That hard work and education guarantee upward mobility. That a nation can expect continuous progress.

These assumptions turn out to be assumptions, not laws of nature. Japan discovered this truth, painfully, over thirty-five years. Whether it has finally escaped—or whether the Lost Decades will become the Lost Half-Century—remains to be seen.