ECONOMY: Could Europe and Cyprus face a fate worse than Japan\’s two-decade stagnation

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Europe’s financial analysts are growing increasingly concerned over the EU catching what economists have called the Japanese disease, which would see a prolonged period of stagnation, bad news for the eurozone.


Japanisation or Japanification, as the ‘disease’ is also known, is a phrase used by economists, which has become shorthand for an extended period of economic stagnation, on the lines of the "two lost decades" that followed on from the collapse of Japan's bubble economy in 1990. 

Finance houses such as Pimco, Societe General and Bank of America Merrill Lynch have repeatedly issued warnings of "turning Japanese" over the past decade. Dutch bank ING and BNP Paribas have even developed indices that purport to measure "the risk of the Japanese disease."

Low growth and rock bottom interest rates have characterised the economic landscape in much of the developed world since the global financial crisis of 2008, setting off the alarm.

Conditions that drove Japan’s lost decades were inadequate corporate investment, imprudent leverage, excessive valuations and asset bubbles.

There was also inflexible economic policies and lavish regulation, as well as a loss of competitiveness and unfavourable demographics. These resulted in falling profitability, sub-par growth, deflation, government sector leveraging, private sector deleveraging and market crashes.

Finding that the eurozone, and consequently Cyprus, may be heading for a prolonged crisis far worse than Japan, Nicos Kousis, Professor of Finance at Frederick University is concerned.

“Due to the different features of the two cases, the symptoms may be similar or the same, but the outcome could be different with the EU finding itself in an even longer period of stagnation,” Kousis told the Financial Mirror.

And this, not so much due to difference in the size of the economy as to the fact that the union is made up of a number of countries with widespread inequalities, which will make it difficult to implement a single cure for the entire bloc.

“Europe appears to have diverse characteristics along these dimensions and lacks the monetary and fiscal tools (due to common currency and one-size-fits-all policies) to move away from the vicious circle of low growth and unemployment,” Kousis explained.

“These significant differences are not in Europe's favour. Japan, for example, has never experienced the disastrous effects of mass unemployment that has afflicted much of southern Europe,” he added.

Even after several years of recovery, youth unemployment in Spain remains at 38%, while overall unemployment in Greece stands above 17%.

Kousis also finds that having a single currency may be a disadvantage for many countries, especially in the south, as they do not have the fiscal tools had they had their own currency.

The Frederick professor said that one of the tools the European Central Bank had at its disposal was to bring down interest rates, which it has already exhausted.

Meanwhile, the ECB is having a hard time convincing local banks to give out loans, increasing the circulation of money and enhancing investments.

“Furthermore, Europe is heavily dependent on its banking system which makes things even more difficult,” said Kousis.

“At the same time, there are no alternatives to the banking system, no alternative forms of financing small businesses and consumers. This is even more true for the Cypriot economy.”

Labour market

One of the things Japan did to overcome the prolonged stagnation was to open up its labour market to immigrants, something which a large number of EU member states are not willing to do.

“Germany may have the room to do so, but this is not the case for the rest of the EU. Thus, the positive impact was limited to Germany.”

Asked what could be done, Kousis said that the EU could leave a bit more breathing space for countries. “Allow them, that is, to have more room for deficit if they are to channel money towards growth.”

Demetris Georgiades, chairman of the Fiscal Council, appeared more concerned over responses proposed to combat the ‘so-called’ Japanisation of the European economy.

Several politicians, he said, are proposing to increase spending to boost the economy.

“However, throwing money into a sector, without making sure that the money doesn’t go for consumption and investment, would be like throwing money down a black hole,” he said.

Georgiades explained that throwing money into investments which will not contribute to real growth, such as equities and real estate, will only lead to bubbles.

He noted the ECB has done what it could to boost liquidity and help the circulation of money in the real economy by lowering interest rates, but it did not work. “Just like in Japan”.

Georgiades is worried about economists who upon reading the statistics and data, suggest that the EU is walking down a path similar to what Japan did a couple of decades ago.

“Some economists and politicians come to the conclusion that they should push countries with surpluses to increase spending in order to bring up the union’s indices.”

Nevertheless, the question is always the same. “How can you be sure that spending, e.g. in a new port, will pay off and there will be no lost money or a perpetual hole?”

These arguments ignore the particularities of each EU member state.

“For example, Cyprus has a large private debt, while a big part of its revenue is not permanent, so by boosting consumption we might be creating permanent expenses which we will not be able to cover in the future”.

“The eurozone today has a surplus in its current account with third countries, and if there is a switch to consumption, with an increase of spending on third-country products, you risk turning the current surplus into a deficit, affecting the eurozone's balance sheet negatively,” said Georgiades.

He said Cyprus is consistently above 3% GDP growth which is quite high under the current circumstances, while unemployment has dropped and is expected to continue dropping, and we are witnessing the increase in the prices of some real estate.

However, there is still a danger that an overarching policy will lead to the economy heating up and bubbles bursting.

“Cyprus has to comply with fiscal rules called for debt reduction surpluses and close its ears to economists calling for the reduction of surpluses to increase consumption,” said Georgiades.