Client Affairs

Europe's Future - Becoming Like Japan

Artur Baluszynski, 26 November 2019


Henderson Rowe’s Artur Baluszynski, director and head of research, explains some of the conditions that point the eurozone and US economies heading down a similar path to Japan, and how that could be avoided.

Europe has a demographic challenge in the form of an ageing population and birth rates that are below replacement level. Absent immigration, population levels could shrink (which might not be such a terrible thing if one buys the arguments of environmentalists who worry about "overpopulation"). An ageing population can, so commentators say, mean a less dynamic or "youthful" economy, with a lower appetite for risk, less adventurousness and lower rates of return. On the flipside it might also - hopefully - make fewer great mistakes. Whatever the outcome, however, it is arguable that Japan's present situation holds many lessons for Europe. There are differences of course: Japan is a single nation state, while much of Europe is under the umbrella of a transnational entity called the European Union, from which one of its main members, the UK, is attempting to remove itself. But even so, a country that has a large debt, low growth and a greying workforce is something European policymakers should examine. This is the view of Artur Baluszynski, director and head of research at Henderson Rowe.

The editors of this news service are pleased to share these views and urge readers who want to take part in debate to contact us at and The usual editorial disclaimers apply.

“Japanisation” might soon afflict Europe and the US. It describes a stagnating economy that goes down a deflationary spiral with almost no demand for credit or consumption from the private sector. No growth and no inflation.

Among the many factors underlying Japan’s ‘Lost Decade’ (or decades, to be more apt) in the 1990s and 2000s, were bubbles in property and equities. Both speculative bubbles were punctured in 1989 when the Bank of Japan started aggressively raising interest rates. Since then, inflexible economic policy, adverse demographics and deleveraging of the private sector have been keeping Japan’s economy in a deflationary state.

Some of the developed economies, like those in Europe, have been making exactly the same mistakes Japan did in the 1990s. Although the US managed to avoid some of the banking system issues Europe experienced in 2011, its over reliance on the Fed’s monetary policy keeps fuelling a potential bubble in financial assets while driving up wealth inequality. This, in turn, will most likely be a drag on future demand and consumption.

Obsessed with deleveraging
Just like those in Japan 30 years ago, European leaders made a serious policy error when they failed to quickly address the banking crisis emerging at its early stage in 2008. The European political leadership were completely unprepared for the deflation that hit the eurozone and, therefore, had very little chance to prevent it from taking hold.

The eurozone is a bank-financed economy, which means corporates and households could not lend from the banking sector even if the demand were there. Obsessed with deleveraging, its banking sector and some parts of its non-financial corporate sector have been prioritising repairing their balance sheets, showing little interest in lending to the real economy. Richard Koo, a former economist at the Fed, developed a term for this scenario, called ‘balance sheet recession’. If the private sector is paying down debt, the public sector has to be borrowing and spending to prevent prolonged deflation from setting in.

The eurozone’s biggest problem is the Maastricht Treaty, which caps the deficit-to-GDP ratio at 3 per cent. Once in a balance sheet recession, if the private sector is saving 10 per cent of GDP and the government can only borrow 3 per cent, the economy is very likely to experience deflation.

In 2011, when Greece was forced to introduce austerity measures to qualify for more “help” from the troika – the decision group on bailouts made up of the European Commission, European Central Bank and the IMF – the banking system experienced an almost complete breakdown. Both the private and the public sector tried to deleverage, resulting in the collapse of the economy. The Greek economy reached 0.8 per cent surplus in 2018, but with unemployment hovering at around 22 per cent.

Demographics are also an important factor. Most developed economies have shrinking populations, creating a strong deflationary headwind. Most people want to pay off their debt before they retire, which usually means higher savings and lower consumption. In the US the babyboomer generation has to retire their debt before they can actually retire, and the average millennial has around $35,000 in student loans. Both are damaging for future consumption.

Monetary policy is impotent when dealing with a structural problem such as demographics; it failed to work in Japan in the 1990s, and it will most likely fail to work in the US and Europe. Yes, quantitative easing in the US and, to some extent, in Europe helped some households and corporates to deleverage smoothly, but one should not hold one's breath for any sharp re-leveraging spurred by the low interest rate environment.

Looking at Japan’s example, we see the self-perpetuating cycle of increasing debt, lower interest rates and slower growth. Developed economies with ageing populations have a severe funding problem. As their residents grow older, the government cost per capita – or more accurately, the cost of healthcare – accelerates. With fewer young people in the workforce, the tax base keeps shrinking. To close the funding gap, the government has to issue bonds, increasing its debt-to-GDP ratio.

For Japan, that ratio is at 236 per cent. However, because most of its debt is held domestically, chances of an outright default are pretty slim at the moment. Furthermore, because the government relies so heavily on Japanese savers, of whom there are fewer every year, it might need to tap into external funding at some point. This is when the situation can deteriorate very quickly as foreign investors will most likely ask for higher interest to reflect the Japanese credit risk.

While the US and the EU, with their debt ratios at 106 per cent and 80 per cent, respectively, are still far behind Japan, their population age profiles are not that dissimilar.

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