Introduction

Japan was hit hard by the global financial crisis of 2008-2009; it was the only major advanced economy that experienced negative economic growth in 2008 and continues to contract sharply in 2009 (Figure 1 [ PDF 26.7KB | 1 page ]). Although most advanced countries are now in recession, according to the latest World Economic Outlook (IMF, 2009a), the economic contraction that Japan will likely experience in 2009 (-6.2%) is forecast to surpass the projected contractions for the United States (US) (-2.8%), the Euro Area (-4.2%),¹ and the United Kingdom (-4.1%), where the financial crisis for the most part originated. Among the major economies, Japan is only surpassed by Singapore (-10.0%) and Taipei,China (-7.5%) in the severity of the real impact of the global financial crisis.

When the US subprime loan problem came to the surface in the summer of 2007, many observers thought that Japan was immune to the subsequent global deleveraging, given its limited exposure to “toxic” assets. Indeed, various indicators suggested that the direct financial impact of the global financial crisis on Japan was relatively small. In fact, Japan's banking sector in particular was hardly affected directly, as was evident in the small estimated value of write-downs and the limited cost of public sector support which were only a fraction of the corresponding amount in the US and Europe (Table 1 [ PDF 36.2KB | 1 page ]).

When the US and much of Europe went into recession in early 2008 (Bosworth and Flaaen 2009; Wyplosz 2009), Japan's real economy did not seem to be affected materially. However, Japan was adversely affected by the large negative terms of trade shock in 2008, with a sharp increase in energy and other commodity prices, but it still maintained positive growth in real gross domestic product (GDP) and private fixed investment through the second quarter; export growth was steady through the third quarter (Figure 2 [ PDF 36.2KB | 1 page ]). It was only in the fourth quarter that the evidence of a severe economic contraction was apparent, with a 12.5% (year-on-year) fall in exports. This was followed by a 36.8% fall in the first quarter of 2009. Similarly, industrial production also contracted sharply; it declined by 15.0%, 34.0% and 27.6% (year-on-year) in the fourth quarter of 2008 and the first and second quarters of 2009, respectively. This decline was one of the worst among the major developed countries—in Europe and North America—and Asian economies. When Japan was finally hit, the impact was indeed very severe.

Why was Japan hit so hard by the global financial crisis when its financial system was considered much more robust than those in other developed countries? The rest of this paper attempts to offer an explanation in the following sequence. Section 2 describes what happened in terms of manufacturing production and exports. Section 3 argues that the sharp contraction of economic activity occurred largely as a result of the structural changes in the Japanese economy that had taken place over the past decade. Section 4 quantifies the impact of the structural changes on the responsiveness of Japanese output to global demand shocks by using a vector autoregression (VAR) model of the world economy. Finally, Section 5 offers concluding remarks.

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