Matt Yglesias points to a recent talk by Adam Posen of the Peterson Institute on Japan:

Japan’s new economic leadership in the early 2000s, Prime Minister Junichiro Koizumi, Cabinet Office and later Financial Services Minister Heizo Takenaka, and Bank of Japan Governor Toshihiko Fukui, turned matters around. They reversed monetary policies that contributed to deflation, turned the fiscal impulse to average net zero (see figure 5), and forced bad loan write-offs and recapitalization by the Japanese banks (figure 6).10 What few seem to appreciate, either inside or outside of Japan, is just how strong the resulting Japanese recovery from 2002-2008 was. It was the longest unbroken recovery of Japan’s postwar history, and, while not as strong as pre-bubble Japanese performance, was in fact stronger than the growth in comparable economies even when fuelled by their own bubbles.

As Matt observes, Japan’s strong performance was masked by demographic change. The size of the workforce was shrinking throughout this period, thus creating a powerful drag on overall output.

Posen does not go into great detail about the Koizumi reform effort, but it’s worth remembering that Koizumi liberalized the labor market. Since Koizumi’s departure from the political scene, he has been attacked as a “free market fundamentalist,” as The Economist noted last August:

Mr Koizumi is playing a big role in this election too. He is not on the ballot, after shamelessly betraying his own anti-dynastic principles by bequeathing the right to run for his seat to his son. But he still looms large—these days, as a target for both Mr Hatoyama and Mr Aso. Both men appear more intent on laying into his legacy of free-market reforms, though some predated his rule from 2001-06, than on attacking each other. They blame his removal of a ban on temporary workers in manufacturing for soaring inequality and high rates of poverty in a country that used to pride itself on being almost universally middle-class.

Among other things, Koizumi also privatized the postal banking system, trimmed the public sector, and dramatically pared back wasteful infrastructure spending. In a 2006 retrospective, The Economist gave a sense of the extraordinary sweep of Koizumi’s free market reforms.

To be sure, Koizumi’s reforms also coincided with a sharp increase in income inequality in Japan. Some will see this as an indictment of the Koizumi era. As I’ve noted in an earlier post, I tend to think that wage dispersion is closely tied to the rise of digital organizations in advanced economies. Restraining wage dispersion through labor market regulation and high marginal tax rates seems to have the unhappy consequence of restraining potential productivity gains that flow from trial-and-error organizational innovation. The explosion of upper-tail inequality is driven in part by political choices. But the alternatives were less attractive than critics of “free market fundamentalism” fully understand.

If anything, I don’t think the Koizumi project went far enough. That will surprise no one.

In the Wall Street Journal, Michael Auslin of AEI adds some thoughts on Japan’s modern-day dilemmas:

The real problem in Japan may be a social one, not governmental or industrial, and therefore much harder to resolve. Every society develops according to its own logic (or illogic), and Japanese society, with all its depth and complexity, has evolved to fit the particular needs of the Japanese themselves. The question is whether these societal structures are too rigid for a globalized economic world, where capital must flow freely, ideas must circulate and consumers must be given a wide menu of choices. Japanese society continues to place strong if not overwhelming emphasis on hierarchy and consensus, which unintentionally dampens the entrepreneurial spirit that drives modern capitalism. In part because of that, the creative energy of many Japanese is diverted into a rich world of personal interests, separate from economic activity.

This bent towards hierarchy and consensus has traditionally restrained economic inequality, as we recently discussed. The country now finds itself in an awkward middle ground. Too unequal to be harmonious, too rigid to be economically dynamic.