Japan's Comeback: Why the Lost Decades Ended and Nobody Noticed

The Japanese stock market spent three decades getting destroyed. From 1989 to 2020, the Nikkei 225 index barely budged. You could have invested £10,000 in 1989 and, in 2020, you'd have roughly £10,000. No returns. No growth. Just a sideways march that made everyone think Japan was finished. The world moved on. Japan became a cautionary tale—a country that had been economic superpower and then simply stopped.

This narrative was wrong. Last year, the Nikkei hit an all-time high. This year, it's hitting new records. Japanese companies are more profitable than they've ever been. Unemployment is at historic lows. Wages are rising. The yen has stabilised. And most of the world is only now realising that Japan's lost decades are over.

How did this happen? And more importantly, how did nobody notice?

The Lost Decades

To understand the comeback, you have to understand the collapse. In the late 1980s, Japan was a miracle. It had gone from devastated, post-war wasteland to the world's second-largest economy in 40 years. Japanese companies dominated electronics. Japanese cars were more reliable than American cars. Japanese manufacturing was the envy of the world.

The problem was that this success created massive asset bubbles. Real estate prices tripled. Stock prices exploded. Everyone assumed it would last forever. Banks lent recklessly. Companies expanded aggressively. Investors poured money into projects with no sensible rate of return.

Then, in 1989, the bubble burst. Asset prices collapsed. Property values crashed 80%. Banks were left holding mortgages on properties worth less than their loans. Companies had expanded into businesses that couldn't possibly be profitable. The financial system nearly broke.

Rather than let the market clear, the Japanese government did what governments always do: it tried to support asset prices artificially. It pumped money into the economy. It cut interest rates to zero. It spent enormous sums on infrastructure projects that nobody needed, just to keep employment up.

For a while, it looked like it was working. The economy seemed to stabilise. But the fundamentals were rotten. Zombie companies kept existing because the government was supporting them. Resources flowed to preserve the old economy rather than build the new one. Innovation suffered. Young people got depressed by the economic stagnation and stopped taking risks.

The result was what economists called "Japanification"—an economy that was technically functioning but actually dead. It produced just enough output to keep society functioning. But it didn't grow. It didn't innovate. It didn't create wealth.

The Obstacles to Recovery

Multiple structural problems kept Japan locked in stagnation. First, the banking system was crippled. Japanese banks held massive quantities of non-performing loans. They were technically solvent but operationally broken. For 20 years, the focus was on stabilising banks, not on lending to new businesses.

Second, Japanese corporate governance was atrocious. Companies were run by networks of executives who had been in the same position for decades. Boards were rubber stamps. Accountability didn't exist. You could run a company into the ground and still get a promotion. This meant that the most innovative and aggressive entrepreneurs left Japan entirely. They went to Silicon Valley or Hong Kong or Singapore. Japan lost an entire generation of risk-takers.

Third, the labour market was rigid in ways that strangled dynamism. In America, you could hire and fire people relatively easily. In Japan, once you hired someone, they were essentially permanent. This created a perverse incentive: companies became extremely cautious about hiring because they were committing to decades of payroll. Rather than hire and fire to match demand, companies preferred to have overcapacity and idle workers.

Fourth, the government kept imposing structural rigidities to protect the old economy. Retailers were protected from foreign competition. Construction contracts were steered to big companies. Import restrictions kept foreign goods out. The Ministry of International Trade and Industry (MITI), which had been the architect of Japan's postwar growth, now became the architect of its stagnation, protecting industries that should have died.

The Generational Shift

The turnaround started slowly, with demographic shifts that nobody saw as relevant. The Japanese population started ageing. Young people had fewer children. The workforce started shrinking. This sounds catastrophic, but it created an opportunity: if you can't get cheap labour, you have to get more productive workers and pay them more.

Companies started raising wages in the early 2020s. For three decades, Japanese wages had been stagnant. Now, for the first time, the tight labour market forced wages up. Workers had power. Companies had to compete for talent.

This should have happened decades earlier. It took Japan 30 years to accept what was obvious: if you can't hire cheaper, you have to hire smarter. You have to invest in technology. You have to treat workers better. You have to innovate.

The Structural Reforms

Around 2015-2018, Japanese corporate governance started changing. The change wasn't revolutionary, but it was real. The government started pushing companies to improve returns on equity. Activist investors like Carl Icahn bought stakes in Japanese companies and demanded better governance. Boards started including independent directors. Executive compensation started being tied to actual performance rather than seniority.

This sounds boring, but it was crucial. Once board members could actually be held accountable, corporate behaviour changed. Zombie companies that had been kept alive through government subsidies started being shut down. Resources flowed to profitable businesses. Unprofitable units were sold or closed.

At the same time, Japan started attracting foreign entrepreneurs. Singapore and Hong Kong had been the startup hubs in Asia. Now, Tokyo started becoming a genuine centre of technological innovation. Startups could raise money. The labour market was flexible for foreign talent. The cultural narrative shifted from "Japan is finished" to "Japan is interesting again."

The Geopolitical Tailwind

Japan benefited from global trends that had nothing to do with Japanese policy. The US-China conflict pushed multinational companies to diversify away from China. Japan became an obvious alternative. Companies that had spent decades in China started moving manufacturing to Japan or using Japan as a hub for regional supply chains.

Also, China's demographic crisis became undeniable. Young people in China were becoming scarce. Labour costs rose. The idea of replacing Chinese manufacturing with Japanese manufacturing started to look sensible. Japan suddenly had a competitive advantage it hadn't had in 20 years.

The yen also weakened for reasons largely outside Japan's control. This made Japanese exports more competitive. Tourism returned. Foreign investment poured in. The export sector, which had been sluggish, suddenly became vibrant.

Warren Buffett's Bet

In 2020, Warren Buffett made a stunning announcement: Berkshire Hathaway had invested over $5 billion in five major Japanese trading companies—Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo. These are massive, diversified conglomerates. They're not sexy. They're not innovative. They're boring, old-school companies.

Why would Buffett, the greatest investor of all time, bet on boring Japanese trading companies? Because they were cheap and they had excellent balance sheets and they would benefit directly from the regional realignment happening in Asia. Buffett was signalling that Japan was back.

The market listened. These companies started trading at higher valuations. Their profitability improved. Other investors started asking: if Buffett thinks Japan is a good bet, maybe I should too. The narrative shifted.

The Nikkei Records

By 2024, the Nikkei index broke through to all-time highs. Japanese companies are reporting record profits. Unemployment is at 2.4%. Wage growth is real. Inflation is moderate. The economy is growing.

This might sound normal, but it's extraordinary for Japan. Three decades of stagnation had created a narrative that Japan was finished. The narrative was wrong, but narratives have power. Young Japanese entrepreneurs had believed the narrative. Capital had believed the narrative. Investors had believed the narrative.

Now that the narrative has shifted, capital is flowing. Young people are starting companies again. Foreign talent is moving to Tokyo. Universities are getting more funding. The research ecosystem is improving.

The Lesson

Japan's comeback offers a crucial lesson: sometimes an economy can appear dead even when it's merely dormant. Japan never became poor. Japanese companies never stopped being well-managed (or, more accurately, they stopped being badly managed). Japanese workers were always productive. The fundamentals were never as bad as the narrative suggested.

What changed was structure. Corporate governance improved. The labour market tightened, creating real wage pressure. The global environment shifted, making Japanese manufacturing competitive again. And most crucially, the narrative shifted. People started believing that Japan could succeed again. That belief changed incentives. Entrepreneurs took risks. Investors deployed capital. The machine started moving.

This is why the Nikkei hitting all-time highs matters. It's not just a stock price. It's a signal that Japan, after 30 years of being written off, is being taken seriously again. The lost decades are over. What comes next is anyone's guess. But after three decades of stagnation, the fact that Japan is growing again should be remarkable.

It's remarkable how long it took everyone to notice.