Andrew DeWit: Japan’s Twenty Year Response to Economic Crisis
We have some good news, and we have some bad news.
First the good news. A little common sense is breaking out both within and about Japan. Within Japan, an election seems almost certain for the month of May. Comfy in his captain's chair, Prime Minister Aso is at present testing his 19% level of public support and -- with helpful advice from Mr. "structural reform" Takenaka Heizo -- is hoping to ride out the storm and his legal tenure. Japanese constitutional law requires that an election be called by September, and both Aso and Takenaka apparently believe that by then there will be some kind of recovery of the economy both globally and within Japan. They also seem to be betting that Aso’s YEN 2 trillion cash payout to residents (about YEN 12,000 per taxpayer) will boost support, even though upwards of 70 percent of poll respondents apparently see it as wasteful (which it is).
Aso’s wishful thinking is not shared by the LDP elders. They are, therefore, pressing him to call an election shortly after the budget is passed by the Diet. They understand that, following a 35% drop in exports in December (year on year), a 2009 recovery is unlikely. And they show signs of grasping that the current crisis is almost certain to be far worse come September. The LDP clearly worry that an electoral loss is almost certain at present, and could turn into a perfect storm, particularly if Aso's "straight on till September" obstinacy holds sway. The February 8 Nikkei makes note of their pressure on Aso, adding that if he ignores it he risks being thrown overboard. So one bit of good news is that the LDP elite know they have no choice but to go to the people quickly. This could mean that Japan’s weak and unimaginative leadership, confronting an historic crisis with a paucity of ideas, may come to an end. If so, one can only hope that the LDP will not simply be followed by more old boys bereft of ideas and leadership skills.
Another note of good news is found in Martin Fackler’s February 6 New York Times article, proclaiming that "Japan's big-works stimulus is lesson." There has been a great deal of discussion about what the United States might learn from Japan's experience of dealing with the collapse of the bubble economy, but most of it has been less than illuminating. Beyond the obvious lesson that the financial and fiscal authorities ought to act much faster than the Japanese did (and note that the Japanese authorities' slowness is often exaggerated), a few pertinent lessons have made it into the public debate. The article notes one of the major lessons is that the size of the fiscal stimulus needs to be huge, and that the spending needs to be sustained "until recovery takes firm root." Moreover, another lesson is that spending should not be willy-nilly. Japan bought itself numerous failed resorts, empty airports, and silent concert halls, in addition to the so-called roads and bridges to nowhere. The huge fiscal stimulus packages of the 1990s not only helped raise the public debt to 180% of Japan's GDP (by far the largest of any big OECD country), but they also imposed onerous burdens on local governments for projects that provided little basis for new economic growth.
The New York Times article points out that spending on education and social services would have delivered far more "bang for the buck than infrastructure spending," but that is not all. Imagine the benefits Japan would be enjoying now had it invested heavily in renewable energy projects, where it sadly lags behind countries such as Germany as well as -- surprise, surprise -- the United States. Indeed, under the Koizumi regime, in 2004, the subsidy for solar power purchases was axed in a striking display of market fundamentalist overreaction to the state's misguided stimulus policies of the 1990s. Japan's focus on old-style infrastructure also bolstered political lobbying for more of the same. All those skewed incentives contributed to the severity of the current downturn, since the workforce and domestic economy were not retrained and focused towards sustainable growth areas. As the article notes, citing an emeritus professor of public finance at Shimane University, "in hindsight, Japan should have built public works that address the problems it faces today, like aging, energy and food sources... This obsession with building roads is a holdover from an earlier era."
So the good news is that we may be approaching the end of an era, both in the governance of Japan as well as in the notions of how the state can most effectively stimulate the economy. The latter is a particularly important lesson for the United States, which at present is embroiled in a debate over whether to use tax cuts to try and resuscitate the unsustainable economy that collapsed, or to emphasize smart spending to stimulate the economy and shift its industrial base. If the smart emphasis becomes common sense in Washington, it will become common sense in Tokyo as well, as it is already emerging among the Japanese Democrats. Even PM Aso has of late been paying lip service to the idea of a Japanese-style “green new deal.” The real deal in Washington, centering on support for renewables, the “smart grid,” and other modern infrastructure, will encourage the same in Tokyo. This could mean that Japan will have to learn from the Americans the right lessons from its own policy failures during the years of waste as well as its “structural reform” road to unsustainable export dependence.
But now the bad news. As the very astute blogger Tobias Harris notes in his February 8 comments entitled "twenty years of crisis," Japan might be on the edge of some desperate and potentially dangerous measures. After the collapse of the asset bubble and the descent into deflation, Paul Krugman argued that the Japanese central bank ought to "credibly promise to be irresponsible." Krugman's advice was that Japan needed to adopt an inflationary target in order to pull itself free of deflation and a liquidity trap (the latter obtains when nominal interest rates are already close to or equal to zero, in order to counter a recession, but the financial system and actors in the real economy do not respond with increased lending as well as increased investment and consumption). Krugman's advice to aim at inflation, even recklessly so, has been deeply controversial within Japan. Advising that the present regime, not particularly renowned for fiscal and financial probity, be let loose seems a recipe for disaster to many observers.
Notwithstanding these concerns, Krugman's advice remains attractive to some domestic actors. As Harris notes, the failure of Japan to escape its "lost decade" (indeed, its "lost twenty years") has seen a group of 15 LDP Diet members form "the Diet members league to consider the issuance of interest-free government bonds and government money." They want the government expand the money supply by a whopping ¥50 trillion, bypassing the Bank of Japan, so as to fund new rounds of economic stimulus. The group understands that there is a risk of hyperinflation, but they argue "we are facing hyper-deflation, so we need a policy to create hyper-inflation. We have to do something to undermine the central bank and government's credibility or else we won't be able to halt the yen's rise. So, while we know this is drastic medicine, we will do it."
As Harris notes, these people have clearly read Krugman. But have they read the more recent contributions from Krugman? In his February 6 opinion column for the New York Times, entitled "On the Edge," Krugman argues for smart public spending. He goes on the attack against the absurd proposals for tax cuts coming from Senate and House Republicans in Washington. The defeated presidential candidate, John McCain, went so far as to propose the fiscal stimulus be scaled back to $420 billion and be focused on tax cuts. This is in contrast to the advice of his unofficial economic adviser during the campaign, Mark Zandi of Moody's Economy.com, who of late has argued before congressional committees for a stimulus in excess of $1 trillion with a focus on such items as food stamps, aid to the states, and other spending. Like Zandi, Krugman warns that "even if a major stimulus bill does pass the Senate, there is a real risk that important parts of the original plan, especially aid to state and local governments, will have been emasculated." Krugman derides the Republicans' focus on tax cuts as "hackneyed political theater" and warns that "Washington has lost any sense of what's at stake -- the reality that we may well be falling into an economic abyss, and if we do it will be very hard to get out again."
In short, Krugman is arguing for smart spending, and nowhere does he urge the financial authorities to, as it were, whip up inflation now. Let's cross our fingers, and hope for a whole lot of learning, fast in Tokyo and Washington.