Comments on the Koo and Takenaka Papers

Koichi MERA (University of Southern California)

In the Glocom Platform, two papers were introduced on August 29, 2002, one from Richard Koo entitled "Japan Needs Stimulative Fiscal Policy," and the other by Heizo Takenaka entitled "Rejoinder to the Groundless Criticism against ‘Restrictive Fiscal Policy." I was shocked by the contrast between the two papers and their contents. The two leading economists of Japan are holding two quite different views and there is no common ground. Koo says Japan is in a critical situation and therefore requires drastic remedial action in the form of a significant increase in government spending. However, Takenaka maintains that the government has to pursue a long-run consistent policy of gradual improvement of the economy, and that fiscal policy cannot address a short-run issue.

What strikes me most is the lack of a sense of crisis in the comments of Takenaka, Minister of Economy and Fiscal Policy of the government of Japan, who is responsible for steering the world's second largest economy. He does not appear to be seriously concerned with the fact that Japan has gone through a "lost decade" with no improvement in sight, the economy is undergoing serious deflation, the stock market is experiencing a 19-year low, and bad loans are increasing rather than decreasing. He is not committed to any drastic action for rectifying the sources of the economic problem. At least within fiscal policy he is not addressing this critical economic/financial issue. He says that he intends to improve the primary fiscal deficit of 4.3 percent of GDP in 2001 by 0.4 – 0.5 percent per year, and to achieve a healthy primary balance in 10 years. This could be done if the economy does not deteriorate in the future. But the outlook is not encouraging to say the least. In fact, the future looks bleak.

On the other hand, Koo sees the current economic woes as extraordinary, caused by a drop of asset value of 1,200 trillion yen since 1990 and Japanese companies unable to borrow money because they first have to repair their balance sheets. Households are saving for rainy days in the future, but there is no demand for their savings. Thus the current deflation will continue unless the government implements a drastic stimulative policy. He recognizes well the important characteristics of the Japanese economy. However, he does not state for what purposes public money should be spent. If we extrapolate from the past, such stimulative expenditures are directed to building of roads, dams, fishery ports and agricultural land improvements, which do not have great productive impacts. Many Japanese are weary of such urban-rural transfers, and would not support his proposition.

I am sympathetic to Koo's position in that he correctly points out the basic problem with the economy. However, a mere expansive fiscal policy will not solve the over-saving and deflationary malaise of the economy within a short span of time. A strategy should be developed for how money should be used to eradicate the fundamental problems of the economy.

As of this writing, the Tokyo stock market has fallen to a 19-year low. Last March Prime Minister Koizumi's price keeping operations (PKO) were successful in raising the stock index to a sufficiently high level to keep major banks from falling into capital deficiency. However, it is a different story today. As Professor Fukao explains in today's Debate, "banks' capital base has become insufficient." This is a critical problem for the entire economy. If banks are not functioning the economy cannot function. The health of banks is the number one problem for the entire economy. Once banks are rejuvenated, young and emerging corporations will be able to invest, giving life to the economy. Other corporations will then be able to do better.

However, banks should not be pardoned for their bad loans. Banks need to be restructured. All banks that have inadequate capital should be nationalized and be sold to new owners. In the process, all bad loans will be transferred to a government agency for this purpose. All senior bank managers who have mismanaged banks in the past should be replaced with new managers. The government has to spend a considerable amount to repair the balance sheets of the banks. This is a quite different way of spending money from the traditional construction expenditure. But this will have a lasting effect as it will correct the fundamental problem with the economy.

Restructuring of the banks alone may not be enough to turn around the economy. Consumers should be encouraged to spend more. This requires the government to present a vision of a bright future to the public. It will not be based on strengthening the traditional life-time employment or restricting competition for security, but will be based on assuring good rewards to skills and performance while promoting mobility and competition. Already such shifts are taking place, and the government's support through the provision of basic infrastructure for such shifts will further encourage the transformation. Lowering income and corporate tax rates is one move, but there should be many others. Transaction costs in general should be lowered. Stamp duties should be terminated, real estate purchase taxes should be eliminated, and the capital requirements for corporations should be lowered.

The government is urged to re-examine its economic and fiscal policy seriously, and I would ask Richard Koo to think beyond mere increases in government spending.