Comments on Japan's Non-Performing Loans Issue

Craig Freedman (Professor, Macquaire University)

This commentary originally appeared in the "Japan-U.S. Discussion Forum" (http://lists.nbr.org/japanforum) on October 10, 2002: posted here with the author's permission.

I believe the non-performing loans issue to be at the heart of Japan's economic problems. Perhaps what has made Japan unusual is its long delay in dealing with this problem. Many countries have faced similar aftermaths of asset inflation (especially following financial deregulation), but all of them have finally bitten the proverbial bullet. I don't see how Japan can escape its current predicament (if it wishes to do so) without following some policy like temporary nationalization of banks. (The case of the Long Term Credit Bank would be an example.)

I may differ with some of the other writers in this forum [the Japan-U.S. Discussion Forum] in stressing deficient aggregate demand as the problem rather than excess aggregate supply. It is here that we can understand the role that asset deflation (especially of the housing sector) has played. Housing prices have a greater wealth effect in most economies than previously credited. (It is the housing sector for instance that has kept the Australian economy out of recession for the last few years.)

Though the logic of the role that zombie corporations may play in the economy seems feasible, I can't recall seeing any empirical evidence of the actual impact this has had. On the other hand, figures for deficient aggregate demand (consumer spending and business investment) are not hard to find. Government spending kept aggregate demand from collapsing and avoided a severe recession. It wasn't however able to keep aggregate demand growing at any self sustaining level. One thing though is clear. Decreasing aggregate supply wouldn't help anything. The ultimate goal is to shift resources, rather than shrink the economy. (I'm not accusing anyone of advocating economic shrinkage.)

One last question which I pose to the political scientists and others in the forum. Why should I think that Koizumi is an economic reformer? Let me be for a minute a hard headed economist and look only at what has been done. By his actions I could say Koizumi is a nationalist, but the only assurance I have that he is an economic reformer is his own statements. Why though couldn't the following be plausible. Koizumi is simply a more or less standard LDP politician. He wanted to be Prime Minister. He could never achieve this aim through the usual route. He jumps on the idea of being a reformer to gain grass roots support. Then once the position is gained, his policies that he claims are meant to be economic reform are really ways to attack opposing LDP factions. If this is the case, he isn't going to do anything that would put his own position at risk. Namely, tackling the non-performing loans problem is politically risky as the short run consequences are unlikely to be popular. In which case, despite all the rhetoric, we may not see Koizumi do anything very constructive about the non performing loan problem. The cabinet shake up was yet another example of a Japanese politician wanting to appear to be doing something without actually taking any real risks. My thinking may have become far too cynical here, but I would be interested in any response.