Japan's Tail-Chasing Economy

Gregory Clark (Honorary President, Tama University)

With the economy still moribund after Prime Minister Junichiro Koizumi's initial round of "structural reforms," we are now told that cleaning up the banking system will save the day.

But bank bad loans are a result, not a cause, of poor economic conditions. Bank policies that aim to put a bottom on declining asset prices would make sense. But "reforms" that seek to purge and punish the delinquent will simply cause more bankruptcies, more asset value declines, more bad loans and more deflation.

Already the government has had to go back on its promises to keep the fiscal deficit below 30 trillion yen. It has had to further postpone its plan to limit liability for deposits at failed banks (the so-called payoff scheme). Almost daily it is being forced into more piecemeal spending increases to prevent more deflation. Like a dog chasing its tail, it is right back to where it started 18 months ago.

Or even worse. It is back to 1997. According to one reliable banking source, most of the current 50 trillion yen of bad loans said to overhang the economy today are the direct result of bankruptcies and asset value declines caused by post-1996 "reforms." Before then, sensible demand-expanding (Keynesian) policies had got rid of most of the 80 trillion yen in bad loans caused by the bubble collapse. Japan's economy was registering 3 to 4 percent annual growth rates -- the highest of the advanced member nations in the Organization for Economic Cooperation and Development. All this came to a shuddering halt with the first round of fiscal stringency and other "reforms" initiated by then-Prime Minister Ryutaro Hashimoto. Now with the return to Hashimoto-style policies under the Koizumi administration, the economy has gone into another free fall.

Yet there is still no sign of self-doubt. Like some second-rate communist nation, every defeat is trumpeted as allowing a forthcoming success; Tokyo now boasts a promised victory over self-inflicted bad loans and deflation. Those in the government who got it right from the beginning are dismissed as forces of darkness, obstinately resistant to the brilliant future just waiting around the corner. The successful pre-1997 policies are condemned as outdated, leftwing Keynesianism.

How do people get to be so dogmatically mistaken?

The prime minister heads the guilty list. He is obsessed by the amount of official debt. True, at 700 trillion yen, the figures are not pretty. But compared with Japan's very high figure of 1.4 quadrillion yen in personal financial assets, it could be argued that without this official spending Japan's demand gap would have been far worse.

Obviously, it would be better if the government relied more on taxes to finance its spending. But that is a secondary matter. If the level of official debt is too high, why are people still very willing to buy government bonds at very low interest rates?

Curiously the Western experts who worry about the level of official debt in Japan are much less concerned about the dangerous levels of consumer debt in their own countries.

Koizumi's economic advisers also rank high on the guilty list. Many are naive, market-fundamentalist, textbook academics from the strongly rightwing economics departments at Keio and Hitotsubashi universities. Once they were great believers in the IT revolution as Japan's economic savior. Now they embrace the Reagan/Thatcher market-oriented reforms that are said to have rescued the U.S. and British economies in the 1980s.

Whether those U.S. and British reforms -- privatization, liberalization, fiscal cutbacks -- were crucial to subsequent economic recovery can be debated, particularly since there were no fiscal cutbacks. More important, I suspect, was the easing of inflationary and balance of payments problems thanks to the weakening of the trade unions plus cheap imports and funds from Asia and elsewhere. But even if the claimed reforms had been carried out to perfection, they would still be of little relevance to Japan.

Those reforms aimed at creating efficiencies to free up the supply of goods and services to meet excessive demand -- supply-side economics. Japan's problem is the exact opposite -- excessive supply and inadequate demand. It needs demand-side economics.

Also guilty are the rightwing and conservative economic media and commentators in the West who have gone overboard to endorse the Koizumi policies. They need only to look at their own Western economies to realize that it is bubbling consumer demand rather than alleged Reaganite/Thatcherite reforms that has kept those economies afloat.

Or maybe they think that corrupt Enron-style accounting and bloated salaries to top executives represent some kind of reform.

They, too, join the anti-Keynesian chorus. If they could get rid of their ideological blinkers they would realize the almost perfect correlation between low savings levels and strong economic growth among all the advanced economies -- the United States and Australia doing best with household savings levels of close to zero and Japan doing worst with savings levels well over 12 percent. In other words, Keynes was right. It is demand, not supply, that leads our economies. Some point to bank reforms in South Korea as the key to that country's fast recovery. But South Korea's recent progress also owes much more to intense consumer demand.

For a variety of reasons, many cultural, Japan lacks that demand. Massive deregulation might just possibly encourage a turn-around in weak private spending. But ultimately tax reforms allowing the government to take up the demand slack will probably also be needed. Needless to say, the market-oriented experts prefer to urge tax cuts as a way to expand private demand, little realizing that much of the cut will simply end up as more surplus savings.

Now Washington has openly endorsed the most outspoken of Japan's market fundamentalists, Heizo Takenaka, the minister in charge of economic and fiscal policy who has also been put in charge of financial services to oversee the purge of the banks. Reports say the U.S. is concerned over the way Japan's decline allows China to dominate the Asian economy. If the people in Washington really think that Takenaka's policies guarantee Japan's recovery, then maybe it is time for us to go off and learn Chinese.

(This article originally appeared in The Japan Times on October 19, 2002)