Response to Miyao's Review on Katz, "Japanese Phoenix"

Richard Katz (The Oriental Economist Report)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on January 12, 2003: posted here with the author's permission.

In reviewing my new book, "Japanese Phoenix: The Long Road to Economic Revival," (which also has a Japanese edition, "Fushicho No Nihon Keizai"), Takahiro Miyao wrote:

"What is missing in Katz' argument ... is the correct understanding and recognition of the seriousness of asset deflation... Losing the value of key assets, stocks and real estate, by more than ten trillion dollars within 10 years could destroy any economy, even the U.S. economy, considering the fact that that matches the size of GDP of the U.S. and twice the size of Japan's GDP...."

"He, just like many other observers of the Japanese economy, seems to dismiss the boom in the asset markets in the 1980s just as a "bubble," or "methods the Japan used to cover up, and offset, its structural flaws."

1) It will be no surprise that I disagree with Miyao-san on several counts. The bubble and its popping are symptoms of deeper problems, not in themselves the main cause of Japan's long stagnation. Many other nations have had property booms and busts, but among rich nations, only Switzerland has done as badly for so long as Japan in the entire postwar era. (On cross-country comparison see ps. 26 of "Japanese Phoenix.")

2) The impact of asset price declines depends heavily on other circumstances. For example, in the first two years after the 1929 stock crash in the U.S., according to economist David Hale, stock wealth disappeared by an amount equal to 60% of U.S. GDP. During 2000-2002, stock wealth disappeared by a much larger amount: 90% of U.S. GDP. Yet, while the U.S. suffered a Great Depression in the 1930s, it had one of the mildest recessions on record in 2001 and is now in the process of getting back to 3% growth or so. If the current U.S. recovery is not as robust as hoped for, is the right prescription trying to push dot.com stock prices back to the stratosphere?

3) In Japan, consumer spending tracks income far more than asset prices. Despite enormous declines in stock and property prices during 1990-97, consumer spending increased at a steady 3% rate. It only turned flat from 1997 onward. Why? Because it mirrored employee income, which also increased 3% annually during 1990-97 and then suffered approximate zero growth from 1997 onward. (See chart on pg. 60 of "Japanese Phoenix")

4) The biggest obstacle to productive business investment in Japan today is not asset price declines, but overcapacity. That overcapacity was generated by, among other things, the price manipulation that Miyao-san seems to advocate. The late 1980s was indeed a bubble. The land underneath the Imperial Palace was not really worth more than the state of California, and trying to recreate such false values is futile. Moreover, the bubble corrupted the banking system and corporate investment. Buildings were treated like stock options. When a building can be built for $25 million and sold for $50 million to someone who in turn thinks he can sell it for $100 million, then buildings will dot the landscape whether or not they can obtain profitable rents. Eventually, when the bubble inevitably pops, building construction will plummet. The same is true of other industries. Auto companies built capacity for 15 million vehicles and yet they've never sold more than 11. Steelmakers can produce 110 million tons and yet have never sold more 80 million in the last two decades. Retailers kept adding capacity in the 1990s even as sales per square foot kept falling. Why would automakers and steelmakers and retailers add still more useless capacity just because stock and land prices are pushed back to bubble prices? To propose that Japan recreate the bubble is to propose yet another bust down the line--even assuming it were possible to recreate it (which it is not). (This is discussed in chapter 4).

5) In my view, the real reasons for Japan's stagnation are twofold:

a) Growing inefficiency throughout the non-traded sectors of the economy, such that an economy once capable of growing 4% a year can now grow only 1% or so even at full capacity; and
b) Chronic shortfalls in demand caused by Japan's failure to make the usual developmental shift toward consumer-led growth fed by household income. (see chapter 2 and 4 on these two points).

It would be nice if Japan could cure its problems via some gimmick like propping up asset prices. In fact, the LDP has repeatedly tried to engineer this "solution"--e.g. the notorious "price-keeping operations" and they have failed to pull it off.

Unfortunately, the path to revived growth is a more arduous one, one entailing thorough structural and institutional reform. In my view, the election of Koizumi signaled the increasing intellectual consensus that structural reform is needed. However, the LDP, even under Koizumi, cannot implement it. Moreover, reformers disagree among themselves as to what constitutes reform. Defining the reform program, creating the institutional vehicle and reaching critical mass will take Japan's reformers several more years.

Finally, Miyao compared my views of those of Heizo Takenaka. Takenaka may not succeed; the odds are against it. Moreover, some of the policies that allow Takenaka's opponents to attack him as a hardliner are determined by Koizumi, not Takenaka. Nonetheless, I believe his efforts are a critical part of the long-term struggle for reform. He has successfully defined cleaning up the bad loans and zombie borrowers as the first critical step in reviving Japan.