Reply to Takahiro Miyao

Richard Katz (The Oriental Economist Report)

To believe that declining asset prices are the main cause of Japan's problems, as Miyao-san does, is to believe three things:

1) the prices from which current prices descended were valid prices, i.e. that there was no bubble; hence government policy can return asset prices to those levels;

2) that declining asset prices in real estate and stocks are the main cause of demand shortfalls; and

3) that demand shortfalls are the main reason for Japan's "lost decade."

Regarding point 1, Miyao-san apparently believes that there was no bubble. He wrote:

"First of all, such an expression as 'the bubble and its popping' tends to cloud one's analysis, likely leading to the underestimation of the seriousness of asset deflation, at least partly caused by policy mistakes, high real interest rates and high taxes on assets, following the end of the boom years in the late 1980s."

Miyao-san, are you really saying that there was no bubble? Do you truly believe that the land underneath the Imperial Palace was correctly value when it was supposedly worth more than the entire state of California? Do you believe stock prices were properly valued when the price/earnings ratio on the Tokyo first section topped out in the late 1980s at 70? If so, I think you will find few economists in agreement. Asset prices fell because they had to; they had risen to unsustainable stratospheric levels.

Regarding point 2, I already addressed this in a previous posting. The main cause of weak personal consumption is not asset price declines but stagnant income. The main cause of weak business investment is that, in a myriad of industries, there is overcapacity. That overcapacity is, in part, a result of the bubble prices to which Miyao-san would apparently like to return. Beyond that, Japan tried to overcome sluggish productivity by pouring on tons of investment. The result is that the overall ratio of capital stock (e.g. factories, offices, stores, machinery, etc.) to GDP is far, far beyond to historical trends. The other result is, in accordance with the law of diminishing returns, a drop in return-on-assets and a big slowdown in potential GDP growth. Firms also overinvested because they believed that Japan's convoy capitalism would bail them out no matter how foolish or excessive their investments. That is no longer possible. Low investment is just the chickens coming home to roost. On the demand-side, Japan needs to shift from investment-led growth to consumption-led growth, as other mature economies have done. That requires a shift of national income toward households.

Regarding point 3, demand shortfalls are only a fifth of the problem. From 1975 through 1990, Japan grew at 4 percent a year. Economists at the time estimated that its long-term potential growth rate was 3.7 percent a year. Had Japan grown 3.7 percent a year, its GDP today would be 30 percent greater than it actually is. Yet GDP is operating "only" at 6 percent below full capacity. So, at best, demand stimulus could only address the 6 percent problem. What about the other 24 percent? (This is discussed on pgs. 30-35 of "Japanese Phoenix")