Economic policies confused

Gregory Clark (Honorary President, Tama University)

In his campaign for re-election as leader of the ruling Liberal Democratic Party, Prime Minister Junichiro Koizumi, has made much of the current mild economic revival. He sees it as vindicating his economic policies.

His three opponents in the Sept. 20 election -- Shizuka Kamei, Takao Fujii and Masahiko Komura -- have been reduced to saying that the revival is not for real. They should have been saying this:

Of course there is a revival. Given the funds available to the economy and the fact that after prolonged recession people eventually want to go out and buy things, some kind of recovery was inevitable the moment someone started the ball rolling. But none of that vindicates the Koizumi policies.

The ball could have started rolling years ago, through pump-priming increases in government spending. Koizumi and his immature academic advisers stopped the ball dead in its tracks through foolish moves to cut spending. They tried to impose the supply-side economic theories needed to cope with excessive demand in the United States and Britain of the 1980s, on a Japan chronically starved of demand.

The recovery we see now has had to rely on external factors. One is improved economic conditions in the U.S. and Asia. The other is speculative stock-market investment by foreigners willing to ignore the mistakes in the Koizumi policies and impressed by restructuring-induced increases in company profits.

The key element in the Koizumi policies -- the promise to reduce Japan's 700 trillion yen official debt -- has been a failure. His small cuts in government spending have been greatly exceeded by the severe fall in tax revenues induced by the recession he created. The debt burden has been increased, not reduced. Koizumi owes much of his public appeal to Japan's love affair with the word "reform" (kaikaku). From the start the critics should have made it clear that his promises to reform the politics and the bureaucrats, and his promises to reform the economy, were two very different things. Only now are some of the Koizumi critics beginning to try to unbundle the two -- accepting elements of the former while criticizing the latter.

But their economic criticisms are clumsy. They are right to try to point out that a pump-priming increase in government spending -- most like a figure of 10 trillion yen or more -- will more than pay for itself through increases in tax revenues once the economy recovers. Kamei has taken the lead in this area.

But to prove fiscal responsibility, they have let themselves get caught up in promises to increase the unpopular consumption tax. Meanwhile, they say little about the 700 trillion yen official debt figure that worries even those critical of the Koizumi economic policies.

They should point out that given Japan's very high level of domestic savings -- some 1.4 quadrillion yen in personal financial assets -- the willingness of past governments to spend 700 trillion yen was crucial. Without that spending, the economy would have been even more starved of demand than it was.

The mistakes were elsewhere. One was the failure to do more to encourage private spending and so reduce those excessive savings. The other was the failure to rely more on taxes to finance needed government spending.

First priority should have been ways to encourage more private spending. Many advocate investment incentives, but investors will only move when the economy improves. Changes in the wage and other systems that deny funds to younger Japanese keen to spend on housing, leisure and families would help. Immigration policies that help boost domestic spending and allow firms competing with low-labor-cost producers abroad to survive are also needed.

The U.S. system of allowing house mortgage payments as full tax deductions would encourage more building activity. The French reverse mortgage system would move the excessive savings of the elderly into current spending.

As for increasing tax revenues, one move -- which would also cut excessive savings -- would be to clamp down on rampant tax evasion by owners of small and medium-size companies. Low-income earners also receive unduly lenient tax treatment in Japan. Schemes by local authorities to impose what amounts to a turnover tax on firms, regardless of profit levels, will also help.

At the level of indirect taxes, few seem to realize than Japan has long had a sensible alternative to consumption taxes -- namely an expansion of the discriminatory product and services taxes that Japan used to impose before it got caught up in the foolish Western economic rationalism that says flat, across-the-board consumption taxes are preferable.

Forced disposal of bad bank loans was another weak link in Koizumi's economic policies. Since the bad loans were a result rather than a cause of bad economic conditions, the policies have increased bankruptcies and added to the bad loans.

Koizumi supporters used to praise him for moving Japan away from financial socialism. But as bankruptcies and bad loans increased, the state has had to intervene to control the banking system and is now even trying to run bankrupt companies. What we see now is more than socialism. It is pure communism.

Ironically, it is communist China that shows Japan what should have been done. China's level of bad loans relative to gross national product was much higher than Japan's. But by encouraging pell-mell capitalistic growth the problem has gradually disappeared, like the morning mist on a hot day.

(Originally appeared in the September 20, 2003, issue of The Japan Times)