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Japan’s economic morality play.

October 26th, 2011 · Gregory Clark · 3 Comments

World attention focuses on the problems of the Greek economy — no doubt with a large helping of schadenfreude added: There, but for the grace of God, go the rest of us is the thought.

But Japan has already been there. Debt relative to GNP in Japan is 30 percent higher even than in Greece. The annual share of budget devoted to debt service has been higher. Japan’s currency and bonds may be seen as a safe haven for funds fleeing Europe. But it too has become a slave to that mistaken economic dogma called “austerity,” and could be headed for the same slippery slope as a result.

Like the original concept of European Union (which many now realize was another mistake — combining prolifigate Greeks, happy-go-lucky Italians and puritanical Germans in the same economic union?) — austerity had respectable origins. Just as the EU was a reaction Europe’s past excessive nationalism, austerity policies were an understandable reaction to the indulgent (mainly welfare) spending in the advanced economies that began in the 1960s and ’70s and has been with us — Japan included — ever since.

Today many of these indulgent economies are in trouble and deserve to be punished for past sins. But economies in trouble usually suffer weak domestic demand. Kill that demand with austerity policies and you kill the economy. To paraphrase U.S. economist Paul Krugman, an economy is not a morality play.

So what happens next?

Commonsense would say that any shortfall in private demand, whether caused by slumps or deeper factors, should be met by in an increase in government demand — the Keynesian solution. But Keynesianism today has been turned on its head by rightwing critics and portrayed as an excuse for governments to spend more at all times.

As someone who has worked in government, I can understand where those critics are coming from even if I do not agree with their anti-Keynesian biases. The political urge in democracies to spend for vote-buying and power-grabbing has always been there. As well, we have the never-ending, bleeding-heart demands for more welfare spending. The Nanny State is out of control. People should be made responsible for much more of their own welfare, perhaps not as much as in China today but certainly more than in most advanced democracies.

But, as in China today, government should also keep tight control of economic policy — spend in slumps and cut back during booms. The austerity believers who argue that cutting back spending in slumps will somehow save economies by boosting investor confidence go beyond even old-time communists in slavish obedience to an unrealistic ideology.

With communism there was always the hope that despite current failures you would eventually reach the pot of gold at the end of the rainbow. Austerity lacks even that saving grace.

Looming right in front of you is a reality so obvious you cannot ignore it. This is the fact that cutting government spending forces recessions that immediately begin to cut government tax revenue faster than the spending cuts reduce the official debt. So the debt you were committed to reducing increases the more you cut spending. You are cutting off the very legs you are trying to stand on.

We saw this only too clearly in Japan during its two decades of austerity policies. The Koizumi “no pain, no gain” austerity period managed to increase the debt by an enormous ¥300 trillion. That Japan’s many austerity advocates still manage to ignore this appalling fact is a tribute to the power of all ideologies, and not just communism, to distort human thinking. Stay-the-course, keep with that pain-inflicting hair shirt called austerity and you will find eventual salvation – that is the mantra.

True, and as in Japan, we see occasional ideology-denying compromises that allow bursts of spending when the pain gets unbearable — rather like the fat man on a diet who cannot resist the occasional binge on chocolate and cream. But that solution will not solve much.

By all means keep the fat man on his diet; do everything to keep government spending under control. But change the menus. Cut excessive welfare spending — old age and medical entitlements especially. Control the military. Sell off unneeded government assets. Hit tax evasion hard. Restrict imports that cut legitimate domestic production.

But do not cut the government spending needed to revive the economy. Instead, insist that this spending concentrate on items with the strong multiplier effects need to boost tax revenues — infrastructure spending especially. Welfare spending rarely has this merit. And finance this spending much more by indirect taxes on specific products, luxury goods especially, and services, while cutting the income taxes, corporate-profit taxes and flat-rate consumption taxes which discourage work incentive and encourage tax evasion.

Meanwhile deregulate almost anything that restricts private investment and consumer spending, even if that means allowing casinos in Odaiba or all-night dancing in Roppongi. Our puritans have yet to realize that even wasteful social indulgencies that encourage people to spend are better that the harm caused by consumers who refuse to spend and who park their surplus funds in banks which refuse to lend because consumers refuse to spend. Here Japan with its cautious consumers is even more guilty than most in its ability to create this dog-tail-chasing, downward, deflationary spiral.

But even better, listen to the voices of reason saying that if there is no inflation risk and official debt is a problem, then governments have the right to create the money, or to force central banks to create the money, needed to overcome recessions and pay back debt. But here we find the dead hand of yet another out-of-date ideology — the one born in those postwar years when excessive government spending led to out-of-control inflation. Those days have gone, possibly forever.

The problem today for the advanced economies is to encourage private demand for domestically produced goods and services. The fiscal conservatives, and they are many in Japan, should not be allowed to keep us fighting the battles of past economic wars when demand tended to outstrip supply. Today that problem has been thoroughly reversed –something that our austerity-addicted, hair-shirt ideologues have yet to realize.

This article by Gregory Clark (website) first appeared in the Japan Times and has been republished on this site with the author’s kind permission. Gregory Clark is vice-president of Akita International University and a former member of the Bank of Japan, Expert Consultative Committee.

3 responses so far ↓

  • 1 Biker // Oct 26, 2011 at 1:31 pm

    Well-written, well-reasoned, balanced argument.
    Very much appreciated.

  • 2 Greg Atkinson // Oct 28, 2011 at 8:46 am

    I am not sure encouraging any consumption is a good idea. One of the problems we have to deal with is over consumption so simply getting people to consume more is just going to cause bigger problems later.

    “Wasteful social indulgencies’ can also lead to an expensive burden on the health care system & higher crime levels for example.

  • 3 Biker // Oct 28, 2011 at 9:00 am

    Greg: “I am not sure encouraging any consumption is a good idea.”

    Difficult call, isn’t it? People practise thrift and your economy (and others) stagnate; but when people save you reduce the need for offshore borrowing.

    Greg: ““Wasteful social indulgences’ can also lead to an expensive burden…”

    No argument there.

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