Shareswatch Australia

Australian stock market investing, ASX charts, analysis & market forecasts.

Shareswatch Australia header image 2


A contrarian view of how ‘austerity’ bleeds Japan

March 4th, 2011 · Gregory Clark · 9 Comments

With the Standard and Poor’s downgrading of Japan’s long-term credit rating from AA to AA minus, the focus even more is on how the economy can get out of its current deflationary quagmire.

For most of the 1970s and ’80s, Japan had no quagmire. It followed sensible Keynesian economic polices — fiscal stimulus when the economy was down, restraint when overheated.

The postwar generation of economists was raised on Keynesian principles. One reason I know this is because my father, British economist Colin Clark, who had worked with Keynes in the 1930s, was a frequent and welcome visitor to Japan. His ideas featured in all Japanese school textbooks. He was often invited to talk and write by the then progressively minded Nihon Keizai Shimbun (Nikkei), Japan’s leading economic mouthpiece. One of his students was a young Finance Ministry official, Kiichi Miyazawa.

Popular legend today says increases in public spending during this Keynesian period created the national debt problem we see today. That is completely false. The figures and graphs show clearly how throughout that entire period government tax revenue increased at almost exactly the same pace as government spending. Public debt also increased, but at a rate much less than the rate of inflation.

True, the immediate post-“bubble” years of the early ’90s saw a large increase in public debt. That was inevitable, given the fall in tax revenue as land prices collapsed and the need for stimulus polices to help the economy recover. Those Keynesian-style policies worked. And the prime minister for much of this period? None other than Kiichi Miyazawa.

By the end of 1995 the economy was registering a 4 percent growth rate. The soft landing in land prices badly needed to rescue the banking system seemed likely. Things only began to go downhill with the anti-Keynesian, fiscally restrictive policies of the Hashimoto administration (1996-98). One reason for the change was concern over the post-bubble increase in public debt. Another factor was more ideological — the prevailing U.S./U.K., anti-communist Reaganite-Thatcherite orthodoxy that said Keynesian economics were out and supply-side economics (emphasizing small government, deregulation and market fundamentalism) were in.

Whether the West needed the new economics can be debated in the wake of the recent U.S./U.K./EU banking fiascos. Japan clearly did not need it. The economy went into a swoon. Tax revenues plummeted. Ryutaro Hashimoto’s pledge to cut new borrowing to zero was quickly forgotten. Public debt began its spectacular increase.

There was a brief but very successful return to normality under the Keynesian stimulus polices of the Obuchi-Mori administrations (1998-2001). But the economy quickly resumed its supply-sider tailspin during the Koizumi regime (2001-06). Severe spending cuts triggered a chain-reaction collapse much worse than that under Hashimoto: Falling land prices caused an increase in bad bank loans leading to increased bankruptcies, a further decrease in land prices and further declines in tax revenue.

The Koizumi era saw a massive ¥200 trillion increase in the very public debt that the policies were supposed to reduce (today the debt exceeds ¥900 trillion). The economy was only rescued by its usual reliance on exports — that is, foreign demand rather than domestic demand.

The disastrous Koizumi years led Tokyo to realize vaguely the need to return to Keynesian-style stimulus policies. But they were halfhearted. Conservative anti-stimulus instincts remained strong, especially with the very influential Nikkei group, which had made a complete about-face, even to the point of telling us that Keynesianism was an anachronism.

So government revenues continued to fall. Debt continued to rise. Japan moved firmly into the impasse we see today.

Supply-side economic policies can make sense in economies where private consumer and investment demand are buoyant enough to take up the slack from government spending cuts. They may even be a useful antidote to bad Keynesian policies that encourage excessive government spending and control. Even then, they walk a fine line.

Severe cuts in government spending — austerity as it is now called — can easily depress an economy to the point where cuts in tax revenue exceed cuts in government spending. Deficits increase rather than decrease, as we see in Greece today and in Japan under Hashimoto and Koizumi.

Calls for austerity policies sometimes refer to the economy as a car headed for the canyon of yawning fiscal deficits unless the brakes are rapidly applied. The true analogy is very different: When your car hits a skid what should you do? The instinct is to brake hard, but any good driver will tell you how that only worsens the skid. Instead you should accelerate and drive out of the skid, as Japan did so successfully during its brief Keynesian post-bubble recovery period. Put on the brakes later, if needed. Think contrarian.

Sadly our policymakers often cannot think contrarian. Ever since the Hooverite policies that led to the U.S. Great Depression of the 1930s, they want instinctively to hit the fiscal brakes that serve simply to worsen a recession.

In Britain and Europe we hear happy talk about how austerity policies will somehow save the day by encouraging enough confidence to increase private spending and investment. That’s nonsense. American economist Paul Krugman rightly calls it the “confidence fairy.”

True, the Europe and U.K. economies may be able to muddle through since, unlike in Japan, consumer confidence is hard to dampen, even in recessions. People eventually will always want to spend. The economies also enjoy the stimulus of the currency devaluation caused by their mistaken policies. And sensible financial policies — lower interest rates, quantitative easing — can counter the harm caused by mistaken fiscal policies.

Japan’s situation is very different. Cultural factors, and now population decline, continue to suppress consumer demand. Current plans to increase the consumption tax will only encourage a chronically purse-tight population to cut spending further. Interest rates cannot go lower, and pushing money into the hands of banks and firms that do not want to lend into an already thoroughly depressed economy simply encourages them to buy more government bonds.

Many, Nikkei especially, seem to think that innovations and productivity improvements will save the day. Few seem to realize that in the real world of business, firms will not invest unless they see rising demand for their products. Under the current deflationary situation, that is just not going to happen.

Any solution needs to take account of Japan’s special problems:

• Excessive accumulated savings: Personal financial assets sitting in bank deposits and cash still exceed an enormous ¥600 trillion. This means governments are still obliged to borrow some of that money and spend it simply to remove deflationary pressures.

• Chronic lack of demand: Everything should be done — deregulations especially — to encourage Japan’s reluctant consumers to spend more and allow firms to invest more. A sensible immigration policy would help. The reverse mortgage systems popular in the United States and Europe would dramatically increase spending by the elderly.

• Copy-cat mentality: More than elsewhere, people are influenced by what others do or say. Recessions intensify naturally as a result. If tax increases are needed, then demand-killing consumption taxes should be replaced by specific product and service taxes that are levied at the source and do much less to antagonize flighty consumers.

Finally, if all else fails, and it will almost certainly will, think contrarian, again. Think about shock therapy — the massive injection of public spending proposed by Shizuka Kamei, leader of the small coalition People’s New Party. Last year he called for a ¥100 trillion injection in the budget. All he got was ¥1 trillion.

With shock therapy it is crucial that the funds concentrate on projects with strong employment and spending multiplier effects — noncorruptible public works for example, or even kindergartens, rather than pensions and welfare handouts.

The copy-cat syndrome means that, in Japan, positive multipliers can have very strong stimulatory effects, as we saw during the bubble years. Indeed, it is quite possible that a massive stimulus would, via multipliers, expand both the economy and government tax revenue enough to cover the cost of the stimulus. Debt levels would fall, not rise.

Do not expect such contrarian common sense to prevail. Foreign and conservative criticisms over the debt will push the planners even further back into their shells. The AA minus rating will soon be A minus, or worse.

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.


9 responses so far ↓

  • 1 Biker // Mar 4, 2011 at 10:29 pm

    Reverse mortgage systems? The same rorts which put the Brits so far in debt their property markers imploded?!!!!

    Saw the results in 2005 and 2009 first-hand.
    Disastrous!`

  • 2 Greg Atkinson // Mar 5, 2011 at 8:38 am

    I am not a big fan or reverse mortgages either. I also think innovation and productivity improvements will help the Japanese economy as they have for decades. Innovation leads to exports…just look at what Apple has done via the iPad and iPhone!

  • 3 Biker // Mar 7, 2011 at 10:12 pm

    Ah, but the true believers have been using Apple computers since ’84! The new generation iPads will rock… but my next ‘portable’ will still be the new Air.

    Watch what happens to their stock*, temporarily, when Steve Jobs passes thru’ the next portal… .

    * I know a very wealthy fella who owns just one stock… and lives very comfortably buying and selling Apple shares.
    Makes my own belief pale to insignificance. 😀

  • 4 Aislabie // Mar 8, 2011 at 4:58 pm

    The elephant in the room which is not mentioned here, is the serious drag of demographic change, which is tying up Japan’s future more and more with every passing month.
    To suggest building kindergartens is bizarre for a country which can hardly close schools fast enough, as the child population continues to fall. (And this is being followed all the way up the education structure).
    Furthermore Japan will not under any conceivable pressure open its immigration policy in any meaningful way. Recent calls for Brazilians to be paid to leave (to open jobs for Japanese) merely underlines the situation.

  • 5 Gregory Clark // Mar 8, 2011 at 11:32 pm

    The population problem is indeed the future elephant (true, Japan’s population has yet to begin to decline; there is still a mild increase due to net immigration. But the problem will soon be upon us).

    But that problem currently is not labor shortage. If it was why are there are so many young Japanese out there looking for jobs?

    The killer is the depressing effect of an aging, and then declining, population on private domestic investment demand. Lack of such demand has long plagued the economy.

    A reverse mortgage system is badly needed. The only other answer is an increase in official demand. And if people are worried about the increase in official debt that would result, then the official spending must go into projects that increase official revenues via multiplier effects which in turn increase official revenues enough to match the increase in debt.

    Needed public works projects are one obvious answer; the simple act of road widening can have dramatic effects by encouraging private rebuilding on either side of roads jammed by out of date construction.

    But anything else that increases employment and encourages private demand at minimum cost is also desirable. Casinos are one good example. Public kindergartens too since they cost little, they employ many, and currently the lack thereof is a major factor keeping able women out of the work force.

    They would also help increase the birthrate.

  • 6 Greg Atkinson // Mar 9, 2011 at 9:30 am

    I just wanted to add a few point here that I think can be often overlooked:

    – Japan is not the only country facing the challenge of an aging or declining population, Russia for example also faces the same challenge as do many other developed nations. Japan is just ahead of the curve and in some respects is using its experience to develop new source of income e.g. aged care facilities and aged care advanced medical care.

    – Inflation can be a worse problem to deal with than inflation. Just ask the poor in the developing nations who are dealing with food inflation.

    – There is indeed a shortage of kindergartens and child care centres in Japan but this is improving. (ask any working mother in Japan about this)

    – Technology can play an important part in overcoming workforce shortages or increasing productivity. There are for example more than 300,000 industrial robots in Japan and I read recently these are effectively equal to a work force of about a million people.

    – Finally let’s not forget that social cohesion, quality of life and public safety are all important issues as well. Propping up GDP sounds great in theory but if it leads to problems such as higher crime and increased pollution then what has a nation really gained?

    By the way. comments can also be made directly to Gregory Clarke at: http://www.gregoryclark.net/index.html

  • 7 Anon // May 18, 2011 at 7:45 pm

    Japan Birthrate Bottomed

    “There are very smart people who are now looking to short the “Miraculous China Demographics” theme and go long Japan as a relative value – see Barron’s recent “Favoring Japan Over China”. And as for that birthrate – again, speaking anecdotally – Japanese technology companies are seeing such consternation over the demographic problem that they are now designing robot infants (called Pneuborns), what does that tell you?”

    http://www.thereformedbroker.com/2011/05/16/three-things-that-are-bottoming/

  • 8 Anon // May 18, 2011 at 7:47 pm

    “A Bottom in the Japanese Birth Rate:

    Fund manager Kyle Bass has postulated that Japanese people will be buying more adult diapers than baby diapers soon as his reason to short the country’s equities. This is a hilarious quip but is not necessarily an investible premise. There are very smart people who are now looking to short the “Miraculous China Demographics” theme and go long Japan as a relative value – see Barron’s recent “Favoring Japan Over China”. And as for that birthrate – again, speaking anecdotally – Japanese technology companies are seeing such consternation over the demographic problem that they are now designing robot infants (called Pneuborns), what does that tell you?

    Many very smart investors are growing more and more excited about how universally hated Japan is as an investment theme. I recommend Geoff Gannon and Barton Biggs for a starting point on the bull case if you’re sick of the knee-jerk negativity.”

    From the Reformed Broker blog.

    This drivel is not advice. Seek a licensed financial advisor. Runaway from the incompetent ones.

  • 9 Jahfre Fire Eater // Jan 11, 2012 at 5:20 am

    The problem with the skidding car analogy is that each new skid is faster and harder to control than the last. The model is based on artificially ensuring perpetual growth to fund a perpetual growth in government spending. (Including defense spending)

    I think the analogy should be more like using a blanket over an open fire to send smoke signals telling everyone everything is OK.
    They more they puff that message the hotter the fire becomes…soon they are not trying to send a message but to use the blanket to put out the fire….too late…the forest burns every time.

Leave a Comment

*


 


This site is not intended to act as any form of financial or investment advice.  © 2008–2015 Shareswatch Australia — DisclaimerCutline by Chris Pearson

The information contained in this website is for general information purposes only. Whilst we endeavour to keep the information up-to-date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the website or the information, products, services, or related graphics contained on the website for any purpose. Any reliance you place on such information is therefore strictly at your own risk.