Sunday, February 10, 2013
Japan is caught in a stimulus trap
Japan’s new prime minister, Shinzo Abe, is trying to revive the country’s flagging economy, and we could all learn from the exercise. You may recall that, in the 1980s, Japan was widely anointed as the next economic superpower, displacing the United States. It’s been a long slide since. In the 1990s, the “bubble economy” of high stock and real estate prices burst. The stock market is roughly a quarter of its high. Land prices have tumbled to 1975 levels. Since 2000, economic growth has averaged less than 1 percent annually. Government debt has ballooned to 214 percent of the economy (gross national product), about double the level of most advanced countries. Some superpower.
To get the economy moving, Abe has proposed a “stimulus” package of 10.3 trillion yen ($114 billion), about 2.2 percent of gross domestic product (GDP), and pushed the Bank of Japan (BOJ) — Japan’s Federal Reserve — to ease credit. This is familiar stuff. For years, Japanese governments have adopted stimulus plans. Since 1995, budget deficits have averaged 6 percent of GDP; that’s why debt (all past deficits) has exploded. The BOJ has repeatedly eased credit. In 1999, it cut short-term rates to near zero. It has had two episodes of “quantitative easing” — pumping more money into the economy — one from 2001 to 2006, the other from 2009 to now.
None of this has restored Japan’s glory days. In the largest sense, Japan is searching for a new economic model. Until the mid-1980s, it relied on export-led growth. Toyota, Panasonic and other multinationals seemed invincible. Exports and investment in new factories provided the main engine of growth. Unfortunately for Japan, developments in the 1980s doomed this model. The yen appreciated on foreign exchange markets, making exports more expensive. And the emergence of other low-cost Asian producers — first South Korea and Taiwan and later Thailand, Malaysia and China — displaced Japan as an export platform.
So the growth engine slowed. What could replace it? Japan has wrestled with this question for two decades. “Japan’s [economic] dynamism was exaggerated,” says economist Adam Posen of the Peterson Institute. “In the 1980s, people focused on a few great companies and ignored how much of Japanese business was relatively backward.” Japan’s domestic-based businesses (retailing, distribution, food production and health care, among others) have not powered the economy the way exports did.
Stimulus policies have been the substitute. To combat deep recessions, they’re justified; President Obama’s 2009 stimulus was warranted. But stimulus is supposed to be temporary. It’s supposed to “jump-start the economy.” Expansion becomes self-sustaining. In Japan, this transition never really occurred. The longest period of growth (2002-07) depended heavily on a cheap yen that revived the export model. Richard Katz, editor of the Oriental Economist, calculates that about 60 percent of GDP growth in those years reflected exports and investment tied to exports. This ended with the 2008-09 financial crisis.
The lesson is that huge budget deficits and ultra-low interest rates — the basics of stimulus — have limits and can be self-defeating. To use a well-worn metaphor: Stimulus becomes a narcotic. People feel better for a while, but the effect wears off. The economy then needs a new fix. Too many fixes may spawn new problems (examples: excessive debt, asset “bubbles,” inflation). That’s already happened in Japan.
It’s caught in a trap. On the one hand, it needs stimulus to grow. On the other, the debt from past stimulus measures threatens future growth. About 95 percent of government debt is held by Japanese investors — banks, insurance companies and pensions — that have been patient, report economists Takeo Hoshi and Takatoshi Ito. If investors lose patience and balk at buying government debt, the economy could implode. But their patience presumes that annual deficits will someday shrink. The trouble is that the required tax increases or spending cuts could act as a drag on the economy. Already, the Diet has voted to raise the consumption tax in 2014 and 2015 from 5 percent to 10 percent.
Considering this, Japan isn’t an attractive place for private investment. A declining population reinforces the effect. Katz of the Oriental Economist suggests spurring growth by dismantling protections for sheltered domestic industries. Higher growth would emerge as “inefficient firms die [and are] replaced by better firms.” But Japan’s leaders have generally shunned this complex and contentious approach. Once the present stimulus fades, Katz writes, it’s likely “Japan will fall back to stagnation.”
The United States isn’t Japan. The American economy is more flexible and entrepreneurial. The natural gas and oil boom is a godsend. Housing is reviving. Still, similarities with Japan loom. Growth rates have been stubbornly low. Both countries rely on stimulus policies — cheap credit, big deficits — to cure problems that are fundamentally structural and psychological. The parallels are worrying.
Read more on this debate: Robert J. Samuelson: Japan’s lost decades — and ours?