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Problems with ‘Abenomics’

by Gregory Clark

Will “Abenomics” succeed? Prime Minister Shinzo Abe, claiming economic success, says “numbers do not lie.” But one number does give lie to his claim: Before Abenomics, gross national product per head in Japan stood at $46,000.

Today, thanks to a 30 percent depreciation of the yen, that figure is now around $37,000 per head — the level of Italy and Hong Kong. “Japan is Back,” Abe likes to tell the world. Well, in one sense it really is back — all the way back to the per capita income of the early ’90s.

The recovery we see now is almost entirely due to that massive 30 percent depreciation, which in turn is the result mainly of the large annual ¥3 trillion increase in imports of fossil fuels caused by the Fukushima nuclear disaster. That currency depreciation, in turn, gives the support to exporters, and to domestic producers competing with imports, that sustains the present recovery — which in turn gives the psychological boost this economy needed so badly.

But depreciation is a fragile weapon. Even the tiny 2 percent yen appreciation we saw recently panicked the stock market into a 10 percent fall. If the yen had returned to its previous levels (which it will as the nuclear power Abe favors comes back), the result would have been mayhem. Other measures to sustain the progress to date are badly needed, and what Abe proposes — his so-called third arrow of reforms and innovations — is very unconvincing.

Nor is his policy of having the Bank of Japan spend trillions to buy up financial assets, mainly bank-held government debt, likely to be very effective if the banks simply continue to use much of the money to buy more government debt, at a profit. The banks say they want to push more money into the real economy but they lack borrowers.

Meanwhile, would-be borrowers say demand is not enough to encourage them to borrow. The government and the BOJ then say there will be more demand when inflation goals are reached. But they will not reach those goals unless there is more demand — an ugly vicious circle. The moderate inflation we have now comes in part from demand-killing increases in import prices, and from a buying rush bound to result in an equal or greater demand slump when the consumption tax rises in April.

Japan, and now increasingly the other developed economies, face demand deficiency problems much more serious than they realize. Population aging sees more elderly cutting back on spending. Increasing inequality also cuts demand; spending by the few at the top cannot compensate for the lack of spending by the many at the bottom.

With the exception of the United States, the threat of population decline severely cuts investment incentives. Taken together it is recipe for chronic deflationary pressures, which even interest rates close to zero cannot counter. Add in the demand-killing effect of mistaken austerity policies and the problem is even greater.

Abe, like many others, urges wage increases or more employment as an answer. But employers will not respond unless they can see higher profits and they will not see higher profits until they see the end to the demand deficiency — yet another vicious circle.

The only way out of all these dilemmas is for governments to rely on their own increased spending to provide the needed demand — the Keynesian solution. Abe has promised us a ¥5 trillion fiscal stimulus to do that. But that is a mere drop in the bucket, and will in any case be more than neutralized by the planned ¥5 trillion increase in the consumption tax.

Promises of future “fiscal consolidation” (the new word for cutting government spending) will do even more damage. We are back to the “structural reform” vicious circle of the Koizumi years — government spending cuts depressing the economy — which cuts tax revenues, which increases official debt, which encourages more fiscal cuts, which further depresses the economy. Then, as now, disaster was only staved off by currency depreciation.

Japan lost two decades of economic growth due to these mistakes (which some of us predicted at the time — back in 1996). The other developed economies are beginning to face the same situation.

Like Japan, they think that low interest rates and some monetary expansion will solve the problem, and hold back from the Keynesian solution fearing the conventional wisdom that says high levels of government borrowing and official debt are bad. They, too, puzzle over why they are still in trouble.

Like Japan, they have failed to realize that our developed economies have shifted radically from the economic paradigms of the past. Then we could assume that economies had unlimited demands needing to be filled but lacked the supply of goods needed to meet that demand. Inflationary pressures were chronic, and to ward them off, government spending had to be strictly restrained. Only in periods of stagnation could they rely on Keynesian fiscal stimuli, it was argued.

Today the problem is almost the reverse. Thanks to information and other new technologies, and the rise of developing economies like China, we now have few problems in the supply of needed goods. Our main problems is that chronic lack of demand for those goods. The inflationary fears of the past have gone. All that remains are its economic dogmas.

True, some economists are starting to realize a new paradigm has arrived. New York Times commentator Paul Krugman has spoken of “depression-like conditions” that might last for decades. “Secular stagnation” has also entered the vocabulary. And investment banker, Daniel Alpert, sounds a warning in his book “The Age of Oversupply: Overcoming the Greatest Challenge to the Global Economy.” But I doubt whether any of these warnings will penetrate the thick walls of dogma surrounding Abe’s advisers.

And few seem to realize the solution — that without inflation dangers the standard anti-Keynesian fears of rising official debt and deficit spending disappear. Why? Because governments no longer have to borrow the funds they want to spend; they are free to create their own funds.

The few who realize this in the U.S. are called deficit owls (as opposed to the majority deficit hawks) and can be found on the Internet. In Japan they focus on a small group called the Association for Japanese Economic Recovery. But neither expect any early breakthroughs, even though it could well be the key to China’s economic success.

Gregory Clark is a longtime resident of Japan who has served on a number of official economic advisory committees for the Bank of Japan and other organizations.