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First, dump the zombie debtors


JAPANESE PHOENIX: The Long Road to Economic Revival, by Richard Katz. M.E. Sharpe: Armonk, NY, 2003, 351 pp., $24.95 (paper)

As Japan limps further into a second decade of recession, optimists about its future economic prospects are thin on the ground. In this provocative and thoughtful study, Richard Katz boldly forecasts recovery beginning in 2010. He argues that improved corporate and state governance can resolve Japan’s substantial problems and emphasizes that there is no way to avoid dealing with the massive bad debt problem.

The implosion of Japan’s economy has brought the snake-oil salesmen out in force, touting their respective magic cure-alls for what ails the economy. Monetary fixes, fiscal remedies, inflation targeting, massive restructuring, exchange-rate manipulations, export-led growth, consumption-tax hikes — all have their advocates in the robust public debate on how to revive a moribund and sclerotic Japan Inc.

Katz refers to these miracle cures as the “chimera du jour” and makes a strong case for cleaning up bad loans as the No. 1 priority. He suggests that a package of reforms including monetary and fiscal stimulus, promotion of productivity by truly opening Japan to global competition, abandonment of convoy capitalism, increased labor mobility and tax cuts are also essential elements in treating the patient. Applying this policy mix in the right doses and correct sequence is the big challenge.

Cleaning up bad debts matters because as long as zombie debtors are kept on life support they represent a huge drag on the economy. Katz argues: “Behind the bad debt stand the bad debtors, the majority in sectors suffering from immense excess capacity and inefficiency. This excess capacity is an anchor on new investment and growth. Moreover, just to survive, the bad debtors are slashing prices, forcing healthier companies to match them. This adds to downward pressure on wages and consumer spending. Keeping bad debtors alive turns marginal companies into losers and good companies into marginal ones.”

Japan suffers from what Katz calls economic anorexia, a chronic insufficiency in private domestic demand that is the cause of deflation. He argues that keeping zombie firms alive is a deflationary policy, and thus to stimulate demand, productivity and economic growth, they must be shut down.

Pulling the plug on the zombies is problematic because the safety net in Japan is very porous. On paper it seems that there are relatively generous unemployment programs in place for retrenched employees, but these are geared toward full-time employees, leaving the most vulnerable workers (part-time and temporary staff) with the least protection.

According to Katz, only about one-half of Japan’s 64 million workers are eligible for government unemployment insurance, compared with 130 million eligible American workers, of the 140 million in total. Ironically, the U.S. is often cited as a nation with miserly unemployment benefits. Katz also cites a study that indicates that only about 1 million Japanese a month receive unemployment benefits, even though 3.4 million are eligible. In this situation, the real safety net for many workers is the current job. Those who lose that face considerable difficulties.

If, according to Katz’s estimates, Japan’s real current unemployment rate is 7.3 percent, then encouraging the collapse of companies with lots of employees in the absence of a decent safety net would seem like a recipe for social catastrophe. Katz argues, though, that keeping workers unproductively employed in deadbeat firms with no prospects is one of the causes of the current malaise. Raising productivity is the key to recovery and job growth; encouraging labor mobility, allowing firms to go bankrupt and adapting more flexible employment policies are part of the cure. Unemployment is not only caused by job losses at failed firms, but also by the barriers to entry that impede the establishment of new firms and the jobs they can generate.

In recent months Nippon Keidanren (the Japan Business Federation) has lobbied hard for a gradual increase in the consumption tax to 16 percent as a fix for fiscal deficits, noting that the current rate of 5 percent is low by international standards. Katz argues that this would be folly and actually exacerbate Japan’s economic problems. In his view, the problem of economic anorexia is one of oversaving by the corporate sector.

It is usually argued that oversaving by Japanese consumers is the cause of anemic demand, but Katz disagrees with this view, pointing out that low real wages and the low returns on investments due to low interest rates and risible dividend payments are depressing consumer demand. People have too little to spend and will have even less if they have to spend more on consumption taxes.

In contrast, corporate Japan is oversaving because there are few good investment opportunities and overcapacity. Firms are hoarding cash and thereby depressing aggregate demand. Captains of industry are extolling the virtues of a regressive consumption tax that will put a bigger bite on middle and lower income classes as a means of plugging public revenue shortfalls. Not only will this stifle demand in an economy desperate for more consumption, but it also will require those with the least to pay the most for repairing the nation’s fiscal woes.

Interestingly, corporate advocates of higher consumption taxes have also lobbied for lower corporate tax rates, which dropped from 42 percent in 1989 to 30 percent in 1999.

Katz argues that various policies helpful to corporations have reduced household income and generated deflation. Recovery, in his view, depends on putting more money in the pockets of consumers and increasing their spending power by stoking productivity-enhancing competition. In this sense, globalization in the form of heightened foreign penetration of Japan’s relatively closed market is essential to recovery.

Can inflation targets jumpstart demand by convincing corporations and consumers that it is better to buy now than wait for coming price increases? Katz disagrees, arguing that this is a misguided policy refuted by economic theory and empirical evidence. He questions whether the Bank of Japan can actually attain inflation targets and points out that investors have little incentive to invest in Japanese stocks if they anticipate a decrease in their value. Moreover, pensioners living on fixed incomes will have an even harder time making ends meet.

Most of this excellent book analyzes the reasons for the current malaise, the problem of various “remedies” and the substantial obstacles to recovery. The cautious optimism embraced in “Japanese Phoenix” is appealing, and I share the author’s belief that 1990-2010 will come to be viewed as a watershed in Japan’s transformation.

But, how will Japan reform and revive? The key “obstacles to growth are woven into the very fabric of its political economy,” and it is not encouraging that Japan’s political elite have been AWOL or in denial instead of crafting needed reforms. The forces of resistance and reform have locked horns, resulting in half measures and inaction. Katz is quite right that “the very things that make structural reform economically necessary also make it politically difficult.”

Overcoming this impasse hinges on awareness that “the pain of inaction will ultimately surpass the pain of action. More fundamentally, Japan is a great nation currently trapped in obsolete institutions . . . Japan abounds with bright, ambitious individuals who know what is wrong and who are capable of leading the new Japan . . . What is missing is the program and institutional vehicle for all of these individuals to coalesce around. With time, that too will come.”

Katz may well be right, but an expansion on ongoing institutional reforms would have been helpful in buttressing his case. Like Bill Emmott’s contrarian “The Sun Also Sets” (1989), which was alone in predicting Japan’s demise at the height of the bubble, the bullish and brash tone of “Japanese Phoenix” will stir strong criticisms and debates. I suspect Katz will get the last laugh.