On a recent whirlwind tour of Asian capitals, peripatetic U.S. Deputy Treasury Secretary Larry Summers offered some advice on how to cure the region’s economic ills. Despite his stature as an economist, he sounded more like a politician spouting protectionist platitudes. Implicit in his commentary was concern over Asian economies’ growing trade surpluses with the United States, especially in steel and semiconductors. Using the specter of revised Super 301 legislation, which would impose sanctions against countries deemed to be engaged in “unfair trading” practices, Summers encouraged reliance on macroeconomic stimulation rather than on an export-led revival.
Care should be taken, however, in interpreting Summers’ remarks on the advisability of fiscal stimulus and expansionary monetary policy. It should be noted that he was not among the few economists who anticipated the Asian crises. His credibility as a dispenser of cures for these crises is surely undermined by the fact that he did not see the underlying problems that caused them.
While he is right to see that the basic issue is promoting growth in the domestic sector of a nation’s economy, there are several ways to approach this. On the one hand, the long-term view focuses upon the restructuring of banks and businesses while restoring purchasing power to households and businesses through deep tax cuts.
On the other hand, the short-term view relies on tools derived from Keynesian economic theory that include monetary stimulation and expanded public spending. In promoting the latter view, Summers’ proposed cures appear to be based on a misdiagnosis of the problem.
This error is most vivid in the case of Japan. Summers’ pleas to Japanese authorities to undertake sustained fiscal stimulus and massive money creation to encourage spending ignore recent experience. Over the past eight years, Japanese interest rates have been kept at historical lows, and nearly $1 trillion of taxpayers’ money has been squandered in stimulus packages. Yet neither policy has come close to halting the rot in the country’s domestic economy.
Now Japan faces the frightening prospect of a continuing deflationary cycle. But the sustained drop in prices is a symptom of other fundamental problems in its domestic economy. While it is true that domestic spending is insufficient, Keynesian tinkering cannot cure Japan’s economic ills. The basic problem is that the current structures and objective conditions provide little impetus for new spending by either households or businesses.
In the case of households, Japanese would not spend more even if money were thrown out of airplanes for that very purpose, possibly not even if a gun were put to their collective heads.
First, demographics work against higher household consumption. Japanese are becoming older, on average, and they are living longer. A graying population saves more by consuming less. To aggravate matters, doubts about the viability of pension funds add to the pressure to save more.
Second, those who are currently employed are insecure about their jobs. This inspires them to save. And young people today face a higher likelihood of either not finding a job or finding a job that pays less. So they cannot contribute to a rise in consumption spending, either.
Third, taxpayers know they face an enormous bill for the costs of recapitalizing banks or to pay off earlier or future rounds of pump-priming. Their rational reaction to an expected burden of higher future taxes is to save more today. (Economists refer to this as “Richardian equivalence.”)
Japanese businesses, meanwhile, cannot spend. Many already have excess capacity and face heavy debt burdens. Absent a rise in household spending, there is no incentive for additional business investment or new hiring.
One remedy ignored by Summers is the remedial effect of cutting taxes. By undertaking radical reforms of its tax structure, perhaps introducing a flat tax, Japanese households and businesses would gain greater control over their future earnings. This would induce them to spend more today. Printing more yen or throwing more government spending at the economy will not.
Unfortunately, putting earned income back into the hands of consumers and investors is only one step toward a sustainable economic recovery. There must also be a corrective restructuring of banks and commercial establishments so that they operate along lines dictated by economic and commercial logic, rather than by bureaucrats and politicians in concert with dominant conglomerates. The key to future growth in the global economy is unleashing creative young entrepreneurs who can produce wealth and jobs by starting up small and medium-size enterprises.
So Summers is half-right: Japan and its troubled neighbors ought to put their macroeconomic houses in order. But the key is for them to fundamentally change the nature of their governments’ involvement in their respective economies. They should not pursue old nostrums that have been tried — and have failed miserably.
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