Japan’s economic debate has moved from the bizarre to the ridiculous. Just two years ago we were told that fiscal restraint was the key to economic recovery. Annual bond issues to finance government spending would not be allowed to exceed 30 trillion yen ($250 billion). In other words, cutting demand was supposed to cure a demand-starved economy. Diet pills for anorexics made about the same kind of sense.
Now, with tax revenues plummeting as the economy weakens further, bond issues will have to go far beyond the promised 30 trillion yen limit. So what does Prime Minister Junichiro Koizumi do when confronted with this complete negation of his economic strategy? He turns around and says it is “not important.”
The farce does not end there. Koizumi and his high-powered academic advisers also told us that structural reforms were the key to economic recovery, as if privatizing a few government corporations and bankrupting a few banks could spark recovery. Now, as the economy moves into a dangerous deflationary spiral, the prime minister turns around and tries to portray himself as a kind of economic hero by promising to fight the deflation he has caused.
Meanwhile, political opposition parties, which advocate the same mistaken economic policies as Koizumi, try to make political capital out of deflation and his failure to meet the 30 trillion yen promise.
And foreign pundits advocating Thatcherite/Reaganite, anti-Keynesian, supply-side policies that were once supposed to have cured Western economies suffering from excessive demand and inadequate supply — the exact opposite of Japan’s problems, incidentally — now insist that Japan’s problems today are due to failure to push structural reforms more fully. Those reforms were always about as relevant as rearranging deckchairs on the Titanic. Now, with the boat fast taking in water, they and the government think that arranging the lifeboats, i.e., rescuing bankrupt companies and the unemployed, will somehow save the boat.
Someone should tell the pundits, most of whom spent much of the 1980s admiring and fearing Japan’s economic success and who now watch the floundering boat with pity and contempt, that the fact that the boat is still afloat, despite their very wrong advice, is a tribute to its underlying strength. Once the mistaken policies are reversed, recovery could be impressive.
How do so many people manage to get it so wrong? Looking back, a key factor was alarm over the 700 trillion yen of official debt overhanging the economy. It can be argued that this is not really the problem it is made out to be, given that almost all this money was borrowed from fellow Japanese, that personal financial assets in Japan total some 1.4 quadrillion yen, and that both banks and individuals in Japan are still more than willing to buy government bonds at very low interest rates.
But if it is a problem, it can easily be cured. The main reason for Japan’s economic difficulties is the demand gap caused by consumers’ chronically high propensity to save. The problem has been around for more than 30 years, but in the past it was disguised by artificial asset booms, excessively competitive investment in facilities and export surpluses.
The main cause of the mountain of official debt has been the need to fill the demand gap with government spending, and a chronic unwillingness to fund that spending with tax monies rather than borrowings. Since the demand gap is largely a cultural problem, and therefore unlikely to go away in the near future, then the need today is reform in tax policies.
Tax revenues are inadequate for several reasons. Low income earners pay almost no taxes. Tax evasion by owners of small and medium companies is easy and rampant. True, unfairly high taxes are imposed on large companies and the deceased; in effect the government says that it prefers to shift the tax burden from those who can vote or complain to those who can’t do either. But that distortion too encourages evasion.
Meanwhile, indirect tax revenues are hard to increase because of the foolish switch from product taxes, which are both easy to collect and to increase, to the very unpopular and demand-stifling consumption tax.
Unfortunately, proper tax reform is difficult now that fighting deflation is the order of the day. Indeed the government, with more mistaken foreign advice, says it will now try to stimulate spending by cutting taxes. This will not only further increase the deficit. It is also the least efficient way to stimulate the economy, since much of the tax cut will simply add to Japan’s surplus savings.
What to do? Since most of Japan’s mountain of personal financial assets is held by elderly people with little plan to spend much in the near future, there is nothing to stop the government from saying that this dead money should be replaced by fresh money from the Bank of Japan pumped directly into the economy, ideally by buying up the collateral for delinquent loans by banks. Future inflation problems can be met if and when they arise; for the moment, at least, Japan badly needs some hint of inflation. BOJ funding for a temporary increase in government deficit spending would also be welcome.
Then when the economy finally gets moving, Tokyo can begin to tackle the deficit problem and tax system reform.
One hope for the future is an anti-Koizumi coup within the ruling LDP by the so-called forces of resistance — by the LDP politicians with the wit to realize the foolishness of current policies. Moves are already afoot. The other hope is the possible appointment of a Keynesian economist as the next BOJ head.
But in the meantime don’t expect any of this economic wisdom to penetrate the minds of the true resistance forces, namely the prime minister, his advisers, the opposition parties or the foreign pundits. Wedded to their dogmas, they still find ways to blame everyone else but themselves for the disaster they have imposed on Japan.
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