A popular pun in Japanese is to take the word kaikaku (reform, or change for the better) and turn it into kaiaku (to change for the worse.)
Certainly kaiaku best describes former Prime Minister Junichiro Koizumi’s promises of kaikaku for the economy. He came to office in 2001 promising structural reforms that would cut government debt, then put at 700 trillion yen, and invigorate the economy. Now five years later government debt has ballooned by as much 187 trillion yen according to the careful calculations by Stephen Church of Japan Invest. And an economy now heavily reliant on the vibrant U.S. and Chinese economies has just managed to struggle back roughly to where it was before.
Fortunately we could be seeing a major change under Prime Minister Shinzo Abe. He has gone out of their way to assuage the Koizumi faithful by repeating the mantras of “structural reform.”
But almost without anyone noticing he has made one very important change in slogan. Under Koizumi it was: No economic growth without structural reform. With Abe it is: no reform in the fiscal situation without economic growth.
Finally the horse is put before the cart and pulling forward. Before it was put behind the cart and pulling backward.
Abe and his cohorts have noted a significant detail, namely that even with last year’s weak economic growth, tax revenues increased by 4 trillion yen.
The moral should be clear. First get your economy up and running, with the help of increased government spending if necessary. Then rely on the resulting tax revenue increases to finance the increased government spending. This is particularly true for Japan, where emotional feel-good and feel-bad factors greatly increase the multiplier effects of shifts in government spending done wisely.
The Koizumi’s policies were the exact reverse: Cut government spending in vital areas, public works especially. Then compound that mistake with a witch hunt against all bad loans in the banking system (which creates more bad loans) combined with accounting changes that magnify losses. The result? A full-scale recession that cuts tax revenues far more than you have been able to cut government spending. A massive increase in government debt is inevitable.
How did Japan end up in this mess? Koizumi’s lack of economic background is no secret. So too, the rumor says, is his propensity to shut himself off in the evenings to enjoy music and wine. For years a late night TV program on the economy was running the Keio University economist Heizo Takenaka as a regular guest advocating structural reform. My guess is that Koizumi liked what he heard and decided there and then that the Keio professor would be his economic guru.
Keio is known for its many heavily U.S.-influenced economists and Takenaka is one of them. The Keio “mafia” embrace the U.S. concepts of free markets, free enterprise and deregulation, and most would agree that the Koizumi-Takenaka willingness to move in that direction was a plus for the economy, even if it did cause income disparities in this formerly fairly egalitarian society and led to increased rip-offs by people freed from government supervision.
But these pluses were far outweighed by another Keio-Takenaka import from the United States — theoretical supply-side economics. This theory is from the days when excessive consumer and government demand in the U.S. and British economies led to chronic inflation and balance of payments deficits. The theoretical answer was to cut back on demand (mainly through cuts in government spending) and stimulate supply through deregulation, privatization, etc.
As it turned out, both the U.S. and British ignored the call for small government. Nor should they have worried. Both the inflation and balance of payments problems have been solved in other ways — cheap Asian imports, crushing the trade unions, persuading foreigners to buy their currencies. Bubbling consumer demand and heavy government spending have continued to boost both economies. As the U.S. economy expanded, the Clinton administration and to some extent even the Bush administration were able to use increased tax revenues to cut the deficits caused by increased government spending.
Meanwhile, back in Japan they still were religiously implementing the supply-side economic mantra of cutting government spending, even as it was being jettisoned by the U.S. and Britain. Worse, they were forcing it on an economy very different from that of the U.S. and Britain. Japan’s problem is not excessive demand and inadequate supply. It is excessive supply and inadequate demand.
As for Japan’s excessive government debt problem, there are many ways that can be solved — better income tax policies, indirect taxes in the form of product taxes rather than increases in the highly deflationary consumption taxes, or simply expanding the money supply (provided there is no risk of inflation).
But as in the U.S., the key policy should be to expand the economy and with it, tax revenues. Ideally this should be done through expanded consumer demand. But if this is too hard to organize in purse-conscious Japan, then expanded government spending with strong multiplier effects, namely public works, in the countryside especially, is a perfectly reasonable answer.
Japan has to do something about its public-works allergy — in particular the naysayers who spout cliches about building bridges to nowhere. In the part of the countryside where I live no one talks about bridges, to anywhere. For the moment the priorities are essentials like sewage, better water supply, road widening, new roads. All have been savagely cut under Koizumi “reforms.” With the cuts come the bankruptcies of the many small construction companies that used to do so much to sustain employment and the local economy. As they go under, others go under. Tax revenues are cut. Government debt increases rather than decreases. Standards of living fall. Is that really a plus for Japan?
Fortunately the voices from the grassroots seem finally to be percolating up to the top leadership of the LDP, including Abe. Maybe that is because Abe does not spend his evening drinking wine and watching theoretical economists on TV.
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