So Much for Conventional Wisdom
UPFRONT – MARCH 2003 J@pan Inc
Why status quo arguments about Japan’s economic weaknesses are mostly hot air.
WHEN AN ECONOMY GOES cold, conventional economic wisdom runs hot. One of the worst examples of this, and the darling insight of the regular Time and Newsweek beat-ups on the sad state of Japan Inc., claims that because official debt in Japan now totals %700 trillion, the nation is bankrupt. “A credit rating on a par with Botswana” is the standard cliché, ignoring the fact that in Japan, the money was borrowed almost entirely from other Japanese, and that there was still plenty left over to lend to the rest of the world, including Botswana.
Some estimates say US net liabilities to the rest of the world will be close to a ¥7OO trillion equivalent by the year 2010. That money will be owed to foreigners, which clearly does mean national bankruptcy. But don’t expect too much on that subject from Time or Newsweek.
Reinforcing the bankruptcy argument is the claim that public works in Japan consist of “highways to nowhere” and simply add to the official debt. Since Japan is one of the very few nations where highways can often recover construction costs simply through tolls and ticket sales, with development effects as a bonus, that particular criticism seems off the mark also. There is no shortage of wasteful public spending in Japan. But those projects involving transport usually make sense, given Japan’s high economic density.
Japan’s official debt is large, but even larger is the ¥l,400 trillion of personal financial assets held by Japan’s over-zealous savers. Unless someone finds a use for this money, it adds up to a massive demand gap sitting right in the middle of the economy. Government borrowing and spending to fill some of the gap may not be the ideal solution. But so far, no one has found a better one.
When the demand gap first began to appear in the early 1970s, Japan did have a solution – namely, chronic export surpluses. It relied on foreign demand to make up for the deficit in domestic demand. By the mid 1980s, the world decided it did not like that solution. So Japan had to opt for another approach: excessive investment in facilities and asset speculation. And we all know what that led to – over-supply and a dangerous bubble. Since the early 1990s, Japan has had little choice beyond expanded government spending.
The conventional wisdom, repeated ad nauseam, says that this government spending should be stopped, as it has done nothing to help a post-bubble recovery. But that is like arguing that the intravenous drip needed by a heart patient should be stopped because it has not cured the heart condition. Government spending did much to spur Japan’s impressive recovery in 1996, and the same spending today aims mainly to sustain the economy. The economy only began to go downhill when the drip was cut back by the Hashimoto administration’s foolish promise to cut deficit spending to zero. In an economy starved of consumption spending, that promise was the coup de grace.
Which brings me to my next example of conventional wisdom gone awry – the assertion that the Japanese are not reluctant consumers at all. Just look at the lavish spending by the businessmen in the Ginza bars and the OLs in the Louis Vuitton shops. If consumers generally are not spending, this argument goes, that is because the system fails to produce the goods and services they want to buy. Japan’s entrepreneurs are able to supply the things that foreigners want, but somehow unable to produce what their fellow Japanese want. We are supposed to believe that this is all due to some plot by Japan Inc. to create an export-led, mercantilist economy able to dominate the world.
This is complete nonsense, of course. Japan does have a cultural and historical bias toward manufacturing over services. But if Japan Inc. ispushing things in that direction, how do we explain the official encouragement for that burst of foolish spending on luxury leisure facilities only a decade ago? The stated aim then was to expand domestic demand and reduce pressure to export.
Structural Reforms that cut demand
are like diet pills for an anorexic.
Why the pressure to export? Until the 1970s, Japan’s economy was able to function quite happily by filling basic domestic demands such as housing, TVs, white goods and transport. High savings helped both production and consumption of those goods. Economic circulation was stable. But unlike the advanced Western economies, Japan after its high growth period never made a proper switch to socalled lifestyle demands – second houses, second cars, expensive vacations, yachts, et cetera. Meanwhile, the high savings continued. One popular explanation for weak lifestyle spending is lack of space for large houses and second cars, though Japan is not quite as crowded as most Japanese like to imagine. More important is lack of time; workplace and social commitments can be cruelly demanding.
There is also a distinct lack of class-status spending in Japan, where status depends much more on one’s workplace rank and prestige (including workplace spending on Ginza bars) than having large houses and cars.
On top of all this is the problem of a skewed wage system that favors the elderly, who have few demands. The nonspending elderly got another income boost when speculators seeking land and younger Japanese seeking housing were forced to pay them exorbitant amounts during the bubble years. One result is that almost half of that Vl,400 trillion figure is said to be held by people over 65.
In short, Japan may have any amount of small-ticket spending on fashion goods, entertainment and knick-knacks like mechanical dogs. But none of this compensates for the lack of big-ticket spending that keeps most Western economies so buoyant and savings rates so low. This is especially true for the Anglo-Saxon nations like the US and Australia, where lifestyle and status seem to depend heavily on spending. In Australia, even the bricklayers want to have their four-bedroom houses, large gardens, country getaways, SUVs and boats. As for the lawyers, doctors and consultants, the sky is the limit.
True, there are also some Japanese who do spend heavily on lifestyle. But they are mainly those who have either spare time or who lack workplace status – doctors, dentists, lawyers, OLs and some affluent retirees. They literally are the exceptions who prove the rule.
Can Tokyo do something to boost private spending? Removing government controls that prevent some industries from providing services with potential demand would help. Work-sharing and compulsory leave-taking could increase leisure spending.
Reverse mortgage systems could encourage the elderly to disgorge land and other assets to local authorities.
Policies to encourage immigration or higher birthrates would also help. Immigrants and young people spending heavily to establish families is a major source of demand and economic vitality in many Western economies.
But even if these and other ideas were to be followed up quickly, Japan would still have its demand gap. Put simply, the Japanese are just not into the spending that many other nationals take for granted. And this is not an East versus West difference. Rich Koreans, Chinese and other Asians will spend just as lustily as Westerners, particularly for status. It is the Japanese who are different.
What to do then? The current conventional wisdom insists that Japan should import the Western-style supply-side economic policies that were supposed to have rescued the Western economies in the 1980s. This is the rationale for the so-called structural reform program. But Japan’s problem is the exact opposite. It is lack of demand, not lack of supply. Structural reforms that cut demand are like diet pills for an anorexic.
The supply-siders worry about the large areas of waste and inefficiency in the economy – over-employment in the service sector, especially. These things do exist. And they do hurt economies lacking supply. But they do little to harm demand-starved economies. They simply represent a transfer of funds from one Japanese worker to another. Provided the recipients spend those funds, the economic damage in terms of reducing demand is slight.
Waste and inefficiency were far worse in the past and seem to have done little harm to Japan’s growth then. During Japan’s boom years, many of today’s critics praised the way service industry over-employment helped spread consumer power to the masses.
Far more harmful than wasteful spending is lack of spending.
For the past 30 years, it is the chronic weakness in consumer spending that has dogged Japan’s otherwise powerful economy.
Solutions exist. In the short term, and with the deflationary spiral deepening, the government has every right simply to print the money needed to fill its demand gap and jumpstart the economy, provided it can control inflation afterwards. Bank of Japan purchases of the banks’ bad loans or surplus shareholdings would be one easy way to spread the wealth. It would also put a much-needed bottom on collapsing asset prices – getting two big birds with one stone. Fortunately, it is very likely that the next head of the Bank of Japan will share this wisdom.
In the longer term, Japan will still have to accept that it has to rely on public spending – much more than other nations do – as an engine of growth. The need for such spending is there, for who wouldn’t want a cleaner environment, better urban infrastructure and improved education? In effect, the government would say that if private individuals do not want to spend money to improve their welfare, then the government will spend it for them. But instead of borrowing to fund the spending, the government should make better and greater use of tax funds.
Tax revenues relative to GDP are low in Japan, thanks mainly to a lenient attitude toward tax evaders and overgenerous tax exemptions for low-income earners. In effect, Japan’s tax policy is that the state should not be harsh on income-earning individuals, since they might complain or vote for opposition parties. Instead, it tries to impose excessively high taxes on individuals when they die and on corporations, neither of whom can complain or vote. But this is a cumbrous operation and lends itself to even more tax evasions.
The move to higher indirect taxes makes sense, but by applying this method broadly, Japan has imported yet another foolish Western economic argument – the one that says product taxes, or taxes that target specific products, should be abolished in favor of across the board consumption taxes. The former are fair and easy to collect and increase. The latter are unfair, easy to evade, and in Japan’s case, both difficult to increase and harmful, as they further discourage consumption.
A major reason for the ¥700 trillion of official debt burdening the economy now is past reluctance to impose sensible tax policies. Reforms are needed. But reforms to increase tax revenues would run counter to yet another conventional wisdom imported mainly from the Republican US: the dubious claim that cutting taxes is the best way to stimulate an economy. Given Japan’s high savings propensity, tax cuts are not only the weakest way to stimulate this economy, but by widening the official deficit, they provide even more excuse for cutting the public works that in Japan’s case provide much more effective stimulation.
We are back to where we started: To rescue this economy, first get rid of conventional wisdom.