Rejoinder to Katz' Comment on Miyao's Book Review
Takahiro MIYAO (Professor, GLOCOM)
This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on January 13, 2003: posted here with the author's permission.
I appreciated Mr. Richard Katz' response to my review on his recent book. I wish to add the following rejoinder to the "Katz-Miyao" debate series.
"(1) It will be no surprise that I disagree with Miyao-san on several counts. The bubble and its popping are symptoms of deeper problems, not in themselves the main cause of Japan's long stagnation."
First of all, such an expression as "the bubble and its popping" tends to cloud one's analysis, likely leading to the underestimation of the seriousness of asset deflation, at least partly caused by policy mistakes, high real interest rates and high taxes on assets, following the end of the boom years in the late 1980s. Unless we deal with the problem of asset deflation, we cannot reverse the trend of "long stagnation," which Katz is always worried about from his long-term viewpoint. In this sense, I said in my review that Katz' reform, as fully articulated in this book, might be a necessary condition for Japan's revival in the long term, but certainly not a sufficient condition for Japan's economic recovery in the short term or in the medium term.
"(2) The impact of asset price declines depends heavily on other circumstances."
That may be true, but at any rate, Japan is probably the worst case, in which neither the government nor the central bank has admitted the seriousness of asset deflation (partly because they don't want to admit their policy mistakes) and taken any significant policy measure to reverse the trends of declining asset prices, especially real estate values. That itself is demoralizing to private sector activities. In any case, Japan has lost an unprecedented amount of asset values, more than 10 trillion dollars, twice as large as Japan's GDP and almost equal to U.S. GDP, for the last ten years, as I pointed out. In recent years, the government seems to have become more willing to listen to some economists, but only to macroeconomists on short-term problems or structural reformists on long-term issues, and not to those economists who really understand the more serious issues of asset deflation and balance-sheet recession.
"(3) In Japan, consumer spending tracks income far more than asset prices. Despite enormous declines in stock and property prices during 1990-97, consumer spending increased at a steady 3% rate. It only turned flat from 1997 onward."
Just observing consumer spending is quite misleading in judging the seriousness of asset deflation, because the household sector as a whole is probably the most fortunate sector in Japan, where quite a few rich elderly people still earn high income, and consume and save a lot to offset losses in their balance sheets. It is rather the corporate and financial sectors that have been hardest hit. No wonder we have huge bad debts in the banking sector as a result. Also let me add that among consumers, middle-aged households, stuck with their high balance of home loans, are doing worse than the rest of the households and have decreased their consumption substantially during the 1990s due to the deterioration in their balance-sheet position. This means that consumption would have increased much higher than 3% annually for the last decade if policy makers had adopted anti-asset deflation policies to stop the downward slide of stock and land prices in the early 1990s.
"(4) The biggest obstacle to productive business investment in Japan today is not asset price declines, but overcapacity. That overcapacity was generated by, among other things, the price manipulation that Miyao-san seems to advocate."
Wrong again! The biggest obstacle to productive business investment is asset price declines, which have caused declining demand, leading to apparent overcapacity (shortage of demand), and weakened corporate vitality to the point where they could not take on risky investment for the future. Besides, I have never advocated any price manipulation. I have been advocating the correction of wrong policies, tax and monetary policies, which have depressed asset prices to unreasonably low levels in the market.
"(5) In my view, the real reasons for Japan's stagnation are twofold:
a) Growing inefficiency throughout the non-traded sectors of the economy...
b) Chronic shortfalls in demand caused by Japan's failure to make the usual developmental shift toward consumer-led growth fed by household income.
Again, Katz seems mainly concerned about the long-term issues such as inefficiency of Japan's non-traded sectors. This kind of argument can give little insight into the current problem that Japan has been facing in the period of asset deflation. Regarding demand shortfalls, I already explained that asset deflation is its main cause.
"In my view, the election of Koizumi signaled the increasing intellectual consensus that structural reform is needed. However, the LDP, even under Koizumi, cannot implement it. Moreover, reformers disagree among themselves as to what constitutes reform."
As I pointed out in my book review, most of the Japanese people including myself agree that reform is needed for Japan's "long-term" revival. Not much intelligence is needed to admit that. Looking back, most of the American people agreed on the necessity of reform in the early 1980s. But it took a really intelligent policy maker like Alan Greenspan for the U.S. to diagnose its nasty recession at the beginning of the 1990s as a "balance-sheet recession" and to deal successfully with asset deflation by slashing the "real interest rate" to zero immediately to revive the asset markets (note that at that time, the Bank of Japan raised, rather than lowered, the discount rate due to its misunderstanding of Japan's economic problems). Greenspan is also intelligent enough to learn from Japan's policy mistakes and for the past two years, has lowered interest rates to support stock and real estate prices.
"Finally, Miyao compared my views of those of Heizo Takenaka. I don't necessary agree with all of Takenaka's views, but it is certainly true that cleaning up the problem of nonperforming loans and nonperforming borrowers is the first critical step in a long program of reform (see chapter 5 and 14). Nothing else will work until this is done, as shown by the experience of other countries..."
It is the wrong prescription that cleaning up nonperforming loans would be the first step. The magnitude of Japan's asset deflation, aggravated by policy mistakes, is beyond comparison with other countries. Japan could have focused solely on the problem of non-performing loans, probably in the early 1990s, when then Prime Minister Miyazawa was wondering if public money should be used to clean up nonperforming loans at Jusen financial institutions. But that kind of prescription would be too late to be effective now. We really need to reverse the trends of declining asset prices first by eliminating all taxes on assets, at least for the time being, and the Bank of Japan should adopt some kind of "asset price inflation target" before cleaning up the balance-sheet of financial institutions. Otherwise, the vicious circle of asset deflation, increasing bad loans, and declining economic performance would continue, and Japan's economy could not revive even in ten years, as Katz predicts "optimistically" in his book.
Finally, let me quote Richard Koo who concurs with my diagnosis of Japan's illnesses (although I do not necessarily agree with Koo's prescription for fiscal spending):
"While the Koizumi government is trying to treat diabetes, that is, 'structural problems including the problem of non-performing loans,' there seems to be no recognition on the part of the government that the Japanese economy is dying of pneumonia, that is, 'balance-sheet recession,' which should be regarded as the fundamental cause for the current economic stagnation."
Richard Koo, "Preemptive Strike to Deal with Balance-Sheet Recession"