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Commentary (April 27, 2004)

Don't credit PM for recovery

Gregory Clark (Vice President, Akita International University)

The Japanese economy is recovering. Why? Prime Minister Junichiro Koizumi can hardly take the credit.

Koizumi used to tell us that government spending had to be cut because annual government borrowings of 30 trillion yen and more were bad for the economy. But in his current budget he has promised 36 trillion yen worth of borrowings (likely to be closer to 40 trillion yen). Meanwhile, his structural reform plans have barely got off the ground.

Two things spur much of the current recovery. One is the export stimulus from China's extraordinary economic progress. As I noted some time ago, sensible policies encouraging investment allowed China in the 1980s to begin to break the infrastructure cost burden that shackles most developing economies. This, together with cheap labor and an expanding domestic market, guaranteed more investment, which in turn guaranteed further cuts in infrastructure costs, which guaranteed even more investment.

I call it the whirlwind effect, and it can only be dampened when the cost of labor begins to rise sharply -- as we saw with Taiwan and South Korea in the 1990s. But this will not happen in China soon.

Eight centuries ago Japan was rescued from Mongol invasion (Japan's anti-China nationalists like to insist it was a Chinese invasion) by the kamikaze, or divine wind -- actually a typhoon that destroyed the Mongol fleets. Today Japan's self-destructed economy is being rescued by another kamikaze, this time from China, to the chagrin of those same anti-China nationalists.

The other plus factor is the rebound effect following a prolonged slump. Other economies have their slumps. But usually they are short-lived. The planners usually have the common sense to apply stimuli, including increased government spending. Consumers and investors are usually unwilling to delay spending for more than two or three years.

But Japan's booms and busts tend to be much more violent and protracted than elsewhere, as we saw in the insanity of the late 1980s' "bubble" and the severity of the subsequent slump. Japan's bandwagon, follow-the-leader psychology leads companies and consumers to spend furiously when they see others spending, and to sink into deep pessimism when they see others in trouble.

In this situation the need for strong counter-cyclical policies is even greater than elsewhere. But for strange, semi-ideological reasons, Koizumi and his supporters chose to go the other way -- decreased government spending during a severe slump. Naturally enough, the slump became even more severe, which is why we now face that 36 trillion yen deficit.

But even the Japanese will not postpone spending on consumption and investment forever. Rising corporate profits due variously to the China factor, vicious restructuring and the digital revolution have triggered a stock-market recovery. That, together with belated Bank of Japan loose-money policies and a U.S. economic recovery fueled by a regime that has ignored its own advice to Japan and indulged in massive deficit spending to overcome its own slump, has helped Japan shake off its deep deflationary pessimism. People are beginning to spend. What was once a vicious downward cycle could well turn into a strong upward trend.

Even so, it was touch and go for a while. If not for the inherent strength of this economy's fundamentals, Japan could easily have been pushed into a deflationary spiral very similar to that of the U.S. Great Depression in the 1930s. The mistaken Koizumi policies closely resembled the 1929 Hooverite policies that triggered the U.S. disaster.

Particular stupidity was attached to the demand that banks dispose of bad loans. The rush of the forced bankruptcies very nearly brought this economy to its knees.

In the part of rural Japan where I spend some time, the tragic story was repeated endlessly -- a basically sound small company forced into bankruptcy by a bank loan recall, with its owners, and their loan guarantors, having to sell everything, even their homes. Then came the chain reaction, as others dependent on that company's business were also forced into bankruptcy.

Meanwhile, Koizumi's economic experts, the academic economist Heizo Takenaka in particular, were upbraiding the banks for refusing loans to small companies in trouble even as they were demanding that the banks recall loans to small companies in trouble. They say they favor laissez-faire privatization and liberalization. But they are quick to impose communistic central government controls over banks and firms that would not have been in trouble but for their own mistaken policies.

They say they are worried about the growing gap between the large cities and the countryside and have set up yet another central government body to handle the problem. But any worsening gap is a direct result of their severe cuts in funds for rural development.

Two factors seem to have underlain the immaturity and folly of these policies. One was an Armageddon complex -- the belief that Japan's business community, the banks especially, had to be punished for past bubble-era sins. To paraphrase the famous Vietnam War quotation, to rescue the economy they needed first to destroy it.

The other was a mistaken belief that the alleged fiscal restraint policies of the United States and Britain in the 1980s were valid for Japan, even though Japan's problems -- excess supply and inadequate demand -- were the mirror-image opposite of those in the Anglo-Saxon economies -- inadequate supply and excess demand.

Nor is the economy entirely out of the woods. Two key problems remain. One is the chronic lack of domestic demand as reflected in a still excessively high savings rate -- the result of cultural factors that are unlikely to change soon. The other is the way the government spending needed to fill the demand gap continues to be financed by borrowing rather than by taxes.

The economy remains very vulnerable to shocks, and to bad economic policies.

(This article appeared in the April 27, 2004 issue of The Japan Times)

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