Devaluing, inflating, exporting its way out of difficulties should not be Japan's solution
By Noriko Hama (Research Director, Mitsubishi Research Institute)
Debate continues to rage over whether or not a cheaper yen is a good or a bad thing for the Japanese economy and the rest of the world. The most recent writer to enter the fray is Martin Wolf ("Why Koizumi will fail Japan," Financial Times, 9 May). Mr. Wolf sides with Professor Jeffrey Sachs ("The benefits of a weaker yen," Financial Times, 18 April) in his advocacy of yen depreciation. Others have written to refute their case.
Devaluing one's way out of recessions can make sense on occasion. It made sense for Britain in the1930s when it pursued a cheaper sterling policy following the currency's enforced departure from the gold standard. But it has to be remembered that Britain at that time was suffering from a steady deterioration in its current account balance, which actually turned into a deficit position in 1931. Thus devaluation also made sense as an urgent means of bolstering export competitiveness. The Japan of today has no such problem. It has a large current account surplus. That chronic current account surplus is at least in part a symptom of Japan's present difficulties.
Professor Sachs writes of Japan's structural current account surplus, which it would be folly to try and eliminate. Mr. Wolf argues for an even larger surplus, the counterpart of which would be greater Japanese investments abroad. The idea of ever larger amounts of Japan moneymaking the world go round is not unattractive. Yet much of the sheen wears off when account is taken of the fact that the expanding pool of surplus money is the product of a closed and non-competitive set of institutions that prevents those funds from being put to efficient use. A cheaper yen contributes nothing to resolving Japan's fundamental malaise of an outdated socio-economic system that stands in the way of optimum resource allocation. It is about time that such practices as that of a host of construction companies, both large and small, sharing out repair work on a minute strip of road so that none would go jobless was consigned to the history books. A cheaper yen will not help us do this. Indeed the temporary fix of export-led growth would only serve to put much needed reforms on hold.
The Japanese economy suffers from two mismatch problems. One is its lack of alignment with globalization. Many of our companies and globetrotting tourists may be well attuned, but our institutions most emphatically are not. Small and open economies suffer from volatility. But a very large and very closed economy, which is what Japan has tried to be over the years, threatens itself with extinction in a highly globalized world.
The second mismatch exists between Japan's financial system and the financial reality that it is trying to accommodate. Postwar Japan's financial framework was created to cope with an acute and chronic savings shortage. Postwar reconstruction required large scale funding. It fell to the financial institutions to suck every drop of the life-blood that was private savings out of Japanese households and channel the flow into construction works and investments by heavy industries. So long as this function was being performed effectively, no tedious questions were asked of the banking sector regarding such matters as efficiency and accountability. To this end, Japanese financial institutions did indeed toil loyally. The fruit of their endeavors is Japan's remarkable postwar development, the culmination of which is that Japan is now the world's largest savings surplus nation. This dramatic shift in its position was not matched by corresponding reforms in the financial system. Having become so adept at coping with savings-short situations, Japanese banks had little idea about what to do in a savings-surplus world. Their panic reaction to changing circumstances led to rash lending activity and the snowballing of none-performing loans. Without an overhaul of the financial system, the allocation of all those surplus savings will never become as efficient as it needs to be, including the issue of how and to what extent they are channeled abroad.
Devaluing, inflating, and exporting your way out of difficult situations may be all very well if your economy is not in a state of institutional fatigue and if you choose to ignore the menace you become to the rest of the world by adopting such remedies. Japan should not be lured into going down this route. It is with consternation that one reads commentary from respected quarters that provide ammunition to the "all gain, no pain" camp.