Fixing Japan’s Fiscal Mess
Image Credit: Jennifer Murawski

Fixing Japan’s Fiscal Mess


Pity the Japanese economic policymaker. Even before the triple whammy of earthquake, tsunami, and nuclear crisis struck in March, Japan was facing the mother of all fiscal headaches. With public debt climbing to new heights, the government was facing an increasingly urgent dilemma: should it try to improve public finances with fiscal austerity measures, or continue to spend in the hope that the persistently weak economy would rebound.

That dilemma is even more pressing now. Japan faces the most expensive recovery bill in history and a serious setback to its economy. Under the circumstances, fiscal hawks will need to wait. But at some point, Japan will have to combine deficit reduction with fiscal expansion. Orthodox approaches that put one before the other haven’t worked so far, and given demographic trends they are unlikely to help in the future.

The Road to Crisis

It’s customary to blame the economic bubble era of the late 1980s for Japan’s current fiscal mess, but in fact the bubble was merely a symptom of an underlying condition: Japan’s postwar hyper-industrialization policy. Widely written about at the time, the policy turbocharged Japan’s reconstruction and industrialization. By the 1980s, though, it had reached the end of its effective life—Japan had caught up and was at full industrial capacity.

That left business looking for new places to put its money. Always a combustible situation, the Bank of Japan (BOJ) added a match when it cut interest rates to combat a rising yen. The cheap money encouraged speculation, called zai-tech (literally, ‘financial technology’), a curious term designed to sound cutting-edge and sophisticated, but which really signalled companies getting in way over their heads with ill-advised investments.

Noted Tokyo-based economist Richard Koo estimates that the inevitable collapse of the bubble wiped out 1.5 quadrillion yen in wealth—about three years’ worth of Japanese GDP. This compares to about one year’s worth of GDP lost by the United States during the Great Depression. Yet Japanese economic activity never experienced anything like the collapse seen in 1930s America. In fact, GDP never dropped below its bubble peak, even though private-sector borrowing and investment contracted sharply as corporations and banks struggled with a mammoth debt hangover.

Japan was able to avoid the soup kitchens because the government responded throughout the 1990s with the classic Keynesian approach of vigorous fiscal spending, which plugged the gap created by the collapse in corporate investment. Combined with dwindling tax revenues from the reduced private-sector activity, this spending expanded the public debt throughout most of the 1990s, albeit to still manageable levels. The approach had the same effect as US spending during World War II, which finally ended the Great Depression.

A Pernicious Problem

Now, had Japan been enjoying the same population growth as 1940s America, the Keynesian approach would have sufficed. A rising population would have created fresh demand for houses, cars, washing machines, TV sets, and other products, and as soon as corporate Japan had paid down its debt—and it mostly had by the 2000s—it could have returned to investing in productive assets once again.

But Japan entering the 2000s was in a very different position: the working population was already in decline, and this was soon to be followed by overall population contraction. Long-term population decline is unprecedented for a modern industrialized economy, and conventional economics really doesn’t have an answer for it, because a shrinking population busts important assumptions about investment and borrowing. And yet the demographic impact on Japanese business is often overlooked by economists, including Keynesian spenders who are still waiting for the private sector to pick up the reins.

Haresh Patel
November 23, 2012 at 10:45

Population growth is not the answer to Japan's prosperity. Population density of Japan is more than ten times that of the USA. Ultimately the prosperity of a country in the long run is dependent on it own natural resources such as land, water, energy and minerals. Think about it, if USA had the same population density as Japan there would be 3 billion people here. There would be no oil left. Japan managed to grow beyond its natural limits by exporting but that does not work in the long run as other underdeveloped countries catch up and the economies of the importing nations are wrecked. In the long term Japan will be better off with much lower population, perhaps a factor of 4 to10. The notion that world prosperity can keep on increasing for ever in the face of dwindling resources is fictitious.

May 16, 2011 at 12:16

Mr. John Chan,
Thanks for your ‘advice’! Just want to ask you, ‘John Chan, the expert’ a simple question, ‘Will China be insolvent or default on its national debts or any loans denominated in its own currency, Renminbi?’ Yes or No?! Don’t talk about Greece, Mexico, and Zimbabwe, etc.! (Actually, you don’t have much knowledge about their own situations!)
Maybe the ordinary Chinese did and will believe in your arguments because they have neither knowledge nor other way nor means to verify everything said or told by their government and their propaganda machine (people like you?)!
Here in this country, we don’t need to believe or follow anything said or told by Mr. N., Ms L, or Representatives X or Y. They have their own opinions & perspectives and of course, we also have our own! We only trust the truth and facts, not myths or fictions (based on our knowledge and judgment)!
No country in this world will be insolvent or default on its national debts denominated in its own currency and serviced by keystrokes (China, Japan, UK, US, etc.). If you really have some knowledge, just try to find out or figure it out! The people talking about this issue are all financial and economic experts (with at least a PhD) not a ‘layperson or local economist’ like Mr. John Chan!
Reread the Myths # 3&4 to understand more about the US Fed & Treasury securities! There will be nothing so-called “flooding-the-market” by the sell-off of US Tbonds by China like you thought! And one more point, don’t talk about the Fed and the US banking system when you had no real knowledge about it!
Finally, thanks for worrying about the US economy! It’s going to be just fine! Better worrying about your own , John Chan! It is on its last leg (and unfortunately, ‘crippled one’!). And BTW, thank you very much for China’s efforts to supply the US all the stuffs it wants (with China’s labor, resources, capital, environment, etc.)! The best way for China now is try to find its own consumption market (domestic) to avoid any waste of its time and energy!!

John Chan
May 16, 2011 at 00:41

@JBrown, National Inflation Association, Peter Schiff, Ron Paul, etc. are trying tireless to turn the US economy and financial around; the US people should follow them instead of the Fed and Co.

Abolish the Fed, USA shall be the issuer of its currency, not the Fed, a private enterprise which major shareholder is the British Crown. There is no need for the USA to pay interest to use its own money that can be printed at will as the article in the link explained. The only thing the USA needs to do is to print the money at controlled and appropriated rate to maintain everybody’s trust in the money. Then financing USA’s social and defence obligations is no long a debt obligation, it is a function of controlling the supply of money. After that, debt becomes irrelevant to the USA. Indeed it is puzzling why those bloggers keep on spreading toxic anti-China rhetoric to poison US-China relationship instead of focusing their energy on the wellbeing of the US.

Valuation of currency is the totally wrong focus to resolve USA’s economic and financial problems. IPad, iPhone and Japanese cars cost way more than their peers, yet people are willing to pay higher prices and the hefty profit margin for those products because their superior quality. Depreciation of currency is the race to the bottom, it is the way the Fed and Co. want to trap people’s attention instead of looking for real solutions, so they can avoid to be scrutinized.

Jbrown, the above is not my idea, it is the idea from people like NIA, Peter Schiff, Ron Paul, etc.

May 14, 2011 at 16:39

With only more than 7% of US national debt (US Treasury Department), then what kind of impact china can cause to the US economy, the ‘greatest-Chinese- economist’ of all times?! And as some links of some American bloggers have been posted before , the ‘bad practice’ of buying US-T bonds of China is not welcome and should be stopped immediately and it could be taxed !! Moreover, The US currently wants the dollar depreciated & the Yuan appreciated! Think about it, John chan!

John Chan
May 14, 2011 at 12:18

Myth #9 in the link said the Fed (a branch of government) is contradictory to the fact that the Fed is a private enterprise, a Government Sponsored Entity (GSE).
Myth #1 said the US government is the issuer of the currency; in fact the Fed is the issuer of the currency. The money in the US is “Federal Revere Note”, a private enterprise printed money, and not a government issued money.

The US government must issue IOU (the treasury/bond/note) to borrow money from the Fed. The US government must pay interest on those IOU by discounting the IOU, at the same time the US government must bid against other bond holders for the money printed by the Fed, highest interest payer gets the money. Although only the Feb can print money through the thin air, but the government can issue IOU through the thin air, as well as the banks can issue loans nearly through the thin air too. Only people need to use blood and sweat to exchange those fiat money that was created through the thin air. The whole system is called debt based financial system, welcome to the modern surf system.

The article in the link implied that the US government could spend without consequence because it is the ‘issuer of the currency’. In fact it is only true as long as everybody believes there are intrinsic values in the money; as soon as that believe is lost, US money is same as Zimbabwe money. If China sells its US treasury to the Feb for US money, then floods the markets with those US money for goods, it will shake that believe in the intrinsic value of US money, the cascade effect will cause more US money chasing too few goods, and the end game is the collapse of US dollar, i.e. US money becomes same as Zimbabwe money. The US history has plenty examples of that kind of disasters.

The article in the link is misleading and specious, it use technicality to confuse and mislead the general public, it seems wanting to divert people’s attention on the paramount debt and deficit problems in the US, as well as the US is incompetent, incapable and lack of will to face the mounting crisis.

May 12, 2011 at 17:18

Maybe Japan needs some new thoughts for its current situation ?!

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