The recent S&P downgrading of US treasuries has prompted a bout of soul-searching among economic commentators in the United States. Quite how the S&P retains any credibility after its AAA-rated subprime CDO fiasco is something of a mystery, but being booted from the AAA sovereign debt club has clearly been upsetting for the United States, if not for bond investors.
One of the memes that has emerged—in fact, it first made its appearance in the wake of the Lehman Brothers collapse—is that the United States is becoming the new Japan. Finance bloggers like to buttress the argument with charts showing the recent performance of US stocks and bonds, looking ominously like Japan’s in its post-bubble days. This time, opines a recent Wall Street Journal article, maybe the United States is Japan.
No, it’s not. Certainly, it’s tempting to draw the comparison. Two rich, post-industrial countries experience massive asset bubbles, followed by crashing prices, bank bailouts, debt retrenchment, burgeoning public debt, and ultimately downgrades.
But they are not the same, for the simple reason that in Japan the economic cycle is dead. The fundamental assumption that underpins the usual tools of economics no longer applies, and Japan’s only way out of a painful decline is structural reform that goes beyond its economy and into the heart of its social fabric. These reforms will be far more painful than anything required by the United States, which still has an economic cycle, meaning monetary and fiscal policy can still be effective, and which could achieve a recovery with a dose of sensible policy and patience.
This isn’t to be sanguine about America’s problems. S&P did get one thing right: US politicians certainly aren’t inspiring much confidence these days. For as long as the country remains in thrall to the arrant nonsense spouted by cartoonish fringe characters, there’s an ongoing risk of poor policy choices that will continue to damage the economy. The recent shift in favour of the policies of Herbert Hoover, circa 1931, puts a fragile recovery at grave risk. An inability to re-regulate its financial sector (the reintroduction of Glass-Steagall would be a good first step) will encourage new asset bubbles, wreaking more havoc. Even with an economic cycle, a country can defenestrate itself. Nor is it to suggest that the United States doesn’t have some deep-seated structural issues—income equality and the evaporation of well-paying, blue-collar jobs, eviscerating the middle class, will require sustained action. But the point is, whether or not it actually chooses to exercise them, the United States still has policy options that Japan now lacks.
Let me explain. In 2009, the United States had a population of 307 million, Japan had 127 million. In 2050, the US is projected to have a population of 393 million, according to the middle series estimate of the US Bureau of the Census. Japan, by contrast, will have just 95 million people, according to its Ministry of Health. So, over the next 40 years, if these projections hold, the US population will grow by about 30 percent, while Japan’s will shrink by 25 percent.
The effects of this contraction on Japan are so profound that no reasonable discussion of macroeconomics can exclude them. Picture yourself as a Japanese manager. What would your thinking be as you made long-term plans for your company’s growth? That’s right, unless they operate in emerging sectors, Japanese companies are shuttering domestic facilities and taking their investment overseas. In disclosure after disclosure, companies are announcing bluntly that they see no more growth in Japan, and are looking abroad. Japan Inc. is becoming a holding company.
Of course, for many companies in Japan’s uncompetitive service sector, competing in foreign markets isn’t realistic. Even for companies that do have an offshore option, overseas expansion can be a slow process. In the meantime, cost cutting and mergers are the only paths to earnings growth. In fact, corporate Japan in the post-bubble era has done these things very well—earnings are generally good. But investment is weak. The upshot is that Japanese companies have been hoarding cash, so that roughly half have more cash than debt.
No investment means no demand for borrowing. This in turn means that monetary policy, whether lowering interest rates or flooding the banks with cash, is ineffective, because the surplus money never leaves the financial system to enter the real economy, at least not through the private sector.
The same lack of investment also contracts the economy, which must be offset by government spending, even as the reduced private sector activity lowers tax revenues. That’s what the Japanese government has been doing for the last two decades, and that’s why it has the world’s largest public debt. The Japanese government is both the spender and borrower of last resort, and it has helped Japan avoid a depression.
The US government also needs to be spending right now, resisting the temptation to tighten too early. Like Japan in the 1990s, the United States is experiencing what economist Richard Koo calls a ‘balance-sheet recession,’ a sustained period of deleveraging that will contract the economy without fiscal stimulus. But the fundamental idea of deficit spending is that at some point the government can stop, returning to relative austerity and budget surpluses once the boom phase of the economic cycle returns. This is where the US and Japan part ways. Japan no longer has an economic cycle—population decline doesn’t allow it. The default position of the Japanese economy is contraction, or with robust productivity gains, something barely above standstill. So the government spending must continue indefinitely, and the debt grows.
Japan is coming to crunch time. Not because of the absolute size of its debt—the gross debt/net debt debate misses the point—but because of the cost of servicing the debt. Even at ludicrously low interest rates, the Japanese government spends almost half its tax take on debt servicing costs. Throw in the rising burdens of an aging population, and the country clearly needs to solve its problems soon.
With neither fiscal nor monetary policy effective, the solutions require reforms that alter one or more of the three components of economic growth: population, workforce participation, and productivity.
On paper, the reforms are not all that hard to imagine, and they have already been widely debated in Japan. The current government has even tried to move forward on several of them: Open up the economy, especially Japan’s unproductive service sector, to competition. Lower the opportunity cost for women of having children. And open the doors to immigration. The problem is that these acts would upend elements that are very much part of the post-war Japanese social contract, which was built on the assumption of an industrializing economy. Many elements of the country still cling to that assumption.
Take immigration, which ultimately is critical for the long term. It’s immigration that accounts most of the difference between US and Japanese population projections. The rapidly rising Hispanic and Asian populations allow the US business owner to anticipate long-term domestic market growth, and hence to invest. Higher immigration will eventually be vital for Japan, because a shrinking market deters the investment needed to produce the productivity breakthroughs that could offset population decline.
Unfortunately, Japanese equate harmony with homogeneity, and see large-scale immigration as tantamount to an invasion. This will be a particularly difficult debate. The government has made a small start by trying to boost the intake of foreign university students, especially from China, but that will not be enough on its own. Yet the longer Japan leaves this issue unresolved, the less likely it will be to attract immigrants from its preferred countries, like China, which are rapidly closing the opportunity gap.
Even short-term fixes are difficult. Tax reform, for instance, could give the government some breathing space, by helping to contain its deficits. I’ve argued elsewhere for the introduction of a balance-sheet tax, combined with a cut in the corporate tax, but the more conventional call is for a significant hike in the consumption tax. Yet this runs the risk of sending already anaemic demand into a tailspin.
Japan has significant latent productivity gains in its giant service sector, one of the largest in the world as a percentage of GDP. Joining the Trans Pacific Partnership is an obvious way of unlocking these gains, and the current government has made this an aim. But it faces almost intractable opposition from aging farmers, worried about protecting their tiny plots from foreign competition.
Supporting working mothers would also seem an obvious policy. Having a baby is generally career suicide for Japanese women. The lack of childcare infrastructure means that many, no matter how qualified, are forced to quit work or accept that their prospects for promotion are over. The outcome is shown by the percentage of senior positions in the workforce held by women. Japan ranks close to Pakistan and Egypt at 9 percent, while the United States tops the chart at 45 percent. Keeping women at home, caring for kids and elderly parents, has enabled Tokyo to spend less on welfare facilities. But it also encourages women to delay or forego marriage and childbirth, at an overwhelming economic cost. Unfortunately, remedying this requires a fundamental change in attitudes, and Japanese politicians offer little reason for confidence.
With robust immigration, a dynamic service sector (Google, Amazon, Disney, FedEx), and much greater equality, the United States doesn’t have these structural problems. It does have long-term fiscal sustainability issues, but bear in mind that just ten years ago its central banker was worrying about what to do with the surplus. There hasn’t been a fundamental change in the makeup of the United States since then, only bad policies. Allow the economy to recover with proven policy tools, withdraw from ill-advised foreign adventures, and repeal the Bush tax cuts. Japanese policymakers wish they had the same options.
James Pach is the publisher of The Diplomat and the founder of Trans-Asia Inc., a Tokyo-based translation and investor relations company.