Who Wrecked Japan's Economy?

Supply-side policies from the West have devastated Japan's demand-starved economy, argues Gregory Clark

It never needed to happen. By 1996, sensible demand-side policies had already helped Japan recover from the "bubble" damage of the early nineties. But then the best and brightest brigade moved in. In the space of a few years they have managed to throw a basically strong economy into the dangerous deflationary spiral we see today. Their "success" matches that of another best and brightest brigade -- the brains behind the US debacle in Vietnam.

In seeking out the guilty, one naturally turns to Prime Minister Junichiro Koizumi. But the rot really began in 1997 with the fiscal restraint policies introduced by his predecessor, Ryutaro Hashimoto. Those policies quickly threw the economy into a swoon. It was just barely rescued by the expansionist policies of the Keizo Obuchi and Yoshiro Mori administrations, the two conservative LDP prime ministers who took over when Hashimoto was forced to resign in disgrace. To its credit, the LDP mainstream has always had a gut understanding of one simple truth: When an economy flags, government stimulation is needed.

Hashimoto himself cannot be blamed too much, as he never pretended to be an economist. Much guiltier was LDP Secretary General Koichi Kato, now in disgrace for milking too much from construction firms in his native Yamagata prefecture. Kato was an ex-Foreign Ministry official who spoke English and Chinese. As an internationalist, he found favor in educated US circles. It was there, I suspect, that he was indoctrinated with the supply-side, anti-Keynesian economics that were supposed to have rescued the Western economies back in the Reagan/Thatcher era.

A strong economy is now
in a dangerous
deflationary spiral

Back in Japan, Kato fell victim to Finance Ministry bureaucrats, right-wing editors at the Nikkei Shimbun and Keidanren rednecks. Kato did most of the legwork to promote the foolish (and later withdrawn) legislation forcing the government to reduce deficit borrowing to zero within a fixed time limit. He also supervised the Darwinian policies that allowed the brutal bankruptcies of Yamaichi Securities and Takushoku Bank. The Obuchi and Mori administrations were left to pick up the pieces of a shattered economy.

But with Obuchi/Mori stimulatory policies pushing the official deficit toward JPY700 trillion, a clamor arose for yet another round of fiscal restraint. Since fiscal expansion had done little to help the economy, the argument went, the exact opposite was the answer.

This is similar to arguing that since the life support needed by a heart attack victim has not cured the heart problem, there is no more need for the life support. From the beginning, Japan should have had the tax policies in place that could have moved some of its huge personal savings into the hands of the government, so it would not have to rely on borrowing. Tokyo has never had the courage to do this.

With promises to cut deficits came the full range of the allegedly miraculous Reaganite/Thatcherite supply-side reforms -- privatization, liberalization, deregulation -- that would fuel private entrepreneurs, who would in turn rush out and make the investments needed to fill the demand gap. In fact, those entrepreneurs went the other way. Rather than expand investments, they have been busy repaying bank loans. The demand gap has widened, not shrunk.

The Bank of Japan has to take some of the blame. Both Masaru Hayami and establishment conservative Toshihiko Fukui got caught up in the bubble insanity of the late 80s: Hayami at Nissho Iwai by encouraging the foolish real estate investments that helped bring that once-proud trading house to its knees; Fukui as deputy Bank of Japan head when it was encouraging the banks to expand real estate financing.

Their major sin was a crude, laissez-faire market fundamentalism that in the past denied the role of government or any other interventions. Here they are joined by the ultra-fundamentalist of them all -- the mild-mannered but rigidly dogmatic 70 year-old Yutaka Kosai, chairman of Nikkei's Center for Economic Research. While with the Economic Planning Agency in the early 90s, Kosai was on record as saying that since the market was willing to decree absurd prices for land, then those prices had to be seen as reasonable. Now he argues that today's collapsed land prices are also reasonable since they too have been decreed by the market. He has consistently tried to oppose the establishment of inflation targets, not to mention the need for fiscal stimulus. God only knows what advice he will be giving Koizumi in his present position. His predecessor in the Cabinet Office, Koichi Hamada, did at least have some inkling of Keynesian realities.

The latest piece of Koizumi/Takenaka nonsense is forcing banks to dispose of bad loans, almost all of which are the result of dysfunctional policies enacted since 1997. (Indeed, informed bankers will tell you that by 1996, they had gotten rid of most of their post-bubble bad loans.) This is the equivalent of thinking that our heart victim would recover if a leg swollen by the heart problem were simply amputated.

Of the guilty men, Takenaka, appointed by Koizumi to take total control of economic and financial policy, stands out. A product of Japan's de-intellectualized (i.e. brain-dead) postwar university education system, Takenaka is an example of a specific type of Japanese bureaucrat: those who spoke English and found it easy to establish an international profile while naively embracing Western supply-side dogma.

Early in the Koizumi deflation years Takenaka told Japanese TV audiences how deregulation would bring about new employment -- the baby-sitting industry being a good example. On a recent Asahi TV debate on the economy, Takenaka had the gall, or the ignorance, to claim that Japan was really doing quite well, since its stock-market fall the past year was much less dramatic than declines in the US and Europe.

Sankei Shimbun's Channel 8 and Nikkei's Channel 12 programs have been even more culpable. The Yomiuri Shimbun clan, though very right wing, has consistently backed setting inflation targets and has criticized spending cuts. The Nikkei has recently begun to question whether cutting demand really is the way to revive a demand-starved economy. At long last some voices of reason. But why so late?

Equally poisonous has been the role of foreign media, with London's Economist at the forefront, just as it was when it backed the best and brightest over Vietnam. Even the normally unbiased International Herald Tribune has since run numerous stories on how brave Koizumi's reforms would turn this economy around. I feel sorry for the many Western investors who took that advice.

All in all, this combination of clueless statesmen and misleading media paints a very sorry picture indeed. @