The Long and Bumpy Road to Revival

An Excerpt from Richard Katz's Japanese Phoenix: The Long Road to Economic Revival.

A half century ago, Japan picked itself up from the ashes of war and within a few short years stunned the world with its economic achievements. It will do so again. Japan will reform and revive. When it does, its economic achievements will once again earn the world's admiration. Once again its per capita GDP will grow faster than that of the United States. Its information technology revolution will prove even greater than America's -- precisely because all the waste and inefficiencies eliminated by IT are greater in Japan. As Japan brings its inefficient industries up to world benchmarks, sustained growth of 3 percent, perhaps more, is within reach.

That's the good news.

The bad news is that it will take 10 more years to reach this promised land. And the road will be very bumpy. The renewed recession and banking troubles that began in 2001 are some of those bumps. So was the grassroots revolt that led to the ascension of reformist Prime Minister Junichiro Koizumi in 2001.

Why10 years?

So deep-seated are Japan's dysfunctions that even if it did everything right today, it would take five years for this to show up in truly vibrant growth.

But Japan will not do everything right today. Opposition to reform is equally deep-seated. A myriad of vested interests and millions of jobs are at stake. Nor is Japan divided clearly between the parties of reform and resistance. Rather, each party and ministry and firm is divided between reformers and resisters.

All this alarmism is
not only wrong
-- it's dangerous

Japan's dilemma is that the obstacles to growth are woven into the very fabric of its political economy. Years of corporate collusion and protective regulations have steadily eaten away at productivity growth, making it impossible for an unreformed Japan to grow faster than 1.25 to 1.5 percent a year, even at full capacity. High prices and negligible interest rates suppress real household income and thus purchasing power. It has become impossible for Japan to attain full capacity despite years of enormous budget deficits and zero interest rates.

Japan Is Not Argentina
In January 2002 a new joke started making the rounds of Tokyo: What is the difference between Japan and Argentina? Answer: two years. The same month, John Makin, a well-connected economist at the American Enterprise Institute, in an essay entitled "Japan in Depression," predicted an imminent "failure of the banking system ... [and a] full-scale 'run' on the banks." Forbes magazine, whose cover only a few years earlier had exhorted its readers to buy Japanese stocks "before it's too late," now warned that "Japan's economic crisis ... might drag the world into Depression." In May 2002, Adam Posen of the Institute for International Economics raised the alarm that, "the Japanese economy is likely to tumble into crisis sometime before the Diet's supplemental budget process begins in September 2002." This follows Posen's failed March 2001 forecast that financial breakdown, complete with capital flight and possible bank runs, were "almost inevitable in Japan this year [2001]." Many forecasters warned, despite all the evidence to the contrary, that bank runs would ensue in the spring of 2002, when the government lifted full guarantees on all time deposits at the banks. It never happened.

All this alarmism is not only wrong -- it's dangerous. Fear of meltdown paralyzes the hand of reform. Even reformers fear that pulling on a few threads risks causing the entire tapestry to unravel. Daiei was bailed out in part because officials and newspapers warned that its failure could cause the entire banking system to collapse. Yet its debt to the big banks amounted to just 0.8 percent of their total loans.

More fundamentally, there is a huge difference between Japan, on the one hand, and countries such as South Korea and Argentina, which suffered genuine implosion. These countries all ran big trade deficits. When the foreigners pulled their money out, the oil and spare parts stopped coming in. Factories shut down. People were thrown on the street. None of that will happen in Japan because it is a net creditor. Tokyo has the capacity to suppress crisis by throwing a lot of money at the problem. And that is exactly what Tokyo has done: always just enough to stave off disaster, but never enough to solve the underlying malady.

In the end, Japan will act -- once the pain of inaction surpasses the pain of action. Until then, the real danger in Japan is not cataclysm but relentless corrosion. Not meltdown, but the paralyzing fear of meltdown.

Conservative Revolutionaries
There are those who say Japan will never reform because it will never accept an "American model" unsuited to Japanese values. This identification of reform with "Americanization" is fanned by the opponents of reform. Yet it reflects some real fears in the population.

But this fear is not insurmountable because it is not soundly based. So many of the institutions and practices that are normally regarded as the embodiment of ancient Japanese culture and values are, in fact, political constructs of rather recent vintage. From "lifetime employment" to bank-centered finance to the cartels run by industry associations, many of Japan's institutions are products of the fight against the Depression, then mobilization for war, and finally post World War II mobilization for revival. Time and again new wine was put in bottles with very old labels to give them authenticity. Reform does not mean becoming more "American." It means becoming a different kind of Japan, one that, in certain ways, resembles an earlier Japan.

Perhaps reformers need to learn the same trick as the resistance: to link needed changes to preservation of what is valuable in traditional values. Japan's communitarian values are admirable. The only problem is the way that these values are implemented. Japan can provide for all its citizens and still have growth. Security can be achieved with a social safety net and fluid labor markets rather than the preservation of unproductive jobs. Egalitarianism can be pursued with redistributive taxes rather than distorted prices.

Yes, Japan's people have been acculturated to be more risk-averse than Americans. And for three decades Japan sacrificed efficiency in the name of security. But the result is that they have ended up with neither. Today efficiency is not the alternative to security but its indispensable prerequisite.

Often, very revolutionary changes occur for very conservative motivations. Japan will reform not because people want changes -- though some, such as young, educated women, do -- but because people want to hold on to what they now feel entitled to. Consider a baby boomer born in 1945 or so. Having seen real hunger as a child, and now grown accustomed to affluence, he or she finds it being snatched away. Baby boomers who never expected to be the main support for their parents now must do so because of the pension crisis. They never expected their grown children would be jobless and living at home -- not after the time and money invested in "cram schools" to get them into the best colleges. But with youth unemployment at 10 percent, that is the case for millions of families. Those seeking rather modest ends will find that far-reaching change is required to achieve them. Were Japan's political-economic system capable of incremental adaptation and reform, this would not be so. Since it isn't, thorough political-economic overhaul is needed just to regain what used to be the status quo.

Skeptics retort: Japan has already fritted away a whole decade. Why should the future be any different? But no society puts itself through wrenching transformation until it has exhausted all other alternatives. And for years many of "the best and brightest" macroeconomists claimed that such alternatives existed: just spend and/or print enough money.

Finally, events have persuaded the majority of the Japanese people and elite that without reform the situation can only get worse. But there is not yet consensus among reformers on the content of reform. The task now is to reach consensus and to create the institutional vehicles to bring it about.