"It is safe to say that enterprise, which depends on hopes stretching into the future, benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplanted and supported by animal spirits, so that the thought of loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death."
John Maynard Keynes, 1936
The Japanese psyche is in a severe state of depression. Anyone who has ever had a depressive disorder can recognize the signs. After seven years of zero growth, Japan's economy teeters on the edge of a recession. Years of ignoring its banks bad debt problems have finally caught up. The banking system is insolvent, pulled under by the staggering weight of more than $600 billion of non-performing loans. The government seems incapable of action. Prime Minister Ryutaro Hashimoto heads an extremely fragile coalition of political factions that spend as much time fighting each other as they do the opposition, paralyzing policymaking during times of crisis. Each day brings news of fresh scandals or suicides in the demoralized Ministry of Finance and the Bank of Japan. When the long awaited financial Big Bang finally arrived in April, deregulation simply provided an opportunity for ordinary Japanese citizens to join the rest of the world in the ongoing flight from the yen. These problems with brain chemistry could hardly have come at a worst time. Japan's stagnating economy and weak yen are drying up a desperately needed market for Southeast Asian and Korean exports, making it even more difficult for these troubled neighbors to work out of their debt crises.
For months Treasury Secretary Robert Rubin and Deputy Secretary Lawrence Summers have been putting the heat on the Hashimoto government to increase domestic demand by cutting taxes and increasing government expenditures. The use of these Keynesian prescriptions to revive the Japanese economy would serve American interests by simultaneously absorbing Southeast Asian exports and reducing Japan's sensitive trade imbalance with the United States. Rubins greatest fear is that Japan will try to export its way to recovery with an undervalued yen. But it is a bit duplicitous for Rubin, who recently told Congressional legislators that they would be reckless to cut taxes even though the United States has a balanced budget, to strong-arm the Japanese into cutting taxes. The Japanese budget deficit is over five percent of GDP, the highest of the G-7 countries, and their government debt is over 100 percent of GDP. Nevertheless, Prime Minister Hashimoto has bowed to American pressure and abandoned the austerity policies on which he had staked his political reputation. Hashimoto agreed to cut income taxes by 4 trillion yen over the next two years and to increase government expenditures by another 12 trillion yen, mostly through public works spending. But this is not Japan's first attempt to jump start its economy with a fiscal stimulus package. Since 1992 the government has spent 75 trillion yen in economic stimulus packages with little lasting effect. There is no reason why this one should turn out differently. The rapidly aging Japanese population is so worried about the future they will probably save any increase in their after- tax income resulting from the tax cut and, therefore, add little to domestic spending. Although public works spending will directly increase employment and profits in the construction industry, the ultimate value of that construction will hardly be worth the cost of financing the public expenditures. There is little space remaining in Japan that has not already been paved over; there are already roads leading to nowhere.
Hashimoto was misled about the strength of the Japanese recovery when he enacted his austerity program last year. The snowballing government debt convinced Hashimoto that he must do something to reduce the deficit. His budget called for an end to the special income tax cuts passed in January, 1996, and raised the national consumption tax from 3 to 5 percent starting April 1, 1997. Ironically, the announcement of the consumption tax had an expansionary effect on domestic spending during the first quarter of 1997, as consumers bought durable goods and increased their inventories of consumer goods to beat the tax hike. This acceleration of economic activity in early 1997 led to optimistic projections that Japan's long stagnation in growth was over. But these consumer purchases did not represent a sustained increase in spending; they were expenditures borrowed from future quarters. When the tax increase actually occurred, consumer spending. plummeted. Just as most economists overestimated the strength of the Japanese economy in early 1997, they may now be underestimating its long-run strength. However misguided Hashimotos tax policies were last year, his concern with Japan's staggering public debt is appropriate.
What Japan needs most to do is to recapitalize its frozen banking system. Despite a record low discount rate of one-half of one percent, the nation is suffering a credit crunch because banks, preoccupied with meeting capital adequacy standards, are reluctant to make loans. An insolvent banking system deprives an economy of life-sustaining oxygen. Japan's economy cannot achieve a sustained recovery until its banking systems balance sheet is cleaned up; just as the American economy did not resume growth in the early 1990s until the credit crunch from the savings and loan crisis ended. A revitalized banking sector could put the huge pool of private savings languishing in dismally low-interest accounts to much better uses. If Japan's rapidly aging population finds it can get a better return on its savings, people will be able to spend more without sacrificing their shot at a comfortable retirement. A solvent banking system is far more important to Japan's recovery than a tax cut. What Japan needs today is not Keynesian deficit spending, but a large dose of what Keynes called the animal spirits. Perhaps some Prozac in the water supply?
Mac Williams
Cosmos Mariner
Destination Unknown
© April 24, 1998