Turning Japanese

Japan's post-bubble policies produced a "lost decade." So why is President Obama emulating them?

Anthony Randazzo, Michael Flynn & Adam B. Summers from the July 2009 issue

(Page 4 of 4)

The principle of creative destruction—the economic mutation that continuously breaks down old forms and creates newer, more productive and efficient ones—was ignored in the hope that legacy corporations could somehow save Japan. From Wall Street to Detroit, under both George W. Bush and Barack Obama, the American government has been equally unwilling to let once-formidable companies fail.

Bad tax policy. In different periods, Japan tried to climb out of its economic mess by both cutting and raising taxes. There were two major tax cuts during the Lost Decade: a ¥5.8 trillion ($69 billion in today’s dollars) income tax cut in 1994 that lasted for one year, and a ¥4 trillion ($46 billion) income tax cut in 1998 spread over two years. The problem was that these tax cuts were not permanent and thus did not increase long-term aggregate consumption.

From 1994 to 1995, the Japanese economy began experiencing modest growth, partially due to the first tax cut. But deflation in 1995 reduced government revenues. In an effort to stem surging national debt, the consumption tax was increased from 3 percent to 5 percent in 1997, which slowed the economy again.

President Obama and Republicans in Congress have proposed various tax cuts and tax credits to stimulate the American economy. The American Recovery and Reinvestment Act (the “stimulus” bill) included the president’s signature “Making Work Pay” $400-per-taxpayer ($800-per-family) tax credit that eliminates all federal income taxes for up to 18 million Americans. The legislation also increased the amount of losses that businesses may write off on their taxes while providing tax credits to new homeowners, students, and efficient energy developers.

Other ideas, such as the GOP push for reductions in capital gains taxes, have been tossed aside.

As welcome as tax cuts are, without a decrease in spending they will require an increase in taxes later to cover the lost revenue and pay off the debt incurred.

Japan found that temporary tax rate cuts combined with increased spending did not spur economic growth. Neither did an attempt to increase government revenues through tax increases. Reducing taxes for businesses—permanently, not until the next shortfall—allows firms to keep more revenue, which in turn lets them reinvest that money to innovate and expand their business, hire new workers, pay out dividends, or just be inspired to continue their hard work. Tax rate cuts for individuals—all individuals, including those with income over the arbitrary $250,000 threshold—give people more control over their income, allowing them to pay down debt, save, invest, or increase consumption. Those tax policies are the quickest way to stem a recession.

Government infrastructure “investment.” In an attempt to encourage growth, the Japanese embarked on a massive, multi-billion-yen infrastructure program. They built roads, bridges, and airports, all with the goal of creating jobs and reviving the economy. This didn’t work either.

During the 1990s, Japan passed 10 fiscal stimulus packages, focused largely on public works, totaling more than ¥120 trillion ($1.4 trillion in today’s dollars). When one construction plan failed to stimulate economic growth, another was tried. Those plans did not succeed in reviving the economy, but they did saddle the nation with a mountain of IOUs that helped postpone recovery for years. Including “off-budget” borrowing, Japan’s debt was estimated to exceed 200 percent of GDP in 2001.

Construction plans often set job growth targets but rarely focused on project prices. From 1992 to 1999, the Japanese government spent more than $500 billion (in today’s dollars) on public works projects. Yet the construction jobs were not long-term and did not lead to sustained economic growth. Public debt sky-rocketed, unemployment actually doubled from 2.3 percent to 5 percent, and the economy remained stagnant. As Gavan McCormack, a historian at Australian National University, noted in his 1996 book The Emptiness of Japanese Affluence, “The construction state is in some respects akin to the military-industrial complex in Cold War America (or the Soviet Union), sucking in the country’s wealth, consuming it inefficiently, growing like a cancer and bequeathing both fiscal crisis and environmental devastation.” The government failed to properly identify which projects should be pursued, ignoring demand signals that the private sector is better at recognizing and responding to.

The United States has started down a similar path. In February, Congress passed nearly $100 billion in transportation and public works spending. Naturally, political interests, not economic viability, are determining how this money is being spent.

An American Lost Decade

The Japanese government’s monetary expansion and poor regulation, coupled with the risky behavior and ineptitude it encouraged in the financial sector, led to distortions in private investment instead of economic recovery. Recessions are the unavoidable costs of unsustainable booms fostered by government policy. While politicians would like to stave off the negative effects they create—business failures, unemployment, falling housing prices—bankruptcies and corrections are necessary steps in realigning consumer preferences and the structure of production.

The U.S. government is repeating many of the same mistakes that created Japan’s Lost Decade, becoming entangled with the business community through bailout equity purchases and trillions of dollars in loans and guarantees to keep failing American firms alive. This policy is making the recession worse, extending it further than it would otherwise last.

Any attempts to artificially spur a credit expansion through either low interest rates or “fiscal stimulus” will only add to the economic distortions and make the market correction longer and more severe. Spending hundreds of billions of dollars on infrastructure, broadband Internet, and the like may provide some short-term benefits for some Americans, but as Japan discovered the hard way, it won’t rescue the economy. The history lessons from Japan are plentiful and clear. If the American government continues its pattern of intervention, the United States may soon be trapped in a zombie business economy and a lost decade of our own, ensuring economic stagnation for a long time to come.

Anthony Randazzo ([e-mail]) is an economics policy analyst at the Reason Foundation. Michael Flynn ([e-mail]) is president of Marengo Strategies. Adam B. Summers ([e-mail]) is a policy analyst at the Reason Foundation.

Comments

Fascitis Necrotizante|6.2.09 @ 7:10AM|#

Obama having turned Japanese.

Chad|6.2.09 @ 7:39AM|#

My first three cents:

1: Yes, we are going to experience something similar to Japan's lost decade. It is a direct consequence of our need to de-leverage and shift towards saving an appropriate fraction of our incomes. Nothing the government can or should do will prevent this.

2: Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality. This idea is almost always false, as changes made by governments are almost always tiny relative to the economy. In the short term and individually, no single policy will have a measurable effect, and in any case, you don't know what would have happened without the policy. For example, did Japanese infrastructure spending prevent the Lost Decade? Obviously not. But did it make it slightly less bad or slightly worse than it otherwise would have been? Only God knows. Odds are, it made it slightly less painful...and at least the Japanese have incredible bridges, dams, roads, and trains that will last generations rather than the junk we tend to blow our money on.

3: Long-term growth rates are going to be much lower than current projections. We should be budgeting for 1% growth, and considering anything else a bonus.

JLM|6.2.09 @ 8:11AM|#

I'm glad I get to read this online before I get my print copy. Wait, what?

|6.2.09 @ 8:23AM|#

Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality.

So if the economy does well, it isn't due to the Obamassiah's economic policies?

Xeones|6.2.09 @ 8:54AM|#

So why is President Barack Obama emulating it?

Because he really does believe that central authority drives all things. The man is a totalitarian, and to a totalitarian, having his hands all over an absolute ratfuck is better than sitting back and letting things stabilize on their own.

Also: hi, Chad! This one's not your best. Maybe you could have tried harder?

Chad|6.2.09 @ 9:00AM|#

So if the economy does well, it isn't due to the Obamassiah's economic policies?

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

People who claim that they can discern the impact of policies by looking what happens to the economy after they are adopted are just plain wrong. Unfortunately, that includes, well, just about everyone, because people can ALWAYS find a policy change they don't like that occured just before the bust, or a policy change that they did like that occured just before the boom. They can then use false causalities to harden their beliefs.

You will not find me making such claims. Instead, you will find me noting that our current economy is a function of a wide variety of factors, including hundreds of policy decisions made both here and abroad over many decades. The impacts of any recent policy changes are almost always minimal and lost in the noise.

As another point. The Democrats and Republicans are arguing over about 2% of the GDP, as the rest of government spending is pretty much agreed upon. Do you honestly think that wild fluctuations in the world economy rest upon what the government does with that tiny fraction of our economy?

Fascitis Necrotizante|6.2.09 @ 9:02AM|#

Chad just won't be happy until we're all doing cosplay while being tentacle raped on a bullet train. Deru kui wa utareru, says Hello Kitty via telescreen.

Spoonman|6.2.09 @ 9:10AM|#

This idea is almost always false, as changes made by governments are almost always tiny relative to the economy.

Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

|6.2.09 @ 9:21AM|#

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Chad|6.2.09 @ 9:35AM|#

Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

Federal spending is usually just a bit over 20% of GDP. State and local push total government spending to just over a third of GDP. My point is that of this 20%, only about 2% is actually disagreed upon the political mainstream. What we do with this 2% has virtually no impact on the world economy.

|6.2.09 @ 9:38AM|#

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

Odds are? Really? The "odds are" that the Obama Administration will create a "Five Year Plan" that will increase economic growth? When it is the market, individuals acting freely, that has produced the most wealth in the history of the world why would the odds favor central planning at this time? Because the administration is going to put the word "smart" in front of everything? Smart bureaucrats instead of the normal, self interested kind can handle it? All they needed was a Messiah to lead them?

Chad|6.2.09 @ 10:02AM|#

When it is the market, individuals acting freely, that has produced the most wealth in the history of the world

If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth", you might have a point. Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

EJM|6.2.09 @ 10:02AM|#

But as Anthony Randazzo, Mike Flynn, and Adam B. Summers write in our July issue, that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits. So why is President Barack Obama emulating it?

Unfortunately, Japan is the Lance White of industrialized East Asian democracies; by extension, South Korea is the Jim Rockford.

That said, Nouriel Roubini is apparently bullish on the Korean economy.

Kris|6.2.09 @ 10:09AM|#

We are Japan.

If we're lucky.

Really, really lucky.

Spoonman|6.2.09 @ 10:11AM|#

Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

The market didn't do that.

Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

|6.2.09 @ 10:27AM|#

What's funny is that Lance became Rockford when he got his own private investigator series.

Chad|6.2.09 @ 10:29AM|#

Spoonman | June 2, 2009, 10:11am | #

The market didn't do that.

There is far more private debt in this country than public debt. What are you talking about?

Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

Let me repeat:

Before ANY boom or bust you can find a:) policies that were adopted that fit your ideology and b:) policies that were adopted that contradict your ideology

Most people then pick-and-choose whichever policy and economic cycle combination fits their beliefs, and assert causality. This is childish logic.

Spoonman|6.2.09 @ 10:37AM|#

There is far more private debt in this country than public debt. What are you talking about?

The Federal Reserve's ability to affect interest rates, and their use of that power to encourage borrowing.

Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

So you've said. Proof?

phalkor|6.2.09 @ 10:43AM|#

doing cosplay while being tentacle raped on a bullet train

What's funny is that this would probably be a sign of economic recovery. Well, or the coming of Robo-Aids; your pick.

squarooticus|6.2.09 @ 10:45AM|#

Chad, what you seem to be arguing is that what will happen will happen, regardless of which of the two major political parties in the US controls the government. For once, I agree.

We were set upon this course decades ago, with the outcome inevitable. I suspect Obama will speed the demise along a tiny bit, but even if Dole were elected in 1996, or Gore in 2000, or McCain in 2008, the ultimate outcome was pre-determined by government policy made long ago: you know, the government policy that comprises the other 28% of GDP that the two political parties functionally agree on.

What I'm saying is that focusing on some silly battle between the two major parties is silly, because they are virtually identical in terms of what policies they support, differing only on a small margin. What is needed is for the other 28% of GDP to be reevaluated. Of course the government will not do this voluntarily, because government is a ratchet on revenue and power: thankfully, our debtors will force us to do this, either nicely (by asking) or not nicely (by destroying the market for our debt). One way or the other, however, this reevaluation is coming.

We'll be lucky if the US goes through only two lost decades. *Lucky*.

In a similar sense, even the warnings of those of us who predicted this are irrelevant: I suspect I've helped some people on a small margin avoid financial ruin when the day of reckoning comes for the dollar, but I have no illusions that my advocacy has had any substantive effect on the overall political composition of the country or will in any substantive way impact the final destruction of the dollar, the (hopefully final) discrediting of central banking, or the lower rates of growth of government during the coming retrenchment and rebalancing of the world economy. These things will happen the way they will happen because the numbers don't allow them to work out any other way: we are armed only with a coffee mug against a rising tide.

|6.2.09 @ 11:34AM|#

Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP.

Funny, that's not what the CBO said. Their take, as I recall, was that the stimulus package would be a net negative in the long run.

The world economy does what it does despite our petty political fights.

To me, this sounds like a reason for the Almighty State to back off and do very little. To Chad, it is a reason for the Almighty State to grow, expand, borrow, and spend like crazy.

Colonel_Angus|6.2.09 @ 12:59PM|#

"McMansions, SUVs, cheap Chinese crap" Chav sure does like typing this. I think it's his catchphrase. Suck a fat one, you twat.

|6.2.09 @ 1:01PM|#

Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

Oh, sure, since a few governmentally controlled infrastructure investments are good then 3 or 4 trillion a year must be great?!
My SUV? Bullet trains? You don't even realize that there will be very few children of the children of the Japanese to ride those trains.

Spending more than you have is a Leftard practice, not a Libertarian one. You are claiming that there is either "Five Year Plans" or "short-term consumption" and never the twain shall meet. Fiscal Responsibility doesn't include pissing away more money than you have times ten. Or perhaps the government would limit what I can consume based upon their superior wisdom? Based upon "need"? You know the mantra

From each according to his ability and to each according to his need?

Jordan|6.2.09 @ 2:27PM|#

Two word re: Japan and bullet trains: population density. And credit-default swaps are not market inventions.

|6.2.09 @ 2:52PM|#

I think the case for not spending the money on infrastruture would be stronger if we didn't have bridges collapsing, or a highway system that gets a "D". If I remember correctly we need to spend 2-3 Trillion just to get our current system back in shape.

See once you build stuff you have to maintain it. Moreover, you need to set aside more money to build it again once you can't repair it anymore.

CA is a great example, we built highways, and universities etc, now everything is falling apart becuase we didn't spend the money to maintain it.

Americans have been living beyond their means for a long time, and it's going to suck now trying to pay everything down, and fix everything that's broken.

Jordan|6.2.09 @ 3:18PM|#

With the amount of money government at all levels currently takes in, they could afford to fix every piece of infrastructure several times over. Cut spending and leave us alone.

|6.2.09 @ 3:25PM|#

I suppose that's true. If we didn't spend any money on SS, or Medicare for a couple of years we could fix everything. But that seems unlikely.

Besides the military nothing else even comes close.

bt6|6.2.09 @ 8:33PM|#

"If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth","

McMansion = home that someone owns, rather than living in a government housing project. Owning a home is wealth.

SUV = car that someone owns, rather than standing in a blizzard hoping that the bus gets there before someone steals the food from the bags you're carrying. Owning an SUV is wealth.

Cheap Chinese crap = things that people buy, rather than doing without. Owning things is wealth.

Default credit swaps = a government-created fiasco. This is not wealth.

janejim|6.3.09 @ 1:39AM|#

Banks have huge debts, but they're getting a helping hand from the federal government. If you have overwhelming debt--perhaps from bad investments, or maybe a job loss, a medical crisis or just plain overspending--you're probably on your own. Check the website http://obamadebthelp2009.blogspot.com
to see if they can help. I am glad I did read it before I talk to my CC company and it helped - Jane Jim, California

Marian Kechlibar|6.3.09 @ 7:05AM|#

Kroneborge: you are SO RIGHT about the need to maintain infrastructure once it is built.

In my opinion, this is one thing that separates reasonable transport management from idiotic one.

From this point of view, Germans, Danes, Swiss or Japanese have reasonable, rational transport management.

My own country (Czechia) is a fencesitter, swaying dangerously to the idiotic half.

From what I have heard of California, it is way beyond the fence.

Ogden Homes|6.5.09 @ 4:00PM|#

That's sick. Didn't economists study Japan's problem back in the 90's? History repeats itself. But sometimes we can learn from past mistakes can't we.

I read something that more than 25% of mortgages are upside down. That will take years to recover.