In his first presidential news conference on Feb. 9, Barack Obama highlighted Japan, the world’s second largest economy, as an example of a country that has suffered from mistaken financial policies. Obama argued the Japanese “lost decade” was the consequence of not acting boldly or swiftly enough.
From 1991 to 2003, Japan’s Gross National Product grew only 1.14 percent annually, significantly below that of other industrialized nations.
Nobel Laureate Paul Krugman worries that although Obama uses bold rhetoric his economic actions have also been too tepid. As a consequence, America might endure even worse economic problems than Japan.
In a March 9 entry on Krugman’s “Conscience of a Liberal” blog on nytimes.com, he wrote, “We may or may not be about to face our own lost decade, but the sheer misery millions of Americans will face in the near future probably exceeds anything that happened in Japan during the ’90s.”
Krugman feels that to fix our system, we must nationalize many of our leading banks.
What caused the Japanese funk? Equity values plunged 60 percent from late 1989 to August 1992, while land values dropped throughout the 1990s, falling an incredible 70 percent by 2001. The pricking of the asset bubble reduced consumption.
During the Great Depression, economist John Keynes discovered a counterintuitive phenomenon, called the “liquidity trap,” in which lower spending by individuals can lead to the perverse result of lower community savings.
Keynes demonstrated that a natural consequence of hoarding is reduced demand for companies’ goods and services. Businesses respond to shrinking sales by reducing employment. Higher unemployment lowers community savings.
Several policy errors prolonged Japan’s financial crisis:
1. The Japanese government did not focus on the major problem — requiring the country’s banks to dispose of nonperforming loans. The government should have enforced direct debt relief for mortgage borrowers and distressed, but viable, corporations. Such straightforward policies would have reenergized Japan’s “zombie banks” to start providing credit — the lifeblood of a capitalist system. Zombie banks avoid lending in order to repair their beleaguered balance sheets. They turn down legitimate businesses loans and thereby prevent firms from carrying on their normal business practices. It must be remembered that almost all commercial enterprises require some external funds.
2. The Japanese decision to raise taxes in the late 1990s aborted the recovery. Policymakers raised taxes because of worries about the country’s growing national debt. Japanese debt stands at 160 percent of its Gross Domestic Product, the highest in the industrialized world.
3. Japan misspent $6.3 trillion on construction-related equipment between 1991 and 2008. Japan spent too much on wasteful roads and bridges and not enough in areas like education and social services. Studies showed the latter delivered more bang for the buck than infrastructure spending because education and social services created something useful for the future.
4. Japan discouraged immigration despite its declining population. If current trends continue, Japan’s population will fall from 130 million to fewer than 90 million in approximately 50 years. By this time, some 40 percent of Japanese could be older than 65.
Japan’s aging population hurts consumption. Seniors distrust Japan’s pension system, which is buckling under the weight of one of the world’s most rapidly aging societies.
5. Japan failed to cut individual taxes enough to stimulate consumer demand. Similar to the Great Depression that permanently changed American buying habits, the “lost decade” made the Japanese tight-fisted. Japan’s economy is now in a free fall because it cannot rely on domestic consumption to pick up the slack. Also it cannot depend on exports, which declined in January 2009 some 46 percent from one year ago.
By learning from Japan’s mistakes, America can avoid a dismal decade. However, it would be arrogant for those in Washington to assume that Japan’s troubles simply reflected its macroeconomic incompetence.
In the main, the Japanese followed Keynesian economic prescriptions; however they made one fundamental mistake. They refused to confront their banking system losses and inject enough funds to enliven their zombie banks.
The Japanese stock market recently hit a 25-year low. Unless we take the right steps, we might find that even worse than a lost decade is a lost generation.
Originally published in the Sarasota Herald-Tribune
