Japan: Land of the Rising Sun? — by W.R. Garside

photo credit:  kusabi cc

photo credit: kusabi cc

As many industrialized nations seek to raise consumer demand, reduce unemployment and trigger seemingly elusive economic growth, all eyes are on Japan.  There, bold measures against past practice are making international headlines. 

The focus is on expansionary monetary policy (or ‘quantitative easing’ as the pundits have it).  The Bank of Japan, nominally independent but now clearly in the embrace of Premier Abe’s newly–elected Liberal Democratic Party, is committed to ending two decades of deflation and to supporting domestic demand, principally by doubling the money supply and purchasing long-term Japanese government bonds alongside other slightly riskier debt.  An accompanying objective is to raise the inflation rate to 2 per cent within two years in the hope that reductions in real interest rates and the prospect of higher prices will prompt companies to invest and consumers to spend.

For years past deflation had resulted in a rise in the real burden of nominally contracted debt held by the Japanese government and corporations. Even so, the Bank of Japan (BOJ) had remained convinced during the 1990s and into the early years of the new millennium that deflation was the result of structural impediments rather than monetary policy. The Bank argued that falling prices, far from being harmful, reflected beneficial technological progress, deregulation and efficient methods of production; developments which together would work to encourage the structural adjustments necessary to stimulate economic recovery.

In hindsight it is arguable that in the 1990s, the BOJ—aware that persistent deflation increased the cost of servicing government debt and continually threatened further bankruptcies in the commercial sector—should have adopted the very policy of inflation targeting that it now proclaims to be at the heart of its new policy stance. If the BOJ in the 1990s and beyond had countenanced an explicit price level target sufficient to encourage a low but positive inflation rate, it might in theory have helped to restore financial and non-financial balance sheets, encourage investment and raise demand to levels high enough to cushion the effects of much-needed industrial restructuring.

Instead, for years unanticipated deflation constrained monetary policy, hampered corporate profitability and raised the real burden of public and private debt, thereby weakening the impulses to recovery that monetary easing, fiscal spending, bank recapitalization and regulatory reform were designed to encourage. As deflation deepened, so did deflationary expectations; this only intensified shrinking demand in the macroeconomy. Japan had fallen into a process of almost self-sustained deflation, and that is what hobbled fiscal policy.

It is understandable therefore that much is expected from the dramatic about turn in monetary policy so evident in Japan today. Yet some of the doubts voiced by BOJ officials in previous years about the efficacy of loose monetary policy and targeted inflation remain. The behavioral presumptions inherent in the policy—that increased liquidity and anticipated inflation will encourage greater household spending and corporate investment to the benefit of employment and growth—may prove to be true.  On the other hand consumers may remain fearful of the burden of public debt; they may resent what is seen as an inflationary attack upon their lifetime savings.  Skepticism about the government’s commitment to social security spending in light of the prevailing level of public debt could encourage households to save rather than spend in an effort to safeguard an uncertain future. Banks and corporations for their part may prefer to repair their balance sheets rather than undertake risky lending and borrowing.   Investors likewise could choose to move resources overseas, a move that the Japanese government could not readily rebuff through higher interest rates without prejudicing the cost of servicing its own debt.

Worse still, the authorities, whatever the current rhetoric, may fail to sustain an integrated economic policy.  It is critical for monetary easing to be combined with effective and targeted fiscal policy and with medium term structural and regulatory reform designed to encourage innovation, entrepreneurship and a boost to private investment.  Japan desperately needs to boost economic competitiveness beyond that gained from currency depreciation alone.

The Abe administration has promised a ‘three-pronged’ approach embracing monetary, fiscal and structural reform to secure such benefits.  Yet its economic strategy still includes a tax on expenditure rather than upon corporate savings (the levels of which far exceed currently available investment opportunities).  The sustained rise in wages needed to help consumers meet the rising cost of imported goods and higher utility bills are yet to materialize. Nor is there much evidence yet of incentives to encourage higher investment, to foster real growth or to reform corporate governance to allow shareholders a greater say in the conduct of business.

The recent flurry of radical economic posturing in Japan reflects a deep-seated desire to stem the country’s apparent slide into self-sustaining deflation, low growth and worsening public finance.   Confidence is crucial to economic betterment and to that end observers within and outside Japan hope that short-term success will breed a sustainable upturn in economic activity.

It is a commonplace that if radical reform is undertaken there will be winners and losers, the latter ranging from the farming sector to the inefficient distribution and service sectors and those hoping for long-term stable employment.  Meeting those challenges will demand more than a lever on the money supply or pandering to the markets.

Indeed in many ways Japan is facing a much deeper, more intractable but ultimately more significant challenge to its future.   It has been estimated that a new Japanese growth miracle – a productivity growth rate faster than 4 per cent a year down to 2021 – would be needed for Japan to eliminate debt at 2011 levels.  Whilst that is never likely to be achieved or even posited as an official target, it should remind the Japanese authorities of what is perhaps its most fundamental and formidable challenge.  That is, to galvanise the government, public and private agencies within the country to work towards the resurrection of a renewed and revised ‘Japanese model’ sufficiently confident in its conception and faithful to the country’s embedded social, cultural and economic priorities to spur behavioural, institutional and political changes extensive enough, as one commentator has put it, ‘to constitute a second miracle.’

Japan accepted such a challenge in the ashes of wartime defeat.  It will strain the statesmanship and vision of the best of Japanese policymakers today to find a way of harnessing those attributes of discipline, co-operation and belief in nationhood that served the country so well in the past. Policymakers will need to garner such a widespread commitment to national revival if reform policies begin to deepen already deepening income inequalities and if the immediate prospects of both the younger labour force and the increasing ranks of the aged are not sufficiently addressed. Much depends upon whether short-termism, uncoordinated policy and political posturing come to dominate the country’s agenda.


Japan's Great Stagnation - W. R. GarsideProfessor William Redvers Garside is Professor of Economics and Economic History at Waseda University, Tokyo and Honorary Professor at the University of Durham, UK.  His most recent book is Japan’s Great Stagnation: Forging Ahead, Falling Behind (Elgar Publishing, 2012).

Available as an eBook for subscribing libraries on elgaronline

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