The Bennett Newsletter
"Japan Precedent "
Japan’s horrific recent economic experience has lessons for the world. The Nikkei was four times its present level in the 1980’s bubble. Following a sharp recession, the next 20 years experienced low growth with some abortive recoveries. Many writers fear some Western countries may share Japan’s fate of unsustainable debt and stagnating deflation.
I have often tried to analyse why Japan could not fully recover. It had advantages not shared by the developed world today: high productivity, innovation, a trade surplus, strong export markets and cheap, reliable supply of raw materials and intermediate goods. Moreover, it began with little debt, low taxes and the world’s greatest savers. The Government launched waves of stimulus, including massive expenditure, zero interest rates and quantitive easing. The country remained in the slough of despond.
So if Japan could not get out of recession, what hope is there for the developed nations? The latest research from the Bank of England is basically positive, although it warns that deflation is possible in the UK.
Adam Posen, who sits on the Bank’s monetary policy committee, delivered the research in a public lecture at the London School of Economics on May 24. Posen’s research has a quantum of corporate funding that New Zealand academics would die for.
Posen is very Keynesian and he gives typically LSE short shrift to his opponents. I will not mention the controversies he pursues in the footnotes, but will warn readers that he is curiously casual in his acceptance of Japan’s debt difficulties and acute problems arising from an aging population. His insights are, nevertheless, most engaging and graphs stunning.
Posen’s Argument summarized -
- Japan’s Great Recession was the result of policy mistakes. Once the shock of the bubble burst had moderated, poor policy delayed recovery. After 2002, Japan had appropriate policy and the economy was strong. Its strength is over-looked.
- Japan had tremendous advantages, especially fiscally, which made stagnation avoidable. Structural deficiencies in finance and corporate governance offset these when deflation persisted
- Japan had a series of recoveries aborted by policy errors.
- The persistency of deflation is surprising, and needs more research as basic economic theory cannot explain it.
- The UK and US economies have a low risk of creating recurrent recessions because their policy is superior. Nevertheless, deflation “cannot be ruled out”.
- The UK combines a couple of financial parallels with Japan, and much less room to compensate for them.
Japan had no problem in the Great Recession with external demand, nor problems in moving production into exports. The US, UK and Euro areas have challenges in marketing which may limit the pace of the global recovery. They are trying simultaneously to increase exports to each other while markets are flat.
Japan’s mistakes
Posen is novel in emphasising the positive in Japan. He asserts that after asset prices collapsed, stagnation was not inevitable. GDP was far from flat, and there were strong recoveries which, importantly, were not dependent on stimulus. These were knee-capped by policy. For example, in 1997-8 public investment was cut creating a recession. Financial fragility often played a part too. The market economy recovery was stymied by policy mistakes.
Yet in 2000-2002 government got it right. Monetary policy loosened and weakened deflation, fiscal policy was neutral, bad loans were written off, and banks recapitalized. A strong recovery followed 2002-8. Indeed, Posen claims that it is unacknowledged although stronger than in most developed economies. Total factor productivity was the highest in G5 in most years; Japan had the highest GDP growth per worker and the fastest innovation.
This is important as some people have argued that Japan was in structural decline. It was not, but policy makers lowered their sights, and an enduring lesson is to remain optimistic. Japan was not doomed to low growth as some observers think.
The real cost of a financial crisis accumulates: into long-term unemployment, under-investment, and capital misallocation. Posen says central banks should apply very strong monetary policy to powerful shocks to offset negative structural effects. He believes that the case is stronger for the UK now than it was for Japan.
He believes that the Bank of Japan was timid and late in loosening monetary conditions. The Bank “could have and should have been more aggressive”. Every measure of inflation turned negative in 1995 and stayed negative to 2004. The Bank then began quantitive easing which impacted on inflation expectations but had little direct effect on asset and other prices. It helped to combat deflation by a commitment in 2002 to maintain low rates until inflation was positive.
Posen’s reflections
Posen calls for more and cleverer research on the costs of deflation. Deflation impedes growth, and even with Japan’s low interest rates, makes debt servicing more expensive.
Moreover, he recognises the need for more humility about what bankers can do with monetary policy, especially with unconventional measures. Monetary policy was not able to remove deflation in Japan in any easy way.
Even the positive inflation in the UK has been less than expected given the scale of the Bank of England’s interventions and asset purchases. Deflation is not well understood, so policy-makers should stay away from mechanistic monetarism that insists on precise results. Results are unpredictable.
The lessons for the UK are scary. Japan was stronger in the 1990’s than the UK is now. Japanese savers were loyal, and would not send investments overseas. The stimulus measures had a strong multiplier, but Britain’s would be less because money is mobile.
Japan had large and efficient export industries and a trade surplus. The UK has to move labour and capital into this sector. Moreover, Japan had good markets available. The UK (like the US and Europe) has a double limitation on export-led growth. These economies are in recession and are competing for export markets. Not everyone can be a net exporter at the same time. Moreover, Europe’s growth is low but it is the UK’s largest market.
Posen also mentions that Japanese corporates accumulated much capital but sat on it. He sees a worrying tendency for British firms to do this now. In Japan’s case, slothful corporates exacerbated the recession.
http://www.bankofengland.co.uk/publications/speeches/2010/speech434.pdf
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